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, 2010 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1863696
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
624 Simpson Avenue, Hoquiam, Washington 98550
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
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 (232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files) YES NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
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Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer Accelerated filer
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Non-accelerated filer Smaller reporting company X
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Indicate by check mark whether the Registrant is a shell company (as defined
in Rule 12b-2 of the Act). YES NO X
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As of November 30, 2010, 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,
2010, was $28.2 million (7,045,036 shares at $4.00). 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 2011 Annual Meeting of
Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2010 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I. Page
Item 1. Business
General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Corporate Developments and 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. . . . . . . . . . . . . . . . . . . . 34
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Competition. . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Subsidiary Activities. . . . . . . . . . . . . . . . . . . . . . 38
Personnel. . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Executive Officers of the Registrant . . . . . . . . . . . . . . 38
Item 1A. Risk Factors. . . . . . . . . . . . . . . . . . . . . . . 39
Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . 51
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . 51
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . 53
Item 4. [Removed and Reserved] . . . . . . . . . . . . . . . . . . 53
PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities. . . . . 54
Item 6. Selected Financial Data. . . . . . . . . . . . . . . . . . 56
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . 58
General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
Special Note Regarding Forward-Looking Statements. . . . . . . . 58
Critical Accounting Policies and Estimates . . . . . . . . . . . 59
New Accounting Pronouncements. . . . . . . . . . . . . . . . . . 61
Operating Strategy . . . . . . . . . . . . . . . . . . . . . . . 61
Market Risk and Asset and Liability Management . . . . . . . . . 62
Comparison of Financial Condition at September 30, 2010 and
September 30, 2009. . . . . . . . . . . . . . . . . . . . . . . 64
Comparison of Operating Results for Years Ended September 30,
2010 and 2009 . . . . . . . . . . . . . . . . . . . . . . . . . 66
Comparison of Operating Results for Years Ended September 30,
2009 and 2008 . . . . . . . . . . . . . . . . . . . . . . . . . 69
Average Balances, Interest and Average Yields/Cost . . . . . . . 72
Rate/Volume Analysis . . . . . . . . . . . . . . . . . . . . . . 74
Liquidity and Capital Resources. . . . . . . . . . . . . . . . . 74
Effect of Inflation and Changing Prices. . . . . . . . . . . . . 76
Item 7A. Quantitative and Qualitative Disclosures About Market Risk . 76
Item 8. Financial Statements and Supplementary Data . . . . . . . . . 76
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure. . . . . . . . . . . . . 133
Item 9A. Controls and Procedures. . . . . . . . . . . . . . . . . . . 133
Item 9B. Other Information. . . . . . . . . . . . . . . . . . . . . . 134
i
PART III.
Item 10. Directors, Executive Officers and Corporate Governance. . 134
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . 134
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters. . . . . . . . 134
Item 13. Certain Relationships and Related Transactions, and
Director Independence . . . . . . . . . . . . . . . . . . 135
Item 14. Principal Accounting Fees and Services. . . . . . . . . . 135
PART IV.
Item 15. Exhibits, Financial Statement Schedules. . . . . . . . . . . 135
ii
PART I
Item 1. Business
General
Timberland Bancorp, Inc. ("Company"), a Washington corporation, was
organized on September 8, 1997 for the purpose of becoming the holding company
for Timberland Savings Bank, SSB ("Bank") upon the Bank's conversion from a
Washington-chartered mutual savings bank to a Washington-chartered stock
savings bank ("Conversion"). The Conversion was completed on January 12, 1998
through the sale and issuance of 13,225,000 shares of common stock by the
Company. At September 30, 2010, on a consolidated basis, the Company had
total assets of $742.7 million, total deposits of $578.9 million and total
shareholders' equity of $85.4 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 ("FHLMC") 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 Developments and Overview
Participation in Troubled Asset Relief Program ("TARP") Capital Purchase
Program ("CPP"). On December 19, 2008, as part of the TARP CPP of the United
States Department of the Treasury ("Treasury"), the Company sold to 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 CPP for the payments due May 15, 2010, August 15, 2010 and
November 15, 2010. 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, Thurston, Pierce, King, Kitsap and Lewis
Counties, Washington as its primary market areas. The Bank conducts
operations from:
* its main office in Hoquiam (Grays Harbor County);
* five branch offices in Grays Harbor County (Ocean Shores, Montesano,
Elma, and two branches in Aberdeen);
* a branch office in King County (Auburn);
* five branch offices in Pierce County (Edgewood, Puyallup, Spanaway,
Tacoma, and Gig Harbor);
* five branch offices in Thurston County (Olympia, Yelm, Tumwater, and
two branches in Lacey);
* two branch offices in Kitsap County (Poulsbo and Silverdale); and
* three branch offices in Lewis County (Winlock, Toledo and Chehalis).
See "Item 2. Properties."
Hoquiam, with a population of approximately 9,000, is located in Grays
Harbor County which is situated along Washington State's central Pacific
coast. Hoquiam is located approximately 110 miles southwest of Seattle and
145 miles northwest of Portland, Oregon.
The Bank considers its primary market area to include six submarkets:
primarily rural Grays Harbor County with its historical dependence on the
timber and fishing industries; Pierce, Thurston and Kitsap Counties with their
dependence on state and federal government; King County with its broadly
diversified economic base; and Lewis County with its dependence on retail
trade, manufacturing, industrial services and local government. Each of these
markets presents operating risks to the Bank. The Bank's expansion into
Pierce, Thurston, King, Kitsap and Lewis Counties represents the Bank's
strategy to diversify its primary market area to become less reliant on the
economy of Grays Harbor County.
2
Grays Harbor County has a population of 72,000 according to the U.S.
Census Bureau 2009 estimates and a median family income of $55,400 according
to 2010 estimates from the Department of Housing and Urban Development (
HUD"). The economic base in Grays Harbor has been historically dependent on
the timber and fishing industries. Other industries that support the economic
base are tourism, agriculture, shipping, transportation and technology.
