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, 2011 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
incorporation or organization) Identification 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 X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of 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, 2011, 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 Market on March 31,
2011, was $39.5 million (7,045,036 shares at $5.61). 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 2012 Annual Meeting of
Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2011 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I. Page
Item 1. Business
General................................................... 1
Corporate Overview........................................ 1
Market Area............................................... 2
Lending Activities........................................ 4
Investment Activities..................................... 21
Deposit Activities and Other Sources of Funds............. 22
Bank Owned Life Insurance................................. 27
Regulation of the Bank.................................... 27
Regulation of the Company................................. 35
Taxation.................................................. 37
Competition............................................... 38
Subsidiary Activities..................................... 38
Personnel................................................. 38
Executive Officers of the Registrant...................... 39
Item 1A. Risk Factors............................................... 41
Item 1B. Unresolved Staff Comments.................................. 54
Item 2. Properties.................................................. 54
Item 3. Legal Proceedings........................................... 55
Item 4. [Removed and Reserved]...................................... 56
PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities........... 56
Item 6. Selected Financial Data..................................... 58
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 60
General................................................... 60
Special Note Regarding Forward-Looking Statements......... 60
Critical Accounting Policies and Estimates................ 61
New Accounting Pronouncements............................. 63
Operating Strategy........................................ 63
Market Risk and Asset and Liability Management............ 64
Comparison of Financial Condition at September 30, 2011
and September 30, 2010................................... 66
Comparison of Operating Results for Years Ended September
30, 2011 and 2010........................................ 68
Comparison of Operating Results for Years Ended September
30, 2010 and 2009........................................ 71
Average Balances, Interest and Average Yields/Cost........ 74
Rate/Volume Analysis...................................... 76
Liquidity and Capital Resources........................... 76
Effect of Inflation and Changing Prices................... 78
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 78
Item 8. Financial Statements and Supplementary Data................. 78
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure......................... 142
Item 9A. Controls and Procedures.................................... 142
Item 9B. Other Information.......................................... 142
i
PART III.
Item 10. Directors, Executive Officers and Corporate Governance..... 142
Item 11. Executive Compensation..................................... 143
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................. 143
Item 13. Certain Relationships and Related Transactions, and
Director Independence...................................... 144
Item 14. Principal Accounting Fees and Services..................... 144
PART IV.
Item 15. Exhibits, Financial Statement Schedules.................... 144
ii
PART I
Item 1. Business
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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, 2011, on a consolidated basis, the Company had
total assets of $738.2 million, total deposits of $592.7 million and total
shareholders' equity of $86.2 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
historically been focused primarily on the origination of loans secured by
real estate, including construction loans and land development, 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 ("Freddie Mac") guidelines. The Bank
also originates commercial business loans and in 1998 established a business
banking division to increase the origination of these loans. During the past
several years, the Bank adjusted its lending strategy and began reducing its
exposure to speculative construction and land development lending.
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").
Corporate Overview
Participation in the Troubled Asset Relief Program ("TARP") Capital
Purchase Program ("CPP"). On December 23, 2008, as part of the TARP CPP
established by the United States Department of the Treasury ("Treasury"), the
Company sold to the Treasury 16,641 shares of Cumulative Perpetual Preferred
Stock, Series A ("Series A Preferred Stock") and a warrant to purchase 370,889
shares of the Company's common stock, par value $0.01 per share, for an
aggregate purchase price of $16.6 million in cash. For additional
information regarding the TARP CPP transaction, see Item 1A, "Risk Factors -
Risks specific to our participation in TARP."
1
Agreements with Banking Regulators. In December 2009, the FDIC
determined that the Bank required supervisory attention and agreed to terms on
a Memorandum of Understanding (the "Bank MOU") with the Bank. The terms of the
Bank 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.
In addition, on February 1, 2010, the Federal Reserve Bank of San
Francisco ("FRB") determined that the Company required additional supervisory
attention and entered into a Memorandum of Understanding with the Company (the
"Company MOU"). Under the agreement, the Company must among other things
obtain prior written approval, or non-objection, from the FRB to declare or
pay any dividends, or make any other capital distributions; issue any trust
preferred securities; or purchase or redeem any of its stock. The FRB has
denied the Company's requests to pay dividends on its Series A Preferred Stock
issued under the TARP CPP for the quarterly payments due for the last six
quarters beginning with the payments due on May 15, 2010. If dividends on the
Series A Preferred Stock are not paid for six quarters, whether or not
consecutive, the Treasury has the right to appoint two members to the Board of
Directors of the Company. There can be no assurances that our regulators will
approve such payments or dividends in the future.
For additional information regarding the Bank MOU and Company MOU, see
"Item 1A, Risk Factors - The Company and the Bank are required to comply with
the terms of separate memoranda of understanding issued by their respective
regulators and lack of compliance could result in additional regulatory
actions."
Market Area
The Bank considers Grays Harbor, Pierce, Thurston, Kitsap, King 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);
* 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);
* a branch office in King County (Auburn); and
* three branch offices in Lewis County (Winlock, Toledo and Chehalis).
For additional information, 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, Kitsap, King 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.
2
Grays Harbor County has a population of 73,000 according to the U.S.
Census Bureau 2010 estimates and a median family income of $56,600 according
to 2011 estimates from the Department of Housing and Urban Development
("HUD"). The economic base in Grays Harbor County 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 12.5% at September
30, 2011 from 11.4% at September 30, 2010. The median price of a resale home
in Grays Harbor County for the quarter ended September 30, 2011 decreased 3.1%
to $126,000 from $130,000 for the comparable prior year period. The number of
home sales increased 20.8% for the quarter ended September 30, 2011 compared
to the same quarter one year earlier. The Bank has six branches (including
its home office) located throughout the county. The downturn in Grays Harbor
County's economy and the decline in real estate values since 2008 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 795,000 according to the U.S. Census Bureau 2010 estimates. The
county's median family income is $70,800 according to 2011 HUD estimates. The
economy in Pierce County is diversified with the presence of military related
government employment (Joint Base Lewis-McChord), 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 9.3% at September
30, 2011 from 8.7% at September 30, 2010. The median price of a resale home in
Pierce County for the quarter ended September 30, 2011 decreased 12.5% to
$192,500 from $220,000 for the comparable prior year period. The number of
home sales increased 34.8% for the quarter ended September 30, 2011 compared
to 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 downturn in Pierce
County's economy and the decline in real estate values since 2008 have had a
negative effect on the Bank's profitability in this market area.
Thurston County has a population of 252,000 according to the U.S. Census
Bureau 2010 estimates and a median family income of $74,000 according to 2011
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 8.0% at
September 30, 2011 from 7.2% in 2010. The median price of a resale home in
Thurston County for the quarter ended September 30, 2011 decreased 3.2% to
$223,600 from $231,000 for the same quarter one year earlier. The number of
home sales decreased 0.6% for the quarter ended September 30, 2011 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 since 2008
have had a negative effect on the Bank's profitability in this market area.
Kitsap County has a population of 251,000 according to the U.S. Census
Bureau 2010 estimates and a median family income of $74,500 according to 2011
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 7.5% at September 30, 2011 from 7.0% at September 30, 2010.
The median price of a resale home in Kitsap County for the quarter ended
September 30, 2011 increased 0.2% to $235,500 from $235,000, the same quarter
one year earlier. The number of home sales increased 11.0% for the quarter
ended September 30, 2011 compared to the same quarter one year earlier. The
downturn in Kitsap County's economy and the decline in real estate values
since 2008 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 2010 estimates. The Bank
has one branch in King County. The county's median family income is $86,800
according to 2011 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
decreased to 8.1% at September 30, 2011 from 8.4% at September 30, 2010. The
median price of a resale home in King County for the quarter ended September
30, 2011 decreased 6.8% to $350,000 from $375,500, for the same quarter one
year earlier. The
3
number of home sales increased 27.3% for the quarter ended September 30, 2011
compared to the same quarter one year earlier. The downturn in King County's
economy and the decline in real estate values since 2008 have had a negative
effect on the Bank's profitability in this market area.
Lewis County has a population of 75,000 according to the U.S. Census
Bureau 2010 estimates and a median family income of $56,600 according to 2011
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, 2011
from 11.7% at September 30, 2010. The median price of a resale home in Lewis
County for the quarter ended September 30, 2011 decreased 12.6% to $141,100
from $161,500, for the same quarter one year earlier. The number of home
sales increased 54.2% for the quarter ended September 30, 2011 compared to the
same quarter one year earlier. The Bank currently has three branches located
in Lewis County. The downturn in Lewis County's economy and the decline in
real estate values since 2008 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.
During the past several years, the Bank adjusted its lending strategy and
began reducing its exposure to speculative construction and land development
lending. The Bank's net loans receivable, including loans held for sale,
totaled $528.0 million at September 30, 2011, representing 71.5% of
consolidated total assets, and at that date commercial real estate,
construction and land development loans (including undisbursed loans in
process), and land loans were $347.8 million, or 62.1%, 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 -
Commercial Real Estate Lending," "- Lending Activities - Construction and Land
Development Lending" and "- Lending Activities - Land 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, 2011, the maximum
amount which the Bank could have lent to any one borrower and the borrower's
related entities was approximately $18.6 million under this policy. At
September 30, 2011, the largest amount outstanding to any one borrower and the
borrower's related entities was $14.0 million. These loans were secured by
commercial buildings located in Pierce and Kitsap counties. These loans were
all performing according to the loan repayment terms at September 30, 2011.
The next largest amount outstanding to any one borrower and the borrower's
related entities was $10.3 million (including $1.5 million in undisbursed
loans in process). These loans were secured by a condominium construction
project, a commercial building, several one- to four-family properties, and
several land parcels. All of the loans were secured by properties located in
Grays Harbor County, except for one property located in Clark County and one
property located in Clatsop County, Oregon. These loans were performing
according to their loan repayment terms at September 30, 2011.
4
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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2011 2010 2009 2008 2007
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to four-
family(1).... $114,680 20.47% $121,014 21.65% $110,556 18.58% $112,299 18.35% $102,434 17.40%
Multi-family.. 30,982 5.53 32,267 5.77 25,638 4.31 25,927 4.24 35,157 5.97
Commercial.... 246,037 43.92 208,002 37.21 188,205 31.62 146,223 23.90 127,866 21.72
Construction
and land
development.. 52,484 9.37 69,271 12.39 139,728 23.48 186,344 30.46 186,261 31.64
Land.......... 49,236 8.79 62,999 11.27 65,642 11.03 60,701 9.92 60,706 10.30
-------- ------ -------- ------ -------- ------ -------- ------- -------- ------
Total mortgage
loans....... 493,419 88.08 493,553 88.29 529,769 89.02 531,494 86.87 512,424 87.03
Consumer Loans:
Home equity
and second
mortgage..... 36,008 6.43 38,418 6.87 41,746 7.01 48,690 7.96 47,269 8.02
Other......... 8,240 1.47 9,086 1.62 9,827 1.66 10,635 1.73 10,922 1.86
-------- ------ -------- ------ -------- ------ -------- ------- -------- ------
Total consumer
loans....... 44,248 7.90 47,504 8.49 51,573 8.67 59,325 9.69 58,191 9.88
Commercial
business
loans........ 22,510 4.02 17,979 3.22 13,775 2.31 21,018 3.44 18,164 3.09
-------- ------ -------- ------ -------- ------ -------- ------- -------- ------
Total loans.. 560,177 100.00% 559,036 100.00% 595,117 100.00% 611,837 100.00% 588,779 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
construction
loans in
process...... (18,265) (17,952) (31,298) (43,353) (65,673)
Deferred loan
origination
fees......... (1,942) (2,229) (2,439) (2,747) (2,968)
Allowance for
loan losses.. (11,946) (11,264) (14,172) (8,050) (4,797)
-------- -------- -------- -------- --------
Total loans
receivable,
net........... $528,024 $527,591 $547,208 $557,687 $515,341
======== ======== ======== ======== ========
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(1) Includes loans held-for-sale of $4.0 million, $3.0 million, $630,000, $1.8 million and $757,000 at
September 30, 2011, 2010, 2009, 2008 and 2007, respectively.
Residential One- to Four-Family Lending. At September 30, 2011, $114.7
million, or 20.5%, 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.
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 Freddie Mac. 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 uses an automated underwriting program, which
preliminarily qualifies a loan as conforming to Freddie Mac underwriting
standards when the loan is originated. At September 30, 2011, $53.7 million,
or 46.8%, 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 and are typically subject to a limitation on
the annual increase of 2% and an overall limitation of 6%. These ARM products
generally 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 2.88% to 4.00%. Loans tied to the prime rate or to the London Inter-Bank
Offered Rate ("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
5
ARM loans that can be originated at any time is largely determined by the
demand for each in a competitive environment. At September 30, 2011, $61.0
million, or 53.2%, 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 Freddie
Mac. Some of these loans are also originated to meet the needs of borrowers
who cannot otherwise satisfy Freddie Mac 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 Freddie Mac's
guidelines. Such borrowers may 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 the 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. 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 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 and 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 Freddie Mac). At September 30, 2011, nine
single family loans totaling $2.2 million were not performing according to
their terms. See "- Lending Activities - Non-performing Loans 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 although, as a result of the current economic
environment, the Bank has sharply curtailed speculative construction and land
development lending.
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 limited basis). The Bank
believes that
6
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, 2011 and 2010, the composition of the Bank's construction
and land development loan portfolio was as follows:
At September 30,
------------------------------------------------
2011 2010
----------------------- -----------------------
Outstanding Percent of Outstanding Percent of
Balance Total Balance Total
----------- ---------- ----------- ----------
(Dollars in thousands)
Custom and owner/builder
construction.............. $26,205 49.93% $30,945 44.67%
Speculative construction... 1,919 3.66 4,777 6.90
Multi-family (including
condominium).............. 9,322 17.76 3,587 5.18
Land development........... 2,175 4.14 6,434 9.29
Commercial real estate..... 12,863 24.51 23,528 33.96
------- ------ ------- ------
Total.................... $52,484 100.00% $69,271 100.00%
======= ====== ======= ======
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 7.00% to 7.88% and with loan-to-value ratios of 80% of the
appraised estimated value of the completed property or sales price, whichever
is less.
Owner/builder construction loans are originated to home owners rather
than home builders and are typically converted to or refinanced into permanent
loans 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 7.00% to 7.88%, and with loan-to-value
ratios of 80% (or up to 95% with PMI) of the appraised estimated value of the
completed property. At the completion of construction, the loan is converted
to or refinanced into 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, 2011, custom and owner/builder construction loans
totaled $26.2 million, or 49.9%, of the total construction and land
development loan portfolio. At September 30, 2011, the largest outstanding
custom and owner/builder construction loan had an outstanding balance of
$980,000 (including $905,000 of undisbursed loans in process) 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 4.75% to
6.50%, and with a loan-to-value ratio of no more than 80% of the appraised
estimated value of the completed property. The Bank is currently originating
speculative construction loans on a limited basis. At September 30, 2011,
speculative construction loans totaled $1.9 million, or 3.7%, of the total
construction and land development loan portfolio. At September 30, 2011, the
Bank had two 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 $861,000 (including
$277,000 of undisbursed loans in process), all of which were
7
performing according to the loan repayment terms. The largest outstanding
balance for a single speculative loan was $700,000 and was performing
according to its restructured terms. At September 30, 2011, all speculative
construction loans were performing according to their original or restructured
terms. See "- Lending Activities - Non-performing Loans and Delinquencies."
The Bank historically originated loans to real estate developers with
whom it had 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, 2011, the Bank
had nine land development loans totaling $2.2 million, or 4.1% 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%. 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, 2011, the Bank had seven land
development loans totaling $1.9 million that were not performing according to
their terms. The non-performing loans consisted of:
* Four loans totaling $756,000 secured by land development projects in
King County;
* One loan with a balance of $837,000 secured by a land development
project in Lewis County;
* One loan with a balance of $225,000 secured by a land development
project in Pierce County; and
* One loan with a balance of $63,000 secured by a land development
project in Grays Harbor 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 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, 2011, these loans amounted to $22.2
million, or 42.3% of construction and land development loans. These loans are
secured by condominiums, apartment buildings, mini-storage facilities, office
buildings, hotels and retail rental space predominantly located in the Bank's
primary market area. At September 30, 2011, the largest outstanding
multi-family construction loan was secured by an apartment building project in
Thurston County and had a balance of $6.5 million (including $2.5 million of
undisbursed loans in process) and was performing according to its terms. At
September 30, 2011, the largest outstanding commercial real estate
construction loan had a balance of $6.1 million (including $4.4 million of
undisbursed loans in process). This loan was secured by a medical office
building being constructed in Thurston County and was performing according to
its 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 Freddie Mac guidelines, by a qualified
Bank 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.
8
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 independent inspectors to
document the reasonableness of draw requests. For most builders, the Bank
disburses loan funds by providing vouchers to borrowers, which when used by
the borrower to purchase supplies are submitted by the supplier to the Bank
for payment.
The Bank regularly monitors 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.
Multi-Family Lending. At September 30, 2011, the Bank had $31.0 million,
or 5.5% 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, 2011 the Bank's largest multi-family loan had an outstanding principal
balance of $3.5 million and was secured by an apartment building located in
the Bank's primary market area. At September 30, 2011, this loan was
performing according to its terms. At September 30, 2011, one multi-family
loan with a balance of $1.4 million was not performing according to its
repayment terms. See "- Lending Activities - Non-performing Loans and
Delinquencies."
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 properties securing such loans. The Bank
also inspects such properties annually. The Bank generally imposes a minimum
debt coverage ratio of approximately 1.20 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
$246.0 million, or 43.9% of the total loan portfolio at September 30, 2011.
The Bank originates commercial real estate loans generally at variable
interest
9
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, 2011, the largest
commercial real estate loan was secured by an office building in Pierce County
and had a balance of $6.2 million and was performing according to its terms.
At September 30, 2011, eight commercial real estate loans totaling $6.6
million were not performing according to their terms. See "- Lending
Activities - Non-performing Loans 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 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.
Land Lending. The Bank has historically originated 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. Currently the
Bank is not offering land loans to new customers and is attempting to decrease
its land loan portfolio. At September 30, 2011, land loans totaled $49.2
million, or 8.8% of the Bank's total loan portfolio as compared to $63.0
million, or 11.3% of the Bank's total loan portfolio at September 30, 2010.
Land loans originated by the Bank generally have maturities of five to ten
years. The largest land loan had an outstanding balance of $4.1 million at
September 30, 2011 and was performing according to its repayment terms. At
September 30, 2011, 31 land loans totaling $8.9 million were not performing
according to their terms. See "- Lending Activities - Non-performing Loans
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, 2011,
consumer loans amounted to $44.2 million, or 7.9%, of the total loan
portfolio.
At September 30, 2011, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $36.0 million, or 6.4%, 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 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
10
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, 2011,
five consumer loans totaling $367,000 were delinquent in excess of 90 days.
See "- Lending Activities - Non-performing Loans and Delinquencies."
Commercial Business Lending. Commercial business loans totaled $22.5
million, or 4.0% of the loan portfolio at September 30, 2011. 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 $2.0 million at September 30, 2011 and was performing
according to its terms. At September 30, 2011, three commercial business
loans totaling $44,000 were not performing according to their repayment terms.
See "- Lending Activities - Non-performing Loans 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.
11
Loan Maturity. The following table sets forth certain information at
September 30, 2011 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)......... $ 6,375 $ 6,769 $ 1,780 $ 10,909 $ 88,847 $114,680
Multi-family........ 7,274 941 547 21,650 570 30,982
Commercial.......... 7,829 24,026 34,738 172,812 6,632 246,037
Construction and
land
development(2)..... 45,529 187 6,768 -- -- 52,484
Land................ 15,797 21,004 7,594 2,778 2,063 49,236
Consumer loans:
Home equity and
second mortgage.... 7,771 2,068 2,302 7,179 16,688 36,008
Other............... 3,099 725 429 695 3,292 8,240
Commercial business
loans............... 11,154 1,303 1,975 6,214 1,864 22,510
-------- ------- ------- -------- -------- -------
Total............... $104,828 $57,023 $56,133 $222,237 $119,956 560,177
======== ======= ======= ======== ========
Less:
Undisbursed portion
of construction
loans in process... (18,265)
Deferred loan
origination fees... (1,942)
Allowance for loan
losses............. (11,946)
--------
Loans receivable,
net................ $528,024
========
----------
(1) Includes $4.0 million of loans held-for-sale.
(2) Includes construction/permanent loans that convert to permanent mortgage
loans once construction is completed.
The following table sets forth the dollar amount of all loans due after
one year from September 30, 2011, 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)............. $ 51,222 $ 57,083 $108,305
Multi-family....................... 1,551 22,157 23,708
Commercial......................... 47,489 190,719 238,208
Construction and land development.. 6,955 -- 6,955
Land............................... 20,217 13,222 33,439
Consumer loans:
Home equity and second mortgage.... 16,651 11,586 28,237
Other.............................. 4,920 221 5,141
Commercial business loans.......... 5,401 5,955 11,356
-------- -------- --------
Total............................. $154,406 $300,943 $455,349
======== ======== ========
----------
(1) Includes loans held-for-sale.
12
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
a certified appraiser retained by the Bank.
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 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 Freddie Mac
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, Chief Credit Administrator, 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, 2011 and 2010, the Bank's total gross loan originations were $160.2
million and $182.5 million, respectively. Periodically, the Bank purchases
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. There were no loan participation interests
purchased during the years ended September 30, 2011 and 2010. During the year
ended September 30, 2009, the Bank purchased loan participation interests of
$1.6 million. The Bank also periodically purchases contracts secured by one-
to four-family residencies from individuals. During the year ended September
30, 2011, the Bank purchased contracts totaling $187,000. 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
Freddie Mac; 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, 2011, the Bank's loan servicing portfolio, which is
not included in the Company's consolidated financial statements, totaled
$298.9 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 years
ended September 30, 2011, 2010 and 2009.
13
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
---------------------------------
2011 2010 2009
-------- --------- --------
Loans originated: (In thousands)
Mortgage loans:
One- to four-family................. $ 57,620 $ 72,015 $ 165,972
Multi-family........................ 2,009 7,772 1,036
Commercial.......................... 38,262 27,248 43,821
Construction and land development... 40,724 35,369 56,287
Land................................ 3,793 11,712 6,519
Consumer............................. 7,424 10,286 14,080
Commercial business loans............ 10,325 18,130 7,601
-------- --------- --------
Total loans originated............. 160,157 182,532 295,316
Loans purchased:
Mortgage loans:
One- to four-family................. 187 50 --
Commercial.......................... - -- 1,606
-------- --------- --------
Total loans purchased.............. 187 50 1,606
-------- --------- --------
Total loans originated and
purchased........................ 160,344 182,582 296,922
Loans sold:
Whole loans sold..................... (62,480) (68,330) (162,913)
-------- --------- --------
Total loans sold..................... (62,480) (68,330) (162,913)
Loan principal repayments............. (96,723) (150,333) (150,729)
Other items, net...................... (708) 16,464 6,241
-------- --------- --------
Net increase (decrease) in loans
receivable........................... $ 433 $ (19,617) $(10,479)
======== ========= ========
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 up 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 $1.9 million at September
30, 2011.
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.
14
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.
The following table sets forth information with respect to the Company's
non-performing assets at the dates indicated.
At September 30,
----------------------------------------------------
2011 2010 2009 2008 2007
Loans accounted for -------- -------- -------- -------- ---------
on a non-accrual basis: (Dollars in thousands)
Mortgage loans:
One- to four-family... $ 2,150 $ 3,691 $ 1,343 $ 300 $ 252
Commercial............ 6,571 7,252 5,004 714 90
Construction and
land development.... 3,522 7,609 17,594 9,840 1,000
Land.................. 8,935 5,460 5,023 726 28
Consumer loans.......... 367 806 258 160 --
Commercial business
loans................ 44 46 65 250 120
-------- -------- -------- -------- ---------
Total.............. 21,589 24,864 29,287 11,990 1,490
Accruing loans which are
contractually past due
90 days or more....... 1,754 1,325 796 -- --
-------- -------- -------- -------- ---------
Total of non-accrual
and 90 days past
due loans............. 23,343 26,189 30,083 11,990 1,490
Non-accrual investment
securities............ 2,796 3,390 477 -- --
Other real estate owned
and other repossessed
assets................ 10,811 11,519 8,185 511 --
-------- -------- -------- -------- ---------
Total non-performing
assets (1).......... $ 36,950 $ 41,098 $ 38,745 $ 12,501 $ 1,490
======== ======== ======== ======== =========
Troubled debt restructured
loans on accrual
status (2)............ $ 18,166 $ 8,995 $ -- $ 272 $ --
Non-accrual and 90 days
or more past due loans
as a percentage of
loans receivable, net. 4.32% 4.86% 5.36% 2.12% 0.29%
Non-accrual and 90 days
or more past due loans
as a percentage of
total assets.......... 3.16% 3.53% 4.28% 1.76% 0.23%
Non-performing assets
as a percentage of
total assets.......... 5.01% 5.53% 5.52% 1.83% 0.23%
Loans receivable,
net (3)............... $539,970 $538,855 $561,380 $565,737 $520,138
======== ======== ======== ======== ========
Total assets $738,224 $742,687 $701,676 $681,883 $644,848
======== ======== ======== ======== ========
----------------
(1) Does not include troubled debt restructured loans on accrual status.
(2) Does not include troubled debt restructured loans totaling $7.4 million,
$7.4 million and $9.5 million reported as non-accrual loans at September
30, 2011, 2010 and 2009, respectively.
(3) Includes loans held-for-sale and is before the allowance for loan losses.
The Bank's non-accrual loans decreased by $3.3 million to $21.6 million
at September 30, 2011 from $24.9 million at September 30, 2010, primarily as a
result of a $4.1 million decrease in construction and land development loans
on non-accrual status, a $1.5 million decrease in one- to four-family loans on
non-accrual status, a $681,000 decrease in commercial real estate loans on
non-accrual status and a $439,000 decrease in consumer loans on non-accrual
status. These decreases were partially offset by a $3.5 million increase in
land loans on non-accrual status. The largest
15
non-performing loan was secured by a mini-storage facility in King County and
had a balance of $2.6 million at September 30, 2011. 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, 2011 had non-accruing loans been current in accordance
with their original terms totaled $3.5 million.
Other Real Estate Owned and Other Repossessed Assets. 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 ("OREO") until sold.
When property is acquired, it is recorded at the estimated fair market value
less estimated costs to sell. At September 30, 2011, the Bank had $10.8
million of OREO and other repossessed assets consisting of 46 individual
properties and four other repossessed assets, a decrease of $708,000 from
$11.5 million at September 30, 2010. The OREO properties consisted of two
condominium projects totaling $3.5 million, 28 land parcels totaling $3.3
million, 11 single family homes totaling $1.9 million, three commercial real
estate properties totaling $1.2 million and two land development projects
totaling $794,000. The largest OREO property was a condominium project with a
balance of $2.6 million.
Restructured Loans. Under accounting principles generally accepted in
the United States of America, the Bank is required to account for certain loan
modifications or restructurings as "troubled debt restructurings." 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 $25.5 million at September 30, 2011, of which $7.4 million 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.
To determine specific valuation allowances, 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 past due and the number of days past due. At September 30, 2011, the
Bank had $48.5 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 as
non-performing, 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 was $62.5 million at September 30, 2011 and $43.7 million at September
30, 2010. 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 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,
16
or weaknesses are not corrected there is the distinct possibility that some
loss will be sustained. 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 Bank is not warranted. When the Bank
classifies problem assets as either substandard or doubtful, it is required to
establish 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 the Bank
classifies problem assets as loss, it charges off the balance of the asset
against the allowance for loan losses. Assets which do not currently expose
the Bank 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 require 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,
-----------------------------------
2011 2010 2009
------- ------- -------
(In thousands)
Loss......................... $ -- $ -- $ --
Doubtful..................... -- -- --
Substandard(1)(2)............ 56,980 56,796 63,188
Special mention(1)........... 27,419 13,070 21,711
------- ------- -------
Total classified and
special mention loans...... $84,399 $69,866 $84,899
======= ======= =======
Allowance for loan losses.... $11,946 $11,264 $14,172
-----------
(1) For further information concerning the change in classified assets, see "-
Lending Activities - Non-performing Loans and Delinquencies."
(2) Includes non-performing loans.
The Bank's classified and special mention loans increased by $14.5
million from September 30, 2010 to $84.4 million at September 30, 2011,
primarily as a result of a $14.3 million increase in loans classified as
special mention.