According to the Washington State Employment Security Department, the
unemployment rate in Grays Harbor County decreased to 11.4% at September 30,
2010 from 11.9% at September 30, 2009. The median price of a resale home in
Grays Harbor County for the quarter ended September 30, 2010 decreased 3.3% to
$130,000 from $134,500 for the comparable prior year period. The number of
home sales increased 23.1% for the quarter ended September 30, 2010 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 797,000 according to the U.S. Census Bureau 2009 estimates. The
county's median family income is $69,000 according to 2010 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 decreased to 8.7% at September
30, 2010 from 9.0% at September 30, 2009. The median price of a resale home in
Pierce County for the quarter ended September 30, 2010 decreased 4.3% to
$220,000 from $230,000 for the comparable prior year period. The number of
home sales increased 21.9% for the quarter ended September 30, 2010 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 251,000 according to the U.S. Census
Bureau 2009 estimates and a median family income of $71,900 according to 2010
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 remained level at 7.2% at
September 30, 2010 and 2009. The median price of a resale home in Thurston
County for the quarter ended September 30, 2010 decreased 5.0% to $231,000
from $243,100 for the same quarter one year earlier. The number of home sales
increased 13.0% for the quarter ended September 30, 2010 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 241,000 according to the U.S. Census
Bureau 2009 estimates and a median family income of $71,900 according to 2010
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 decreased to 7.0% at September 30, 2010 from 7.3% at September 30, 2009.
The median price of a resale home in Kitsap County for the quarter ended
September 30, 2010 decreased 6.0% to $235,000 from $249,900, the same quarter
one year earlier. The number of home sales increased 16.5% for the quarter
ended September 30, 2010 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 2009 estimates. The Bank
has one branch in King County. The county's median family income is $85,600
according to 2010 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 8.4% at September 30, 2010 from 8.8% at September 30, 2009. The
median price of a resale home in King County for the quarter ended September
30, 2010 decreased 1.7% to $375,500 from $382,000, for the same quarter one
year earlier. The
3
number of home sales increased 33.0% for the quarter ended September 30, 2010
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 2009 estimates and a median family income of $55,400 according to 2010
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 decreased to 11.7% at September 30, 2010
from 12.1% at September 30, 2009. The median price of a resale home in Lewis
County for the quarter ended September 30, 2010 decreased 1.1% to $161,500
from $163,300, for the same quarter one year earlier. The number of home
sales increased 8.2% for the quarter ended September 30, 2010 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 527.6 million at September 30, 2010, representing 71.0% 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 $340.3 million, or 60.9%, 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, 2010, the maximum
amount which the Bank could have lent to any one borrower and the borrower's
related entities was approximately $18.2 million under this policy. At
September 30, 2010, the largest amount outstanding to any one borrower and the
borrower's related entities was $11.5 million (including $1.1 million in
undisbursed loans in process). These loans were secured by commercial
buildings and a land parcel, all of which were located in Pierce County.
These loans were all performing according to the loan repayment terms at
September 30, 2010. The next largest amount outstanding to any one borrower
and the borrower's related entities was $8.9 million. 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 one land
parcel located in Clatsop County, Oregon. These loans were performing
according to the loan terms at September 30, 2010.
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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2010 2009 2008 2007 2006
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to four-
family(1)....$121,014 21.65% $110,556 18.58% $112,299 18.35% $102,434 17.40% $ 98,709 20.11%
Multi-family.. 32,267 5.77 25,638 4.31 25,927 4.24 35,157 5.97 17,689 3.60
Commercial.... 208,002 37.21 188,205 31.62 146,223 23.90 127,866 21.72 137,609 28.04
Construction
and land
development.. 69,271 12.39 139,728 23.48 186,344 30.46 186,261 31.64 146,855 29.92
Land.......... 62,999 11.27 65,642 11.03 60,701 9.92 60,706 10.30 29,598 6.03
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total
mortgage
loans....... 493,553 88.29 529,769 89.02 531,494 86.87 512,424 87.03 430,460 87.70
Consumer Loans:
Home equity
and second
mortgage..... 38,418 6.87 41,746 7.01 48,690 7.96 47,269 8.02 37,435 7.63
Other......... 9,086 1.62 9,827 1.66 10,635 1.73 10,922 1.86 11,127 2.27
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer
loans....... 47,504 8.49 51,573 8.67 59,325 9.69 58,191 9.88 48,562 9.90
Commercial
business
loans......... 17,979 3.22 13,775 2.31 21,018 3.44 18,164 3.09 11,803 2.40
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans.. 559,036 100.00% 595,117 100.00% 611,837 100.00% 588,779 100.00% 490,825 100.00%
======== ====== ======== ====== ======== ====== ======== ====== ======== ======
Less:
Undisbursed
portion of
construction
loans in
process...... (17,952) (31,298) (43,353) (65,673) (59,260)
Deferred loan
origination
fees......... (2,229) (2,439) (2,747) (2,968) (2,798)
Allowance for
loan losses.. (11,264) (14,172) (8,050) (4,797) (4,122)
-------- -------- -------- -------- --------
Total loans
receivable,
net...........$527,591 $547,208 $557,687 $515,341 $424,645
======== ======== ======== ======== ========
------------
(1) Includes loans held-for-sale of $3.0 million, $630,000, $1.8 million,
$757,000 and $2.4 million at September 30, 2010, 2009, 2008, 2007 and
2006, respectively.
Residential One- to Four-Family Lending. At September 30, 2010, $121.0
million, or 21.7%, 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 the FHLMC. From time to time, however, a portion of these
fixed-rate loans, which include five and seven year balloon reset loans, may
be retained in the loan portfolio to meet the Bank's asset/liability
management objectives. The Bank periodically retains some fixed rate loans
including five and seven year balloon reset loans in its loan portfolio as it
intends to hold them to maturity. The Bank uses an automated underwriting
program, which preliminarily qualifies a loan as conforming to FHLMC
underwriting standards when the loan is originated. At September 30, 2010,
$57.1 million, or 47.2%, of the Bank's one- to four-family loan portfolio
consisted of fixed-rate mortgage loans.
The Bank also offers adjustable-rate mortgage ("ARM") loans. All of the
Bank's ARM loans are retained in its loan portfolio and not sold. The Bank
offers several ARM products which adjust annually after an initial period
ranging from one to five years subject to a limitation on the annual increase
of 2% and an overall limitation of 6%. These ARM products 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 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
5
rates, the expectations of changes in the level of interest rates and the
difference between the initial interest rates and fees charged for each type
of loan. The relative amount of fixed-rate mortgage loans and ARM loans that
can be originated at any time is largely determined by the demand for each in
a competitive environment. At September 30, 2010, $63.9 million, or 52.8%, of
the Bank's one- to four- family loan portfolio consisted of ARM loans.