Special mention loans 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. Thirty-one individual loans comprised $25.6
million, or 93.3%, of the $27.4 million in loans classified as special
mention. They include eight multi-family loans totaling $10.4 million, seven
commercial real estate loans totaling $6.3 million, eight land loans totaling
$4.8 million, six one- to four-family loans totaling $2.6 million, one
multi-family construction loan with a balance of $752,000 and one speculative
single-family construction loan with a balance of $700,000. All of these loans
were current and paying in accordance with their required loan repayment terms
at September 30, 2011, except three loans totaling $2.8 million that were 60
days past due.
The aggregate amount of loans classified as substandard at September 30,
2011 increased by $184,000 to $57.0 million from $56.8 million at September
30, 2010. At September 30, 2011, 134 loans were classified as substandard
compared to 146 at September 30, 2010.
Of the $57.0 million in loans classified as substandard at September 30,
2011, $21.6 million were on non-accrual status and $1.8 million were past due
90 days or more and still accruing. Troubled debt restructured loans
17
totaling $20.1 million were classified as substandard at September 30, 2011,
with $7.4 million in troubled debt restructured loans on non-accrual status
and $12.7 million in troubled debt restructured loans on accrual status. The
largest loan classified as substandard at September 30, 2011 had a balance of
$4.7 million and was secured by a mini-storage facility in Pierce County.
This loan was performing according to its loan repayment terms at September
30, 2011. The next largest loan classified as substandard at September 30,
2011 had a balance of $4.6 million and was secured by a mini-storage facility
in Pierce County and was 60 days past due at September 30, 2011.
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 net realizable 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, 2011, the Bank's allowance for loan losses totaled $11.9
million. The Bank's allowance for loan losses as a percentage of total loans
receivable and non-performing loans increased to 2.21% and 51.2%,
respectively, at September 30, 2011 from 2.09% and 43.0%, respectively, at
September 30, 2010.
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.
18
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended September 30,
---------------------------------------
2011 2010 2009 2008 2007
------ ------- ------- ------- ------
(Dollars in thousands)
Allowance at beginning of year....... $11,264 $14,172 $ 8,050 $4,797 $4,122
Provision for loan losses............ 6,758 10,550 10,734 3,900 686
Allocated to loan commitments........ - -- (169) - --
Recoveries:
Mortgage loans:
One- to four-family................. 151 - -- -- --
Multi-family........................ 41 - -- -- --
Commercial.......................... -- 13 - -- --
Construction........................ 109 104 - -- --
Land................................ 46 153 83 - --
Consumer loans:
Home equity and second mortgage..... 42 86 - -- --
Other............................... 2 6 5 1 1
Commercial business loans............ 1 - - - --
------- ------- ------- ------- ------
Total recoveries................... 392 362 88 1 1
Charge-offs:
Mortgage loans:
One- to four-family................. 543 200 46 - --
Construction........................ 3,972 8,012 3,108 648 --
Commercial.......................... 47 1,888 235 - --
Land................................ 1,704 3,285 705 - --
Consumer loans:
Home equity and second mortgage..... 150 399 162 - --
Other............................... 30 36 25 - 12
Commercial business loans............ 22 - 250 - --
------- ------- ------- ------- ------
Total charge-offs................... 6,468 13,820 4,531 648 12
------- ------- ------- ------- ------
Net charge-offs..................... 6,076 13,458 4,443 647 11
------- ------- ------- ------- ------
Allowance at end of year............ $11,946 $11,264 $14,172 $8,050 $4,797
======= ======= ======= ======= ======
Allowance for loan losses as a
percentage of total loans receivable
(net)(1) outstanding at the end of
the year............................ 2.21% 2.09% 2.52% 1.42% 0.92%
Net charge-offs as a percentage
of average loans outstanding
during the year..................... 1.13% 2.45% 0.79% 0.12% 0.00%
Allowance for loan losses as a
percentage of non-performing loans
at end of year...................... 51.2% 43.01% 47.11% 67.14% 321.95%
------------
(1) Total loans receivable (net) includes loans held for sale and is before
the allowance for loan losses.
19
The following table sets forth the allocation of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
----------------------------------------------------------------------------------------------
2011 2010 2009 2008 2007
----------------- ------------------ ---------------- ----------------- ------------------
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.. $ 760 20.47% $ 530 21.65% $ 616 18.58% $ 476 18.35% $ 396 17.40%
Multi-family.. 1,076 5.53 392 5.77 431 4.31 248 4.24 200 5.97
Commercial.... 4,035 43.92 3,173 37.21 2,719 31.63 1,521 23.90 1,368 21.72
Construction
and land
development.. 1,618 9.37 1,626 12.39 5,132 23.48 3,254 30.46 1,047 31.64
Land.......... 2,795 8.79 3,709 11.27 3,348 11.03 1,435 9.92 549 10.30
Non-mortgage
loans:
Consumer
loans........ 875 7.90 461 8.49 1,216 8.66 457 9.69 412 9.88
Commercial
business
loans........ 787 4.02 1,373 3.22 710 2.31 659 3.44 825 3.09
------- ----- ------- ------ ------- ------ ------ ------ ------ ------
Total allowance
for loan
losses......$11,946 100.0% $11,264 100.00% $14,172 100.00% $8,050 100.00% $4,797 100.00%
======= ===== ======= ====== ======= ====== ====== ====== ====== ======
20
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, 2011, the Company's investment portfolio totaled $10.9
million, primarily consisting of $5.7 million of mortgage-backed securities
available-for-sale, $1.0 million of mutual funds available-for-sale, and $4.1
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 $16.2 million at September 30, 2010, primarily
consisting of $10.1 million of mortgage-backed securities available-for-sale,
$988,000 of mutual funds available-for-sale, and $5.0 million of
mortgaged-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,
----------------------------------------------------------------
2011 2010 2009
-------------------- -------------------- --------------------
Recorded Percent of Recorded Percent of Recorded Percent of
Value Total Value Total Value Total
--------- ---------- --------- ---------- --------- ----------
(Dollars in thousands)
Held-to-
Maturity:
U.S. agency
securities.. $ 27 0.25% $ 28 0.17% $ 27 0.13%
Mortgage-
backed
securities.. 4,118 37.91 5,038 31.13 7,060 34.34
Available-for-
Sale (at fair
value):
Mortgage-backed
securities.. 5,717 52.63 10,131 62.59 12,503 60.82
Mutual funds. 1,000 9.21 988 6.11 968 4.71
------- ----- ------- ------ ------- ------
Total
portfolio.... $10,862 100.0% $16,185 100.00% $20,558 100.00%
======= ===== ======= ====== ======= ======
21
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, 2011. 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........ $ - --% $ 13 3.25% $ 14 3.98% $ - --%
Mortgage-backed
securities........ - -- 10 4.70 24 3.16 4,084 3.01
Available-for-Sale:
Mortgage-backed
securities........ 1 4.40 - -- 117 5.90 5,599 2.74
Mutual funds....... 1,000 2.82 - - -- - -- --
------ ----- ------ ------
Total portfolio.... $1,001 2.82% $ 23 3.85% $ 155 5.28% $9,683 2.85%
====== ===== ====== ======
There were no securities which had an aggregate book value in excess of
10% of the Company's total equity at September 30, 2011. At September 30,
2011, the Company had $3.4 million of private label mortgage-backed securities
of which $2.8 million was on non-accrual status. The private label
mortgage-backed securities were acquired from the in-kind redemption of the
Company's investment in the AMF family of mutual funds in June 2008. For
additional information regarding investment securities, see "Item 1A, Risk
Factors - Other-than-temporary impairment charges in our investment securities
portfolio could result in additional losses" 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 and
the FRB 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 checking account acquisition marketing programs. At
September 30, 2011, the Bank had 37.1% of total deposits in non-interest
bearing accounts and NOW checking accounts.
At September 30, 2011 the Bank had $86.3 million of jumbo certificates of
deposit of $100,000 or more. The Bank had no brokered certificates of
deposits at September 30, 2011. The Bank believes that its jumbo certificates
of deposit, which represented 14.6% of total deposits at September 30, 2011,
present similar interest rate risk compared to its other deposits.
22
The following table sets forth information concerning the Bank's deposits
at September 30, 2011.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
---------------------------------------- ------------- --------- ----------
(In thousands)
Non-interest bearing.................... --% $ 64,494 10.88%
Negotiable order of
withdrawal ("NOW") checking........... 0.90 155,299 26.20
Savings................................. 0.62 83,636 14.11
Money market............................ 0.75 61,028 10.30
-------- ------
Subtotal............................... 0.80 364,457 61.49
Certificates of Deposit(1)
----------------------------------------
Maturing within 1 year.................. 1.19 157,161 26.52
Maturing after 1 year but
within 2 years ........................ 1.44 39,793 6.71
Maturing after 2 years but
within 5 years ........................ 2.54 30,641 5.17
Maturing after 5 years.................. 2.10 626 0.11
-------- ------
Total certificates of deposit.......... 1.42 228,221 38.51
-------- ------
Total deposits........................ 1.04 $592,678 100.0%
======== ======
______________________
(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, 2011. 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.................... $15,767
Over three through six months........... 16,027
Over six through twelve months.......... 26,067
Over twelve months...................... 28,461
-------
Total................................. $86,322
=======
23
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,
------------------------------------------------------------------------------------
2011 2010 2009
------------------------------ ----------------------------- -------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- ---------- -------- -------- ---------- ------- --------
(Dollars in thousands)
Non-interest-bearing... $ 64,494 10.88% $ 5,739 $ 58,755 10.15% $ 8,460 $ 50,295 9.95%
NOW checking........... 155,299 26.20 1,995 153,304 26.48 35,947 117,357 23.21
Savings................ 83,636 14.11 16,188 67,448 11.65 8,839 58,609 11.59
Money market........... 61,028 10.30 5,305 55,723 9.63 (6,755) 62,478 12.36
Certificates of deposit
which mature:
Within 1 year........ 157,161 26.52 (20,750) 177,911 30.74 (4,374) 182,285 36.04
After 1 year, but
within 2 years...... 39,793 6.71 (3,239) 43,032 7.43 20,445 22,587 4.47
After 2 years, but
within 5 years...... 30,641 5.17 8,255 22,386 3.87 10,652 11,734 2.32
Certificates maturing
thereafter.......... 626 0.11 316 310 0.05 (6) 316 0.06
-------- ----- ------- -------- ------ ------- -------- ------
Total.................. $592,678 100.0% $13,809 $578,869 100.00% $73,208 $505,661 100.00%
======== ===== ======= ======== ====== ======= ======== ======
24
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,
--------------------------------
2011 2010 2009
-------- -------- --------
(In thousands)
0.00 - 1.99%................. $193,790 $194,142 $ 59,466
2.00 - 3.99%................. 33,345 48,059 146,513
4.00 - 5.99%................. 1,086 1,374 10,569
6.00% - and over............. -- 64 374
-------- -------- --------
Total........................ $228,221 $243,639 $216,922
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth
the amount and maturities of certificates of deposit at September 30, 2011.
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%........... $153,898 $34,972 $ 4,771 $149 $193,790
2.00 - 3.99%........... 2,603 4,553 25,712 477 33,345
4.00 - 5.99%........... 660 268 158 -- 1,086
6.00% and over......... -- -- -- -- --
-------- ------- ------- ---- --------
Total.................. $157,161 $39,793 $30,641 $626 $228,221
======== ======= ======= ==== ========
Deposit Activities. The following table sets forth the deposit
activities of the Bank for the periods indicated.
Year September 30,
--------------------------------
2011 2010 2009
-------- -------- --------
(In thousands)
Beginning balance.................. $578,869 $505,661 $498,572
Net deposits (withdrawals) before
interest credited................ 7,673 65,401 (2,383)
Interest credited.................. 6,136 7,807 9,472
-------- -------- --------
Net increase in deposits........... 13,809 73,208 7,089
-------- -------- --------
Ending balance..................... $592,678 $578,869 $505,661
======== ======== ========
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, 2011, 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 $55.0 million was outstanding.
25
The Bank also utilizes overnight repurchase agreements with customers. These
overnight repurchase agreements are classified as other borrowings and totaled
$729,000 at September 30, 2011. The Bank also maintains a short-term
borrowing line with the FRB with total credit based on eligible collateral.
At September 30, 2011, the Bank had no outstanding balance and $58.7 million
in unused borrowing capacity on this borrowing line.
The following table sets forth certain information regarding borrowings
including repurchase agreements by the Bank at the end of and during the
periods indicated:
At or For the
Year September 30,
---------------------------------
2011 2010 2009
-------- -------- --------
(Dollars in thousands)
Average total borrowings........... $55,511 $ 78,402 $ 97,393
Weighted average rate paid on
total borrowings................. 4.32% 4.03% 4.14%
Total borrowings outstanding at
end of period.................... $55,729 $ 75,622 $105,777
The following table sets forth certain information regarding short-term
borrowings including repurchase agreements 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 September 30,
---------------------------------
2011 2010 2009
-------- -------- --------
(Dollars in thousands)
Maximum amount outstanding at
any month end:
FHLB advances................... $ -- $ -- $ --
Repurchase agreements........... 729 750 844
Pacific Coast Bankers'
Bank ("PCBB") borrowings...... -- -- --
FRB borrowings.................. -- 10,000 10,000
Average outstanding during period:
FHLB advances................... $ -- $ -- $ 15
Repurchase agreements........... 511 539 624
PCBB borrowings................. -- -- 6
FRB borrowings.................. -- 384 27
--------- -------- --------
Total average outstanding during
period........................... $ 511 $ 923 $ 672
========= ======== ========
Weighted average rate paid during
period:
FHLB advances................... --% --% 0.71%
Repurchase agreements........... 0.05 0.05 0.08
PCBB borrowings................. -- -- 1.48
FRB borrowings.................. -- 0.66 0.50
Total weighted average rate
paid during period............... 0.05 0.30 0.12
(table continued on following page)
26
At or For the
Year September 30,
---------------------------------
2011 2010 2009
-------- -------- --------
(Dollars in thousands)
Outstanding at end of period:
FHLB advances................... $ -- $ -- $ --
Repurchase agreements........... 729 622 777
PCBB borrowings................. -- -- --
FRB borrowings.................. -- -- 10,000
--------- -------- --------
Total outstanding at end of period. $ 729 $ 622 $ 10,777
========= ======== ========
Weighted average rate at end
of period:
FHLB advances................... --% --% --%
Repurchase agreements........... 0.05 0.05 0.05
PCBB borrowings................. -- -- --
FRB borrowings.................. -- -- 0.50
Total weighted average rate at
end of period.................... 0.05 0.05 0.50
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 cash
surrender charges. Increases in cash surrender value, net of policy premiums,
and proceeds from death benefits are recorded in non-interest income. At
September 30, 2011, the cash surrender value of bank owned life insurance
("BOLI") was $15.9 million.
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 the Bank
MOU informal supervisory agreement. The terms of the Bank MOU restrict the
Bank from certain activities, and require that the Bank obtain the prior
written approval, or non-objection, of the FDIC and/or the DFI to engage in
certain activities. In addition, on February 1, 2010, the FRB determined that
the Company required additional supervisory attention and entered into the
Company MOU. Under the Company MOU, the Company must among other things
obtain prior written approval, or non-objection, from the FRB to declare or
pay any dividends, or make any other capital distributions; issue any trust
preferred securities; or purchase or redeem any of its stock. The FRB has
denied the Company's requests to pay dividends on its Series A Preferred Stock
issued under the CPP for the quarterly payments due for the last six quarters
beginning with the payments due on May 15, 2010. Since dividends on the
Series A Preferred Stock have not been paid for more than six quarters, the
Treasury has the right to appoint two members to the Board of Directors of the
Company. See "- Risks specific to our participation in TARP." There can be no
assurances that the FRB will approve such payments or dividends in the future.
For additional information regarding the Bank MOU and the Company MOU, see
"Item 1A, Risk Factors - The Company and the Bank are required to comply with
the terms of separate memorandums
27
of understanding issued by their respective regulators and lack of compliance
could result in additional regulatory actions." and "- Risks specific to our
participation in TARP."
New Legislation. On July 21, 2010, the Dodd-Frank Act was signed into
law. The Dodd-Frank Act implements far-reaching changes across the financial
regulatory landscape, including provisions that, among other things, has or
will:
* Centralize responsibility for consumer financial protection by
creating a new agency within the Federal Reserve Board, the Bureau of
Consumer Financial Protection, with broad rulemaking, supervision and
enforcement authority for a wide range of consumer protection laws
that would apply to all banks and thrifts. Smaller financial
institutions, including the Bank, will be subject to the supervision
and enforcement of their primary federal banking regulator with
respect to the federal consumer financial protection laws.
* Require the federal banking regulators to promulgate new capital
regulations and seek to make their capital requirements
countercyclical, so that capital requirements increase in times of
economic expansion and decrease in times of economic contraction.
* Provide for new disclosure and other requirements relating to
executive compensation and corporate governance.
* Make permanent the $250,000 limit for federal deposit insurance and
provide unlimited federal deposit insurance until January 1, 2013 for
non interest-bearing demand transaction accounts at all insured
depository institutions.
* Effective July 21, 2011, repealed the federal prohibitions on the
payment of interest on demand deposits, thereby permitting depository
institutions to pay interest on business transaction and other
accounts.
* Require all depository institution holding companies to serve as a
source of financial strength to their depository institution
subsidiaries in the event such subsidiaries suffer from financial
distress.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will
take effect over several years, making it difficult to anticipate the overall
financial impact on the Company and the financial services industry more
generally. The elimination of the prohibition on the payment of interest on
demand deposits could materially increase our interest expense, depending on
our competitors' responses. Provisions in the legislation that require
revisions to the capital requirements of the Company and the Bank could
require the Company and the Bank to seek additional sources of capital in the
future.
Insurance of Accounts and Regulation by the FDIC. The Bank's deposits
are insured up to applicable limits by the Deposit Insurance Fund ("DIF") of
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. 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 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.
In addition to the regular quarterly assessments, due to losses and
projected losses attributed to failed institutions, the FDIC imposed a special
assessment of five 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 regularly quarterly premiums) as of June 30,
2009, which was collected on September 30, 2009.
28
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 adopted a rule requiring each
insured institution 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 was due on December 30, 2009). The prepaid amount is recorded as
an asset with a zero risk weight and the Bank will continue to record
quarterly expenses for deposit insurance. For purposes of calculating the
prepaid amount, assessments were measured at the Bank's assessment rate as of
September 30, 2009, with a uniform increase of 3 basis points effective
January 1, 2011, and were based on the Bank's assessment base for the third
quarter of 2009, with deposit growth assumed quarterly at annual rate of 5%.
If events cause actual assessments during the prepayment period to vary from
the prepaid amount, the Bank will pay excess assessments in cash or receive a
rebate of prepaid amounts not exhausted after collection of assessments due on
June 30, 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. In December 2009, the Bank paid the prepaid assessment
of $4.4 million; and as of September 30, 2011, the remaining prepaid balance
was $2.1 million.
As required by the Dodd-Frank Act, the FDIC adopted rules effective April
1, 2011, under which insurance premium assessments are based on an
institution's total assets minus its tangible equity (defined as Tier 1
capital) instead of its deposits. Under these rules, an institution with
total assets of less than $10 billion will be assigned to a Risk Category as
described above and a range of initial base assessment rates will apply to
each category, subject to adjustment downward based on unsecured debt issued
by the institution and, except for an institution in Risk Category I,
adjustment upward if the institution's brokered deposits exceed 10% of its
domestic deposits, to produce total base assessment rates. Total base
assessment rates range from 2.5 to 9 basis points for Risk Category I, nine to
24 basis points for Risk Category II, 18 to 33 basis points for Risk Category
III and 30 to 45 basis points for Risk Category IV, all subject to further
adjustment upward if the institution holds more than a de minimis amount of
unsecured debt issued by another FDIC-insured institution. The FDIC may
increase or decrease its rates by 2.0 basis points without further rulemaking.
In an emergency, the FDIC may also impose a special assessment.
The Dodd-Frank Act establishes 1.35% as the minimum reserve ratio. The
FDIC has adopted a plan under which it will meet this ratio by September 30,
2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires
the FDIC to offset the effect on institutions with assets less than $10
billion of the increase in the statutory minimum reserve ratio to 1.35% from
the former statutory minimum of 1.15%. The FDIC has not yet announced how it
will implement this offset. In addition to the statutory minimum ratio the
FDIC must designate a reserve ratio, known as the designated reserve ratio
("DRR"), which may exceed the statutory minimum. The FDIC has established
2.0% as the DRR. In addition, all institutions with deposits insured by the
FDIC are required to pay assessments to fund interest payments on bonds issued
by the Financing Corporation, an agency of the Federal government established
to fund the costs of failed thrifts in the 1980s. These assessments, which may
be revised based upon the level of DIF deposits, will continue until the bonds
mature in the years 2017 through 2019. For the quarterly period ended
September 30, 2011, the Financing Corporation assessment equaled 0.680 basis
points for each $100 in domestic deposits. These assessments, which may be
revised based upon the level of DIF deposits, will continue until the bonds
mature in the years 2017 through 2019.
Under the Dodd-Frank Act, beginning on January 1, 2011, all non-interest
bearing transaction accounts and interest on lawyers trust accounts ("IOLTA")
qualify for unlimited deposit insurance by the FDIC through December 31, 2012.
NOW accounts, which were previously fully insured under the Transaction
Account Guarantee Program, are no longer eligible for an unlimited guarantee
due to the expiration of this program on December 31, 2010. NOW accounts,
along with all other deposits maintained at the Bank, are now insured by the
FDIC up to $250,000 per account owner.
As insurer, the FDIC 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 threat to the DIF. The FDIC also has
the authority to take enforcement actions against banks and savings
associations.
29
The Dodd-Frank Act contains a number of provisions that will affect the
capital requirements applicable to the Company and the Bank. In addition, on
September 12, 2010, the Basel Committee adopted the Basel III capital rules.
These rules, which will be phased in over a period of years, set new standards
for common equity, tier 1 and total capital, determined on a risk-weighted
basis. The impact on the Company and the Bank of the Basel III rules cannot be
determined at this time. For additional information, see "- Capital
Requirements - Possible Changes to Capital Requirements Resulting from Basel
III" set forth below.
A significant increase in insurance premiums would likely have an adverse
effect on the operating expenses and results of operations of the Bank. There
can be no prediction as to what insurance assessment rates will be in the
future. Insurance of deposits may be terminated by the FDIC upon a finding
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.
Management of the Bank is not aware of any practice, condition or violation
that might lead to termination of the Bank's deposit insurance.
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 meets certain criteria. 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 deemed
to be 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, 2011, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC. For additional
information on capital requirements, see Note 18 of the Notes to the
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
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,
30
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, 2011, the Bank had a Tier
1 leverage capital ratio of 10.3%. 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, 2011, the
Bank's ratio of total capital to risk-weighted assets was 15.3% and the ratio
of Tier 1 capital to risk-weighted assets was 14.0%.
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, 2011, the Bank had a net
worth of 10.1% of total assets.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2011. 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 is
required to comply with in connection with the Bank MOU. For additional
information regarding the MOU, see "Item 1A, Risk Factors - The Company and
the Bank are required to comply with the terms of separate memoranda of
understanding issued by their respective regulators and lack of compliance
could result in additional regulatory actions."
At September 30, 2011
------------------------------
Percent of Adjusted
Amount Total Assets (1)
-------- -------------------
(Dollars in thousands)
Tier 1 (leverage) capital.................... $74,588 10.3%
Tier 1 (leverage) capital requirement (2).... 72,662 10.0
------- -----
Excess....................................... $ 1,926 0.3%
======= =====
Tier 1 risk adjusted capital................. $74,588 14.0%
Tier 1 risk adjusted capital requirement..... 31,951 6.0
------- -----
Excess....................................... $42,637 8.0%
======= =====
Total risk-based capital..................... $81,310 15.3%
Total risk-based capital requirement......... 53,251 10.0
------- -----
Excess ...................................... $28,059 5.3%
======= =====
--------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $726.6 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $532.5 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 MOU, the Bank is required to maintain at least a
10.0% Tier 1 leverage capital ratio.
31
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 - The Company and the
Bank are required to comply with the terms of separate memoranda of
understanding issued by their respective regulators and lack of compliance
could result in additional regulatory actions."
Possible Changes to Capital Requirements Resulting from Basel III. In
December 2010 and January 2011, the Basel Committee on Banking Supervision
published the final texts of reforms on capital and liquidity generally
referred to as "Basel III." Although Basel III is intended to be implemented
by participating countries for large, internationally active banks, its
provisions are likely to be considered by United States banking regulators in
developing new regulations applicable to other banks in the United States,
including the Bank.
For banks in the United States, among the most significant provisions of
Basel III concerning capital are the following:
* A minimum ratio of common equity to risk-weighted assets reaching
4.5%, plus an additional 2.5% as a capital conservation buffer, by
2019 after a phase-in period.
* A minimum ratio of Tier 1 capital to risk-weighted assets reaching
6.0% by 2019 after a phase-in period.
* A minimum ratio of total capital to risk-weighted assets, plus the
additional 2.5% capital conservation buffer, reaching 10.5% by 2019
after a phase-in period.
* An additional countercyclical capital buffer to be imposed by
applicable national banking regulators periodically at their
discretion, with advance notice.
* Restrictions on capital distributions and discretionary bonuses
applicable when capital ratios fall within the buffer zone.
* Deduction from common equity of deferred tax assets that depend on
future profitability to be realized.
* Increased capital requirements for counterparty credit risk relating
to OTC derivatives, repos and securities financing activities.
* For capital instruments issued on or after January 13, 2013 (other
than common equity), a loss-absorbency requirement such that the
instrument must be written off or converted to common equity if a
trigger event occurs, either pursuant to applicable law or at the
direction of the banking regulator. A trigger event is an event
under which the banking entity would become nonviable without the
write-off or conversion, or without an injection of capital from the
public sector. The issuer must maintain authorization to issue the
requisite shares of common equity if conversion were required.
The Basel III provisions on liquidity include complex criteria
establishing a liquidity coverage ratio ("LCR") and net stable funding ratio
("NSFR"). The purpose of the LCR is to ensure that a bank maintains adequate
unencumbered, high quality liquid assets to meet its liquidity needs for 30
days under a severe liquidity stress scenario. The purpose of the NSFR is to
promote more medium and long-term funding of assets and activities, using a
one-year horizon. Although Basel III is described as a "final text," it is
subject to the resolution of certain issues and to further guidance and
modification, as well as to adoption by United States banking regulators,
including decisions as to whether and to what extent it will apply to United
States banks that are not large, internationally active banks.
Federal Home Loan Bank System. The Bank is a member of the FHLB-Seattle,
which is one of 12 regional FHLBs that administer the home financing credit
function of savings institutions. Each FHLB serves as a reserve or central
bank for its members within its assigned region. It is funded primarily from
proceeds derived from the sale of
32
consolidated obligations of the FHLB System. It makes loans or advances to
members in accordance with policies and procedures, established by the Board
of Directors of the FHLB, which are subject to the oversight of the Federal
Housing Finance Board. All advances from the FHLB are required to be fully
secured by sufficient collateral as determined by the FHLB. In addition, all
long-term advances are required to provide funds for residential home
financing. See "Business - Deposit Activities and Other Sources of Funds
Borrowings."
As a member, the Bank is required to purchase and maintain stock in the
FHLB-Seattle. At September 30, 2011, the Bank had $5.7 million in FHLB stock,
which was in compliance with this requirement. The Bank did not receive any
dividends from the FHLB-Seattle for the year ended September 30, 2011.
Subsequent to December 31, 2008, the FHLB-Seattle announced that it was below
its regulatory risk-based capital requirement and it is now precluded from
paying dividends or repurchasing capital stock. The FHLB-Seattle is not
anticipated to resume dividend payments until its financial results improve.
The FHLB-Seattle has not indicated when dividend payments may resume. For
additional information, see Item 1A, "Risk Factors - Our investment in Federal
Home Loan Bank of Seattle stock may become impaired."
The FHLBs continue to contribute to low- and moderately-priced housing
programs through direct loans or interest subsidies on advances targeted for
community investment and low- and moderate-income housing projects. These
contributions have affected adversely the level of FHLB dividends paid and
could continue to do so in the future. These contributions could also have an
adverse effect on the value of FHLB stock in the future. A reduction in value
of the Bank's FHLB stock may result in a corresponding reduction in its
capital.
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.
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 in excess of the supervisory loan-to-value ratios
should not exceed 30% of total capital. Loans in excess of the supervisory
loan-to-value 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,
2011, the Bank's aggregate loans in excess of the supervisory loan-to-value
ratios
33
were 29% 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 25% 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, (iv) acting as agent for a customer in many
capacities, and (v) 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. 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"), is a federal statute that generally imposes strict liability on
all prior and present "owners and operators" of sites containing hazardous
waste. However, Congress acted 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, 2011, 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 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.
34
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.
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.
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 BHCA, 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
35
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 may approve an application of a
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 except with respect to 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. The Federal Reserve may not
approve an application if the applicant controls 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, and that it is inappropriate for a company experiencing
serious financial problems to borrow funds to pay dividends. Under the terms
of the Bank MOU, the Bank may not pay dividends to the Company without the
prior consent of the FDIC and
36
the Division. In addition, the FRB has denied the Company's request to pay
cash dividends on its common stock since May 2010. In addition, the FRB has
denied the Company's requests to pay dividends on its Series A Preferred Stock
issued under the CPP for the quarterly payments due for the last six quarters
beginning with the payments due on May 15, 2010. The Company's ability to
pay dividends with respect to common stock is subject to obtaining approval
from the FRB and the Treasury and is further restricted until the dividend
obligations under the Series A Preferred Stock are brought current.
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 $500 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, 2011, the Company's total risk based capital was 16.5% of risk-weighted
assets, its risk based capital of Tier 1 (core) capital was 15.2% of
risk-weighted assets and its Tier 1 (core) capital was 11.1% of average
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
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.
Taxation
Federal Taxation
General. The Company and the Bank report their operations 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 allowance for loan losses 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.
Allowance for Loan Losses. 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 an allowance for loan losses and to make annual additions
thereto, which may have been deducted in arriving at their taxable income.
37
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 allowance for loan losses 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 allowance for loan
losses ("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 allowance for loan losses. 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 34% 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 allowance for loan
losses.
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.
Audits. The Company is no longer subject to United States federal tax
examination by tax authorities for years ended on or before September 30,
2007.
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, 2011, the Bank had 247 full-time employees and 23
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.
38
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, 2011 Company Bank
----------------- --------- ------------------------- ----------------------
Michael R. Sand 57 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 44 Executive Vice President, Executive Vice
Chief Financial Officer President, Chief
and Secretary Financial Officer and
Secretary
Robert A. Drugge 60 Executive Vice President Executive Vice
President and
Business
Banking Division
Manager
John P. Norawong 46 Executive Vice President Executive Vice
President and
Community Banking
Division Manager
Michael J. Scott 65 Executive Vice
President and Chief
Credit Administrator
Marci A. Basich 42 Senior Vice President and Senior Vice President
Treasurer and Treasurer
Kathie M. Bailey 59 Senior Vice President Senior Vice President
and Chief Operations
Officer
Jonathan A. Fischer 37 Senior Vice President Senior Vice President
and Chief Risk Officer and Chief Risk
Officer
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 a senior officer and most recently served as Senior Vice
President and Commercial Banking
39
Manager. 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.
Michael J. Scott has been affiliated with the Bank since January 2008 and
has served as 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 in both Seattle and Tacoma, Washington. He
began his banking career at Seafirst in 1973, which was acquired by Bank
America Corp. and became known as Bank of America.
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.
Jonathan A. Fischer has been affiliated with the Bank since October 1997
and has served as the Chief Risk Officer since October 2010. Mr. Fischer has
served as the Compliance Officer, Community Reinvestment Act Officer, and
Privacy Officer since January 2000. Mr. Fischer has been the Bank's Bank
Secrecy Act Officer since November 2007.
40
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 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.
The Company and the Bank are required to comply with the terms of separate
memoranda of understanding issued by their respective regulators and lack of
compliance could result in additional regulatory actions.
In December 2009, the FDIC and the Division determined that the Bank
required additional supervisory attention and on December 29, 2009 entered
into the Bank MOU. Under the terms of the Bank 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.;
or
* 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 Bank MOU require the Bank 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% of 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.
In addition on February 1, 2010, the FRB determined that the Company
required additional supervisory attention and entered into the Company MOU.
Under the terms of the Company MOU, the Company, without prior written
approval, or non-objection, of the FRB, may not:
* appoint any new director or senior executive officer or change the
responsibilities of any current senior executive officers;
* receive dividends or any other form of payment or distribution
representing a reduction in capital from the Bank;
* declare or pay any dividends, or make any other capital distributions;
* incur, renew, increase, or guarantee any debt;
* issue any trust preferred securities; or
* purchase or redeem any of its stock.
The Bank MOU and the Company MOU will remain in effect until stayed,
modified, terminated or suspended by the FDIC and the Division or FRB, as the
case may be. If either the Company or the Bank is found not in compliance
41
with their respective MOU, it could be subject to 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 growth, to remove
officers and/or directors, and to assess civil monetary penalties. Management
of the Company and the Bank have been taking action and implementing programs
to comply with the requirements of the Company MOU and the Bank MOU,
respectively. Compliance will be determined by the FDIC, Division and FRB.
Any of these regulators may determine in their sole discretion that the issues
raised by the Company MOU or the Bank 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 further limitations on the
Company's business and negatively affect its ability to implement its business
plan, pay dividends on its common stock or the value of its common stock, as
well as its financial condition and result of operations.
As of September 30, 2011, the FRB has denied the Company's requests to
pay dividends on its Series A Preferred Stock issued under the CPP for the
quarterly payments due for the last six quarters beginning with the payments
due on May 15, 2010. There can be no assurance that our regulators will
approve such payments or dividends in the future. The Company may not declare
or pay dividends on its common stock or, with certain exceptions, repurchase
common stock without first having paid all cumulative preferred dividends that
are due. If dividends on the Series A Preferred Stock are not paid for six
quarters, whether or not consecutive, the Treasury has the right to appoint
two members to the Board of Directors of the Company. See "- Risks specific
to our participation in TARP."
Financial reform legislation enacted by Congress will, among other things,
tighten capital standards, create a new Consumer Financial Protection Bureau
and result in new laws and regulations that are expected to increase our costs
of operations.
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (the "Dodd-Frank Act"). This new law will
significantly change the current bank regulatory structure and affect the
lending, deposit, investment, trading and operating activities of financial
institutions and their holding companies. The Dodd-Frank Act requires various
federal agencies to adopt a broad range of new implementing rules and
regulations, and to prepare numerous studies and reports for Congress. The
federal agencies are given significant discretion in drafting the implementing
rules and regulations, and consequently, many of the details and much of the
impact of the Dodd-Frank Act may not be known for many months or years.
Among the many requirements in the Dodd-Frank Act for new banking
regulations is a requirement for new capital regulations to be adopted within
18 months. These regulations must be at least as stringent as, and may call
for higher levels of capital than, current regulations. In addition, the
banking regulators are required to seek to make capital requirements for banks
and bank holding companies, countercyclical so that capital requirements
increase in times of economic expansion and decrease in times of economic
contraction.
Certain provisions of the Dodd-Frank Act are expected to have a near term
impact on the Company. For example, effective one year after the date of
enactment, the Dodd-Frank Act eliminated the federal prohibitions on paying
interest on demand deposits, thus allowing businesses to have interest bearing
checking accounts. Depending on competitive responses, this significant change
to existing law could have an adverse impact on the Company's interest expense
and deposit balances.
The Dodd-Frank Act also broadens the base for FDIC insurance assessments.
Assessments are now based on the average consolidated total assets less
tangible equity capital of a financial institution. The Dodd-Frank Act also
permanently increased the maximum amount of deposit insurance for banks,
savings institutions and credit unions to $250,000 per depositor and
non-interest-bearing transaction accounts and IOLTA accounts have unlimited
deposit insurance through December 31, 2012.
The Dodd-Frank Act requires publicly traded companies to give
stockholders a non-binding vote on executive compensation and so-called
"golden parachute" payments and authorizes the Securities and Exchange
Commission to promulgate rules that would allow stockholders to nominate their
own candidates using a company's proxy materials.
42
The legislation also directs the federal banking regulators to issue rules
prohibiting incentive compensation that encourages inappropriate risks. The
legislation also directs the Federal Reserve Board to promulgate rules
prohibiting excessive compensation paid to bank holding company executives,
regardless of whether the company is publicly traded or not.
The Dodd-Frank Act created a new Consumer Financial Protection Bureau
with broad powers to supervise and enforce consumer protection laws. The
Consumer Financial Protection Bureau has broad rule-making authority for a
wide range of consumer protection laws that apply to all banks and savings
institutions, including the authority to prohibit "unfair, deceptive or
abusive" acts and practices. The Consumer Financial Protection Bureau has
examination and enforcement authority over all banks and savings institutions
with more than $10 billion in assets. Financial institutions with $10 billion
or less in assets, such as Timberland Bank, will continue to be examined for
compliance with the consumer laws by their primary bank regulators.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will
take effect over several years, making it difficult to anticipate the overall
financial impact on the Bank. However, it is expected that at a minimum
compliance with this law and implementing regulations will increase our
operating and compliance costs and could increase our interest expense. Any
additional changes in our regulation and oversight, whether in the form of new
laws, rules and regulations could make compliance more difficult or expensive
or otherwise materially adversely affect our business, financial condition or
prospects.
The current weak economic conditions 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 our local market
areas of Grays Harbor, Pierce, Thurston, King, Kitsap and Lewis counties in
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 has 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 possibly resulting in
a decrease in our total loans or assets;
* 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;
* the amount of our low-cost or non-interest bearing deposits may
decrease; and
* the price of our common stock may decrease.
Our real estate construction and land development loans expose us to
significant risks.
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, 2011, construction and land development
loans totaled $52.5 million, or 9.4% of our total loan portfolio, of which
$37.4 million were for residential real estate projects. Approximately $26.2
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 $2.2 million, or 0.4% of
our total loan portfolio at September 30, 2011. 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
43
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 builders 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, 2011, $1.9 million of our construction portfolio was comprised of
speculative one- to four- family construction loans. Approximately $3.5
million, or 6.7%, of our total real estate construction and land development
loans were non-performing at September 30, 2011. A material increase in our
non-performing construction and loan development loans could have a material
adverse effect on our financial condition and results of operation.
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, a further downturn in 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.
At September 30, 2011, we had $246.0 million of commercial real estate
mortgage loans, representing 43.9% 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 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 real estate loans may be
larger as a percentage of the total principal outstanding 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 the Comptroller of the
Currency 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
44
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 balance in commercial
real estate loans at September 30, 2011 represents more than 300% 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, 2011, we had $22.5 million or 4.0% 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 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, 2011, $150.7 million, or 26.9% of our total loan
portfolio, was secured by one- to four-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. These declines may have a greater effect on our earnings and
capital than on the earnings and capital of financial institutions whose loan
portfolios are more diversified.
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 or no equity because
either we originated upon purchase a first mortgage with an 80% loan-to-value
ratio, have originated a home equity loan with a combined loan-to-value ratio
of up to 90%, or because of the decline in home values in our market areas.
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.
45
Our provision for loan losses has increased substantially during recent years
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 years ended September 30, 2011 and 2010 we recorded a
provision for loan losses of $6.8 million and $10.6 million, respectively. We
also recorded net loan charge-offs of $6.1 million and $13.5 million for the
fiscal years ended September 30, 2011 and 2010, respectively. During these
last two fiscal years, we experienced higher loan delinquencies and credit
losses. Our non-performing loans and assets have historically reflected 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 non-performing loans.
Slower sales and excess inventory in the housing market have been the primary
causes of the increase in delinquencies and foreclosures for construction and
land development loans and land loans, which represent 35.1% of our
non-performing assets at September 30, 2011. Further, our portfolio is
concentrated in construction and land development loans, land loans and
commercial and commercial real estate loans, all of which have a higher risk
of loss than residential mortgage loans.
If current trends in the housing and real estate markets continue, and
until general economic conditions improve, 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.
We may have losses in the future
We reported net losses of $(2.3 million) and $(242,000) for the fiscal
years ended September 30, 2010 and 2009, respectively. These losses primarily
resulted from our high level of non-performing assets and the resultant
increased provisions for loan losses and OREO related expenses and
write-downs. We reported net income of $1.1 million for the fiscal year ended
September 30, 2011, however, we may suffer losses in the future which could
materially adversely affect our financial condition and require us to raise
additional capital.
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:
* an ongoing review of the quality, size and diversity of the loan
portfolio;
* evaluation of non-performing loans;
* historical default and loss experience;
* existing economic conditions;
* risk characteristics of the various classifications of loans; and
the amount and quality of collateral, including guarantees; securing
the loans.
46
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 $11.9
million or 2.21% of gross loans and 51.2% of non-performing loans at September
30, 2011. In addition, bank regulatory agencies periodically review our
allowance for loan losses and may require an increase in the provision for
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 may 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 non-performing assets increase, our earnings will be adversely
affected.
At September 30, 2011 our non-performing assets (which consist of
non-accruing loans, accruing loans 90 days or more past due, non-accrual
investment securities, and other real estate owned and other repossessed
assets) were $37.0 million, or 5.01% of total assets. Our non-performing
assets adversely affect our net income in various ways:
* We do not record interest income on non-accrual loans, non-performing
investment securities, or other real estate owned.
* We must provide for probable loan losses through a current period
charge to the provision for loan losses.
* Non-interest expense increases when we must write down the value of
properties in our other real estate owned portfolio to reflect
changing market values or recognize other-than-temporary impairment
on non-performing investment securities.
* There are legal fees associated with the resolution of problem
assets, as well as carrying costs, such as taxes, insurance, and
maintenance fees related to our other real estate owned.
* The resolution of non-performing assets requires the active
involvement of management, which can distract them from more
profitable activity.
If additional borrowers become delinquent and do not pay their loans and
we are unable to successfully manage our non-performing assets, our losses and
troubled assets could increase significantly, which could have a material
adverse effect on our financial condition and results of operations.
The Company has classified an additional $18.2 million in loans as
performing troubled debt restructurings at September 30, 2011.
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 allowances, 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 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 estimated 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
or if the property declines in value after foreclosure, the fair value of our
OREO may not be sufficient to recover our NBV in such assets, resulting in the
need for a valuation allowance. Additional material valuation allowances on
our OREO could have a material adverse effect on our financial condition and
results of operations.
47
In addition, bank regulators periodically review our OREO and may require
us to recognize further valuation allowances. Any increase in our valuation
allowances, 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 additional losses.
During the year ended September 30, 2011, we recognized a $447,000 other
than temporary impairment ("OTTI") charge on private label mortgage backed
securities we hold for investment. 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 through non-interest income. At September
30, 2011 our remaining private label mortgage backed securities portfolio
totaled $3.4 million.
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 private label mortgage backed securities or other investment
securities are other than temporarily impaired, our results of operations
could be adversely affected.
An increase in interest rates, change in the programs offered by Freddie Mac
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 Freddie Mac 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 Freddie
Mac 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.
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
48
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.
In addition, 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 defaults that may adversely affect our
profitability.
Increases in deposit insurance premiums and special FDIC assessments will hurt
our earnings.
The Dodd-Frank Act established 1.35% as the minimum reserve ratio. The
FDIC has adopted a plan under which it will meet this ratio by the statutory
deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset
the effect on institutions with assets less than $10 billion of the increase
in the minimum reserve ratio to 1.35% from the former minimum of 1.15%. The
FDIC has not announced how it will implement this offset. In addition to the
statutory minimum ratio, the FDIC must set a designated reserve ratio, or DRR,
which may exceed the statutory minimum. The FDIC has set 2.0% as the DRR.
As required by the Dodd-Frank Act, the FDIC has adopted final regulations
under which insurance premiums are based on an institution's total assets
minus its tangible equity instead of its deposits. While our FDIC insurance
premiums initially will be reduced by these regulations, it is possible that
our future insurance premiums will increase under the final regulations.
Liquidity risk could impair our ability to fund operations and jeopardize our
financial condition, growth and prospects.
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, borrowings from the Federal Reserve Bank of
San Francisco 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 on terms 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 deposits 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.
49
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. If we are able to raise capital it may not be on
terms that are acceptable to us. Accordingly, we cannot make assurances that
we will be able to raise additional capital. If we cannot raise additional
capital when needed, our operations could be materially impaired and our
financial condition and liquidity could be materially and adversely affected.
As a result, we may have to raise additional capital on terms that may be
dilutive to our shareholders. In addition, if we are unable to raise
additional capital when required by the FDIC, we may be subject to adverse
regulatory action. See "- The Company and the Bank are required to comply
with the terms of separate memoranda of understanding issued by their
respective regulators and lack of compliance could result in additional
regulatory actions."
We may experience future goodwill impairment, which could reduce our earnings.
We performed our test for goodwill impairment for fiscal year 2011, 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 and liabilities. Our evaluation of the fair value of goodwill
involves a substantial amount of judgment. If our judgment was incorrect, or
if events or circumstances change, and an impairment of goodwill was deemed to
exist, we would be required to write down our goodwill 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 of Seattle stock may become impaired.
At September 30, 2011, 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 has 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. On October 26, 2010, the FHLB announced that it had entered
into a Consent Agreement with the FHFA, which requires the FHLB to take
certain specified actions related to its business and operations. We will
continue to monitor the financial condition of the FHLB as it relates to,
among other things, the recoverability of our investment.
We may experience further decreases in the fair value of our mortgage
servicing rights, which could reduce our earnings.
Mortgage servicing rights ("MSRs") are capitalized at estimated fair
value when acquired through the origination of loans that are subsequently
sold with servicing rights retained. MSRs are amortized to servicing income
on loans sold over the period of estimated net servicing income. The
estimated fair 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. On a quarterly basis we periodically evaluate the fair
value
50
of MSRs 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. Our methodology for estimated the fair value of MSRs is highly
sensitive to changes in assumptions, such as prepayment speeds. The effect of
changes in market interest rates on estimated rates of loan prepayments
represents the predominant risk characteristic underlying the MSRs portfolio.
For example, a decrease in mortgage interest rates typically increases the
prepayment speeds of MSRs and therefore decreases the fair value of the MSRs.
We recorded a $405,000 valuation recovery to our MSRs during the year ended
September 30, 2011, which increased our earnings. Future decreases in
mortgage interest rates could decrease the fair value of our MSRs, which would
decrease our earnings.
Our assets as of September 30, 2011 include a deferred tax asset and we may
not be able to realize the full amount of such asset.
We recognize deferred tax assets and liabilities based on differences
between the financial statement recorded amounts and the tax bases of assets
and liabilities. At September 30, 2011, the net deferred tax asset was
approximately $3.8 million, an increase from a balance of approximately $3.4
million at September 30, 2010. The net deferred tax asset results primarily
from our provisions for loan losses recorded for financial reporting purposes,
which have been larger than net loan charge-offs deducted for tax reporting
purposes.
We regularly review our net deferred tax assets for recoverability based
on history of earnings expectations for future earnings and expected timing of
reversals of temporary differences and record a valuation allowance if deemed
necessary. Realization of deferred tax assets ultimately depends on the
existence of sufficient taxable income, including taxable income in prior
carryback years, as well as future taxable income. We believe the recorded
net deferred tax asset at September 30, 2011 is fully realizable; however, if
we determine that we will be unable to realize all or part of the net deferred
tax asset, we would adjust this net deferred tax asset, which would negatively
impact our financial condition and results of operations.
New or changing tax, accounting, and regulatory rules and interpretations
could significantly impact strategic initiatives, results of operations, cash
flows, and financial condition.
The financial services industry is extensively regulated. Federal and
state banking regulations are designed primarily to protect the deposit
insurance funds and consumers, not to benefit a company's stockholders. These
regulations may sometimes impose significant limitations on operations. The
significant federal and state banking regulations that affect us are described
in this report under the heading "Item 1. Business - Regulation of the Bank"
and "- Regulation of the Company." These regulations, along with the
currently existing tax, accounting, securities, insurance, and monetary laws,
regulations, rules, standards, policies, and interpretations control the
methods by which financial institutions conduct business, implement strategic
initiatives and tax compliance, and govern financial reporting and
disclosures. These laws, regulations, rules, standards, policies, and
interpretations are constantly evolving and may change significantly over
time.
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
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
51
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 which as of September 30, 2011 we were not. See "- Regulatory and
contractual restrictions may limit or prevent us from paying dividends on our
common stock." As of September 30, 2011, the FRB has denied the Company's
requests to pay dividends on its Series A Preferred Stock issued under the CPP
for the quarterly payments due for the last six quarters beginning with the
payments due on May 15, 2010. In addition, because dividends on the Series A
Preferred Stock have not been paid for six quarters, the Treasury has the
right to appoint two members to the Board of Directors of the Company. The
foregoing, 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.
The Series A Preferred Stock impacts net income (loss) to our common
shareholders and net income (loss) per common share and the warrant we issued
to Treasury may be dilutive to holders of our common stock. The dividends
declared or accrued on the Series A Preferred Stock reduce the net income
(increase the net loss) to common shareholders and our net income (loss) 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, 2011
(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.
If we are unable to redeem our Series A Preferred Stock by December 2013, the
cost of this capital to us will increase substantially.
The Company MOU prohibits us from redeeming our outstanding capital stock
without the prior written approval of the Federal Reserve Bank of San
Francisco. If we are unable to redeem our Series A Preferred Stock prior to
December 23, 2013, the cost of this capital to us will increase substantially
on that date, from 5.0% per annum (approximately $830,000 annually) to 9.0%
per annum (approximately $1.5 million annually). Depending on our financial
condition at the time, this increase in the annual dividend rate on the Series
A Preferred Stock could have a material negative effect on our liquidity and
ability to pay dividends to common shareholders.
Regulatory and contractual restrictions may limit or prevent us from paying
dividends on our common stock.
Holders of our common stock are only entitled to receive such dividends
as our Board may declare out of funds legally available for such payments.
Further, holders of our common stock are subject to the prior dividend rights
of any holders of our preferred stock at any time outstanding or depositary
shares representing such preferred stock then outstanding. Although we have
historically declared cash dividends on our common stock, we are not required
to do so. We suspended our cash dividend during the quarter ended June 30,
2010 and we do not know if we will resume the payment of dividends in the
future. As discussed above, the Company is not current on its dividend
payments on its Series A preferred stock and may not pay dividends to common
stockholders under the securities purchase agreement with the Treasury. In
addition, under the terms of the Company MOU the payment of dividends by the
Company to its shareholders is subject to the prior written non-objection of
the FRB. As an entity separate and distinct from the Bank, the Company
derives substantially all of its revenue in the form of dividends from the
Bank. Accordingly, the Company is and will be dependent upon dividends from
the Bank to satisfy its cash needs and to pay dividends on its common
52
stock. The inability to receive dividends from the Bank could have a material
adverse effect on the Company's business, financial condition and results of
operations. The Bank's ability to pay dividends is subject to its ability to
earn net income and, to meet certain regulatory requirements. The Bank does
not currently meet these regulatory requirements. As discussed above, under
the Bank MOU, the Bank may not pay dividends to the Company without prior
approval from the FDIC and DFI, which also limits the Company's ability to pay
dividends on its common stock. The lack of a cash dividend could adversely
affect the market price of our common stock.
We rely heavily on the proper functioning of our technology.
We rely heavily on communications and information systems to conduct our
business. Any failure, interruption or breach in security of these systems
could result in failures or disruptions in our customer relationship
management, general ledger, deposit, loan and other systems. While we have
policies and procedures designed to prevent or limit the effect of the
failure, interruption or security breach of our information systems, there can
be no assurance that any such failures, interruptions or security breaches
will not occur or, if they do occur, that they will be adequately addressed.
The occurrence of any failures, interruptions or security breaches of our
information systems could damage our reputation, result in a loss of customer
business, subject us to additional regulatory scrutiny, or expose us to civil
litigation and possible financial liability, any of which could have a
material adverse effect on our financial condition and results of operations.
We rely on third-party service providers for much of our communications,
information, operating and financial control systems technology. If any of our
third-party service providers experience financial, operational or
technological difficulties, or if there is any other disruption in our
relationships with them, we may be required to locate alternative sources of
such services, and we cannot assure that we could negotiate terms that are as
favorable to us, or could obtain services with similar functionality, as found
in our existing systems, without the need to expend substantial resources, if
at all. Any of these circumstances could have an adverse effect on our
business.
Changes in accounting standards may affect our performance.
Our accounting policies and methods are fundamental to how we record and
report our financial condition and results of operations. From time to time
there are changes in the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be
difficult to predict and can materially impact how we report and record our
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in a
retrospective adjustment to prior financial statements.
We are dependent on key personnel and the loss of one or more of those key
personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry
is intense and there are a limited number of qualified persons with knowledge
of, and experience in, the community banking industry where the Bank conducts
its business. The process of recruiting personnel with the combination of
skills and attributes required to carry out our strategies is often lengthy.
Our success depends to a significant degree upon our ability to attract and
retain qualified management, loan origination, finance, administrative,
marketing and technical personnel and upon the continued contributions of our
management and personnel. In particular, our success has been and continues to
be highly dependent upon the abilities of key executives, including our
President, and certain other employees. In addition, our success has been and
continues to be highly dependent upon the services of our directors, and we
may not be able to identify and attract suitable candidates to replace such
directors.
53
Item 1B. Unresolved Staff Comments
-----------------------------------
Not applicable.
Item 2. Properties
-------------------
At September 30, 2011 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, 2011
--------------------------- ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $68,544
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 32,973
Aberdeen, Washington 98520
201 Main Street South 2004 3,200 32,894
Montesano, Washington 98563
361 Damon Road 1977 2,100 22,081
Ocean Shores, Washington 98569
2418 Meridian Avenue East 1980 2,400 38,329
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 27,730
Auburn, Washington 98002
12814 Meridian Avenue East
(South Hill) 1996 4,200 32,949
Puyallup, Washington 98373
1201 Marvin Road, N.E. 1997 4,400 20,724
Lacey, Washington 98516
101 Yelm Avenue W. 1999 3,400 18,543
Yelm, Washington 98597
20464 Viking Way NW 1999 1,800 15,686
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,900 27,511
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 28,588
Tumwater, Washington 98512
7805 South Hosmer Street 2001 5,000 26,795
Tacoma, Washington 98408
(Table continued on following page)
54
Approximate Deposits at
Location Year Opened Square Footage September 30, 2011
--------------------------- ----------- -------------- ------------------
(In thousands)
2401 Bucklin Hill Road 2003 4,000 $47,206
Silverdale, Washington 98383
423 Washington Street SE 2003 3,000 17,286
Olympia, Washington 98501
3105 Judson Street 2004 2,700 24,343
Gig Harbor, Washington 98335
117 N. Broadway 2004 3,700 21,112
Aberdeen, Washington 98520
313 West Waldrip Street 2004 5,900 21,474
Elma, Washington 98541
1751 Circle Lane SE 2004 900 15,650
Lacey, Washington 98503
101 2nd Street 2004 1,800 21,284
Toledo, Washington 98591
209 NE 1st Street 2004 3,400 15,865
Winlock, Washington 98586
714 W. Main Street 2009 4,600 15,111
Chehalis, Washington 98532
Loan Center/Data Center:
120 Lincoln Street 2003 6,000 N/A
Hoquiam, Washington 98550
Other Properties:
305 8th Street(1) 2004 4,100 N/A
Hoquiam, Washington 98550
----------
(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 developed into additional office space
for Bank personnel.
Management believes that all facilities are appropriately insured and are
adequately equipped for carrying on the business of the Bank.
At September 30, 2011 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
55
legal proceedings that it believes would have a material adverse effect on the
financial condition or operations of the Bank.
Item 4. [Removed and Reserved]
------------------------------
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, 2011, there were 7,045,036 shares of
common stock issued and approximately 580 shareholders of record. The
following table sets forth the high and low sales prices of, and dividends
paid on, the Company's common stock for each quarter during the years ended
September 30, 2011 and 2010. The high and low price information was provided
by the Nasdaq Stock Market.
Dividends per
High Low Common Share
-------- ------- -----------
Fiscal 2011
-----------
First Quarter.................. $ 4.30 $ 3.28 $ --
Second Quarter................. 5.95 3.62 --
Third Quarter.................. 6.38 4.75 --
Fourth Quarter................. 6.25 3.90 --
Dividends per
High Low Common Share
-------- ------- -----------
Fiscal 2010
-----------
First Quarter.................. $ 4.75 $ 3.95 $ 0.03
Second Quarter................. 4.42 3.59 0.01
Third Quarter.................. 5.28 3.30 --
Fourth Quarter................. 4.25 2.98 --
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, an institution that has
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 the Company under the terms of the Bank
MOU. The Company is also subject to restrictions on its ability to pay
dividends to stockholders under the terms of the Company MOU. 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. As of September 30, 2011, the FRB has denied the
Company's requests to pay dividends on its Series A Preferred Stock issued
under the CPP for the quarterly payments due for the last six quarters
beginning with the payments due on May 15, 2010. For additional information
regarding the Company's and the Bank's restrictions on the payment of
dividends, see "Item 1A, Risk Factors - The Company and the Bank are required
to comply with the terms of separate memoranda of understanding issued by
their respective regulators and lack of compliance could result in additional
regulatory actions," and "- Risks specific to our participation in TARP" and
see "- Regulatory and contractual restrictions may limit or prevent us from
paying dividends on our common stock."