A portion of the Bank's ARM loans are "non-conforming" because they do
not satisfy acreage limits, or various other requirements imposed by the
FHLMC. Some of these loans are also originated to meet the needs of borrowers
who cannot otherwise satisfy the FHLMC credit requirements because of personal
and financial reasons (i.e., divorce, bankruptcy, length of time employed,
etc.), and other aspects, which do not conform to the FHLMC's guidelines.
Many of these borrowers have higher debt-to-income ratios, or the loans are
secured by unique properties in rural markets for which there are no sales of
comparable properties to support 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. Loans originated since
1994 also require flood insurance, if appropriate.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 95% of the
lesser of the appraised value or the purchase price. However, the Bank
usually obtains private mortgage insurance ("PMI") on the portion of the
principal amount that exceeds 80% of the appraised value of the security
property. The maximum loan-to-value ratio on mortgage loans secured by
non-owner-occupied properties is generally 80% (90% for loans originated for
sale in the secondary market to the FHLMC). At September 30, 2010, 17 single
family loans totaling $3.7 million were not performing according to their
terms. See "- Lending Activities - Non-performing Assets and Delinquencies."
Construction and Land Development Lending. Prompted by unfavorable
economic conditions in its primary market area in the 1980s, the Bank sought
to establish a market niche and, as a result, began originating construction
loans outside of Grays Harbor County. In recent periods, construction lending
activities have been primarily in the Pierce, King, Thurston, Grays Harbor,
and Kitsap County markets although, as a result of the current economic
environment, the Bank has sharply curtailed speculative construction and land
development lending.
6
The Bank currently originates three types of residential construction
loans: (i) custom construction loans, (ii) owner/builder construction loans
and (iii) speculative construction loans (on a very limited basis). The Bank
believes that its computer tracking system has enabled it to establish
processing and disbursement procedures to meet the needs of these borrowers.
The Bank also originates construction loans for the development of
multi-family and commercial properties.
At September 30, 2010 and 2009, the composition of the Bank's
construction and land development loan portfolio was as follows:
At September 30,
------------------------------------------------
2010 2009
----------------------- -----------------------
Outstanding Percent of Outstanding Percent of
Balance Total Balance Total
----------- ---------- ----------- ----------
(In thousands)
Custom and owner/builder
onstruction............... $30,945 44.67% $ 35,414 25.34%
Speculative construction... 4,777 6.90 16,959 12.14
Multi-family (including
condominium).............. 3,587 5.18 18,800 13.46
Land development........... 6,434 9.29 19,158 13.71
Commercial real estate..... 23,528 33.96 49,397 35.35
------- ------ -------- ------
Total.................... $69,271 100.00% $139,728 100.00%
======= ====== ======== ======
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 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 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, 2010, custom and owner/builder construction loans totaled $30.9 million,
or 44.7%, of the total construction and land development loan portfolio. At
September 30, 2010, the largest outstanding custom and owner/builder
construction loan had an outstanding balance of $600,000 (including $172,000
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 6.50% to
7.88%, 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 very limited basis. At September 30,
2010, speculative construction loans totaled $4.8 million, or 6.9%, of the
total construction and land development loan portfolio. At September 30,
2010, the Bank had two borrowers each with aggregate outstanding
7
speculative loan balances of more than $500,000. The largest aggregate
outstanding balance to one borrower for speculative construction loans totaled
$1.7 million (including $311,000 of undisbursed loans in process), all of
which were performing according to the loan repayment terms. The largest
outstanding balance for a single speculative loan was $759,000 and was on
non-accrual status. At September 30, 2010, four speculative construction
loans with an aggregate balance of $2.1 million were not performing according
to their terms. These non-performing loans were located in Pierce, Thurston
and King Counties. See "- Lending Activities - Non-performing Assets and
Delinquencies."
The Bank historically originated loans to real estate developers with
whom it has established relationships for the purpose of developing
residential subdivisions (i.e., installing roads, sewers, water and other
utilities) (generally with ten to 50 lots). The Bank is not currently
originating any new land development loans. At September 30, 2010, the Bank
had 11 land development loans totaling $6.4 million, or 9.3% 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, 2010, the Bank had eight land
development loans totaling $3.8 million that were not performing according to
their terms. The non-performing loans consisted of
* Four loans totaling $1.5 million secured by land development projects
in King County;
* One loan with a balance of $1.4 million secured by a land development
project in Lewis County;
* One loan with a balance of $534,000 secured by a land development
project in Thurston County;
* One loan with a balance of $230,000 secured by a land development
project in Pierce County; and
* One loan with a balance of $71,000 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, 2010, these loans amounted to $27.1
million, or 39.1% 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, 2010, the largest outstanding
multi-family construction loan was secured by a condominium project in King
County and had a balance of $1.5 million (including $12,000 of undisbursed
loans in process) and was not performing according to its repayment terms. At
September 30, 2010, the largest outstanding commercial real estate
construction loan had a balance of $4.0 million (including $196,000 of
undisbursed loans in process). This loan was secured by a hotel being
constructed in King County and was performing according to its repayment
terms.
All construction loans must be approved by a member of one of the Bank's
Loan Committees or the Bank's Board of Directors, or in the case of one- to
four-family construction loans meeting FHLMC guidelines, by a qualified 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
8
requires that the borrower increase the funds available for construction by
depositing its own funds into a secured savings account, the proceeds of which
are used to pay construction costs.
Loan disbursements during the construction period are made to the
builder, materials supplier or subcontractor, based on a line item budget.
Periodic on-site inspections are made by qualified independent inspectors to
document the reasonableness of draw requests. For most builders, the Bank
disburses loan funds by providing vouchers to suppliers, which when used by
the builder to purchase supplies are submitted by the supplier to the Bank for
payment.
The Bank regularly monitors the construction loan disbursements using an
internal monitoring system which the Bank believes reduces many of the risks
inherent with construction lending.
The Bank originates construction loan applications primarily through
customer referrals, contacts in the business community and occasionally real
estate brokers seeking financing for their clients.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost of
the project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the
estimate of value upon completion proves to be inaccurate, the Bank may be
confronted with a project whose value is insufficient to assure full repayment
and it may incur a loss. Projects may also be jeopardized by disagreements
between borrowers and builders and by the failure of builders to pay
subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the payoff for the loan depends on
the builder's ability to sell the property prior to the time that the
construction loan is due. The Bank has sought to address these risks by
adhering to strict underwriting policies, disbursement procedures, and
monitoring practices. The Bank's construction loans are primarily secured by
properties in its primary market area, and changes in the local and state
economies and real estate markets have adversely affected the Bank's
construction loan portfolio.