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.
56
Stock Repurchases
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, and pursuant to the terms of the
Company MOU. For additional information, see Item 1A, "Risk Factors - The
Company and the Bank are required to comply with the terms of separate
memoranda of understanding issued by their respective regulators and lack of
compliance could result in additional regulatory actions." and "- Risks
specific to our participation in TARP."
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 million 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, 2006.
[Graph appears here]
Period Ending
----------------------------------------------------------
Index 09-30-06 09-30-07 09-30-08 09-30-09 09-30-10 09-30-11
------------------ -------- -------- -------- -------- -------- --------
Timberland
Bancorp, Inc. $100.00 $ 91.07 $ 45.75 $ 30.20 $ 26.54 $ 26.54
NASDAQ Composite 100.00 120.52 94.10 96.49 108.79 112.05
SNL $250M-$500 M
Thrift Index 100.00 92.40 78.57 73.67 75.20 85.01
SNL $500M-$1 B
Thrift Index 100.00 96.38 72.16 60.41 57.95 60.22
* Source: SNL Financial LC, Charlottesville, VA
57
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
its subsidiary 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,
----------------------------------------------
2011 2010 2009 2008 2007
------- ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets................ $738,224 $742,687 $701,676 $681,883 $644,848
Loans receivable and loans
held for sale, net........ 528,024 527,591 547,208 557,687 515,341
MBS and other investments
held-to-maturity.......... 4,145 5,066 7,087 14,233 71
MBS and other investments
available-for-sale........ 6,717 11,119 13,471 17,098 63,898
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........ 112,065 111,786 66,462 42,874 16,670
Certificates of deposit
held for investment....... 18,659 18,047 3,251 -- --
Deposits.................... 592,678 578,869 505,661 498,572 466,735
FHLB advances............... 55,000 75,000 95,000 104,628 99,697
Federal Reserve Bank
advances.................. -- -- 10,000 -- --
Shareholders' equity........ 86,205 85,408 87,199 74,841 74,547
Year Ended September 30,
----------------------------------------------
2011 2010 2009 2008 2007
------- ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income.................... $ 33,966 $36,596 $38,801 $43,338 $41,944
Interest expense............ 8,533 10,961 13,504 16,413 15,778
-------- ------- ------- ------- -------
Net interest income......... 25,433 25,635 25,297 26,295 26,166
Provision for loan losses... 6,758 10,550 10,734 3,900 686
-------- ------- ------- ------- -------
Net interest income after
provision for loan losses. 18,675 15,085 14,563 23,025 25,480
Non-interest income......... 8,681 5,696 6,949 4,178 5,962
Non-interest expense........ 25,963 24,641 22,739 20,349 19,451
Income (loss) before
income taxes.............. 1,393 (3,860) (1,227) 6,854 11,991
Provision (benefit) for
federal and state income
taxes..................... 304 (1,569) (985) 2,849 3,828
-------- ------- ------- ------- -------
Net income (loss)........... 1,089 (2,291) (242) 4,005 8,163
-------- ------- ------- ------- -------
Preferred stock dividends... (832) (832) (643) -- --
Preferred stock accretion... (225) (210) (129) -- --
-------- ------- ------- ------- -------
Net income (loss) to
common shareholders....... $ 32 $(3,333) $(1,014) $ 4,005 $ 8,163
======== ======= ======= ======= =======
Net income (loss) per
common share (1):
Basic.................... $ -- $ (0.50) $ (0.15) $ 0.62 $ 1.20
Diluted.................. $ -- $ (0.50) $ (0.15) $ 0.61 $ 1.17
Dividends per common
share (1)................. $ -- $ 0.04 $ 0.39 $ 0.43 $ 0.37
Dividend payout ratio (2)... N/A N/A N/A 74.33% 32.86%
------------
(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) to
common shareholders.
58
At September 30,
----------------------------------------------
2011 2010 2009 2008 2007
------- ------ ------ ------ ------
(In thousands)
OTHER DATA:
Number of real estate loans
outstanding............... 2,796 2,919 3,062 3,261 3,295
Deposit accounts............ 56,152 55,598 53,941 53,501 53,166
Full-service offices........ 22 22 22 21 21
At or For the Year Ended September 30,
----------------------------------------------
2011 2010 2009 2008 2007
------- ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return (loss) on average
assets (1).............. 0.15% (0.32)% (0.04)% 0.61% 1.34%
Return (loss) on average
equity (2).............. 1.26 (2.65) (0.28) 5.35 10.67
Interest rate spread (3).. 3.58 3.63 3.64 3.98 4.18
Net interest margin (4)... 3.78 3.87 4.01 4.41 4.69
Average interest-earning
assets to average
interest-bearing
liabilities............. 115.24 114.51 117.42 115.70 118.01
Noninterest expense as a
percent of average
total assets............ 3.54 3.43 3.35 3.10 3.20
Efficiency ratio (5)...... 76.11 78.65 70.52 65.42 60.54
Book value per common
share................... $9.97 $ 9.89 $10.17 $10.74 $10.72
Asset Quality Ratios:
Non-accrual and 90 days
or more past due loans
as a percent of total
loans receivable, net... 4.32% 4.86% 5.36% 2.12% 0.29%
Non-performing assets as
a percent of total
assets (6).............. 5.01 5.53 5.52 1.83 0.23
Allowance for loan losses
as a percent of total
loans receivable,
net (7)................. 2.21 2.09 2.59 1.44 0.92
Allowance for losses as a
percent of non-performing
loans (8)............... 51.18 43.01 47.11 67.14 321.95
Net charge-offs to average
outstanding loans....... 1.13 2.45 0.79 0.12 --
Capital Ratios:
Total equity-to-assets
ratio................... 11.68% 11.50% 12.43% 10.98% 11.56%
Average equity to average
assets.................. 11.81 12.05 12.72 11.47 12.58
------------------
(1) Net income (loss) divided by average total assets.
(2) Net income (loss) 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) Non-interest expenses divided by the sum of net interest income and
non-interest income.
(6) Non-performing assets include non-accrual loans, loans past due 90 days
or more and still accruing, non-accrual investment securities, other real
estate owned and other repossessed assets.
(7) Loans receivable includes loans held for sale and is before the allowance
for loan losses.
(8) Non-performing loans include non-accrual loans and loans past due 90 days
or more and still accruing. Troubled debt restructured loans that are on
accrual status are not included.
59
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
Certain matters discussed on this Annual Report on Form 10-K may contain
forward-looking statements within the meaning of 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 economic performance. These forward-looking statements are
subject to known and unknown risks, uncertainties and other factors that could
cause our 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 non-performing 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
loan loss 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 Board of Governors of the Federal Reserve
System and our bank subsidiary by the Federal Deposit Insurance Corporation,
the Washington State Department of Financial Institutions, Division of Banks
or other regulatory authorities, including the possibility that any such
regulatory authority may, among other things, institute a formal or informal
enforcement action or require us to increase our allowance for loan losses,
write-down assets, change our regulatory capital position or affect our
ability to borrow funds or maintain or increase deposits or impose additional
requirements or restrictions, which could adversely affect our liquidity and
earnings; our compliance with regulatory enforcement actions, including
regulatory memoranda of understandings ("MOUs") to which we are subject;
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; the impact of the Dodd Frank Wall Street
Reform and Consumer Protection Act and the implementation of related rules and
regulations; 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 consolidated 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; our ability to manage loan delinquency
rates; increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits; legislative or
regulatory changes that adversely affect our business including changes in
regulatory policies and principles, the interpretation of regulatory capital
or other rules and any changes in the rules applicable to institutions
participating in the TARP Capital Purchase Program; the
60
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
and preferred stock; 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 methods; the economic impact
of war or any terrorist activities; other economic, competitive, governmental,
regulatory, and technological factors affecting our operations; pricing,
products and services; and other risks described elsewhere in this Form 10-K.
Any of the forward-looking statements that we make in this Form 10-K and
in the other public statements we make 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 fiscal 2012 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
results of operations 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.
While the Company believes it has established its existing allowance for
loan losses in accordance with GAAP, there can be no assurance that
regulators, in reviewing the Company's loan portfolio, will not request the
Company to significantly increase or decrease 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 elsewhere in this document. Although management believes
the level of the allowance as of
61
September 30, 2011 was adequate to absorb probable losses inherent in the loan
portfolio, a decline in local economic conditions, results of examinations by
the Company's or the Bank's regulators or other factors, could result in a
material increase in the allowance for loan losses and may adversely affect
the Company's financial condition and results of operations.
Mortgage Servicing Rights. MSRs 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
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.
OTTI (Other-Than-Temporary Impairment) in the Estimated Fair Value of
Investment Securities. Unrealized investment securities losses on available
for sale and held to maturity securities are evaluated at least quarterly by a
third-party firm 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 less than 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 and liabilities assumed. Goodwill is presumed
to have an indefinite useful life and is analyzed annually for impairment. An
annual test is performed during 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 estimated 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 June 30, 2011, the Company
engaged a third party firm to perform the annual test for goodwill impairment.
The test concluded that recorded goodwill was not impaired. As of September
30, 2011, 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.
62
Other Real Estate Owned and Other Repossessed Assets. Other real estate
owned and other repossessed assets consist of properties or assets acquired
through or in lieu of foreclosure, and are recorded initially at the estimated
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 valued 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."
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.
Since 2008, depressed economic conditions have prevailed in portions of the
United States, including Washington State where we hold substantially all of
our loans and conduct all of our operations. The majority of our loans are
secured by collateral and made to borrowers located in Washington State.
Western Washington, which includes our primary market areas, has experienced
home price declines, increased foreclosures, and has experienced above average
unemployment rates. In response to the financial challenges in our market
areas we have taken actions to manage our capital, reduce our exposure to
speculative construction and land development loans and maintain higher levels
of on balance sheet liquidity. We have continued in this low interest
environment to originate residential fixed rate mortgage loans primarily for
sale in the secondary market. We continue to manage the growth of our
commercial and multi-family real estate loan portfolios in a disciplined
fashion while continuing to dispose of other real estate owned properties and
grow retail deposits.
We believe the resolution of problem financial institutions and
continued bank consolidation in Western Washington will provide opportunities
for the Company to increase market share within the communities it serves. We
are currently pursuing the following strategies:
Improve Asset Quality. We are focused on monitoring existing performing
loans, resolving non-performing assets and selling foreclosed assets. We have
sought to reduce the level of non-performing assets through collections,
write-downs, modifications and sales of other real estate owned properties. We
have taken proactive steps to resolve our non-performing loans, including
negotiating payment plans, forbearances, loan modifications and loan
extensions and accepting short payoffs on delinquent loans when such actions
have been deemed appropriate.
Expand our presence within our existing market areas by capturing
opportunities resulting from changes in the competitive environment. We
currently conduct our business primarily in Western Washington. We have a
community bank strategy that emphasizes responsive and personalized service to
our customers. As a result of FDIC bank resolutions and anticipated
consolidation of banks in our market areas, we believe there is an opportunity
for a community and customer focused bank to expand its customer base. By
offering timely decision making, delivering appropriate banking products and
services, and providing customer access to our senior managers we believe
community banks, such as Timberland Bank, can distinguish themselves from
larger banks operating in our market areas. We believe we have a significant
opportunity to attract additional borrowers and depositors and expand our
market presence and market share within our extensive branch footprint.
Continue generating revenues through mortgage banking operations. The
substantial majority of the fixed rate residential mortgage loans we originate
are sold into the secondary market with servicing retained. This strategy
produces gains on the sale of such loans and reduces the interest rate and
credit risk associated with fixed rate residential lending. We will continue
to originate custom construction and owner builder loans for sale into the
secondary market upon the completion of construction.
63
Portfolio Diversification. In recent years, we have strictly limited the
origination of speculative construction, land development and land loans in
favor of loans that possess credit profiles representing less risk to the
Bank. We will continue originating owner/builder and custom construction
loans, multi-family loans, commercial business loans and certain commercial
real estate loans which offer higher risk adjusted returns, shorter maturities
and more sensitivity to interest rate fluctuations. We anticipate capturing
more of each customer's banking relationship by cross selling our loan and
deposit products and additional services to our customers.
Increase Core Deposits and other Retail Deposit Products. We focus on
establishing a total banking relationship with our customers with the intent
of internally funding our loan portfolio. We anticipate that the continued
focus on customer relationships will help increase our level of core deposits
and locally-based retail certificates of deposit. In addition to our retail
branches we maintain technology based products such as business cash
management and a business remote deposit product that enables us to compete
effectively with banks of all sizes.
Limit Exposure to Increasing Interest Rates. For many years the majority
of the loans the Bank has retained in its portfolio have generally possessed
periodic interest rate adjustment features or have been relatively short term
in nature. Loans originated for portfolio retention have included ARM loans,
short term construction loans, and to a lesser extent commercial business
loans with interest rates tied to a market index such as the prime rate.
Longer term fixed-rate mortgage loans have generally been originated for sale
into the secondary market.
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 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, 2011, an immediate increase in interest rates of 200
basis points would increase the Bank's projected net interest income by
approximately 7.3%, 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. See "- Quantitative Aspects of Market Risk" below
for
64
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, 2011, adjustable-rate mortgage loans constituted
$300.9 million or 66.1%, 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, commercial business 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, 2011, the consumer, commercial business and
construction and land development portfolios amounted to $44.2 million, $22.5
million and $52.5 million, or 7.9%, 4.0% and 9.4% 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, 2011.
Net Interest Income(1)(2) Current Market Value
Hypothetical ------------------------------ -----------------------------
Interest Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario(3) Value from Base from Base Value from Base from Base
------------- --------- --------- --------- --------- --------- ---------
(Basis Points) (Dollars in thousands)
+400 $27,597 $3,253 13.36% $100,199 $(1,608) (1.58)%
+300 26,892 2,548 10.47 100,406 (1,401) (1.38)
+200 26,126 1,782 7.32 101,291 (516) (0.51)
+100 25,208 864 3.55 101,672 (135) (0.13)
BASE 24,344 -- -- 101,807 -- --
-100 23,680 (664) (2.73) 101,508 (299) (0.29)
-200 22,911 (1,433) (5.89) 109,528 7,721 7.58
-300 22,134 (2,210) (9.08) 122,757 20,950 20.58
-400 21,673 (2,671) (10.97) 138,834 37,027 36.37
-----------
(1) Does not include loan fees.
(2) Includes BOLI income, which is included in non-interest income on the
Consolidated Financial Statements.
(3) No rates in the model are allowed to go below zero.
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 100 basis point decrease in interest rates, the Bank
would be expected to experience a 0.3% decrease in NPV and a 2.7% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 0.5% decrease in NPV and a 7.3% 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
65
interest rate scenario and increases in net interest income in a rising rate
scenario. This structure also generally results in a decrease in NPV when
rates increase and an increase in NPV when rates decrease by 200 basis points
or more.
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, 2011 and September 30, 2010
The Company's total assets decreased by $4.5 million, or 0.6%, to $738.2
million at September 30, 2011 from $742.7 million at September 30, 2010. The
decrease was primarily attributable to a decrease in mortgage-backed
securities and other investments and a decrease in the prepaid FDIC insurance
assessment. These decreases were partially offset by an increase in BOLI.
Net loans receivable increased by $433,000, or 0.1%, to $528.0 million at
September 30, 2011 from $527.6 million at September 30, 2010. While the total
of the loan portfolio was relatively unchanged year over year, the composition
of the portfolio changed as commercial real estate loan balances increased and
construction and land development loan balances and land loan balances
decreased.
Total deposits increased by $13.8 million, or 2.4%, to $592.7 million at
September 30, 2011 from $578.9 million at September 30, 2010, primarily as a
result of increases in savings account balances, non-interest bearing account
balances and money market account balances.
Shareholders' equity increased by $797,000, or 0.9%, to $86.2 million at
September 30, 2011 from $85.4 million at September 30, 2010. The increase was
primarily due to net income for the year ended September 30, 2011, and was
partially offset by accrued preferred stock dividends. The Company remains
well capitalized with a total risk based capital ratio of 16.5% at September
30, 2011.
A more detailed explanation of the changes in significant balance sheet
categories follows:
Cash and Cash Equivalents and Certificates of Deposit Held for
Investment: Cash and cash equivalents and certificates of deposit ("CDs") held
for investment increased by $891,000, or 0.7%, to $130.7 million at September
30, 2011 from $129.8 million at September 30, 2010. The Company continued to
maintain high levels of liquidity primarily for regulatory and asset-liability
management purposes.
Mortgage-backed Securities and Other Investments: MBS and other
investments decreased by $5.3 million, or 32.9%, to $10.9 million at September
30, 2011 from $16.2 million at September 30, 2010. The decrease was primarily
as a result of regular amortization and prepayments on MBS, the sale of $2.3
million in MBS and OTTI charges recorded on private label residential MBS.
The securities on which the OTTI charges were recognized were acquired from
the in-kind redemption of the Company's investment in the AMF family of mutual
funds in June 2008. 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, increased by
$433,000 or 0.1% to $528.0 million at September 30, 2011 from $527.6 million
at September 30, 2010. While the total of the loan portfolio was relatively
unchanged year over year, the composition of the portfolio changed as
commercial real estate loan balances increased by $38.0 million, construction
66
and land development loan balances decreased by $16.8 million, land loan
balances decreased by $13.8 million and one-to four-family loan balances
decreased by $6.3 million. The increase in commercial real estate loan
balances and the decrease in construction loan balances were in part due to a
number of commercial real estate construction projects completing the
construction phase and converting to permanent financing.
Loan originations decreased by 12.3% to $160.2 million for the year ended
September 30, 2011 from $182.5 million for the year ended September 30, 2010,
primarily due to a reduction in the demand for single family home loan
refinances. The Company continued to sell longer-term fixed rate loans for
asset-liability management purposes and to generate non-interest income. The
Company sold $62.5 million in fixed rate one- to four-family mortgage loans
during the year ended September 30, 2011 compared to $68.3 million for the
fiscal year ended September 30, 2010. For additional information on loans,
see "Item 1, Business - Lending Activities - Loan Originations, Purchases and
Sales" 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 totaled $17.4 million at
both September 30, 2011 and September 30, 2010. 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 and other repossessed assets decreased by
$708,000, or 6.1% to $10.8 million at September 30, 2011 from $11.5 million at
September 30, 2010. At September 30, 2011, the balance was comprised of 46
individual properties and four other repossessed assets. The properties
consisted of two condominium projects totaling $3.5 million, 28 land parcels
totaling $3.3 million, 11 single family homes totaling $1.9 million, three
commercial real estate properties totaling $1.2 million and two land
development projects totaling $794,000. The largest OREO property was a
condominium project with a balance of $2.6 million. For additional
information on OREOs, see "Item 1, Business Lending Activities - Other Real
Estate Owned and Other Repossessed Assets" and Note 7 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplementary Data."
Bank Owned Life Insurance: BOLI increased $2.5 million, or 18.8%, to
$15.9 million at September 30, 2011 from $13.4 million at September 30, 2010.
The increase was due to the purchase of $2.0 million in additional BOLI
policies and BOLI net earnings of $517,000.
Goodwill and Core Deposit Intangible: The value of goodwill at $5.7
million at September 30, 2011 remained unchanged from September 30, 2010. The
amortized value of core deposit intangible decreased by $167,000 to $397,000
at September 30, 2011 from $564,000 at September 30, 2010 due to scheduled
amortization. The Company recorded goodwill and core deposit intangible in
connection with an acquisition of seven branches and related deposits in
October 2004. The Company performed its annual review of goodwill during the
quarter ended June 30, 2011 and determined that there was no impairment to
goodwill. For additional information on goodwill and core deposit intangible,
see Note 1 and Note 8 of the Notes to Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplemental Data."
Mortgage Servicing Rights: MSRs increased $179,000, or 9.3%, to $2.1
million at September 30, 2011 from $1.9 million at September 30, 2010,
primarily due to a partial recovery of the MSR valuation allowance established
during the year ended September 30, 2010. The principal amount of loans
serviced for Freddie Mac increased $18.0 million, or 6.4%, to $298.9 million
at September 30, 2011 from $280.9 million at September 30, 2010. The Company
recorded a $405,000 valuation recovery on MSRs during the year ended September
30, 2011. For additional information on MSRs, see Note 5 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
Prepaid FDIC Insurance Assessment: The prepaid FDIC insurance assessment
decreased $1.2 million, or 35.6%, to $2.1 million at September 30, 2011 from
$3.3 million at September 30, 2010 as a portion of the prepaid amount was
expensed.
67
Deposits: Deposits increased by $13.8 million, or 2.4%, to $592.7 million
at September 30, 2011 from $578.9 million at September 30, 2010. The increase
was primarily a result of a $16.2 million increase in savings account
balances, $5.7 million increase in non-interest-bearing account balances, a
$5.3 million increase in money market account balances and a $2.0 million
increase in NOW checking account balances. These increases were partially
offset by a $15.4 million decrease in CD account balances. The increases in
savings account balances and money market account balances and the decrease in
CD accounts were in part due to the low interest rate environment, as some
depositors opted to place maturing CD funds into non-maturity accounts to
retain flexibility if interest rates increased. The Company also experienced
deposit inflows due to a number of customers transferring funds from other
financial institutions during the year ended September 30, 2011. 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: FHLB advances decreased by $20.0 million, or 26.7%, to
$55.0 million at September 30, 2011 from $75.0 million at September 30, 2010
as the Company used a portion of its liquid assets to repay maturing advances.
For additional information on borrowings, see "Item 1, Business - Deposit
Activities and Other Sources of Funds - Borrowings" and Note 10 of the Notes
to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplementary Data."
Shareholders' Equity: Total shareholders' equity increased by $797,000,
or 0.9%, to $86.2 million at September 30, 2011 from $85.4 million at
September 30, 2010. The increase was primarily due to net income of $1.1
million, a $264,000 reduction in unearned shares issued to ESOP equity account
and a $196,000 reduction in the accumulated other comprehensive loss equity
component. These increases to shareholders' equity were partially offset by
the accrual of $832,000 in preferred stock dividends.
The FRB has denied the Company's request to pay cash dividends on its
outstanding Series A Preferred Stock issued under the CPP for quarterly
payments due for the last six quarters commencing with the payment due May 15,
2010. Cash dividends on the Series A Preferred Stock are cumulative and
accrue and compound on each subsequent date. Accordingly, during the deferral
period, the Company will continue to accrue, and reflect in the consolidated
financial statements, the deferred dividends on the outstanding Series A
Preferred Stock. As a result of not receiving permission from the FRB, the
Company has not made these six quarterly payments as of September 30, 2011.
Since the Company has six unpaid quarterly dividend payments on the Series A
Preferred Stock, the Treasury has the right to appoint two directors to the
Company's board of directors until all accrued but unpaid dividends have been
paid.
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, 2011 and
2010
The Company reported net income of $1.09 million for the year ended
September 30, 2011 compared to a net loss of $(2.29 million) for the year
ended September 30, 2010. Net income to common shareholders after adjusting
for preferred stock dividends and preferred stock discount accretion was
$32,000 for the year ended September 30, 2011 compared to net loss to common
shareholders of $(3.33 million) for the year ended September 30, 2010. The
improved earnings were primarily due to decreased provision for loan losses
and increased non-interest income, which were partially offset by increased
non-interest expenses and decreased net interest income. Net income per
diluted common share was $0.00 for the year ended September 30, 2011 compared
to a loss per diluted common share of $(0.50) for the year ended September 30,
2010.
The decrease in the provision for loan losses was primarily a result of a
decrease in the level of net charge-offs, a decrease in non-performing loans
and a decrease in the Company's construction and land development loan
balances.
The increase in non-interest income was primarily a result of a reduction
in net OTTI on MBS and other investments and a net change in the valuation
recovery (allowance) on MSRs. These increases to non-interest income were
partially offset by a decrease in service charges on deposits.
68
The increase in non-interest expense was primarily attributable to
increases in salaries and employee benefits expense, OREO related expenses,
loan foreclosure related expenses and ATM expenses. These increases to
non-interest expense were partially offset by a decrease in FDIC insurance
expense.
The decrease in net interest income was primarily attributable to
interest margin compression as the yield on interest earning assets decreased
at a greater rate than funding costs decreased.
A more detailed explanation of the income statement categories is
presented below.
Net Income (Loss): The Company reported net income of $1.09 million for
the year ended September 30, 2011 compared to a net loss of $(2.29 million)
for the year ended September 30, 2010. Net income to common shareholders
after adjusting for preferred stock dividends and preferred stock discount
accretion was $32,000 for the year ended September 30, 2011 compared to net
loss to common shareholders of $(3.33 million) for the year ended September
30, 2010. Net income per diluted common share was $0.00 for the year ended
September 30, 2011 compared to a loss per diluted common share of $(0.50) for
the year ended September 30, 2010.
The $0.50 increase in net income per diluted common share for the year
ended September 30, 2011 was primarily the result of a $3.79 million ($2.50
million net of income tax - approximately $0.37 per diluted common share)
decrease in provision for loan losses and a $2.99 million ($1.97 million net
of income tax - approximately $0.28 per diluted common share) increase in
non-interest income. These increases to earnings per diluted common share
were partially offset by a $1.32 million ($873,000 net of income tax -
approximately $0.13 per diluted common share) increase in non-interest expense
and a $202,000 ($133,000 net of income tax - approximately $0.02 per diluted
common share) decrease in net interest income.
Net Interest Income: Net interest income decreased by $202,000, or 0.8%,
to $25.43 million for the year ended September 30, 2011 from $25.64 million
for the year ended September 30, 2010. The decrease in net interest income
was primarily attributable to interest margin compression as the yield on
interest earning assets decreased at a greater rate than funding costs
decreased.
Total interest and dividend income decreased by $2.63 million, or 7.2%,
to $33.97 million for the year ended September 30, 2011 from $36.60 million
for the year ended September 30, 2010 as the yield on interest earning assets
decreased to 5.04% from 5.53%. The decrease in the weighted average yield on
interest earning assets was primarily a result of a decrease in overall market
rates, an increase in the level of lower yielding cash equivalents and other
liquid assets and a change in the composition of the loan portfolio as the
level of higher yielding construction and land development loans decreased.
Total interest expense decreased by $2.43 million, or 22.2%, to $8.53
million for the year ended September 30, 2011 from $10.96 million for the year
ended September 30, 2010 as the average rate paid on interest-bearing
liabilities decreased to 1.46% for the year ended September 30, 2011 from
1.90% for the year ended September 30, 2010. The decrease in funding costs
was primarily a result of a decrease in overall market rates and a decrease in
the level of average FHLB advances.
The net interest margin decreased nine basis points to 3.78% for the year
ended September 30, 2010 from 3.87% for the year ended September 30, 2010 as
the yield on interest earning assets decreased at a greater rate than the
funding costs decreased. The margin compression was primarily due to a
decrease in overall market rates and an increased level of average liquid
assets with lower yields.
Provision for Loan Losses: The provision for loan losses decreased by
$3.79 million, or 35.9%, to $6.76 million for the year ended September 30,
2011 from $10.55 million for the year ended September 30, 2010. The decrease
in the provision for loan losses was primarily a result of a decrease in the
level of net charge-offs, a decrease in non-performing loans and a decrease in
the Company's construction and land development loan balances. The Company
had net charge-offs of $6.08 million for the year ended September 30, 2011
compared to net charge-offs of
69
$13.46 million for the year ended September 30, 2010. The net charge-offs to
average outstanding loans ratio was 1.13% for the year ended September 30,
2011 compared to 2.45% for the year ended September 30, 2010.
The Company has established a comprehensive methodology for estimating
the provision for loan losses. On a quarterly basis the Company performs an
analysis that considers pertinent factors underlying the quality of the loan
portfolio. These factors include changes in the amount and composition of the
loan portfolio, historic loss experience for various loan segments, changes in
economic conditions, delinquency rates, a detailed analysis of impaired loans,
and other factors to determine an appropriate level of allowance for loan
losses. Impaired loans are subject to an impairment analysis to determine an
appropriate reserve to be held against each loan. The aggregate principal
impairment amount determined at September 30, 2011 was $2.29 million.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $11.95 million at September 30, 2011 (2.21% of loans
receivable and loans held for sale and 51.2% 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 Company believes it has
established its existing allowance for loan losses in accordance with GAAP,
there can be no assurance that regulators, in reviewing the Company's loan
portfolio, will not request the Company 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 Company'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 $2.99
million, or 52.4%, to $8.68 million for the year ended September 30, 2011 from
$5.70 million for the year ended September 30, 2010. This increase was
primarily a result of a $1.73 million reduction in net OTTI on MBS and other
investments, a $1.30 million net change in the valuation recovery (allowance)
on MSRs and a $292,000 increase in ATM transaction fees. These increases to
non-interest income were partially offset by a $333,000 decrease in service
charges on deposits.
The Company's net OTTI loss on MBS and other investments decreased by
$1.73 million to $447,000 for the year ended September 30, 2011 from $2.18
million for the year ended September 30, 2010. The OTTI charges for both
years were on private label MBS that were acquired from an in-kind redemption
from the AMF family of mutual funds in June 2008. At September 30, 2011, the
Company's remaining private label MBS had been reduced to $3.42 million from
an original acquired balance of $15.30 million. The Company recorded a
$405,000 MSR valuation recovery during the year ended September 30, 2011
compared to an $890,000 valuation allowance recorded during the year ended
September 30, 2010. The partial recovery of the valuation allowance was
primarily due to an increase in the expected life and corresponding estimated
fair value of the MSR portfolio. The increased income from ATM transaction
fees was primarily due to several deposit promotions designed to increase ATM
and debit card usage. The reduction in service charges on deposits was
primarily a result of fewer overdrafts on checking accounts.
Non-interest Expense: Total non-interest expense increased by $1.32
million, or 5.4%, to $25.96 million for the year ended September 30, 2011 from
$24.64 million for the year ended September 30, 2010. The increase was
primarily attributable to a $512,000 increase in salaries and employee
benefits, a $492,000 increase in OREO and other repossessed assets expense, a
$478,000 increase in loan administration and foreclosure related expenses, a
$197,000 increase in deposit operations related expenses and a $104,000
increase in ATM expenses. These increases to non-interest expense were
partially offset by a $498,000 decrease in FDIC insurance expense. The
comparison between periods for FDIC insurance expense was affected by a
non-recurring accrual adjustment in the prior year which increased the expense
by $400,000 for the year ended September 30, 2010.
The increase in salaries and employee benefits expense was partially a
result of a decreased level of loan originations. Under GAAP, the portion of
a loan origination fee that is attributable to the estimated employee costs to
generate the loan is recorded as a reduction to salaries and employee benefit
expense. With the decrease in loan originations, the loan origination fees
that reduced salaries and employee benefit expense decreased by $127,000
during the year ended September 30, 2011 compared to the year ended September
30, 2010. The comparison between periods
70
for salaries and employee benefits was also affected by a change in the Bank's
vacation accrual policy during the prior year which reduced salaries and
employee benefits expense by $340,000 during the year ended September 30,
2010.
The increase in OREO related expenses and loan foreclosure related
expenses were primarily a result of an increase in the number of OREO
properties held and an increase in foreclosure activity. The OREO related
expenses were also increased as a result of valuation write-downs based on
updated appraisals received for several properties.
The Company's efficiency ratio improved to 76.11% for the year ended
September 30, 2011 from 78.65% for the year ended September 30, 2010.
Provision (Benefit) for Federal and State Income Taxes: The Company
recorded a provision for federal and state income taxes of $304,000 for the
year ended September 30, 2011 as income before income taxes was $1.39 million.
This compares to a benefit for federal and state income taxes of $(1.57
million) recorded for the year ended September 30, 2010 as the loss before
income taxes was $(3.86 million). The Company's effective federal and state
income tax (benefit) rate was 21.8% for the year ended September 30, 2011
compared to (40.6%) for the year ended September 30, 2010. The change in the
effective tax (benefit) rate is primarily due to changes in the percentage of
non-taxable income (such as BOLI) and changes to the Company's deferred tax
valuation allowance. In periods with income before income taxes, the
effective tax rate is reduced by non-taxable income items. In periods with a
loss before income taxes, the effective benefit rate is increased by
non-taxable income items and other adjustments that increase the tax benefit.
For additional information on federal income taxes, see Note 13 of the
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplementary Data."
Comparison of Operating Results for the Years Ended September 30, 2010 and
2009
The Company reported a net loss of $(2.29 million) for the year ended
September 30, 2010 compared to a net loss of $(242,000) for the year ended
September 30, 2009. Net loss to common shareholders after adjusting for
preferred stock dividends and preferred stock discount accretion was $(3.33
million) for the year ended September 30, 2010 compared to a net loss to
common shareholders of $(1.01 million) for the year ended September 30, 2009.
The increased loss was primarily due to increased non-interest expenses and
decreased non-interest income, which were partially offset by increased net
interest income, a decreased provision for loan losses and an increased
benefit for federal income taxes. Loss per diluted common share was $(0.50)
for the year ended September 30, 2010, compared to a loss per diluted common
share of $(0.15) for the year ended September 30, 2009.
The increased non-interest expense was primarily attributable to an
increase in FDIC insurance expense, an increase in salaries and employee
benefits expense, an increase in OREO related expenses, an increase in the
Company's general liability insurance expense and increases in premises and
equipment expenses.
The decrease in non-interest income was primarily a result of a decrease
in gain on sale of loans, a decrease in BOLI net earnings and an MSR valuation
allowance. These decreases to non-interest income were partially offset by a
decrease in the OTTI loss on mortgage-backed securities.
A more detailed explanation of the Statement of Operations categories is
presented below.
Net Loss: The net loss for the year ended September 30, 2010 increased
by $2.05 million to $(2.29 million) from $(242,000) for the year ended
September 30, 2009. Net loss to common shareholders after adjusting for
preferred stock dividends and preferred stock discount accretion was $(3.33
million) or $(0.50) per diluted common share for the year ended September 30,
2010, compared to a net loss to common shareholders of $(1.01 million) or
$(0.15) per diluted common share for the year ended September 30, 2009.
The $0.35 increase in loss per diluted common share for the year ended
September 30, 2010 was primarily the result of a $1.90 million ($1.26 million
net of income tax - $0.19 per diluted common share) increase in non-interest
expense, a $1.25 million ($826,000 net of income tax - $0.13 per diluted
common share) decrease in non-interest income
71
and a $270,000 increase in preferred stock dividends and preferred stock
discount accretion which increased the net loss to common shareholders by
approximately $0.04 per diluted common share. Changes to the benefit for
income taxes due to a decrease in the amount of dividend deductions and
adjustments to the Company's deferred tax valuation allowance also increased
the loss per diluted common share by approximately $0.04 per diluted common
share. These increases to the loss per diluted common share were partially
offset by a $338,000 ($223,000 net of income tax - $0.03 per diluted common
share) increase in net interest income and a $184,000 ($121,000 net of income
tax - $0.02 per diluted common share) decrease in the provision for loan
losses.
Net Interest Income: Net interest income increased by $338,000, or 1.3%,
to $25.64 million for the year ended September 30, 2010 from $25.30 million
for the year ended September 30, 2009. The increase in net interest income
was primarily attributable to an increased average level of interest earning
assets which was partially offset by margin compression due to an increased
level of relatively low yielding cash equivalents and other liquid assets.
Total interest and dividend income decreased by $2.21 million, or 5.7%,
to $36.60 million for the year ended September 30, 2010 from $38.80 million
for the year ended September 30, 2009 as the yield on interest earning assets
decreased to 5.53% from 6.15%. The decrease in the weighted average yield on
interest earning assets was primarily a result of an increase in the amount of
lower yielding cash equivalents and other liquid assets and a change in the
composition of the loan portfolio as the level of higher yielding construction
and land development loans decreased.
Total interest expense decreased by $2.54 million to $10.96 million for
the year ended September 30, 2010 from $13.50 million for the year ended
September 30, 2009 as the average rate paid on interest-bearing liabilities
decreased to 1.90% for the year ended September 30, 2010 from 2.51% for the
year ended September 30, 2009. The decrease in funding costs was primarily a
result of a decrease in overall market rates and a decrease in the level of
average FHLB advances.
The net interest margin decreased 14 basis points to 3.87% for the year
ended September 30, 2010 from 4.01% for the year ended September 30, 2009 as
the yield on interest earning assets decreased at a greater rate than the
funding costs decreased. The margin compression was primarily due to an
increased level of liquid assets with lower yields and the reversal of
interest income on loans placed on non-accrual status during the year ended
September 30, 2010. The reversal of interest income on loans placed on
non-accrual status during the year ended September 30, 2010 reduced the net
interest margin by approximately 12 basis points.
Provision for Loan Losses: The provision for loan losses decreased by
$184,000, or 1.7%, to $10.55 million for the year ended September 30, 2010
from $10.73 million for the year ended September 30, 2009. The small decrease
in the provision for loan losses was primarily a result of a decrease in the
level of non-performing loans and a decrease in the Bank's construction and
land development loan balances. The Company had net charge-offs of $13.46
million for the year ended September 30, 2010 compared to net charge-offs of
$4.44 million for the year ended September 30, 2009. The net charge-off total
for the year ended September 30, 2010 included $3.36 million in impairments
that were identified and specifically provisioned for in the previous fiscal
year. The net charge-offs to average outstanding loans ratio was 2.45% for
the year ended September 30, 2010 and 0.79% for the year ended September 30,
2009.
Non-interest Income: Total non-interest income decreased by $1.25
million, or 18.0%, to $5.70 million for the year ended September 30, 2010 from
$6.95 million for the year ended September 30, 2009. This decrease was
primarily a result of a $1.28 million decrease in gain on sale of loans, an
$890,000 valuation allowance on mortgage servicing rights, and a $474,000
decrease in BOLI net earnings. Also impacting the comparison between the
years was $139,000 in non-recurring income recorded during the year ended
September 30, 2009 for property easements sold. These decreases to
non-interest income were partially offset by a $1.37 million decrease in net
OTTI losses recorded and a $358,000 increase in ATM transaction fees.
The decreased income from loan sales was primarily a result of a decrease
in the amount of residential mortgage loans sold in the secondary market for
the year ended September 30, 2010. The sale of one-to four-family mortgage
loans totaled $68.3 million for the year ended September 30, 2010 compared to
$162.6 million for the year ended September 30, 2009. The higher loan sales
during the year ended September 30, 2009 was primarily due to increased
72
refinance activity that was attributable to decreased interest rates for fixed
rate mortgage loans. The $890,000 valuation allowance on the Company's
mortgage servicing rights was primarily the result of lower mortgage interest
rates at September 30, 2010 relative to September 30, 2009. The lower
interest rates reduced the market value of the Company's mortgage servicing
rights by reducing the expected duration of the cash flows associated with the
asset. The higher BOLI income for the year ended September 30, 2009 was
primarily due to a $377,000 gain on a BOLI death claim benefit and a $134,000
non-recurring gain associated with transferring a portion of the BOLI
portfolio to a new insurance company during the year ended September 30, 2009.
The Company's net OTTI loss on mortgage-backed securities decreased by
$1.37 million to $2.18 million for the year ended September 30, 2010 from
$3.55 million for the year ended September 30, 2009. The OTTI charges for
both years were on private label mortgage-backed securities that were acquired
from an in-kind redemption from the AMF family of mutual funds in June 2008.
At September 30, 2010, the Company's remaining private label mortgage-backed
securities had been reduced to $4.95 million from an original acquired balance
of $15.30 million.
Non-interest Expense: Total non-interest expense increased by $1.90
million, or 8.4%, to $24.64 million for the year ended September 30, 2010 from
$22.74 million for the year ended September 30, 2009. The increase was
primarily attributable to an $881,000 increase in FDIC insurance expense, a
$353,000 increase in the Company's general liability insurance expense, a
$265,000 increase in salaries and employee benefit expense, a $239,000
increase in OREO related expenses and a $194,000 increase in premises and
equipment expense.
The increase in FDIC insurance expense was primarily due to increased
assessments rates and a non-recurring accrual adjustment which increased the
expense by $400,000 for the year ended September 30, 2010. The increase in
general liability insurance expense was primarily due to increased insurance
costs for financial institutions in this economic cycle.
The increase in salaries and employee benefit expense was primarily a
result of a decreased level of loan originations. Under GAAP, the portion of
a loan origination fee that is attributable to the estimated employee costs to
generate the loan is recorded as a reduction of salaries and employee benefit
expense. With the decrease in loan originations, the loan origination fees
that reduced salaries and employee benefit expense decreased by $381,000
during the year ended September 30, 2010 compared to the year ended September
30, 2009.
The increase in OREO related expenses was primarily a result of valuation
write-downs based on updated appraisals received for several properties. The
increase in premises and equipment expense for the current fiscal year was
primarily the result of a capital gain on the sale of Company owned property
that reduced premises and equipment expenses by $235,000 for the year ended
September 30, 2009.
The Company's efficiency ratio increased to 78.65% for the year ended
September 30, 2010 from 70.52% for the year ended September 30, 2009.
Benefit for Federal and State Income Taxes: The benefit for federal and
state income taxes increased by $584,000 to $1.57 million for the year ended
September 30, 2010 from $985,000 for the year ended September 30, 2009
primarily as a result of an increased loss before income taxes. The Company's
effective federal and state income tax (benefit) rate was (40.5%) for the year
ended September 30, 2010 compared to (80.0%) for the year ended September 30,
2009. The change in the effective tax (benefit) rate is primarily due to
changes in the percentage of non-taxable income and changes to the Company's
deferred tax valuation allowance. The benefit for federal and state income
taxes for the year ended September 30, 2009 was increased by a higher level of
non-taxable income, primarily due to an increase in BOLI net earnings. The
benefit for income taxes 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. In periods with a loss before income taxes, the effective
benefit rate is increased by non-taxable income items and other adjustments
that increase the tax benefit.
73
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.
74
Year Ended September 30,
--------------------------------------------------------------------------------
2011 2010 2009
-------------------------- ------------------------ -------------------------
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)... $537,740 $32,976 6.13% $555,050 $35,344 6.43% $564,741 $37,249 6.60%
Mortgage-backed
securities and other
investments.............. 11,625 612 5.26 17,513 910 5.20 25,762 1,379 5.35
FHLB stock and equity
securities............... 6,680 31 0.46 6,679 35 0.52 6,655 38 0.57
Federal funds sold........ -- -- -- -- -- -- 9,032 36 0.40
Interest-bearing
deposits................. 117,491 347 0.29 82,455 307 0.37 24,964 99 0.40
-------- ------- -------- ------- -------- -------
Total interest-
earning assets......... 673,536 33,966 5.04 661,697 36,596 5.53 631,154 38,801 6.15
Non-interest-earning
assets.................... 59,792 56,482 47,851
-------- -------- --------
Total assets............ $733,328 $718,179 $679,005
======== ======== ========
Interest-bearing liabilities:
Savings accounts.......... $ 73,696 459 0.62 $ 63,695 454 0.71 $ 55,814 394 0.71
Money market accounts..... 57,996 435 0.75 59,988 677 1.13 61,777 1,036 1.68
NOW accounts.............. 157,095 1,415 0.90 141,240 1,749 1.24 97,879 1,031 1.05
Certificates of deposit... 240,174 3,827 1.59 234,550 4,927 2.10 224,673 7,011 3.12
Short-term borrowings(3).. 511 -- 0.05 923 3 0.33 672 1 0.12
Long-term borrowings (4).. 55,000 2,397 4.35 77,479 3,151 4.07 96,721 4,031 4.17
-------- ------- -------- ------- -------- -------
Total interest bearing
liabilities............ 584,472 8,533 1.46 577,875 10,961 1.90 537,536 13,504 2.51
Non-interest bearing
liabilities............... 62,225 53,734 55,086
-------- -------- --------
Total liabilities....... 646,697 631,609 592,622
Shareholders' equity....... 86,631 86,570 86,383
-------- -------- --------
Total liabilities
and shareholders'
equity................. $733,328 $718,179 $679,005
======== ======== ========
Net interest income........ $25,433 $25,635 $25,297
======= ======= =======
Interest rate spread....... 3.58% 3.63% 3.64%
====== ====== ======
Net interest margin (5).... 3.78% 3.87% 4.01%
====== ====== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities............... 115.24% 114.51% 117.42%
====== ====== ======
--------------
(1) Does not include interest on loans on non-accrual status. Includes loans originated for sale.
Amortized net deferred loan fees, late fees, extension fees and prepayment penalties (2011, $835; 2010,
$829; and 2009, $1,229) included with interest and dividends.
(2) Average balance includes non-accrual 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.
75
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,
2011 Compared to Year 2010 Compared to Year
Ended September 30, 2010 Ended September 30, 2009
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------ ------------------------
Net Net
Rate Volume Change Rate Volume Change
---- ------ -------- ---- ------ ------
(In thousands)
Interest-earning assets:
Loans receivable (1).... $(1,283) $(1,085) $(2,368) $(1,273) $(632) $(1,905)
Mortgage-backed
securities and other
investments............ 11 (309) (298) (38) (431) (469)
FHLB stock and equity
securities............. (4) -- (4) (3) -- (3)
Federal funds sold -- -- -- (36) (36)
Interest-bearing
deposits............... (72) 112 40 (5) 213 208
Total net change in
income on interest-
earning assets......... (1,348) (1,282) (2,630) (1,319) (886) (2,205)
Interest-bearing liabilities:
Savings accounts....... (61) 66 5 3 57 60
NOW accounts........... (515) 180 (335) 204 514 718
Money market accounts.. (220) (21) (241) (330) (29) (359)
Certificate accounts... (1,216) 115 (1,101) (2,408) 324 (2,084)
Short-term borrowings.. (1) (1) (2) 1 -- 1
Long-term borrowings... 212 (966) (754) (94) (785) (879)
------- ------- ------- ------- ----- -------
Total net change in
expense on interest-
bearing liabilities.... (1,801) (627) (2,428) (2,624) 81 (2,543)
------- ------- ------- ------- ----- -------
Net change in net
interest income........ $ 453 $ (655) $ (202) $ 1,305 $(967) $ 338
======= ======= ======= ======= ===== =======
----------
(1) Excludes interest on loans on non-accrual status. 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,
2011, 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 22.20%. At September 30, 2011, the Bank maintained an uncommitted credit
facility with the FHLB that provided for immediately available advances up to
an aggregate amount
76
equal to 30% of total assets, limited by available collateral, under which
$55.0 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, 2011 the Bank had no outstanding balance on this
borrowing line.
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 and collateral for repurchase
agreements.
The Bank's primary investing activity is the origination of mortgage
loans. During the years ended September 30, 2011, 2010 and 2009, the Bank
originated $142.4 million, $154.1 million and $273.6 million of mortgage
loans, respectively. At September 30, 2011, the Bank had loan commitments
totaling $34.2 million and undisbursed loans in process totaling $18.3
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, 2011 totaled $157.2 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, 2011, 2010 and
2009, the Bank sold $62.5 million, $68.3 million and $162.9 million in fixed
rate, one- to four-family mortgage loans, respectively. During the years
ended September 30, 2011, 2010 and 2009, the Bank received $96.7 million,
$150.3 million and $150.7 million in principal repayments, respectively.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2011, 2010 and 2009, deposits increased
by $13.8 million, $73.2 million and $7.1 million, respectively.
Cash and cash equivalents, certificate of deposits held for investment
and mortgage-backed securities and other investments decreased to $141.6
million at September 30, 2011 from $146.0 million at September 30, 2010.
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 Bank MOU. At September 30, 2011, the Bank was
in compliance with all applicable capital requirements, including the higher
Tier 1 leverage capital ratio required by the Bank MOU . For additional
details see Note 18 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."
77
Contractual obligations. The following table presents, as of September
30, 2011, 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, 2011.
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... $ 729 $ -- $ -- $ -- $ 729
Long-term debt obligations ... 10,000 -- -- 45,000 55,000
Operating lease obligations... 211 355 240 -- 806
------- ----- ------ ------- -------
Total contractual
obligations................ $10,940 $ 355 $ 240 $45,000 $56,535
======= ===== ====== ======= =======
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.
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. All internal control
systems, no matter how well designed, have inherent limitations, including the
possibility of human error and the circumvention of overriding controls. Also,
projections of any evaluation of
78
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, 2011.
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Reports of Independent Registered Public Accounting Firms.......... 80
Consolidated Balance Sheets as of September 30, 2011 and 2010...... 82
Consolidated Statements of Operations For the Years Ended
September 30, 2011, 2010, and 2009.............................. 83
Consolidated Statements of Comprehensive Income (Loss) For the
Years Ended September 30, 2011, 2010 and 2009................... 85
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2011, 2010 and 2009................... 86
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2011 2010 and 2009................................ 88
Notes to Consolidated Financial Statements......................... 90
79
Report of Independent Registered Public Accounting Firm
----------------------------------------------------------------------------
To the Board of Directors and
Shareholders of Timberland Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Timberland
Bancorp, Inc. and Subsidiary (collectively, "the Company") as of September 30,
2011 and 2010, and the related consolidated statements of operations,
comprehensive income (loss), shareholders' equity, and cash flows for the
years then ended. The Company's management is responsible for these
consolidated financial statements. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. The
consolidated financial statements of the Company for the year ended September
30, 2009 were audited by other auditors whose report dated December 14, 2009,
expressed an unqualified opinion on those statements.
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
consolidated financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements, 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 2011 and 2010 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, 2011 and 2010, and
the results of their operations and their cash flows for the years then ended
in conformity with accounting principles generally accepted in the United
States of America.
/s/ Delap LLP
Lake Oswego, Oregon
December 12, 2011
80
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Timberland Bancorp, Inc.
We have audited the consolidated statements of operations, shareholders'
equity, cash flows, and comprehensive income of Timberland Bancorp, Inc. and
Subsidiary for the year 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 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 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 our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of the operations and
cash flows of Timberland Bancorp, Inc. and Subsidiary for the year ended
September 30, 2009, in conformity with U.S. generally accepted accounting
principles.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 14, 2009
81
Consolidated Balance Sheets
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010 2011 2010
Assets --------- --------
Cash and cash equivalents:
Cash and due from financial institutions $ 11,455 $ 9,466
Interest-bearing deposits in banks 100,610 102,320
--------- --------
Total cash and cash equivalents 112,065 111,786
--------- --------
Certificates of deposit ("CDs") held for
investment (at cost which approximates fair value) 18,659 18,047
Mortgage-backed securities ("MBS") and other
investments - held to maturity, at amortized cost
(estimated fair value $4,229 and $4,842) 4,145 5,066
MBS and other investments - available for sale 6,717 11,119
Federal Home Loan Bank of Seattle ("FHLB") stock 5,705 5,705
Loans receivable, net of allowance for loan losses
of $11,946 and $11,264 523,980 524,621
Loans held for sale 4,044 2,970
--------- --------
Net loans receivable 528,024 527,591
Premises and equipment, net 17,390 17,383
Other real estate owned ("OREO") and other
repossessed assets 10,811 11,519
Accrued interest receivable 2,411 2,630
Bank owned life insurance ("BOLI") 15,917 13,400
Goodwill 5,650 5,650
Core deposit intangible ("CDI") 397 564
Mortgage servicing rights ("MSRs"), net 2,108 1,929
Prepaid Federal Deposit Insurance Corporation
("FDIC") insurance assessment 2,103 3,268
Other assets 6,122 7,030
--------- --------
Total assets $738,224 $742,687
========= ========
Liabilities and shareholders' equity
Liabilities
Deposits:
Non-interest-bearing demand $ 64,494 $ 58,755
Interest-bearing 528,184 520,114
--------- --------
Total deposits 592,678 578,869
--------- --------
FHLB advances 55,000 75,000
Repurchase agreements 729 622
Other liabilities and accrued expenses 3,612 2,788
--------- --------
Total liabilities 652,019 657,279
--------- --------
Commitments and contingencies (See Note 16) -- --
Shareholders' equity
Preferred stock, $0.01 par value; 1,000,000 shares
authorized; 16,641 shares, Series A, issued and
outstanding; $1,000 per share liquidation value 15,989 15,764
Common stock, $0.01 par value; 50,000,000 shares
authorized; 7,045,036 shares issued and outstanding 10,457 10,377
Unearned shares issued to Employee Stock Ownership
Plan ("ESOP") (1,983) (2,247)
Retained earnings 62,270 62,238
Accumulated other comprehensive loss (528) (724)
--------- --------
Total shareholders' equity 86,205 85,408
--------- --------
Total liabilities and shareholders' equity $738,224 $742,687
========= ========
See notes to consolidated financial statements.
82
Consolidated Statements of Operations
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
2011 2010 2009
-------- ------- -------
Interest and dividend income
Loans receivable $32,976 $35,344 $37,249
MBS and other investments 612 910 1,379
Dividends from mutual funds and FHLB stock 31 35 38
Interest-bearing deposits in banks 347 307 135
-------- ------- -------
Total interest and dividend income 33,966 36,596 38,801
-------- ------- -------
Interest expense
Deposits 6,136 7,807 9,472
FHLB advances - long term 2,397 3,151 4,031
Federal Reserve Bank of San Francisco ("FRB")
borrowings and repurchase agreements -- 3 1
-------- ------- -------
Total interest expense 8,533 10,961 13,504
-------- ------- -------
Net interest income 25,433 25,635 25,297
Provision for loan losses 6,758 10,550 10,734
-------- ------- -------
Net interest income after provision for loan
losses 18,675 15,085 14,563
Non-interest income
Other than temporary impairment ("OTTI")
on MBS and other investments (236) (998) (5,820)
Adjustment for portion recorded as (transferred
from)other comprehensive income (loss) before
taxes (211) (1,178) 2,274
-------- ------- -------
Net OTTI on MBS and other investments (447) (2,176) (3,546)
Realized losses on MBS and other investments (2) (20) (76)
Gain on sales of MBS and other investments 79 -- --
Service charges on deposits 3,907 4,240 4,312
ATM transaction fees 1,911 1,619 1,261
BOLI net earnings 517 491 965
Gain on sale of loans, net 1,548 1,547 2,828
Servicing income on loans sold 9 135 103
Escrow fees 73 74 158
Fee income from non-deposit investment sales 92 84 102
Valuation recovery (allowance) on MSRs, net 405 (890) --
Other 589 592 842
-------- ------- -------
Total non-interest income, net 8,681 5,696 6,949
-------- ------- -------
See notes to consolidated financial statements.
83
Consolidated Statements of Operations (continued)
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
2011 2010 2009
------- ------- -------
Non-interest expense
Salaries and employee benefits $12,578 $12,066 $11,801
Premises and equipment 2,743 2,768 2,574
Advertising 800 829 895
OREO and other repossessed assets, net 1,374 882 643
ATM 802 698 613
Postage and courier 540 539 549
Amortization of CDI 167 191 217
State and local taxes 622 626 604
Professional fees 753 664 745
FDIC insurance 1,161 1,659 778
Other insurance 359 435 82
Loan administration and foreclosure 959 481 374
Data processing and telecommunication 996 941 921
Deposit operations 675 478 515
Other 1,434 1,384 1,428
------- ------- -------
Total non-interest expense 25,963 24,641 22,739
------- ------- -------
Income (loss) before income taxes 1,393 (3,860) (1,227)
Provision (benefit) for federal and state
income taxes 304 (1,569) (985)
------- ------- -------
Net income (loss) 1,089 (2,291) (242)
Preferred stock dividends (832) (832) (643)
Preferred stock discount accretion (225) (210) (129)
------- ------- -------
Net Income (loss) to common shareholders $ 32 $(3,333) $(1,014)
======= ======= =======
Net income (loss) per common share
Basic $ 0.00 $ (0.50) $ (0.15)
Diluted 0.00 (0.50) (0.15)
See notes to consolidated financial statements.
84
Consolidated Statements of Comprehensive Income (Loss)
-----------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
2011 2010 2009
------- -------- -------
Comprehensive income (loss)
Net income (loss) $ 1,089 $ (2,291) $ (242)
Cumulative effect of FASB guidance
regarding recognition of OTTI -- -- (91)
Unrealized holding gain on securities
available for sale, net of tax 14 491 18
Change in OTTI on securities held to
maturity, net of tax:
Additions (65) (23) (1,804)
Additional amount recognized related to
credit loss for which OTTI was
previously recognized 16 580 574
Amount reclassified to credit loss for
previously recorded market loss 188 209 (248)
Accretion of OTTI securities held to maturity,
net of tax 43 31 --
------- -------- -------
Total comprehensive income (loss) $ 1,285 $ (1,003) $(1,793)
======= ======== =======
See notes to consolidated financial statements.