Multi-Family Lending. At September 30, 2010, the Bank had $32.3 million,
or 5.8% 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, 2010, the Bank's largest multi-family loan had an outstanding principal
balance of $4.9 million and was secured by an apartment building located in
the Bank's primary market area. At September 30, 2010, this loan was
performing according to its terms. At September 30, 2010, there were no
non-performing multi-family real estate loans. See "- Lending Activities -
Non-performing Assets 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 subject property annually. The Bank also
inspects the subject property 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.
9
Commercial Real Estate Lending. Commercial real estate loans totaled
$208.0 million, or 37.2% of the total loan portfolio at September 30, 2010.
The Bank originated $27.2 million of commercial real-estate loans during the
year ended September 30, 2010 compared to $43.8 million originated during the
year ended September 30, 2009. The Bank originates commercial real estate
loans generally at variable interest rates and these loans are secured by
properties, such as restaurants, motels, mini-storage facilities, office
buildings and retail/wholesale facilities, located in the Bank's primary
market area. At September 30, 2010, the largest commercial real estate loan
was secured by an office building in Pierce County, had a balance of $6.3
million and was performing according to its terms. At September 30, 2010, 12
commercial real estate loans totaling $7.3 million were not performing
according to their terms. See "- Lending Activities - Non-performing Assets
and Delinquencies."
The Bank typically requires appraisals of properties securing commercial
real estate loans. For loans that are less than $250,000, the Bank may use
the tax assessed value and a property inspection in lieu of an appraisal.
Appraisals are performed by independent appraisers designated by the Bank, all
of which are reviewed by management. The Bank considers the quality and
location of the real estate, the credit history of the borrower, the cash flow
of the project and the quality of management involved with the property. The
Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for
originated loans secured by income producing commercial properties.
Loan-to-value ratios on commercial real estate loans are generally limited to
not more than 80%. If the borrower is other than an individual, the Bank also
generally obtains personal guarantees from the principals based on a review of
personal financial statements.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to
four-family residential lending. However, loans secured by such properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by commercial
properties often depend upon the successful operation and management of the
properties, repayment of these loans may be affected by adverse conditions in
the real estate market or the economy. The Bank seeks to minimize these risks
by generally limiting the maximum loan-to-value ratio to 80% and 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, 2010, land loans totaled $63.0
million, or 11.3% of the Bank's total loan portfolio as compared to $65.6
million, or 11.0% of the Bank's total loan portfolio at September 30, 2009.
Land loans originated by the Bank are generally fixed-rate loans and have
maturities of five to ten years. The largest land loan had an outstanding
balance of $4.2 million at September 30, 2010 and was performing according to
its repayment terms. At September 30, 2010, 24 land loans totaling $5.5
million were not performing according to their terms. See "- Lending
Activities - Non-performing Assets and Delinquencies."
Loans secured by undeveloped land or improved lots involve greater risks
than one- to four-family residential mortgage loans because these loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
in the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer loans generally have shorter terms to
maturity and higher interest rates than mortgage loans. Consumer loans
include home equity lines of credit, second mortgage loans, savings account
loans, automobile loans, boat loans, motorcycle loans, recreational vehicle
loans and unsecured loans. Consumer loans are made with both fixed and
variable interest rates and with varying terms. At September 30, 2010,
consumer loans amounted to $47.5 million, or 8.5%, of the total loan
portfolio.
At September 30, 2010, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $38.4 million, or 6.9%, 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
10
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 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, 2010,
eight consumer loans totaling $806,000 were delinquent in excess of 90 days.
See "- Lending Activities - Non-performing Assets and Delinquencies."
Commercial Business Lending. Commercial business loans totaled $18.0
million, or 3.2% of the loan portfolio at September 30, 2010. Commercial
business loans are generally secured by business equipment, accounts
receivable, inventory or other property and are made at variable rates of
interest equal to a negotiated margin above the prime rate. The Bank also
generally obtains personal guarantees from the principals based on a review of
personal financial statements. The largest commercial business loan had an
outstanding balance of $1.8 million at September 30, 2010 and was performing
according to its terms. At September 30, 2010, two commercial business loans
totaling $46,000 were not performing according to their repayment terms. See
"- Lending Activities - Non-performing Assets and Delinquencies."
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral based lending with loan
amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business
loans are often collateralized by equipment, inventory, accounts receivable or
other business assets, the liquidation of collateral in the event of a
borrower default is often an insufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete
or of limited use, among other things. Accordingly, the repayment of a
commercial business loan depends primarily on the creditworthiness of the
borrower (and any guarantors), while liquidation of collateral is a secondary
and often insufficient source of repayment.
11
Loan Maturity. The following table sets forth certain information at
September 30, 2010 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Loans having no stated maturity
and overdrafts are reported as due in one year or less.
After After After
1 Year 3 Years 5 Years
Within Through Through Through After
1 Year 3 Years 5 Years 10 Years 10 Years Total
------ ------- ------- -------- -------- -----
(In thousands)
Mortgage loans:
One- to four-family
(1)..................$ 2,718 $ 8,252 $ 1,255 $ 12,242 $ 96,547 $121,014
Multi-family.......... 5,482 2,698 1,066 22,466 555 32,267
Commercial............ 9,348 31,728 37,132 123,488 6,306 208,002
Construction and
land development(2).. 67,820 1,451 - - - 69,271
Land.................. 32,770 20,974 5,217 2,211 1,827 62,999
Consumer loans:
Home equity and second
mortgage............. 10,589 1,614 748 8,149 17,318 38,418
Other................. 3,323 1,267 228 779 3,489 9,086
Commercial business
loans................. 9,453 1,445 1,002 4,704 1,375 17,979
-------- ------- ------- -------- -------- --------
Total.................$141,503 $69,429 $46,648 $174,039 $127,417 $559,036
======== ======= ======= ======== ======== ========
Less:
Undisbursed portion
of construction
loans in process..... (17,952)
Deferred loan
origination fees..... (2,229)
Allowance for loan
losses............... (11,264)
--------
Loans receivable,
net.................. $527,591
========
--------------
(1) Includes $3.0 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, 2010, which have fixed interest rates and have
floating or adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates Total
------- ---------------- -------
(In thousands)
Mortgage loans:
One- to four-family(1)............... $ 54,876 $ 63,420 $118,296
Multi-family......................... 3,352 23,433 26,785
Commercial........................... 31,935 166,719 198,654
Construction and land development.... -- 1,451 1,451
Land................................. 24,983 5,246 30,229
Consumer loans:
Home equity and second mortgage...... 18,049 9,780 27,829
Other................................ 5,659 104 5,763
Commercial business loans............. 4,071 4,455 8,523
-------- -------- --------
Total.............................. $142,925 $274,608 $417,533
======== ======== ========
-------------
(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
an appraiser retained by the Bank and certified by the State of Washington.