85
Consolidated Statements of Shareholders' Equity
-----------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
Accumu-
lated
Number of Shares Amount Unearned Other
------------------- ----------------- Shares Compre-
Preferred Common Preferred Common Issued to Retained hensive
Stock Stock Stock Stock ESOP Earnings Loss Total
--------- ------ --------- ------ --------- -------- -------- -----
Balance, September 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 compensation
expense -- - -- 3 -- -- -- 3
Cumulative effect of
Financial Accounting
Standards Board ("FASB")
guidance regarding
recognition of OTTI -- - -- -- -- 91 (91) --
Unrealized holding gain on
securities available for
sale, net of tax -- - -- -- -- - 18 18
Change in OTTI on securities
held to maturity, net
of tax -- - -- -- -- - (1,478) (1,478)
Balance, September 30, ------ --------- ------ ------ ------ ------ ------ ------
2009 16,641 7,045,036 15,554 10,315 (2,512) 65,854 (2,012) 87,199
Net loss -- -- -- -- -- (2,291) -- (2,291)
Accretion of preferred
stock discount -- -- 210 -- -- (210) -- --
Cash dividends
($0.04 per common share) -- - -- -- -- (283) -- (283)
(5% preferred stock) -- - -- -- -- (832) -- (832)
Earned ESOP shares -- - -- (78) 265 - -- 187
MRDP compensation expense -- - -- 134 -- -- -- 134
Stock option compensation
expense -- - -- 6 -- - -- 6
Unrealized holding gain on
securities available for
sale, net of tax -- - -- -- -- -- 491 491
Change in OTTI on securities
held to maturity,
net of tax -- - -- -- -- - 766 766
Accretion of OTTI on
securities held to
maturity, net of tax -- - -- -- -- - 31 31
Balance, September 30, ------ --------- ------ ------ ------ ------ ------ ------
2010 16,641 7,045,036 15,764 10,377 (2,247) 62,238 (724) 85,408
(1) 1998 Management Recognition and Development Plan ("MRDP").
See notes to consolidated financial statements.
86
Consolidated Statements of Shareholders' Equity (continued)
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
Accumu-
lated
Number of Shares Amount Unearned Other
------------------- ----------------- Shares Compre-
Preferred Common Preferred Common Issued to Retained hensive
Stock Stock Stock Stock ESOP Earnings Loss Total
--------- ------ --------- ------ --------- -------- -------- -----
Balance, September 30,
2010 16,641 7,045,036 $15,764 $10,377 $(2,247) $62,238 $(724) $85,408
Net income -- -- -- -- -- 1,089 -- 1,089
Accretion of preferred
stock discount -- -- 225 -- -- (225) -- --
5% preferred stock
dividend -- - -- -- -- (832) -- (832)
Earned ESOP shares -- - -- (61) 264 - -- 203
MRDP compensation expense -- - -- 134 -- - -- 134
Stock option compensation
expense -- - -- 7 -- - -- 7
Unrealized holding gain on
securities available for
sale, net of tax -- - -- -- -- - 14 14
Change in OTTI on securities
held to maturity, net of
tax -- - -- -- -- - 139 139
Accretion of OTTI on
securities held to maturity,
net of tax -- - -- -- -- - 43 43
Balance, September 30, ------ --------- ------- ------- ------- -------- ------ -------
2011 16,641 7,045,036 $15,989 $10,457 $(1,983) $ 62,270 $ (528) $86,205
====== ========= ======= ======= ======= ======== ====== =======
See notes to consolidated financial statements.
87
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
2011 2010 2009
------ -------- ---------
Cash flows from operating activities
Net income (loss) $1,089 $ (2,291) $ (242)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation 992 1,141 1,136
Deferred federal income taxes (526) 466 (1,813)
Amortization of CDI 167 191 217
Earned ESOP shares 264 265 264
MRDP compensation expense 171 173 169
Stock option compensation expense 7 6 3
Stock option tax effect -- -- 46
Gain on sale of MBS and other investments (79) -- --
Net OTTI on MBS and other investments 447 2,176 3,546
Realized losses on MBS and other investments 2 20 76
Gain on sale of OREO and other repossessed
assets, net (548) (291) (60)
Gain on sale of loans, net (1,548) (1,547) (2,828)
(Gain) loss on disposition of premises
and equipment, net 16 6 (233)
Provision for loan losses 6,758 10,550 10,734
Provision for OREO losses 1,402 535 306
Loans originated for sale (63,264) (69,123) (158,942)
Proceeds from sale of loans 63,738 68,330 162,913
MSRs valuation allowance 405 890 --
BOLI net earnings (517) (491) (965)
Decrease in deferred loan origination
fees (287) (210) (308)
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses 2,010 (4,752) (2,546)
------ -------- ---------
Net cash provided by operating activities 10,699 6,044 11,473
Cash flows from investing activities
Net increase in CDs held for investment (612) (14,796) (3,251)
Activity in securities held to maturity:
Maturities and prepayments 850 1,222 1,763
Activity in securities/mutual funds
available for sale:
Maturities and prepayments 2,243 3,062 3,451
Proceeds from sales 2,272 -- --
(Increase) decrease in loans receivable,
net (10,157) 3,532 (11,158)
Additions to premises and equipment (1,015) (484) (2,347)
Proceeds from sale of OREO and other
repossessed assets 4,181 4,507 2,317
Purchase of BOLI (2,000) -- --
Proceeds from the disposition of
premises and equipment -- -- 282
------ -------- ---------
Net cash used by investing activities (4,238) (2,957) (8,943)
See notes to consolidated financial statements.
88
Consolidated Statements of Cash Flows (continued)
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2011, 2010 and 2009
2011 2010 2009
--------- -------- --------
Cash flows from financing activities
Net increase in deposits $ 13,809 $ 73,208 $ 7,089
Repayment of FHLB advances - long term (20,000) (20,000) (9,628)
Net increase (decrease) in FRB borrowings -
short term -- (10,000) 10,000
Net increase (decrease) in repurchase agreements 107 (155) 19
Proceeds from exercise of stock options -- -- 346
ESOP tax effect (61) (78) (47)
MRDP compensation tax effect (37) (39) (32)
Issuance of stock warrants -- -- 1,158
Issuance of preferred stock -- -- 15,425
Payment of dividends -- (699) (3,272)
--------- -------- --------
Net cash provided (used) by financing
activities (6,182) 42,237 21,058
--------- -------- --------
Net increase in cash and cash equivalents 279 45,324 23,588
Cash and cash equivalents
Beginning of year 111,786 66,462 42,874
--------- -------- --------
End of year $ 112,065 $111,786 $ 66,462
========= ======== ========
Supplemental disclosures of cash flow information
Income taxes paid $ 2,097 $ 3 $ 1,452
Interest paid 8,725 11,189 13,674
Supplemental disclosures of non-cash investing
and financing activities
Loans transferred to OREO and other repossessed
assets $ 5,782 $ 9,434 $ 10,237
Shares issued to MRDP -- -- 138
Loans originated to facilitate sale of OREO 1,538 1,349 1,021
See notes to consolidated financial statements.
89
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying 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 in consolidation.
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, primarily to provide
residential real estate, construction, commercial real estate, commercial
business and consumer loans to borrowers primarily in western Washington and
to a lesser extent, to invest in mortgage-backed securities and other
investment 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
("GAAP") and prevailing 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 consolidated balance sheet, and the reported amounts of income
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 OTTI in the estimated fair
value of mortgage-backed securities and FHLB stock, the valuation of MSRs, the
valuation of OREO and the determination of goodwill impairment.
Certain prior year amounts have been reclassified to conform to the fiscal
2011 presentation with no change to net income (loss) or shareholders' equity
previously reported.
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)
90
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
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 ("CPP"). The CPP was established as part of the Troubled Asset Relief
Program ("TARP"). The Company sold 16,641 shares of 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 through December 23, 2018.
The preferred stock has a 5.0% dividend for the first five years, after which
the rate increases to 9.0% until the preferred shares are redeemed by the
Company.
Preferred stock 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 (or accrued) and any accretion is
deducted from (added to) net income (loss) for computing net income (loss) to
common shareholders and net income (loss) per share computations.
On February 1, 2010, the FRB determined that the Company required additional
supervisory attention and entered into a Memorandum of Understanding with the
Company (the "Company MOU"). Under the agreement the Company must among other
things obtain prior written approval, or non-objection from the FRB to declare
or pay any dividends (see Note 18). The FRB has denied the Company's requests
to pay dividends on its Series A Preferred Stock issued under the CPP for
quarterly payments due for the last seven quarters commencing with the
payments due May 15, 2010. There can be no assurance that the FRB will
approve such payments or dividends in the future. The Company may not declare
or pay dividends on its common stock or, with certain exceptions, repurchase
common stock without first having paid all cumulative preferred dividends that
are due. Since dividends on the Series A Preferred Stock have not been paid
for six quarters, the Treasury has the right to appoint two members to the
Board of Directors of the Company.
MBS and Other Investments
MBS and other investments 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 using the interest method
over the contractual life of the securities. Gains and losses on sales of
securities are recognized on the trade date and determined using the specific
identification method.
In estimating whether there are any OTTI 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.
(continued)
91
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
MBS and Other Investments (concluded)
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 which 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 which the Company intends to sell the security or more likely than
not will not recover all of its amortized cost, the OTTI is recognized in
earnings equal to the entire difference between the security's cost basis and
its fair value at the balance sheet date. For individual securities for which
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.
FHLB Stock
The Company, as a member of the 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 estimated 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, 2011, the FHLB reported that it had met all of its regulatory
capital requirements, but remained classified as "undercapitalized" by its
regulator, the Federal Housing Finance Agency ("FHFA"). On October 25, 2010,
the FHLB announced that it had entered into a Consent Agreement with the FHFA,
which requires the FHLB to take certain specified actions related to its
business and operations. 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, 2011, 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.
(continued)
92
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
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
the allowance for loan losses.
Troubled Debt Restructured Loans
A troubled debt restructured loan is a loan for 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 and renewals. Troubled
debt restructured loans are considered impaired and are individually evaluated
for impairment.
Impaired Loans
A loan is generally considered impaired when it is probable that the Company
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 discounted
at the loan's original effective interest rate.
The categories of non-accrual loans and impaired loans overlap, although they
are not coextensive. The Company 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 estimated collateral value, reasons for the delays in
payment, payment record, the amount 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 a 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.
Qualitative factors are determined by loan type and adjust historical
(continued)
93
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (concluded)
loss experience to reflect the current environment and portfolio performance
trends including recent charge-off trends. Allowances are provided based on
management's continuing evaluation of the pertinent factors underlying the
quality of the loan portfolio, including changes in the size and composition
of the loan portfolio, actual loan loss experience, current economic
conditions, collateral values, geographic concentrations, seasoning of the
loan portfolio, specific industry conditions, and the duration of the current
business cycle. The appropriateness of the allowance for loan losses on loans
is estimated based upon these factors and trends identified by management at
the time consolidated financial statements are prepared.
In accordance with the 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 impairment. 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 estimated fair value of the collateral, reduced by estimated costs to
sell, is used. The valuation of real estate collateral is subjective in nature
and may be adjusted in future periods because of changes in economic
conditions. Management considers third-party appraisals, as well as
independent fair market value assessments from realtors or persons involved in
selling real estate in determining the estimated fair value of particular
properties. In addition, as certain of these third-party appraisals and
independent fair market value assessments are only updated periodically,
changes in the values of specific properties may have occurred subsequent to
the most recent appraisals. Accordingly, the amounts of any such potential
changes and any related adjustments are generally recorded at the time such
information is received. 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), impairment is recognized by creating
or adjusting an allocation of the allowance for loan losses and 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 operations 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.
The ultimate recovery of all loans is susceptible to future market factors
beyond the Company's control. These factors may result in losses or recoveries
differing significantly from those provided in the consolidated financial
statements. The Company has experienced a significant decline in valuations
for some real estate collateral since October 2008. If real estate values
continue to decline and as updated appraisals are received on collateral for
impaired loans, the Company 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 Company's allowance for loan
losses, and may require the Company to make additions to the allowance based
on their judgment about information available to them at the time of their
examinations.
(continued)
94
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
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.
MSRs
The Bank holds rights to service loans that it has originated and sold to
Federal Home Loan Mortgage Corporation ("Freddie Mac"). MSRs 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 MSRs at the date of the sale of
loans is estimated 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 MSRs based on product type, and term of the underlying loans. The
amount of impairment recognized is the amount, if any, by which the amortized
cost of the rights 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.
BOLI
BOLI policies are recorded at their cash surrender value less applicable cash
surrender charges. Income from BOLI is recognized when earned.
(continued)
95
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
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 during 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.
During the quarter ended June 30, 2011, the Company engaged a third party firm
to perform the annual test for goodwill impairment. The test concluded that
recorded goodwill was not impaired. As of September 30, 2011, management
believes that 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.
CDI
The CDI 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 using
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
discounted recovery amount or estimated fair value of the assets. No events
or changes in circumstances have occurred during the years ended September 30,
2011 or 2010 that would cause management to evaluate the recoverability of the
Company's long-lived assets.
(continued)
96
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
Other Real Estate Owned and Other Repossessed Assets
Other real estate owned and other repossessed assets consist of properties or
assets acquired through or in lieu of foreclosure, and are recorded initially
at the estimated 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. The valuation of real estate collateral is subjective in
nature and may be adjusted in future periods because of changes in economic
conditions. Management considers third-party appraisals, as well as
independent fair market value assessments from realtors or persons involved in
selling real estate in determining the estimated fair value of particular
properties. In addition, as certain of these third-party appraisals and
independent fair market value assessments are only updated periodically,
changes in the values of specific properties may have occurred subsequent to
the most recent appraisals. Accordingly, the amounts of any such potential
changes and any related adjustments are generally recorded at the time such
information is received.
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 the Bank. The
Bank provides for income taxes separately and remits to (receives from) 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 temporary differences will result in
differences between income (loss) for tax purposes and income (loss) 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 (benefit) 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.
With respect to accounting for uncertainty in incomes taxes a tax provision is
recognized as a benefit only if it is "more likely than not" that the tax
position would be sustained in a tax examination, with a tax examination being
presumed to occur. The amount recognized is the largest amount of tax benefit
that is greater than 50% likely to be realized on examination. For tax
positions not meeting the "more likely than not" test, no tax benefit is
recorded. The Company recognizes interest and or/penalties related to income
tax matters as income tax expense.
(continued)
97
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
Income Taxes (concluded)
The Company is no longer subject to United States federal income tax
examination by tax authorities for years ended on or before September 30,
2007.
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 plan on the
consolidated balance sheets. The debt of the ESOP is payable to the Company
and is therefore 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 net income (loss) per common share calculations. Dividends
paid on unallocated shares reduce the Company's cash contributions to the
ESOP.
Cash and Cash Equivalents and Cash Flows
The Company considers amounts included in the consolidated balance sheets'
captions "Cash and due from financial institutions," and "Interest-bearing
deposits in banks," all of which mature within ninety days, to be cash
equivalents for purpose of reporting cash flows. Cash flows from loans,
deposits, FRB borrowings and repurchase agreements are reported net.
Interest-bearing deposits in banks as of September 30, 2011 and 2010 included
deposits with the Federal Reserve Bank of San Francisco of $93,465,000 and
$88,805,000, respectively. The Company also maintains balances in
correspondent bank accounts which, at times, may exceed FDIC insurance limits
of $250,000. Management believes that its risk of loss associated with such
balances is minimal due to the financial strength of the correspondent banks.
Advertising
Costs for advertising and marketing are expensed as incurred.
Stock-Based Compensation
The Company measures compensation cost for all stock-based awards based on the
grant-date fair value and recognizes compensation cost over the service period
of stock-based awards.
The fair value of stock options is determined using the Black-Scholes
valuation model. 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.
(continued)
98
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
Net Income (Loss) Per Common Share
Basic net income (loss) per common share is computed by dividing net income
(loss) available for common stock by the weighted average number of common
shares outstanding during the period, without considering any dilutive items.
Diluted net income per common share is computed by dividing net income
available for common stock 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. Diluted loss per common share
is the same as basic loss per common share for the years ended September 30,
2010 and 2009 due to the anti-dilutive effect of common stock equivalents.
Common stock equivalents arise from assumed conversion of outstanding stock
options and outstanding warrants to purchase common stock. Shares owned by
the Bank's ESOP that have not been allocated are not considered to be
outstanding for the purpose of computing net income (loss) per common share.
Related Party Transactions
The Chairman of the Board of 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, 2011, 2010 and 2009 totaled $176,000,
$133,000 and $125,000, respectively.
Recent Accounting Pronouncements
In July 2010, the FASB issued updated guidance on disclosure requirements for
the credit quality of financing receivables and the allowance for loan losses.
The new guidance requires entities to provide disclosures designed to
facilitate financial statement users' evaluation of (i) the nature of credit
risk inherent in the entity's portfolio of financing receivables, (ii) how
that risk is analyzed and assessed in arriving at the allowance for credit
losses and (iii) the changes and reasons for those changes in the allowance
for loan losses. Disclosures must be disaggregated by portfolio segment, the
level at which an entity develops and documents a systematic method for
determining its allowance for loan losses, and class of financing receivable,
which is generally a disaggregation of portfolio segment. The required
disclosures include, among other things, a roll forward of the allowance for
loan losses as well as information about modified, impaired, non-accrual and
past due loans and credit quality indicators. This guidance became effective
for the Company's consolidated financial statements as of December 31, 2010
and for the year ended September 30, 2011.
(continued)
99
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (continued)
In December 2010, the FASB issued updated guidance on goodwill and other
intangibles regarding when to perform step two of the goodwill impairment test
for reporting units with zero or negative carrying amounts. This guidance
became effective for the Company on October 1, 2011. The Company does not
expect it to have a material impact on its consolidated financial statements.
In September 2011, the FASB issued guidance regarding testing goodwill for
impairment. The new guidance allows an entity the option to make a
qualitative evaluation about the likelihood of goodwill impairment to
determine whether it should calculate the fair value of the reporting unit.
The guidance is effective for annual and interim goodwill impairment tests
performed for fiscal years beginning after December 15, 2011, with early
adoption permitted. The Company does not expect the adoption of this guidance
to have a material impact on its consolidated financial statements.
In April 2011, the FASB issued updated guidance on receivables and the
determination of whether a loan modification is a troubled debt restructuring.
The new guidance clarifies which loan modifications constitute troubled debt
restructurings and is intended to assist creditors in determining whether a
modification of the terms of a receivable meets the criteria to be considered
a troubled debt restructuring, both for purposes of recording an impairment
loss and for disclosure of troubled debt restructurings. In evaluating
whether a restructuring constitutes a troubled debt restructuring, a creditor
must separately conclude under the guidance that both of the following exist:
(a) the restructuring constitutes a concession; and (b) the debtor is
experiencing financial difficulties. This guidance became effective for the
Company as of July 1, 2011, and applies retrospectively to restructurings
occurring on or after October 1, 2010. The adoption of this guidance did not
have a material impact on the Company's consolidated financial statements.
In April 2011, the FASB issued guidance regarding Transfer and Servicing for
the Reconsideration of Effective Control for Repurchase Agreements. The
guidance removes from the assessment of effective control the criterion
requiring the transferor to have the ability to repurchase or redeem the
financial assets on substantially the agreed terms, even in the event of
default by the transferee, and the collateral maintenance implementation
guidance related to that criterion. Other criteria applicable to the
assessment of effective control are not changed by the amendments. The
guidance is effective for the first interim or annual period beginning on or
after December 15, 2011. The guidance should be applied prospectively to
transactions or modifications of existing transactions that occur on or after
the effective date. Early adoption is not permitted.
The Company does not expect the adoption of this guidance to have a material
impact on its consolidated financial statements.
In May 2011, the FASB issued amended guidance regarding the application of
existing fair value measurement guidance. The provisions of the amended
guidance clarify the application of existing fair value measurement guidance
and revise certain measurement and disclosure requirements to achieve
convergence of GAAP and International Financial Reporting Standards. The
provisions of this amended guidance are effective for the Company's first
reporting period beginning January 1, 2012, with early adoption not permitted.
The Company is in the process of evaluating the impact of adoption of this
guidance and does not expect it to have a material impact on its consolidated
financial statements.
(continued)
100
Notes to Consolidated Financial Statements
----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 1 - Summary of Significant Accounting Policies (concluded)
Recent Accounting Pronouncements (concluded)
In June 2011, the FASB issued amended guidance on the presentation of
comprehensive income (loss). The new guidance eliminates the current option
to present the components of other comprehensive income (loss) in the
statement of changes in equity and requires the presentation of net income
(loss) and other comprehensive income (loss) (and their respective components)
either in a single continuous statement or in two separate but consecutive
statements. The amendments do not alter any current recognition or
measurement requirements with respect to the items of other comprehensive
income (loss). The provisions of this guidance are effective for the
Company's first reporting period beginning on January 1, 2012, with early
adoption permitted. The Company does not expect it to have a material impact
on its 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 amounts of the
reserve requirement balances as of September 30, 2011 and 2010 were
approximately $933,000 and $781,000, respectively.
101
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 3 - Mortgage-Backed Securities and Other Investments
Mortgage-backed securities and other investments were as follows as of
September 30 (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
2011
----
Held to Maturity
Mortgage-backed
securities:
U.S. government
agencies $ 1,831 $ 45 $ (4) $ 1,872
Private label
residential 2,287 311 (271) 2,327
U.S. agency
securities 27 3 -- 30
-------- ------ ------ --------
Total $ 4,145 $ 359 $ (275) $ 4,229
======== ====== ====== ========
Available for Sale
Mortgage-backed
securities:
U.S. government
agencies $ 4,395 $ 188 $ -- $ 4,583
Private label
residential 1,227 59 (152) 1,134
Mutual Funds 1,000 -- -- 1,000
-------- ------ ------ --------
Total $ 6,622 $ 247 $ (152) $ 6,717
======== ====== ====== ========
2010
----
Held to Maturity
Mortgage-backed
securities:
U.S. government
agencies $ 2,107 $ 29 $ (5) $ 2,131
Private label
residential 2,931 161 (411) 2,681
U.S. agency
securities 28 2 -- 30
-------- ------ ------ --------
Total $ 5,066 $ 192 $ (416) $ 4,842
======== ====== ====== ========
Available for Sale
Mortgage-backed
securities:
U.S. government
agencies $ 7,846 $ 262 $ -- $ 8,108
Private label
residential 2,198 73 (248) 2,023
Mutual Funds 1,000 -- (12) 988
-------- ------ ------ --------
Total $ 11,044 $ 335 $ (260) $ 11,119
======== ====== ====== ========
(continued)
102
Notes to Consolidated Financial Statements
----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 3 - Mortgage-Backed Securities and Other Investments (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, 2011 (in thousands):
Less Than 12 Months 12 Months or Longer Total
---------------------- ---------------------- ----------------------
Estimated Estimated Estimated
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
--------- ---------- --------- ---------- --------- ----------
Held to Maturity
Mortgage-backed securities:
U.S. government agencies $ 109 $ (1) $ 357 $ (3) $ 466 $ (4)
Private label residential -- -- 819 (271) 819 (271)
----- ----- --------- ------ --------- -------
Total $ 109 $ (1) $ 1,176 $ (274) $ 1,285 $ (275)
===== ===== ========= ====== ========= =======
Available for Sale
Mortgage-backed securities:
Private label residential $ -- $ -- $ 760 $ (152) $ 760 $ (152)
----- ----- --------- ------ --------- -------
Total $ -- $ -- $ 760 $ (152) $ 760 $ (152)
===== ===== ========= ====== ========= =======
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.
Furthermore, as of September 30, 2011, management does not have the intent to
sell any of the securities classified as available for sale where the
estimated fair value is below the recorded value and believes that it is more
likely than not that the Company will not have to sell such securities before
a recovery of cost (or recorded value if previously written down).
During the year ended September 30, 2011, the Company recorded net OTTI
charges through earnings on residential mortgage-backed securities of
$447,000. For the year ended September 30, 2010, the Company recorded net
OTTI charges through earnings on residential mortgage-backed securities of
$2,176,000. Effective January 1, 2009, the Company adopted new accounting
guidance in accordance with GAAP, 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).
(continued)
103
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 3 - Mortgage-Backed Securities and Other Investments (continued)
To determine the component of the gross OTTI related to credit losses, the
Company compared the amortized cost basis of the OTTI security to the present
value of its revised expected cash flows, discounted using its pre-impairment
yield. The revised expected cash flow estimates for individual securities are
based primarily on an analysis of default rates, prepayment speeds and
third-party analytic reports. Significant judgment of management is required
in this analysis that includes, but is not limited to, assumption regarding
the collectability of principal and interest, net of related expenses, on the
underlying loans.
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, 2011 and 2010:
Range
--------------------- Weighted
Minimum Maximum Average
--------- -------- --------
At September 30, 2011
Constant prepayment rate 6.00% 15.00% 10.71%
Collateral default rate 0.43% 24.23% 8.03%
Loss severity rate 11.93% 64.54% 39.22%
At September 30, 2010
Constant prepayment rate 6.00% 15.00% 8.28%
Collateral default rate 3.69% 68.09% 34.75%
Loss severity rate 30.02% 60.43% 45.35%
The following table presents the OTTI losses for the years ended September 30,
2011 and 2010 (in thousands).
2011 2010
------------------- --------------------
Held to Available Held to Available
Maturity For Sale Maturity For Sale
-------- --------- -------- ---------
Total OTTI losses $ 210 $ 26 $ 895 $ 103
Portion of OTTI losses recognized in
other comprehensive loss (before
taxes)(1) 211 -- 1,178 --
-------- --------- -------- ---------
Net impairment losses recognized in
earnings (2) $ 421 $ 26 $ 2,073 $ 103
======== ========= ======== =========
----------------------------------
(1) Represents OTTI losses related to all other factors.
(2) Represents OTTI losses related to credit losses.
(continued)
104
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 3 - Mortgage-Backed Securities and Other Investments (continued)
The following table presents a roll forward of the credit loss component of
held to maturity and available for sale debt securities that have been written
down for OTTI with the credit loss component recognized in earnings for the
years ended September 30, 2011 and 2010 (in thousands).
2011 2010
-------- ---------
Balance, beginning of year $ 4,725 $ 3,551
Additions:
Credit losses for which OTTI was
not previously recognized 53 400
Additional increases to the amount
related to credit loss for which OTTI
was previously recognized 398 1,818
Subtractions:
Realized losses recorded previously
as credit losses (1,811) (1,044)
Recovery of prior credit loss (4) --
-------- ---------
Balance, end of year $ 3,361 $ 4,725
======== =========
During the year ended September 30, 2011 there were realized gains on two
available for sale securities in the amount of $79,000. There were no gross
realized gains on sales of securities for the years ended September 30, 2010
and 2009. During the year ended September 30, 2011, the Company recorded a
$1,813,000 realized loss (as a result of securities being deemed worthless) on
twenty-eight held to maturity and one available for sale residential
mortgage-backed securities of which $1,811,000 had been recognized previously
as a credit loss. During the year ended September 30, 2010, the Company
recorded a $1,064,000 realized loss (as a result of securities being deemed
worthless) on eighteen held to maturity residential mortgage-backed securities
of which $1,044,000 had been recognized previously as a credit loss. During
the year ended September 30, 2009, the Company recorded a $109,000 realized
loss on three held to maturity residential mortgage-backed securities of which
$33,000 had been recognized previously as a credit loss.
The recorded amount of residential 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 $7,883,000 and $12,800,000 at September 30, 2011
and 2010, respectively.
(continued)
105
Notes to Consolidated Financial Statements
----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 3 - Mortgage-Backed Securities and Other Investments (concluded)
The contractual maturities of debt securities at September 30, 2011, are as
follows (in thousands). Expected maturities may differ from scheduled
maturities due to the prepayment of principal or call provisions.
Held to Maturity Available for Sale
---------------- ------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
---- ----- ---- -----
Due within one year $ -- $ -- $ 1 $ 1
Due after one year to five
years 23 24 -- --
Due after five to ten years 38 40 110 117
Due after ten years 4,084 4,165 5,511 5,599
------- ------ ------- -------
Total $ 4,145 $ 4,229 $ 5,622 $ 5,717
======= ======= ======= =======
106
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses
Loans receivable and loans held for sale by portfolio segment consisted of the
following at September 30 (in thousands):
2011 2010
--------- ---------
Mortgage loans:
One- to four-family $ 110,636 $ 118,044
Multi-family 30,982 32,267
Commercial 246,037 208,002
Construction - custom and owner / builder 26,205 30,945
Construction - speculative one- to four-family 1,919 4,777
Construction - commercial 12,863 23,528
Construction - multi-family 9,322 3,587
Construction - land development 2,175 6,434
Land 49,236 62,999
--------- ---------
Total mortgage loans 489,375 490,583
Consumer loans:
Home equity and second mortgage 36,008 38,418
Other 8,240 9,086
--------- ---------
Total consumer loans 44,248 47,504
Commercial business loans 22,510 17,979
--------- ---------
Total loans receivable 556,133 556,066
Less:
Undisbursed portion of construction loans in process 18,265 17,952
Deferred loan origination fees 1,942 2,229
Allowance for loan losses 11,946 11,264
--------- ---------
32,153 31,445
--------- ---------
Loans receivable, net 523,980 524,621
Loans held for sale (one- to four-family) 4,044 2,970
--------- ---------
Total loans receivable and loans held for sale, net $ 528,024 $ 527,591
========= =========
Certain related parties of the Bank, principally Bank directors and officers,
are loan customers of the Bank in the ordinary course of business. These
loans were performing according to their terms at September 30, 2011 and 2010.