Loan applications are initiated by loan officers and are required to be
approved by an authorized loan underwriter, one of the Bank's Loan Committees
or the Bank's Board of Directors. The Bank's Consumer Loan Committee consists
of three underwriters, each of whom can approve one- to four-family mortgage
loans and other consumer loans up to and including the current FHLMC
single-family limit. Certain consumer loans up to and including $25,000 may
be approved by individual loan officers and the Bank's Consumer Lending
Department Manager may approve consumer loans up to and including $75,000.
The Bank's Regional Manager of Commercial Lending has individual lending
authority for loans up to and including $250,000, excluding speculative
construction loans and unsecured loans. The Bank's Commercial Loan Committee,
which consists of the Bank's President, Chief Credit Administrator, Executive
Vice President of Commercial Lending, Executive Vice President of Community
Lending, and Regional Manager of Commercial Lending, may approve commercial
real estate loans and commercial business loans up to and including $1.5
million. The Bank's President, 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, 2010 and 2009, the Bank's total gross loan originations were $182.5
million and $295.3 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 year ended September 30, 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,
2010, the Bank purchased contracts totaling $50,000. 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
the FHLMC; however, from time to time, a portion of fixed-rate loans may be
retained in the Bank's portfolio to meet its asset-liability objectives.
Loans sold in the secondary market are generally sold on a servicing retained
basis. At September 30, 2010, the Bank's loan servicing portfolio, which is
not included in the Company's consolidated financial statements, totaled
$280.9 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, 2010 and 2009.
13
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
2010 2009 2008
--------- -------- --------
Loans originated: (In thousands)
Mortgage loans:
One- to four-family...................... $ 72,015 $ 165,972 $ 45,844
Multi-family............................. 7,772 1,036 4,710
Commercial............................... 27,248 43,821 29,306
Construction and land development........ 35,369 56,287 118,186
Land..................................... 11,712 6,519 25,858
Consumer.................................. 10,286 14,080 22,411
Commercial business loans................. 18,130 7,601 12,268
--------- -------- --------
Total loans originated.................. 182,532 295,316 258,583
Loans purchased:
Mortgage loans:
One- to four-family...................... 50 -- --
Commercial............................... -- 1,606 --
Construction and land development........ -- -- 2,862
--------- -------- --------
Total loans purchased................... 50 1,606 2,862
--------- -------- --------
Total loans originated and purchased.. 182,582 296,922 261,445
Loans sold:
Whole loans sold.......................... (68,330) (162,913) (45,269)
Participation loans sold.................. -- -- (17,035)
--------- -------- --------
Total loans sold.......................... (68,330) (162,913) (62,304)
Loan principal repayments.................. (150,333) (150,729) (176,083)
Other items, net........................... 16,464 6,241 19,288
--------- -------- --------
Net increase (decrease) in loans
receivable................................ $ (19,617) $(10,479) $ 42,346
========= ======== ========
Loan Origination Fees. The Bank receives loan origination fees on many
of its mortgage loans and commercial business loans. Loan fees are a
percentage of the loan which are charged to the borrower for funding the loan.
The amount of fees charged by the Bank is generally 0.0% to 2.0% of the loan
amount. Current accounting principles generally accepted in the United States
of America require fees received and certain loan origination costs for
originating loans to be deferred and amortized into interest income over the
contractual life of the loan. Net deferred fees or costs associated with
loans that are prepaid are recognized as income at the time of prepayment.
Unamortized deferred loan origination fees totaled $2.2 million at September
30, 2010.
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.
14
If the borrower is chronically delinquent and all reasonable means of
obtaining payment on time have been exhausted, foreclosure is initiated
according to the terms of the security instrument and applicable law.
Interest income on loans in foreclosure is reduced by the full amount of
accrued and uncollected interest.
When a consumer loan borrower or commercial business borrower fails to
make a required payment on a loan by the payment due date, the Bank institutes
similar collection procedures as for its mortgage loan borrowers. Loans
becoming 90 days or more past due are placed on non-accrual status, with any
accrued interest reversed against interest income, unless they are well
secured and in the process of collection.
The Bank's Board of Directors is informed monthly as to the status of
loans that are delinquent by more than 30 days, and the status of all
foreclosed and repossessed property owned by the Bank.
The following table sets forth information with respect to the Company's
non-performing assets at the dates indicated.
At September 30,
------------------------------------------------
2010 2009 2008 2007 2006
-------- -------- -------- -------- --------
Loans accounted for on a (In thousands)
non-accrual basis:
Mortgage loans:
One- to four-family........ $ 3,691 $ 1,343 $ 300 $ 252 $ 80
Commercial................. 7,252 5,004 714 90 --
Construction and land
development............... 7,609 17,594 9,840 1,000 --
Land....................... 5,460 5,023 726 28 --
Consumer loans.............. 806 258 160 -- --
Commercial business loans... 46 65 250 120 --
-------- -------- -------- -------- --------
Total.................... 24,864 29,287 11,990 1,490 80
Accruing loans which are
contractually past due 90
days or more............... 1,325 796 -- -- --
-------- -------- -------- -------- --------
Total of non-accrual and 90
days past due loans........ 26,189 30,083 11,990 1,490 80
Non-accrual investment
securities................. 3,390 477 -- -- --
Other real estate owned and
other repossessed assets... 11,519 8,185 511 -- 15
-------- -------- -------- -------- --------
Total non-performing
assets (1).............. $ 41,098 $ 38,745 $ 12,501 $ 1,490 $ 95
======== ======== ======== ======== ========
Troubled debt restructured
loans on accrual status
(2)........................ $ 8,995 $ -- $ 272 $ -- $ --
Non-accrual and 90 days
or more past due loans
as a percentage of loans
receivable, net............ 4.86% 5.36% 2.12% 0.29% 0.02%
Non-accrual and 90 days or
more past due loans as a
percentage of total
assets..................... 3.53% 4.28% 1.76% 0.23% 0.01%
Non-performing assets as a
percentage of total
assets..................... 5.53% 5.52% 1.83% 0.23% 0.02%
Loans receivable, net (3)... $538,855 $561,380 $565,737 $520,138 $428,767
======== ======== ======== ======== ========
Total assets................ $742,687 $701,676 $681,883 $644,848 $577,087
======== ======== ======== ======== ========
-------------
(1) Does not include troubled debt restructured loans on accrual status.