Activity in related party loans during the years ended September 30 was as
follows (in thousands):
2011 2010
------ ------
Balance, beginning of year $2,746 $1,781
New loans 17 1,044
Repayments (265) (79)
------ ------
Balance, end of year $2,498 $2,746
====== ======
(continued)
107
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
Loan Segment Risk Characteristics
---------------------------------
The Company believes that its loan classes are the same as its loan segments.
One- To Four-Family Residential Lending: The Company originates both fixed
rate and adjustable rate loans secured by one- to four-family residences. A
portion of the fixed-rate one- to four-family loans are sold in the secondary
market for asset/liability management purposes and to generate non-interest
income. The Company's lending policies generally limit the maximum
loan-to-value on one- to four-family loans to 90% of the lesser of the
appraised value or the purchase price. However, the Company usually obtains
private mortgage insurance on the portion of the principal amount that exceeds
80% of the appraised value of the property.
Multi-Family Lending: The Company originates loans secured by multi-family
dwelling units (more than four units). Multi-family lending generally affords
the Company 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
the 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 economy.
The Company attempts 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.
Commercial Mortgage Lending: The Company originates commercial real estate
loans secured by properties such as office buildings, retail/wholesale
facilities, motels, restaurants, mini-storage facilities and other commercial
properties. Commercial real estate lending generally affords the Company an
opportunity to receive interest at higher rates than those 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 economy. The Company attempts to mitigate these
risks by generally limiting the maximum loan-to-value ratio to 80% and
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan.
Construction Lending: The Company currently originates the following types of
construction loans: custom construction loans, owner/builder construction
loans, speculative construction loans (on a very limited basis), commercial
real estate construction loans, and multi-family construction loans. The
Company is not currently originating new land development loans.
Construction lending affords the Company 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 one-to four
family residential 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 estimated cost of construction
proves to be inaccurate, the Company may be required to advance funds beyond
the amount originally committed to complete the project. If the estimate of
value upon completion proves to be inaccurate, the Company 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 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 Company
attempts to mitigate these risks by adhering to strict underwriting policies,
disbursement procedures, and monitoring practices.
(continued) 108
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
Construction Lending - Custom and Owner/Builder: 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.
Owner/builder construction loans are originated to home owners rather than
home builders and are typically refinanced into permanent loans at the
completion of construction.
Construction Lending - Speculative One- To Four-Family: Speculative one-to
four-family construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of the loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with the Bank or another lender for the finished home.
The home buyer may be identified either during or after the construction
period. The Company is currently originating speculative one-to four-family
construction loans on a very limited basis.
Construction Lending - Commercial: Commercial construction loans are
originated to construct properties such as office buildings, hotels, retail
rental space and mini-storage facilities.
Construction Lending - Multi-Family: Multi-family construction loans are
originated to construct apartment buildings and condominium projects.
Construction Lending - Land Development: The Company historically originated
loans to real estate developers for the purpose of developing residential
subdivisions. The Company is not currently originating any new land
development loans.
Land Lending: The Company has historically originated 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. Currently, the
Company is not offering land loans to new customers and is attempting to
decrease its land loan portfolio. 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 or
foreclosure, the Company may be confronted with a property value which is
insufficient to assure full repayment. The Company attempts to minimize this
risk by generally limiting the maximum loan-to-value ratio on land loans to
75%.
Consumer Lending - Home Equity and Second Mortgages: The Company originates
home equity lines of credit and second mortgage loans. Home equity lines of
credit and second mortgage loans have a 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 Company. The Company attempts to mitigate these risks by
adhering to its underwriting policies in evaluating the collateral and the
credit worthiness of the borrower.
(continued)
109
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
Consumer Lending - Other: The Company originates other consumer loans, which
include automobile loans, boat loans, motorcycle loans, recreational vehicle
loans, savings account loans and unsecured loans. Other consumer loans
generally have shorter terms to maturity than mortgage loans. Other consumer
loans generally 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 Company attempts
to mitigate these risks by adhering to its underwriting policies in evaluating
the credit worthiness of the borrower.
Commercial Business Lending: The Company originates commercial business loans
which are generally secured by business equipment, accounts receivable,
inventory or other property. The Company also generally obtains personal
guarantees from the principals based on a review of personal financial
statements. Commercial business lending generally 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. Accordingly, the repayment
of a commercial business loan depends primarily on the creditworthiness of the
borrower (and any guarantors), while the liquidation of collateral is a
secondary and potentially insufficient source of repayment. The Company
attempts to mitigate these risks by adhering to its underwriting policies in
evaluating the management of the business and the credit worthiness of the
borrowers and the guarantors.
Allowance for Loan Losses
-------------------------
The following table sets forth information for the year ended September 30,
2011 regarding activity in the allowance for loan losses by portfolio segment
(in thousands):
For the Year Ended September 30, 2011
-------------------------------------
Beginning Ending
Allowance Provision Charge-offs Recoveries Allowance
--------- --------- ----------- ---------- ---------
Mortgage loans:
One-to four-family $ 530 $ 622 $ 543 $ 151 $ 760
Multi-family 393 642 - - 41 1,076
Commercial 3,173 804 47 105 4,035
Construction - custom
and owner / builder 481 (211) 48 - - 222
Construction -
speculative one- to
four-family 414 (142) 103 - - 169
Construction -
commercial 245 1,993 1,444 - - 794
Construction -
multi-family 245 1,328 1,219 - - 354
Construction -
land
development 240 993 1,158 4 79
Land 3,709 744 1,704 46 2,795
Consumer loans:
Home equity and
second mortgage 922 354 150 42 460
Other 451 (8) 30 2 415
Commercial business
loans 462 347 22 1 787
------- ------ ------ ------ -------
Total $11,264 $6,758 $6,468 $ 392 $11,946
======= ====== ====== ====== =======
(continued)
110
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
A summary analysis of activity in the allowance for loan losses for the years
ended September 30 is as follows (in thousands):
2010 2009
-------- --------
Balance, beginning of year $ 14,172 $ 8,050
Provision for loan losses 10,550 10,734
Allocated to commitments - - (169)
Loans charged off (13,820) (4,531)
Recoveries 362 88
-------- --------
Net charge-offs (13,458) (4,443)
-------- --------
Balance, end of year $ 11,264 $ 14,172
======== ========
The following table presents information on the loans evaluated individually
and collectively for impairment in the allowance for loan losses by portfolio
segment at September 30, 2011 (in thousands):
Allowance for Loan Losses Recorded Investment in Loans
----------------------------------- ------------------------------------
Individually Collectively Individually Collectively
Evaluated for Evaluated for Evaluated for Evaluated for
Impairment Impairment Total Impairment Impairment Total
---------- ---------- ------- ---------- ---------- -------
Mortgage loans:
One- to four-family $ 45 $ 715 $ 760 $ 3,701 $110,979 $114,680
Multi-family 632 444 1,076 5,482 25,500 30,982
Commercial 255 3,780 4,035 19,322 226,715 246,037
Construction - custom
and owner / builder 11 211 222 320 16,777 17,097
Construction - speculative
one- to four-family 37 132 169 700 906 1,606
Construction - commercial 738 56 794 5,435 2,479 7,914
Construction - multi-family -- 354 354 632 4,867 5,499
Construction - land
development -- 79 79 1,882 221 2,103
Land 560 2,235 2,795 9,997 39,239 49,236
Consumer loans:
Home equity and second
mortgage 10 450 460 1,014 34,994 36,008
Other 1 414 415 1 8,239 8,240
Commercial business loans -- 787 787 44 22,466 22,510
------ ------ ------- ------- -------- --------
$2,289 $9,657 $11,946 $48,530 $493,382 $541,912
====== ====== ======= ======= ======== ========
(continued)
111
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
The following table presents an age analysis of past due status of loans by
portfolio segment at September 30, 2011 (in thousands):
Past Due 90
Days or More
30-59 Days 60-89 Days Non- and Still Total Total
Past Due Past Due Accrual (1) Accruing Past Due Current Loans
-------- -------- ----------- ---------- -------- ------- ------
Mortgage loans:
One- to four-family $ -- $ 1,822 $ 2,150 $ -- $ 3,972 $110,708 $114,680
Multi-family -- -- -- 1,449 1,449 29,533 30,982
Commercial -- 12,723 6,571 -- 19,294 226,743 246,037
Construction - custom
and owner / builder -- -- 320 -- 320 16,777 17,097
Construction - speculative
one- to four-family -- -- -- -- -- 1,606 1,606
Construction - commercial -- -- 688 -- 688 7,226 7,914
Construction - multi-family -- 752 632 -- 1,384 4,115 5,499
Construction - land
development -- -- 1,882 -- 1,882 221 2,103
Land 1,100 2,558 8,935 29 12,622 36,614 49,236
Consumer loans:
Home equity and second
mortgage 643 441 366 -- 1,450 34,558 36,008
Other 9 7 1 -- 17 8,223 8,240
Commercial business loans -- 14 44 276 334 22,176 22,510
------- ------- ------- ------ -------- -------- --------
Total $ 1,752 $18,317 $21,589 $1,754 $ 43,412 $498,500 $541,912
======= ======= ======= ====== ======== ======== ========
---------------
(1) Includes non-accrual loans past due 90 days or more and manual non-accrual loans.
Credit Quality Indicators
-------------------------
The Company uses credit risk grades which reflect the Company's assessment of
a loan's risk or loss potential. The Company categorizes loans into risk
grade categories based on relevant information about the ability of borrowers
to service their debt such as: current financial information, historical
payment experience, credit documentation, public information and current
economic trends, among other factors such as the estimated fair value of the
collateral. The Company uses the following definitions for credit risk
ratings as part of the on-going monitoring of the credit quality of its loan
portfolio:
Pass: Pass loans are defined as those loans that meet acceptable quality
underwriting standards.
Watch: Watch loans are defined as those loans that still exhibit marginal
acceptable quality, but have some concerns that justify greater attention. If
these concerns are not corrected, a potential for further adverse
categorization exists. These concerns could relate to a specific condition
peculiar to the borrower or its industry segment or the general economic
environment.
Special Mention: Special mention loans are defined as those loans deemed by
management to have some potential weaknesses 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
do not expose the Company to sufficient risk to warrant a substandard
classification.
Substandard: Substandard loans are defined as those loans that are
inadequately protected by the current net worth and paying capacity of the
obligor, or of the collateral pledged. Loans 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.
Loss: Loans in this classification are considered uncollectible and of such
little value that continuance as bankable assets is not warranted. This
classification does not mean that the loan has absolutely no recovery or
salvage value, but rather it is not practical or desirable to defer writing
off this basically worthless loan even though partial recovery may be realized
in the future.
(continued) 112
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
The following table lists the loan credit risk grades by portfolio segment
utilized by the Company that serve as credit quality indicators. The credit
risk loan grades include high and low factors associated with their segments
that are utilized to calculate the aggregate ranges of the allowance for loan
losses at September 30, 2011 (in thousands):
Loan Grades
------------------------------------------------------
Pass Watch Special Mention Substandard Total
----- ------ --------------- ----------- ------
Mortgage loans:
One- to four-family $100,159 $ 6,131 $ 2,450 $ 5,940 $114,680
Multi-family 19,279 199 10,380 1,124 30,982
Commercial 212,898 1,042 6,320 25,777 246,037
Construction -
custom and
owner / builder 16,522 255 -- 320 17,097
Construction -
speculative one-
to four-family 323 -- 700 583 1,606
Construction -
commercial 2,479 -- -- 5,435 7,914
Construction -
multi-family 4,115 -- 752 632 5,499
Construction -
land development 83 -- -- 2,020 2,103
Land 26,825 6,604 5,084 10,723 49,236
Consumer loans:
Home equity and
second mortgage 32,389 901 1,513 1,205 36,008
Other 8,179 50 -- 11 8,240
Commercial business
loans 19,060 20 220 3,210 22,510
-------- ------- ------- ------- --------
Total $442,311 $15,202 $27,419 $56,980 $541,912
======== ======= ======= ======= ========
Impaired Loans
--------------
At September 30, 2011, 2010 and 2009, the Bank had impaired loans totaling
approximately $48,530,000, $42,245,000 and $47,622,000 respectively. Interest
income recognized on impaired loans for the years ended September 30, 2011,
2010 and 2009 was $2,054,000, $1,296,000 and $803,000 respectively. Interest
income recognized on a cash basis on impaired loans for the years ended
September 30, 2011, 2010 and 2009 was $1,299,000, $816,000 and $647,000,
respectively. The average investment in impaired loans for the years ended
September 30, 2011, 2010 and 2009 was $46,630,000, $42,747,000 and
$32,597,000, respectively. The Bank had $25,542,000 in troubled debt
restructured loans included in impaired loans at September 30, 2011. The Bank
had $144,000 in commitments to lend additional funds on these loans. The Bank
had $16,400,000 in troubled debt restructured loans included in impaired loans
at September 30, 2010 and there were commitments to lend an additional
$1,055,000 in funds on these loans. The Bank had $9,492,000 in troubled debt
restructured loans included in impaired loans at September 30, 2009 and there
were commitments to lend an additional $1,433,000 in funds on these loans.
Following is a summary of information related to impaired loans at September
30 (in thousands):
2011 2010
-------- --------
Impaired loans without a valuation
allowance $ 31,863 $ 36,475
Impaired loans with a valuation
allowance 16,667 5,770
-------- --------
Total impaired loans $ 48,530 $ 42,245
======== ========
(continued)
113
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (continued)
The following table is a summary of information related to impaired loans by
portfolio segment as of and for the year ended September 30, 2011 (in
thousands):
For the Year Ended
September 30, 2011 September 30, 2011
------------------------------------------------- -----------------------
Unpaid Principal Cash Basis
Balance (Loan Average Interest Interest
Recorded Balance Plus Related Recorded Income Income
Investment Charge Off) Allowance Investment Recognized Recognized
---------- ----------- --------- ---------- ---------- ----------
With no related allowance
recorded:
Mortgage loans:
One- to four-family $ 2,092 $ 2,387 $ -- $ 2,908 $ 30 $ 22
Multi-family -- 982 -- 681 -- --
Commercial 18,137 19,279 -- 14,623 1,060 573
Construction - custom and
owner / builder 209 209 -- 303 7 1
Construction - speculative
one- to four-family -- -- -- 502 7 7
Construction - multi-family 632 1,135 -- 1,287 4 4
Construction - land development 1,882 7,179 -- 2,920 5 --
Land 8,198 11,533 -- 7,883 69 42
Consumer loans:
Home equity and second mortgage 669 719 -- 430 26 16
Other -- -- -- 13 -- --
Commercial business loans 44 65 -- 44 2 2
------- ------- ------ ------- ------ ------
Subtotal 31,863 43,488 -- 31,594 1,210 667
With an allowance recorded:
Mortgage loans:
One- to four-family 1,609 1,609 45 768 47 38
Multi-family 5,482 5,482 632 4,798 298 222
Commercial 1,185 1,185 255 1,409 50 118
Construction - custom and
owner / builder 111 111 11 45 2 2
Construction - speculative
one- to four-family 700 700 37 1,042 50 37
Construction - commercial 5,435 6,879 738 3,537 273 123
Construction - multi-family -- -- -- 65 -- --
Land 1,799 1,821 560 2,946 114 83
Consumer loans:
Home equity and second mortgage 345 345 10 425 10 9
Other 1 1 1 1 -- --
------- ------- ------ ------- ------ ------
Subtotal 16,667 18,133 2,289 15,036 844 632
Total
Mortgage loans:
One- to four-family 3,701 3,996 45 3,676 77 60
Multi-family 5,482 6,464 632 5,479 298 222
Commercial 19,322 20,464 255 16,032 1,110 691
Construction - custom and
owner / builder 320 320 11 348 9 3
Construction - speculative one-
to four-family 700 700 37 1,544 57 44
Construction - commercial 5,435 6,879 738 3,537 273 123
Construction - multi-family 632 1,135 -- 1,352 4 4
Construction - land development 1,882 7,179 -- 2,920 5 --
Land 9,997 13,354 560 10,829 183 125
Consumer loans:
Home equity and second mortgage 1,014 1,064 10 855 36 25
Other 1 1 1 14 -- --
Commercial business loans 44 65 -- 44 2 2
------- ------- ------ ------- ------ ------
Total $48,530 $61,621 $2,289 $46,630 $2,054 $1,299
======= ======= ====== ======= ====== ======
(continued) 114
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 4 - Loans Receivable and Allowance for Loan Losses (concluded)
The following table sets forth information with respect to the Company's
troubled debt restructurings by portfolio segment during the year ended
September 30, 2011 (dollars in thousands):
Pre-Modification Post-Modification
Outstanding Outstanding
Number of Recorded Recorded
Contracts Investment Investment
--------- ---------- ----------
One-to four family 5 $ 1,619 $ 1,619
Multi-family 4 6,534 5,482
Commercial 8 5,903 6,226
Construction -
speculative one-to four-
family 1 700 700
Construction - commercial 2 6,800 5,451
Construction - land
development 4 5,433 5,433
Land 12 7,263 7,051
Home Equity 3 654 654
--- ------- -------
Total 39 $34,906 $32,616
=== ======= =======
The balance of troubled debt restructured loans by portfolio segment modified
during the year ended September 30, 2011 that subsequently defaulted were as
follows (dollars in thousands):
Number of Recorded
Contracts Investment
--------- ----------
Commercial 1 $ 919
Land 1 147
----- ------
Total 2 $1,066
===== ======
115
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 5 - Mortgage Servicing Rights
Loans serviced for Freddie Mac are not included in the accompanying
consolidated balance sheets. The principal amounts of those loans at
September 30, 2011, 2010 and 2009 were $298,924,000, $280,852,000 and
$251,837,000, respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (in thousands):
2011 2010 2009
------ ------ ------
Balance, beginning of year $1,929 $2,618 $1,306
Additions 455 805 1,785
Amortization (681) (604) (473)
Valuation allowance (434) (890) (169)
Recovery of valuation allowance 839 - - 169
------ ------ ------
Balance, end of year $2,108 $1,929 $2,618
====== ====== ======
At September 30, 2011, 2010 and 2009, the fair value of mortgage servicing
rights totaled $2,108,000, $1,929,000 and $2,650,000, respectively. The fair
values for 2011, 2010, and 2009 were estimated using discounted cash flow
analyses with discount rates of 10.11%, 10.40% and 10.52%, respectively, and
prepayment speed factors of 324, 350 and 185, respectively. At September 30,
2011 and 2010, there were mortgage servicing rights valuation allowances of
$485,000 and $890,000, respectively. There was no valuation allowance at
September 30, 2009.
116
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (in
thousands):
2011 2010
------- -------
Land $ 4,291 $ 4,291
Buildings and improvements 16,517 16,054
Furniture and equipment 6,700 6,758
Property held for future expansion 110 110
Construction and purchases in progress 170 95
------- -------
27,788 27,308
Less accumulated depreciation 10,398 9,925
------- -------
Premises and equipment, net $17,390 $17,383
======= =======
The Bank leases certain premises under operating leases. Rental expense of
leased premises was $232,000, $228,000 and $243,000 for the years ended
September 30, 2011, 2010, and 2009, respectively, which is included in
premises and equipment expense.
Minimum net rental commitments under non-cancellable leases having an original
or remaining term of more than one year for future years ending September 30
are as follows (in thousands):
2012 $ 211
2013 211
2014 144
2015 144
2016 96
-----
Total minimum payments required $ 806
=====
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
117
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 7 - OREO and Other Repossessed Assets
The following table presents the activity related to OREO and other
repossessed assets for the year ended September 30, 2011 (dollars in
thousands):
2011 2010
Amount Number Amount Number
------ ------ ------ ------
Balance, beginning of year $11,519 30 $ 8,185 26
Additions to OREO and other
repossessed assets 5,782 39 9,434 31
Capitalized improvements 83 -- 288 --
Lower of cost or fair value losses (1,402) -- (829) --
Disposition of OREO and other
repossessed assets (5,171) (19) (5,559) (27)
------- --- ------- ---
Balance, end of year $10,811 50 $11,519 30
======= === ======= ===
At September 30, 2011, OREO and other repossessed assets consisted of 46
properties in Washington, with balances ranging from $4,000 to $2,647,000 and
four other repossessed assets totaling $81,000. At September 30, 2010, OREO
consisted of 27 properties in Washington, with balances ranging from $5,000 to
$3,048,000 and three other repossessed assets totaling $67,000. The Bank
recorded a net gain on sale of OREO and other repossessed assets for the years
ended September 30, 2011, 2010 and 2009 of $548,000, $291,000 and $60,000,
respectively, which is netted against OREO and other repossessed assets
expense in the accompanying consolidated statements of operations.
Note 8 - Core Deposit Intangibles
During the year ended September 30, 2005, the Company recorded a CDI of
$2,201,000 in connection with the October 2004 acquisition of seven branches
and related deposits. Net unamortized CDI totaled $397,000 and $564,000 at
September 30, 2011 and 2010, respectively. Amortization expense related to
the CDI for the years ended September 30, 2011, 2010 and 2009 was $167,000,
$191,000 and $217,000, respectively.
Amortization expense for the CDI for future years ending September 30 is
estimated to be as follows (in thousands):
2012 $ 147
2013 131
2014 116
2015 3
-----
Total $ 397
=====
118
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 9 - Deposits
Deposits consisted of the following at September 30 (in thousands):
2011 2010
-------- --------
Non-interest-bearing demand $ 64,494 $ 58,755
NOW checking 155,299 153,304
Savings 83,636 67,448
Money market accounts 61,028 55,723
Certificates of deposit 228,221 243,639
-------- --------
Total deposits $592,678 $578,869
======== ========
Certificates of deposit of $100,000 or greater totaled $86,322,000 and
$93,006,000 at September 30, 2011 and 2010, respectively. The Bank did not
have any brokered deposits at September 30, 2011 or 2010.
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (in thousands):
2012 $157,161
2013 39,793
2014 8,779
2015 9,453
2016 12,409
Thereafter 626
--------
Total $228,221
========
Interest expense by account type is as follows for the years ended September
30 (in thousands):
2011 2010 2009
------- ------- --------
NOW checking $ 1,415 $ 1,749 $ 1,031
Savings 459 454 394
Money market accounts 435 677 1,036
Certificates of deposit 3,827 4,921 6,387
Certificates of deposit - brokered -- 6 624
------- ------- --------
Total $ 6,136 $ 7,807 $ 9,472
======= ======= ========
119
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 10 - FHLB Advances and FRB Borrowings
The Bank has long- and short-term borrowing lines with the FHLB 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. The Bank had $55,000,000 and $75,000,000 of
long-term FHLB advances outstanding at September 30, 2011 and 2010,
respectively.
The long-term borrowings at September 30, 2011 mature at various dates through
September 2017 and bear interest at rates ranging from 3.49% to 4.34%. 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):
2012 $ 10,000
2013 --
2014 --
2015 --
2016 --
Thereafter 45,000
--------
$ 55,000
========
A portion of the long-term advances have a putable feature and may be called
by the FHLB earlier than the scheduled maturities.
The Bank also maintains a short-term borrowing line with the FRB with total
credit based on eligible collateral. At September 30, 2011 the Bank had a
borrowing capacity on this line of $58,669,000 with no balance outstanding.
The Bank had no outstanding balance on this line at September 30, 2010.
Information concerning total short-term borrowings as of and for the years
ended September 30 is summarized as follows (dollars in thousands):
2011 2010 2009
------- ------- -------
Average daily balance during the period $ -- $ 384 $ 48
Average daily interest rate during the period --% 0.66% 0.69%
Maximum month-end balance during the period $ -- $10,000 $10,000
Weighted average interest rate at end of the
period -- -- 0.50%
120
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 11 - Repurchase Agreements
Repurchase agreements at September 30, 2011 and 2010 consisted of overnight
repurchase agreements with customers totaling $729,000 and $622,000,
respectively.
Information concerning repurchase agreements as of and for the years ended
September 30 is summarized as follows (dollars in thousands):
2011 2010
------ ------
Average daily balance during the period $ 511 $ 539
Average daily interest rate during the period 0.05% 0.05%
..
Maximum month-end balance during the period $ 729 $ 750
Weighted average rate at end of the period 0.05% 0.05%
Securities underlying the agreements at end
of the period:
Recorded value $ 673 $ 690
Estimated fair value 688 695
The securities underlying the agreements at September 30, 2011 and 2010 were
under the Company's control in safekeeping at third-party financial
institutions.
Note 12 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses were comprised of the following at
September 30 (in thousands):
2011 2010
------ ------
Accrued deferred compensation and profit sharing
plans payable $ 184 $ 81
Accrued preferred stock dividends payable 1,248 416
Accrued interest payable on deposits, advances,
borrowings and repurchase agreements 545 737
Accounts payable and accrued expenses - other 1,635 1,554
------- -------
Total other liabilities and accrued expenses $ 3,612 $ 2,788
======= =======
121
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
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):
2011 2010 2009
------- ------ ------
Current $ 830 $(2,030) $ 831
Deferred (526) 466 (1,813)
------ ------- -------
Provision (benefit) $ 304 $(1,564) $ (982)
====== ======= =======
At September 30, 2011 and 2010, the Company recorded income taxes receivable
of $1,071,000 and $2,564,000, respectively, which are included in other assets
in the accompanying consolidated balance sheets.
The components of the Company's deferred tax assets and liabilities at
September 30 were as follows (in thousands):
2011 2010
------ ------
Deferred Tax Assets
Accrued interest on loans $ 215 $ 479
Unearned ESOP shares 355 439
Allowance for loan losses 4,362 3,977
Allowance for OREO losses 590 153
CDI 264 257
Unearned MRDP shares 98 60
Net unrealized securities losses 225 341
Capital loss carry-forward 677 680
OTTI credit impairment 185 111
Other 163 159
------- -------
Total deferred tax assets 7,134 6,656
(continued)
122
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 13 - Federal Income Taxes (concluded)
2011 2010
------ ------
Deferred Tax Liabilities
FHLB stock dividends $ 880 $ 880
Depreciation 228 319
Goodwill 896 768
Mortgage servicing rights 717 656
Prepaid expenses 167 195
Other 15 17
------ ------
Total deferred tax liabilities 2,903 2,835
Valuation allowance for capital loss on sale of
securities (421) (421)
------ ------
Net deferred tax assets $3,810 $3,400
====== ======
The Company has a capital loss carry forward in the amount of $1,992,000 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):
2011 2010 2009
------ ------ ------
Expected tax provision (benefit) at statutory
rate $ 474 $(1,312) $ (429)
BOLI income (175) (167) (337)
Dividends on ESOP -- (12) (121)
Other - net 5 (73) (95)
----- ------- ------
Provision (benefit) for federal income taxes $ 304 $(1,564) $ (982)
===== ======= ======
123
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
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 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 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. There were no dividends used to
service debt for the year ended September 30, 2011. Dividends of $35,000 and
$331,000 were used to service the debt during the years ended September 30,
2010 and 2009, respectively. As of September 30, 2011, 208,032 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 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 $291,000, $315,000, and $337,000 for the
years ended September 30, 2011, 2010 and 2009, respectively. The balance of
the loan at September 30, 2011 was $3,240,000.
Shares held by the ESOP as of September 30 were classified as follows:
2011 2010 2009
------ ------ ------
Unallocated shares 264,500 299,786 335,052
Shares released for allocation 585,468 565,523 550,755
------- ------- -------
Total ESOP shares 849,968 865,309 885,807
======= ======= =======
The approximate fair market value of the Bank's unallocated shares at
September 30, 2011, 2010 and 2009, was $1,069,000, $1,211,000 and $1,555,000,
respectively. Compensation expense recognized under the ESOP for the years
ended September 30, 2011 and 2010 was $172,000 and $109,000, respectively. A
compensation benefit of $138,000 was recognized for the year ended September
30, 2009.
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 according to the plan document. Bank contributions totaled
$290,000, $294,000 and $475,000 for the years ended September 30, 2011, 2010
and 2009, respectively.
124
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 15 - Stock Compensation Plans
Stock Option Plans
------------------
Under the Company's stock option plans (1999 Stock Option Plan and 2003 Stock
Option Plan), the Company was able to 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. Generally, options vest in 20% annual
installments on each of the five anniversaries from the date of the grant. At
September 30, 2011, options for 250,238 shares were available for future grant
under the 2003 Stock Option Plan and no shares were available for future grant
under the 1999 Stock Option Plan.
Stock option activity for the years ended September 30 is summarized as
follows:
Number of Weighted Average
Shares Exercise Price
--------- ----------------
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
Options granted 26,000 4.55
-------
Outstanding September 30, 2010 194,864 8.71
Options forfeited (57,138) 7.42
-------
Outstanding September 30, 2011 137,726 $9.25
=======
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 in effect at the time the options
were granted. The expected volatility is based on historical volatility of
the Company's stock price. There were no options granted during the years
ended September 30, 2011 and 2009. There were 26,000 options granted during
the year ended September 30, 2010 with an aggregate grant date fair value of
$34,000. The weighted average assumptions for options granted during the year
ended September 30, 2010 were as follows:
Expected volatility 38%
Expected term (in years) 5
Expected dividend yield 2.64%
Risk free interest rate 2.47%
Grant date fair value per share $1.29
(continued)
125
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 15 - Stock Compensation Plans (continued)
There were 5,200 shares that vested during the year ended September 30, 2011
with a total fair value of $7,000. There were no shares that vested during the
year ended September 30, 2010. The total fair value of shares that vested
during the year ended September 30, 2009 was $13,000.
At September 30, 2011 there were 20,400 unvested options with an aggregate
grant date fair value of $26,000, all of which the Company assumes will vest.
There was no aggregate intrinsic value of unvested options at September 30,
2011, as the exercise price was greater than the stock's current market value.
At September 30, 2010 there were 26,000 unvested options with an aggregate
grant date fair value of $34,000.
Proceeds and related tax benefits realized from options exercised and the
intrinsic value of options exercised for the years ended September 30 were as
follows (in thousands):
2011 2010 2009
------ ------ ------
Proceeds from options exercised $ -- $ -- $ 346
Related tax benefit recognized -- -- 46
Intrinsic value of options exercised -- -- 56
Additional information regarding options outstanding at September 30, 2011, is
as follows:
Options Outstanding Options Exercisable
------------------------------- ------------------------------
Weighted Weighted
Weighted Average Weighted Average
Range of Average Remaining Average Remaining
Exercise Exercise Contractual Exercise Contractual
Prices Number Price Life (Years) Number Price Life (Years)
-------- ------ -------- ------------ ------ -------- -----------
$ 4.55 25,500 $ 4.55 8.1 5,100 $ 4.55 8.1
7.85 -
7.98 6,000 7.91 0.6 6,000 7.91 0.6
9.52 56,680 9.52 1.4 56,680 9.52 1.4
11.46 -
11.63 49,546 11.51 2.3 49,546 11.51 2.3
------- -------
137,726 $ 9.25 2.9 117,326 $10.06 2.0
======= =======
There was no aggregate intrinsic value of options outstanding at September 30,
2011, 2010 and 2009, as the exercise price of all options outstanding was
greater than the stock's current market value.
Stock Grant Plan
----------------
The Company adopted the MRDP in 1998 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.
(continued)
126
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 15 - Stock Compensation Plans (continued)
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, 2011, 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:
2011 2010 2009
------ ------ ------
Shares granted -- -- 19,758
Weighted average grant date fair value $ -- -- $ 7.01
Shares vested 13,435 13,431 9,479
Aggregate vesting date fair value $61,000 $56,000 $46,000
A summary of unvested MRDP shares as of September 30, 2011 and changes during
the year ended September 30, 2011, were as follows:
Weighted Average
Grant Date
Shares Fair Value
------- ----------
Unvested shares, beginning of period 36,427 $ 11.27
Shares vested (13,435) 12.74
Shares forfeited (500) 10.09
------
Unvested shares, end of period 22,492 $ 10.42
======
At September 30, 2011, there were 22,492 unvested MRDP shares with an
aggregate grant date fair value of $234,000.
Expense for Stock Compensation Plans
------------------------------------
Compensation expense recorded in the consolidated financial statements for all
stock-based plans was as follows for the years ended September 30, (in
thousands):
2011 2010 2009
------ ------ ------
Stock options $ 7 $ 6 $ 3
MRDP stock grants 171 134 137
Less: related tax benefit recognized (37) (49) (49)
----- ----- -----
$ 141 $ 91 $ 91
===== ===== =====
(continued)
127
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 15 - Stock Compensation Plans (concluded)
The compensation expense to be recognized in the future for stock-based awards
that have been awarded but not vested for the years ending September 30, is as
follows (in thousands):
Stock
Stock Grants Total
Options (MRDP) Awards
------- ------ ------
2012 $ 7 $ 112 $ 119
2013 7 38 45
2014 6 2 8
2015 1 - - 1
------- ------ ------
$ 21 $ 152 $ 173
======= ====== ======
Note 16 - 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 in 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):
2011 2010
------- -------
Undisbursed portion of construction loans
in process (see Note 4) $18,265 $17,952
Undisbursed lines of credit 18,560 26,030
Commitments to extend credit 15,683 8,357
(continued)
128
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 16 - Commitments and Contingencies (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. However, such loan
to value ratios will subsequently change, based on increases and decreases in
the supporting collateral values. Collateral held varies, but may include
accounts receivable, inventory, property and equipment, residential real
estate, land, and income-producing commercial properties.
The Company maintains a separate reserve for losses related to unfunded loan
commitments. Management estimates the amount of probable losses related to
unfunded loan commitments by applying the loss factors used in the allowance
for loan loss methodology to an estimate of the expected amount of funding and
applies this adjusted factor to the unused portion of unfunded loan
commitments. The reserve for unfunded loan commitments totaled $223,000 and
$158,000 at September 30, 2011 and 2010, respectively. These amounts are
included in other liabilities and accrued expenses in the accompanying
consolidated balance sheet. Increases (decreases) in the reserve for unfunded
loan commitments are recorded in non-interest expense in the accompanying
consolidated statement of operations.
The Bank has an employee severance compensation plan which expires in 2017,
and which provides 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 CPP) 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 his or her 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 consolidated financial
position of the Company.
Note 17 - 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, 2011, the Bank had
$529,427,000 (including $18,265,000 of undisbursed construction loan proceeds)
in loans secured by real estate, which represents 94.5% 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, 2011,
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 originates real estate loans with loan-to-value ratios of no greater
than 90%. Collateral and/or guarantees are required for all loans. The
Company also had $18,659,000 in CDs held for investment at September 30, 2011.
The CDs are held with FDIC insured institutions, and each CD is below the FDIC
insurance limit of $250,000.
129
Notes to Consolidated Financial Statements
-----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 18 - 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.
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 4.0%, (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%.
In December 2009, the FDIC and the Washington State Department of Financial
Institutions, Division of Banks ("Division") determined that the Bank required
supervisory attention and on December 29, 2009 entered into a Memorandum of
Understanding with the Bank (the "Bank MOU"). Under the Bank MOU, the Bank
must among other things, maintain Tier 1 Capital of not less than 10.0% of the
Bank's adjusted total assets and maintain capital ratios above the "well
capitalized" thresholds as defined under FDIC Rules and Regulations; obtain
the prior consent from the FDIC and the Division prior to the Bank declaring a
dividend to its holding company; and not engage in any transactions that would
materially change the Bank's balance sheet composition, including growth in
total assets of five percent or more or significant changes in funding sources
without the prior non-objection of the FDIC.
In addition, on February 1, 2010, the FRB determined that the Company required
additional supervisory attention and entered into the Company MOU. Under the
Company MOU, the Company must among other things obtain prior written
approval, or non-objection from the FRB to declare or pay any dividends, or
make any other capital distributions; issue any trust preferred securities; or
purchase or redeem any of its stock (see note 1).
The following table compares the Company's and the Bank's actual capital
amounts at September 30, 2011 and 2010 to its minimum regulatory capital
requirements at that date (dollars in thousands):
(continued)
130
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 18 - Regulatory Matters (concluded)
To be Well
Capitalized
Under Prompt
Capital Adequacy Corrective
Actual Purposes Action Provisions
-------------- ---------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ ------
September 30, 2011
Tier 1 leverage
capital:
Consolidated $81,107 11.1% $29,261 4.0% N/A N/A
Timberland Bank 74,588 10.3 72,662 10.0(1) $72,662 10.0%
Tier 1 risk
adjusted
capital:
Consolidated 81,107 15.2 21,351 4.0 N/A N/A
Timberland Bank 74,588 14.0 31,951 6.0(1) 31,951 6.0
Total risk based
capital:
Consolidated 87,844 16.5 42,702 8.0 N/A N/A
Timberland Bank 81,310 15.3 53,251 10.0(1) 53,251 10.0
September 30, 2010
Tier 1 leverage
capital:
Consolidated $80,243 11.0% $29,279 4.0% N/A N/A
Timberland Bank 72,784 10.0 72,809 10.0(1) $72,809 10.0%
Tier 1 risk
adjusted
capital:
Consolidated 80,243 15.0 21,397 4.0 N/A N/A
Timberland Bank 72,784 13.6 32,036 6.0(1) 32,036 6.0
Total risk based
capital:
Consolidated 86,986 16.3 42,794 8.0 N/A N/A
Timberland Bank 79,515 14.9 53,393 10.0(1) 53,393 10.0
---------------------------------------
(1) Reflects the higher Tier 1 leverage capital ratio that the Bank is
required to comply with under terms of the Bank MOU. Also reflects that the
Bank is required to maintain Tier 1 risk adjusted capital ratio and Total
risk-based capital ratio at or above the "well capitalized" thresholds under
the terms of the Bank MOU.
Restrictions on Retained Earnings
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. At September 30, 2011 management estimates the value
of the liquidation account to be $688,000. 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.
131
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 19 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(in thousands)
2011 2010
Assets -------- --------
Cash and cash equivalents:
Cash and due from financial institutions $ 323 $ 641
Interest-bearing deposits in banks 3,864 3,516
-------- --------
Total cash and cash equivalents 4,187 4,157
Loan receivable from Bank 3,240 3,538
Investment in Bank 79,686 77,949
Other assets 483 327
-------- --------
Total assets $ 87,596 $ 85,971
======== ========
Liabilities and shareholders' equity
Accrued expenses $ 1,391 $ 563
Shareholders' equity 86,205 85,408
-------- --------
Total liabilities and shareholders' equity $ 87,596 $ 85,971
======== ========
Condensed Statements of Operations - Years Ended September 30
(in thousands)
2011 2010 2009
------ ------- -------
Operating income
Interest on deposits in banks $ 1 $ 31 $ 25
Interest on loan receivable from Bank 291 315 338
Dividends from Bank -- -- 416
------ ------- -------
Total operating income 292 346 779
Non-operating income -- -- 37
Operating expenses 541 683 642
------ ------- -------
Income (loss) before income taxes and equity
in undistributed income (loss) of Bank (249) (337) 174
Benefit for income taxes (85) (127) (200)
Income (loss) before equity in undistributed
income (loss) of Bank (164) (210) 374
Equity in undistributed income (loss) of bank
(dividends in excess of income of Bank) 1,253 (2,081) (616)
------ ------- -------
Net income (loss) 1,089 (2,291) (242)
Preferred stock dividends 832 832 643
Preferred stock accretion 225 210 129
------ ------- -------
Net income (loss) to common shareholders $ 32 $(3,333) $(1,014)
====== ======= =======
(continued)
132
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 19 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(in thousands)
2011 2010 2009
------- -------- --------
Cash flows from operating activities
Net income (loss) $ 1,089 $ (2,291) $ (242)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
(Equity in undistributed (income) loss of
Bank) dividends in excess of income
of Bank (1,253) 2,081 616
ESOP shares earned 264 265 264
MRDP compensation expense 171 173 169
Stock option compensation expense 7 6 3
Stock option tax effect -- - 46
Other, net (160) 471 (608)
------- -------- --------
Net cash provided by operating activities 118 705 248
Cash flows from investing activities
Investment in Bank (288) (6,958) (6,308)
Principal repayments on loan receivable
from Bank 298 273 252
------- -------- --------
Net cash provided by (used in) investing
activities 10 (6,685) (6,056)
Cash flows from financing activities
Proceeds from exercise of stock options -- -- 346
Payment of dividends -- (699) (3,272)
ESOP tax effect (61) (78) (47)
MRDP compensation tax effect (37) (39) (32)
Issuance of preferred stock -- -- 15,425
Issuance of stock warrants -- -- 1,158
------- -------- --------
Net cash provided by (used in) financing
activities (98) (816) 13,578
------- -------- --------
Net increase (decrease) in cash 30 (6,796) 7,770
Cash and cash equivalents
Beginning of year 4,157 10,953 3,183
------- -------- --------
End of year $ 4,187 $ 4,157 $ 10,953
======= ======== ========
133
Notes to Consolidated Financial Statements
---------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 20 - Net Income (Loss) Per Common Share
Basic net income (loss) per common share is computed by dividing net income
(loss) available for common stock by the weighted average number of common
shares outstanding during the period, without considering any dilutive items.
Diluted net income per common share is computed by dividing net income
available for common stock 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. Diluted net loss per common
share is the same as basic net loss per common share due to the anti-dilutive
effect of common stock equivalents. Common stock equivalents arise from
assumed conversion of outstanding stock options and outstanding warrants to
purchase common stock. 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 net income
(loss) per common share. Information regarding the calculation of basic and
diluted net income (loss) per common share for the years ended September 30 is
as follows (dollars in thousands, except per share amounts):
2011 2010 2009
--------- --------- ---------
Basic net income (loss) per common share
computation
Numerator - net income (loss) $ 1,089 $(2,291) $ (242)
Preferred stock dividends (832) (832) (643)
Preferred stock discount accretion (225) (210) (129)
------- ------- -------
Net income (loss) to common stockholders $ 32 $(3,333) $(1,014)
Denominator - weighted average common
shares outstanding 6,745,347 6,713,766 6,621,399
Basic net income (loss) per common share $ 0.00 $ (0.50) $ (0.15)
Diluted net income (loss) per common share
computation
Numerator - net income (loss) $ 1,089 $(2,291) $ (242)
Preferred stock dividends (832) (832) (643)
Preferred stock discount accretion (225) (210) (129)
------- ------- -------
Net income (loss) to common stockholders $ 32 $(3,333) $(1,014)
Denominator - weighted average common
shares outstanding 6,745,347 6,713,766 6,621,399
Effect of dilutive stock options 177 -- --
Weighted average common shares
outstanding-assuming dilution 6,745,524 6,713,766 6,621,399
Diluted net income (loss) per common
share $ 0.00 $ (0.50) $ (0.15)
For the years ended September 30, 2011, 2010 and 2009, options to purchase
154,081, 193,083 and 176,899 shares of common stock, respectively, were
outstanding but not included in the computation of diluted net income (loss)
per common share 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.
(continued)
134
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 20 - Net Income (Loss) Per Common Share (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 net loss per common share
computation for the year ended September 30, 2009 because the Company reported
a net loss to common shareholders for that period and, therefore, their effect
would have been anti-dilutive.
For the years ended September 30, 2011, 2010 and 2009, a warrant to purchase a
weighted average of 370,899, 370,899 and 278,174 shares of common stock,
respectively, was outstanding but not included in the computation of diluted
net income (loss) per common share because the warrant's exercise price was
greater than the average market price of the common shares and, therefore, its
effect would have been anti-dilutive.
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 net loss per common share computation for the
year ended September 30, 2009 because the Company reported a net loss to
common shareholders for that period and, therefore, their effect would have
been anti-dilutive.
Note 21 - Fair Value Measurement
GAAP 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. In addition, as the
Company normally intends to hold the majority of its financial instruments
until maturity, it does not expect to realize many of the estimated amounts
disclosed. The disclosures also do not include estimated fair value amounts
for items which are not defined as financial instruments but which may have
significant value. The Company does not believe that it would be practicable
to estimate a representational fair value for these types of items as of
September 30, 2011 and 2010. Because GAAP excludes certain items from fair
value disclosure requirements, any aggregation of the fair value amounts
presented would not represent the underlying value of the Company. Major
assumptions, methods and fair value estimates for the Company's significant
financial instruments are set forth below:
Cash and Due from Financial Institutions and Interest-Bearing
Deposits in Banks
-------------------------------------------------------------
The estimated fair value of financial instruments that are short-term or
re-price frequently and that have little or no risk are considered to have
an estimated fair value equal to the recorded value.
CDs Held for Investment
-----------------------
The estimated fair value of financial instruments that are short-term or
re-price frequently and that have little or no risk are considered to have
an estimated fair value equal to the recorded value.
(continued)
135
Notes to Consolidated Financial Statements
---------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 21 - Fair Value Measurement (continued)
MBS and Other Investments
-------------------------
The estimated fair value of MBS and other investments 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.
FHLB Stock
----------
FHLB stock is not publicly traded; however, the recorded value of the stock
holdings approximates the estimated fair value, as the FHLB is required to
pay par value upon re-acquiring this stock.
Loans Receivable, Net
---------------------
At September 30, 2011 and 2010, because of the illiquid market for loan
sales, loans were priced using comparable market statistics. The loan
portfolio was segregated into various categories and a weighted average
valuation discount that approximated similar loan sales was applied to each
category.
Loans Held for Sale
-------------------
The estimated fair value has been based on quoted market prices obtained
from Freddie Mac.
Accrued Interest
----------------
The recorded amount of accrued interest approximates the estimated fair
value.
Deposits
--------
The estimated fair value of deposits with no stated maturity date is
included at the amount payable on demand. The estimated fair value of
fixed maturity certificates of deposit is computed by discounting future
cash flows using the rates currently offered by the Bank for deposits of
similar remaining maturities.
FHLB Advances
-------------
The estimated fair value of FHLB advances is computed 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.
Repurchase Agreements
---------------------
The recorded value of repurchase agreements approximates the estimated fair
value due to the short-term nature of the borrowings.
Off-Balance-Sheet Instruments
-----------------------------
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 estimated fair value.
(continued)
136
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 21 - Fair Value Measurement (continued)
The estimated fair value of financial instruments at September 30, were as
follows (in thousands):
2011 2010
------------------- -------------------
Estimated Estimated
Recorded Fair Recorded Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets
Cash and due from financial
institutions and interest-
bearing deposits in banks $ 112,065 $112,065 $111,786 $111,786
CDs held for investment 18,659 18,659 18,047 18,047
MBS and other investments 10,862 10,946 16,185 15,961
FHLB stock 5,705 5,705 5,705 5,705
Loans receivable, net 523,980 490,322 524,621 473,986
Loans held for sale 4,044 4,185 2,970 3,059
Accrued interest receivable 2,411 2,411 2,630 2,630
Financial Liabilities
Deposits $ 592,678 $595,331 $578,869 $581,046
FHLB advances - long term 55,000 61,009 75,000 81,579
Repurchase agreements 729 729 622 622
Accrued interest payable 545 545 737 737
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
estimated 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.
(continued)
137
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 21 - Fair Value Measurement (continued)
Accounting guidance regarding fair value measurements defines fair value and
establishes a framework for measuring fair value in accordance with 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:
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 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 estimated fair value on a recurring basis at September 30 and the total
losses resulting from these fair value adjustments for the years ended
September 30 (in thousands):
Fair Value
-----------------------------
Level 1 Level 2 Level 3 Total Losses
------- ------- ------- ------------
2011
----
Available for Sale Securities
Mutual funds $ 1,000 $ -- $ - $ --
MBS -- 5,717 -- 26
------- -------- ------ --------
Total $ 1,000 $ 5,717 $ -- $ 26
======= ======== ====== ========
2010
Available for Sale Securities
Mutual funds $ 988 $ -- $ - $ --
MBS -- 10,131 -- 103
------- -------- ------ --------
Total $ 988 $ 10,131 $ -- $ 103
======= ======== ====== ========
(continued)
138
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 21 - Fair Value Measurement (concluded)
The following table summarizes the balance of assets and liabilities measured
at fair value on a non-recurring basis at September 30 and the total losses
resulting from these fair value adjustments for the years ended September 30
(in thousands):
Fair Value
-----------------------------
Level 1 Level 2 Level 3 Total Losses
------- ------- ------- ------------
2011
----
Impaired loans (1) $ -- $ -- $18,523 $ 6,468
MBS held to maturity (2) -- 211 -- 421
OREO and other repossessed
assets (3) -- -- 10,811 1,305
MSRs (4) -- -- 2,108 (405)
------- ------ ------- -------
Total $ -- $ 211 $31,442 $ 7,789
======= ====== ======= =======
2010
----
Impaired loans (1) $ -- $ -- $ 5,770 $13,820
MBS held to maturity (2) -- 866 -- 2,115
OREO and other repossessed
assets (3) -- -- 11,519 377
MSRs (4) -- -- 1,929 890
------- ------ ------- -------
Total $ -- $ 866 $19,218 $17,202
======= ====== ======= =======
___________________________
(1) The loss represents charge offs on collateral dependent loans for
estimated fair value adjustments based on the estimated 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
estimated fair value of the collateral less estimated costs to sell. The
estimated 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
estimated fair value measurement has been categorized as a Level 3
measurement. (2) The loss represents OTTI credit-related charges on held to
maturity MBS. (3) The Company's OREO and other repossessed assets are
initially recorded at estimated fair value less estimated costs to sell. This
amount becomes the property's new basis. Estimated fair value was generally
determined by management based on a number of factors, including third-party
appraisals of estimated fair value in an orderly sale. Estimated costs to
sell were based on standard market factors. The valuation of OREO and other
repossessed assets is subject to significant external and internal judgment.
Management periodically reviews the recorded value to determine whether the
property continues to be recorded at the lower of its recorded book value or
estimated fair value, net of estimated costs to sell. (4) The fair value of
the MSRs was determined using a third-party model, which incorporates the
expected life of the loans, estimated cost to service the loans, servicing
fees received and other factors. The estimated fair value is calculated by
stratifying the mortgage servicing rights based on the predominant risk
characteristics that include the underlying loan's interest rate, cash flows
of the loan, origination date and term. The amount of impairment recognized
is the amount, if any, by which the amortized cost of the rights exceed their
estimated fair value. Impairment, if deemed temporary, is recognized through
a valuation allowance to the extent that estimated fair value is less than the
recorded amount.
139
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 22 - 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,
2011 2011 2011 2010
------------ ------- -------- -----------
Interest and dividend
income $8,231 $8,431 $8,493 $8,811
Interest expense (1,893) (2,019) (2,141) (2,480)
------ ------ ------ ------
Net interest income 6,338 6,412 6,352 6,331
Provision for loan losses (1,758) (3,400) (700) (900)
Non-interest income 1,861 1,761 2,108 2,951
Non-interest expense (6,627) (6,782) (6,178) (6,376)
------ ------ ------ ------
Income (loss) before income
taxes (186) (2,009) 1,582 2,006
Provision (benefit) for income
taxes (113) (729) 499 647
------ ------ ------ ------
Net income (loss) (73) (1,280) 1,083 1,359
Preferred stock dividends (208) (208) (208) (208)
Preferred stock discount accretion (58) (57) (56) (54)
------ ------ ------ ------
Net income (loss) to common
shareholders $(339) $(1,545) $ 819 $1,097
====== ====== ====== ======
Net Income (loss) per common
share
Basic $(0.05) $ (0.23) $ 0.12 $ 0.16
Diluted (0.05) (0.23) 0.12 0.16
(continued)
140
Notes to Consolidated Financial Statements
-------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2011 and 2010
Note 22 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30, June 30, March 31, December 31,
2010 2010 2010 2009
------------ ------- -------- -----------
Interest and dividend
income $8,996 $9,102 $9,157 $9,341
Interest expense (2,589) (2,711) (2,711) (2,950)
------ ------ ------ ------
Net interest income 6,407 6,391 6,446 6,391
Provision for loan losses (2,005) (750) (5,195) (2,600)
Non-interest income 1,356 1,941 430 1,969
Non-interest expense (6,029) (6,422) (6,692) (5,498)
------ ------ ------ ------
Income (loss) before income
taxes (271) 1,160 (5,011) 262
Provision (benefit) for income
taxes (130) 356 (1,833) 38
------ ------ ------ ------
Net income (loss) (141) 804 (3,178) 224
Preferred stock dividends (208) (208) (208) (208)
Preferred stock discount
accretion (54) (53) (52) (51)
------ ------ ------ ------
Net income (loss) to common
shareholders $(403) $ 543 $(3,438) $ (35)
====== ======= ======= ======
Net Income (loss) per common
share
Basic $(0.06) $0.08 $ (0.51) $(0.01)
Diluted (0.06) 0.08 (0.51) (0.01)
141
Item 9. Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------
None.
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, 2011 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 have 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, 2011, 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 auditor 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 be 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, Executive Officers and Corporate Governance
----------------------------------------------------------------
The information required by this item is contained under the section
captioned "Proposal I - Election of Directors" in the Company's Definitive
Proxy Statement for the 2011 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."
142
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 Matters and Audit Committee Financial Expert
The Company has a separately designated standing Audit Committee,
composed of Directors Robbel, Smith, Goldberg and Stoney. 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 Directors Robbel
and Stoney as the Audit Committee financial experts, as defined in the SEC's
Regulation S-K. Directors Robbel, Smith, Goldberg and Stoney 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, 2011. 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.
Nomination Procedures
There have been no material changes to the procedures by which
stockholder may recommend nominees to the Company's Board of Directors.
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
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.
143
(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,
2011.
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............. 100,094 10.15 --
2003 Stock Option
Plan............. 37,632 6.83 250,238
Equity compensation
plans not approved
by security
holders............ -- -- --
------- -------
Total............ 137,726 250,238
======= =======
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)
144
10.8 Form of Management Recognition and Development Award
Agreement (7)
14 Code of Ethics (9)
21 Subsidiaries of the Registrant
23.1 Consent of Delap LLP
23.2 Consent of McGladrey & Pullen, LLP
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 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, 2011
99.2 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, 2011
101 The following materials from Timberland Bancorp, Inc.'s
Annual Report on Form 10-K for the year ended September 30,
2011, formatted in Extensible Business Reporting Language
(XBRL): (a) Consolidated Balance Sheets; (b) Consolidated
Statements of Operations; (c) Consolidated Statements of
Comprehensive Income (Loss); (d) Consolidated Statements of
Shareholders' Equity; (e) Consolidated Statements of
Cash Flows; and (f) Notes to Consolidated Financial
Statements (10)
------------
(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 April 27, 2010.
(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 Annual Report on Form 10-K
for the year ended September 30, 2003.
(10)Pursuant to Rule 406T of Regulation S-T, these interactive data
files are deemed not filed or part of a registration statement or
prospectus for purposes of Sections 11 or 12 of the Securities Act
of 1933 or Section 18 of the Securities Exchange Act of 1934, as
amended, and otherwise are not subject to liability under those
sections.
145
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 12, 2011 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 December 12, 2011
------------------------ Officer and Director
Michael R. Sand (Principal Executive Officer)
/s/ Jon C. Parker Chairman of the Board December 12, 2011
------------------------
Jon C. Parker
/s/ Dean J. Brydon Chief Financial Officer December 12, 2011
------------------------ (Principal Financial and
Dean J. Brydon Accounting Officer)
/s/ Andrea M. Clinton Director December 12, 2011
------------------------
Andrea M. Clinton
/s/ Larry D. Goldberg Director December 12, 2011
------------------------
Larry D. Goldberg
/s/ James C. Mason Director December 12, 2011
------------------------
James C. Mason
/s/ Ronald A. Robbel Director December 12, 2011
------------------------
Ronald A. Robbel
/s/ David A. Smith Director December 12, 2011
------------------------
David A. Smith
/s/ Michael J. Stoney Director December 12, 2011
------------------------
Michael J. Stoney
146
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ---------------------------------------------
21 Subsidiaries of the Registrant
23.1 Consent of Delap LLP
23.2 Consent of McGladrey & Pullen LLP
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 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, 2011
99.2 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, 2011
101 The following materials from Timberland Bancorp, Inc.'s
Annual Report on Form 10-K for the year ended September
30, 2011, formatted in Extensible Business Reporting
Language (XBRL): (a) Consolidated Balance Sheets; (b)
Consolidated Statements of Operations; (c) Consolidated
Statements of Comprehensive Income (Loss);
(d) Consolidated Statements of Shareholders' Equity; (e)
Consolidated Statements of Cash Flows; and (f) Notes to
Consolidated Financial Statements