(2) Does not include troubled debt restructured loans totaling $7.4 million
and $9.5 million reported as non-accrual loans at September 30, 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 $4.4 million to $24.9 million
at September 30, 2010 from $29.3 million at September 30, 2009, primarily as a
result of a $10.0 million decrease in construction and land development
15
loans on non-accrual status, which was partially offset by a $2.3 million
increase in one to four-family loans on non-accrual status and a $2.2 million
increase in commercial real estate loans on non-accrual status. The largest
non-performing loan was secured by a mini-storage facility in King County and
had a balance of $2.7 million at September 30, 2010. 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, 2010 had non-accruing loans been current in accordance
with their original terms totaled $3.0 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, 2010, the Bank had $11.5
million of OREO and other repossessed assets consisting of 27 individual
properties and three other repossessed assets, an increase of $3.3 million
from $8.2 million at September 30, 2009. The OREO properties consisted of two
condominium projects totaling $3.9 million, three land development projects
totaling $3.3 million, eight single family homes totaling $1.7 million, 11
land parcels totaling $1.4 million and three commercial real estate properties
totaling $1.1 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 $16.4 million at September 30, 2010, 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.
Impaired loans are measured based on the estimated fair value of the
collateral less estimated cost to sell if the loan is considered collateral
dependent. Impaired loans not considered to be collateral dependent are
measured based on the present value of expected future cash flows.
The categories of non-accrual loans and impaired loans overlap, although
they are not coextensive. The Bank considers all circumstances regarding the
loan and borrower on an individual basis when determining whether an impaired
loan should be placed on non-accrual status, such as the financial strength of
the borrower, the collateral value, reasons for delay, payment record, the
amount of past due and the number of days past due. At September 30, 2010,
the Bank had $42.2 million in impaired loans. For additional information on
impaired loans, see Note 4 of the Notes to the Consolidated Financial
Statements included in Item 8 of this Annual Report on Form 10-K.
Other Loans of Concern. Loans not reflected in the table above, but
where known information about possible credit problems of borrowers causes
management to have doubts as to the ability of the borrower to comply with
present repayment terms and that may result in disclosure of such loans as
non-performing assets in the future are commonly referred to as "other loans
of concern" or "potential problem loans." The amount included in potential
problem loans results from an evaluation, on a loan-by-loan basis, of loans
classified as "substandard" and "special mention," as those terms are defined
under "Asset Classification" below. The amount of potential problem loans was
$43.7 million at September 30, 2010 and $54.8 million at September 30, 2009.
The vast majority of these loans are collateralized by real estate. See "-
Asset Classification" below for additional information regarding our problem
loans.
Asset Classification. Applicable regulations require that each insured
institution review and classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, regulatory examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
substandard, doubtful and loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not
16
corrected. Doubtful assets have the weaknesses of substandard assets with the
additional characteristic that the weaknesses make collection or liquidation
in full on the basis of currently existing facts, conditions and values
questionable, and there is a high possibility of loss. An asset classified as
loss is considered uncollectible and of such little value that continuance as
an asset of the institution is not warranted. When an insured institution
classifies problem assets as either substandard or doubtful, it is required to
establish allowances for loan losses in an amount deemed prudent by
management. These allowances represent loss allowances which have been
established to recognize the inherent risk associated with lending activities
and the risks associated with particular problem assets. When an insured
institution classifies problem assets as loss, it charges off the balance of
the asset against the allowance for loan losses. Assets which do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are required to be designated as special mention. The Bank's determination of
the classification of its assets and the amount of its valuation allowances is
subject to review by the FDIC and the Division which can 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,
-----------------------------
2010 2009 2008
------- ------- -------
(In thousands)
Loss............................. $ -- $ -- $ --
Doubtful......................... -- -- --
Substandard(1)(2)................ 56,796 63,188 24,603
Special mention(1)............... 13,070 21,711 18,225
------- ------- -------
Total classified and special
mention loans................... $69,866 $84,899 $42,828
======= ======= =======
Allowance for loan losses........ $11,264 $14,172 $ 8,050
-------------
(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 decreased by $15.0
million from September 30, 2009 to September 30, 2010, primarily as a result
of a $6.4 million decrease in loans classified as substandard and a $8.6
million decrease 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. Eight individual loans comprised $8.9 million,
or 68.4%, of the $13.1 million in loans classified as special mention. They
include two commercial real estate loans totaling $3.3 million, three land
loans totaling $2.6 million, two condominium construction loans totaling $2.1
million and one condominium construction loan with a balance of $975,000. At
September 30, 2010 these loans were current and paying in accordance with
their required terms.
Substandard loans are classified as those loans that are inadequately
protected by the current net worth, and paying capacity of the obligor, or of
the collateral pledged. Assets classified as substandard have a well-defined
weakness, or weaknesses that jeopardize the repayment of the debt. If the
weakness, or weaknesses are not corrected there is the distinct possibility
that some loss will be sustained. The aggregate amount of loans classified as
substandard at September 30, 2010 decreased by $6.4 million to $56.8 million
from $63.2 million at September 30, 2009. At September 30, 2010, 146 loans
were classified as substandard compared to 121 at September 30, 2009.
17
Of the $56.8 million in loans classified as substandard at September 30,
2010, $24.9 million were on non-accrual status and $1.3 million were past due
90 days or more and still accruing. Troubled debt restructured loans totaling
$16.4 million were classified as substandard at September 30, 2010, with $7.4
million in troubled debt restructured loans on non-accrual status and $9.0
million in troubled debt restructured loans on accrual status. The largest
loan classified as substandard at September 30, 2010 had a balance of $4.6
million and was secured by a mini-storage facility in Pierce County. This
loan was 60 days past due at September 30, 2010. The next largest loan
classified as substandard at September 30, 2010 had a balance of $3.4 million
and was secured by an apartment building in King County. This loan was
performing according to its loan repayment terms at September 30, 2010.
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, 2010, the Bank's allowance for loan losses totaled $11.3
million. This represents 2.09% of the total loans receivable and 43.01% of
non-performing loans. The Bank's allowance for loan losses as a percentage of
total loans receivable has decreased to 2.09% at September 30, 2010 from 2.52%
at September 30, 2009 primarily due to a decrease in the level of
non-performing loans, a decrease in the level of classified loans and a
decrease in Bank's construction and land development loan balances.
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,
------------------------------------------------
2010 2009 2008 2007 2006
-------- -------- -------- -------- --------
(Dollars in thousands)
Allowance at beginning of
year....................... $14,172 $ 8,050 $4,797 $4,122 $4,099
Provision for loan losses... 10,550 10,734 3,900 686 --
Allocated to loan
commitments................ -- (169) -- -- --
Recoveries:
Mortgage loans:
Commercial................. 13 -- -- -- --
Construction............... 104 -- -- -- --
Land....................... 153 83 -- -- --
Consumer loans:
Home equity and second
mortgage.................. 86 -- -- -- --
Other...................... 6 5 1 1 5
Commercial business loans... -- -- -- -- 20
------- ------- ------ ------ ------
Total recoveries......... 362 88 1 1 25
Charge-offs:
Mortgage loans:
One- to four-family........ 200 46 -- -- --
Construction............... 8,012 3,108 648 -- --
Commercial................. 1,888 235 -- -- --
Land....................... 3,285 705 -- -- --
Consumer loans:
Home equity and second
mortgage.................. 399 162 -- -- --
Other...................... 36 25 -- 12 2
Commercial business loans... -- 250 -- -- --
------- ------- ------ ------ ------
Total charge-offs.......... 13,820 4,531 648 12 2
------- ------- ------ ------ ------
Net charge-offs
(recoveries).............. 13,458 4,443 647 11 (23)
------- ------- ------ ------ ------
Balance at end of year.... $11,264 $14,172 $8,050 $4,797 $4,122
======= ======= ====== ====== ======
Allowance for loan losses
as a percentage of total
loans receivable (net)(1)
outstanding at the end of
the year................... 2.09% 2.52% 1.42% 0.92% 0.96%
Net charge-offs (recoveries)
as a percentage of average
loans outstanding during
the year................... 2.45% 0.79% 0.12% 0.00% (0.01%)
Allowance for loan losses
as a percentage of non-
performing loans at end
of year.................... 43.01% 47.11% 67.14% 321.95% 5,152.50%
------------
(1) Total loans receivable (net) includes loans held for sale and is before
the allowance for loan losses.
19
The following table sets forth the allocation of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
----------------------------------------------------------------------------------------------
2010 2009 2008 2007 2006
----------------- ------------------ ---------------- ----------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- -------- -------- -------- ------ -------- ------- -------- ------- ---------
(Dollars in thousands)
Mortgage loans:
One- to four-
family.......$ 530 21.65% $ 616 18.58% $ 476 18.35% $ 396 17.40% $ 502 20.11%
Multi-family.. 392 5.77 431 4.31 248 4.24 200 5.97 112 3.60
Commercial.... 3,173 37.21 2,719 31.63 1,521 23.90 1,368 21.72 1,222 28.04
Construction.. 1,626 12.39 5,132 23.48 3,254 30.46 1,047 31.64 761 29.92
Land.......... 3,709 11.27 3,348 11.03 1,435 9.92 549 10.30 275 6.03
Non-mortgage loans:
Consumer
loans........ 461 8.49 1,216 8.66 457 9.69 412 9.88 497 9.90
Commercial
business
loans........ 1,373 3.22 710 2.31 659 3.44 825 3.09 753 2.40
------- ------ ------- ------ ------ ------ ------ ------ ------ ------
Total
allowance
for loan
losses......$11,264 100.00% $14,172 100.00% $8,050 100.00% $4,797 100.00% $4,122 100.00%
======= ====== ======= ====== ====== ====== ====== ====== ====== ======
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, 2010, the Company's investment portfolio totaled $16.2
million, 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 Company does not
maintain a trading account for any investments. This compares with a total
investment portfolio of $20.6 million at September 30, 2009, primarily
consisting of $968,000 of mutual funds available-for-sale, $12.5 million of
mortgage-backed securities available-for-sale, and $7.1 million of
mortgage-backed securities held-to-maturity. The composition of the
portfolios by type of security, at each respective date is presented in the
following table.
At September 30,
--------------------------------------------------------
2010 2009 2008
----------------- ----------------- ------------------
Percent Percent Percent
Recorded of Recorded of Recorded of
Value Total Value Total Value Total
-------- ------- -------- ------- -------- --------
(Dollars in thousands)
Held-to-Maturity:
U.S. agency
securities......... $ 28 0.17% $ 27 0.13% $ 28 0.09%
Mortgage-backed
securities......... 5,038 31.13 7,060 34.34 14,205 45.34
Available-for-Sale
(at fair value):
Mortgage-backed
securities......... 10,131 62.59 12,503 60.82 16,162 51.58
Mutual funds........ 988 6.11 968 4.71 936 2.99
------- ------ ------- ------ ------- ------
Total portfolio...... $16,185 100.00% $20,558 100.00% $31,331 100.00%
======= ====== ======= ====== ======= ======
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, 2010. Mutual funds, which by their
nature do not have maturities, are classified in the one year or less
category.
After One to After Five to After Ten
One Year or Less Five Years Ten Years Years
---------------- ---------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Held-to-Maturity:
U.S. agency securities $ -- --% $ 14 3.25% $ 14 3.98% $ -- --%
Mortgage-backed
securities -- -- 5 4.90 26 4.73 5,007 5.73
Available-for-Sale:
Mortgage-backed
securities 271 0.88 9 5.53 141 5.92 9,710 3.37
Mutual funds 988 3.30 -- -- -- -- -- --
------ ---- ---- -------
Total portfolio $1,259 2.78% $ 28 4.27% $181 5.58% $14,717 4.15%
====== ==== ==== =======
There were no securities which had an aggregate book value in excess of
10% of the Company's total equity at September 30, 2010. At September 30,
2010, the Company had $5.0 million of private label mortgage backed securities
of which $3.4 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 Federal Reserve Bank ("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 a checking account acquisition marketing program
that was implemented in 2000. At September 30, 2010, the Bank had 36.6% of
total deposits in non-interest bearing accounts and NOW checking accounts.
At September 30, 2010 the Bank had $93.0 million of jumbo certificates of
deposit of $100,000 or more. The Bank had no brokered certificates of
deposits at September 30, 2010. The Bank believes that its jumbo certificates
of deposit, which represented 16.1% of total deposits at September 30, 2010,
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, 2010.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
---------------------------------------- ------------- --------- ----------
(In thousands)
Non-interest bearing.................... --% $ 58,755 10.15%
Negotiable order of withdrawal ("NOW")
checking............................... 1.24 153,304 26.48
Savings................................. 0.71 67,448 11.65
Money market............................ 1.13 55,723 9.63
-------- ------
Subtotal............................... 1.09% $335,230 57.91%
Certificates of Deposit(1)
----------------------------------------
Maturing within 1 year 1.63% $177,911 30.73%
Maturing after 1 year but within 2
years.................................. 1.91 43,032 7.43
Maturing after 2 years but within 5
years.................................. 3.03 22,386 3.87
Maturing after 5 years.................. 2.53 310 0.05
-------- ------
Total certificates of deposit.......... 1.81 243,639 42.09
-------- ------
Total deposits....................... 1.39% $578,869 100.00%
======== ======
----------------
(1) Based on remaining maturity of certificates.
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of September 30, 2010. Jumbo
certificates of deposit have principal balances of $100,000 or more and the
rates paid on these accounts are generally negotiable.
Maturity Period Amount
------------------------------ ----------
(In thousands)
Three months or less.............. $23,157
Over three through six months..... 20,549
Over six through twelve months.... 26,715
Over twelve months................ 22,585
-------
Total........................... $93,006
=======
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,
------------------------------------------------------------------------------------
2010 2009 2008
------------------------------ ----------------------------- -------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- ---------- -------- -------- ---------- ------- --------
(Dollars in thousands)
Non-interest-bearing.... $ 58,755 10.15% $ 8,460 $ 50,295 9.95% $ (1,660) $ 51,955 10.42%
NOW checking............ 153,304 26.48 35,947 117,357 23.21 26,889 90,468 18.15
Savings................. 67,448 11.65 8,839 58,609 11.59 2,218 56,391 11.31
Money market............ 55,723 9.63 (6,755) 62,478 12.36 (7,901) 70,379 14.11
Certificates of deposit
which mature:
Within 1 year......... 177,911 30.74 (4,374) 182,285 36.04 6,468 175,817 35.26
After 1 year, but
within 2 years....... 43,032 7.43 20,445 22,587 4.47 (23,820) 46,407 9.31
After 2 years, but
within 5 years....... 22,386 3.87 10,652 11,734 2.32 4,975 6,759 1.36
Certificates maturing
thereafter........... 310 0.05 (6) 316 0.06 (80) 396 0.08
-------- ------ ------- -------- ------ ------ -------- ------
Total................... $578,869 100.00% $73,208 $505,661 100.00% $7,089 $498,572 100.00%
======== ====== ======= ======== ====== ====== ======== ======
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,
------------------------------
2010 2009 2008
-------- -------- --------
(In thousands)
0.00 - 1.99%............... $194,142 $ 59,466 $ 866
2.00 - 3.99%............... 48,059 146,513 203,859
4.00 - 5.99%............... 1,374 10,569 24,274
6.00% - and over........... 64 374 380
-------- -------- --------
Total...................... $243,639 $216,922 $229,379
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth
the amount and maturities of certificates of deposit at September 30, 2010.
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%.............. $152,796 $39,880 $ 1,466 $ -- $194,142
2.00 - 3.99%.............. 24,741 2,509 20,499 310 48,059
4.00 - 5.99%.............. 310 643 421 -- 1,374
6.00% and over............ 64 -- -- -- 64
-------- ------- ------- ------ --------
Total..................... $177,911 $43,032 $22,386 $ 310 $243,639
======== ======= ======= ====== ========
Deposit Activities. The following table sets forth the deposit
activities of the Bank for the periods indicated.
Year Ended September 30,
------------------------------
2010 2009 2008
-------- -------- --------
(In thousands)
Beginning balance.................... $505,661 $498,572 $466,735
Net deposits (withdrawals) before
interest credited................... 65,401 (2,383) 20,075
Interest credited.................... 7,807 9,472 11,762
-------- -------- --------
Net increase in deposits............. 73,208 7,089 31,837
-------- -------- --------
Ending balance....................... $578,869 $505,661 $498,572
======== ======== ========
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, 2010, 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 $75.0 million was outstanding.
25
The Bank also utilizes overnight repurchase agreements with customers. These
overnight repurchase agreements are classified as other borrowings and totaled
$622,000 at September 30, 2010. The Bank also maintains a short-term
borrowing line with the FRB with total credit based on eligible collateral.
At September 30, 2010, the Bank had no outstanding balance and $41.4 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 Ended September 30,
-------------------------------
2010 2009 2008
-------- -------- --------
(Dollars in thousands)
Average total borrowings................... $ 75,408 $ 97,393 $108,858
Weighted average rate paid on total
borrowings................................ 4.03% 4.14% 4.27%
Total borrowings outstanding at end of
period.................................... $ 75,622 $105,777 $105,386
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 Ended September 30,
-------------------------------
2010 2009 2008
-------- -------- --------
(Dollars in thousands)
Maximum amount outstanding at any month end:
FHLB advances............................... $ -- $ -- $42,600
Repurchase agreements....................... 750 844 1,884
Pacific Coast Bankers' Bank ("PCBB")
borrowings................................. -- -- --
FRB borrowings.............................. 10,000 10,000 --
Average outstanding during period:
FHLB advances............................... $ -- $ 15 $13,366
Repurchase agreements....................... 539 624 943
PCBB borrowings............................. -- 6 12
FRB borrowings.............................. 384 27 --
------- ------- -------
Total average outstanding during period...... $ 923 $ 672 $14,321
======= ======= =======
Weighted average rate paid during period:
FHLB advances............................... --% 0.71% 4.44%
Repurchase agreements....................... 0.05 0.08 2.12
PCBB borrowings............................. -- 1.48 5.27
FRB borrowings.............................. 0.66 0.50 --
Total weighted average rate paid during
period...................................... 0.30 0.12 4.29
(table continued on following page)
26
At or For the
Year Ended September 30,
-------------------------------
2010 2009 2008
-------- -------- --------
(Dollars in thousands)
Outstanding at end of period:
FHLB advances................................ $ -- $ -- $ --
Repurchase agreements........................ 622 777 758
PCBB borrowings.............................. -- -- --
FRB borrowings............................... -- 10,000 --
------ ------- ------
Total outstanding at end of period............ $ 622 $10,777 $ 758
====== ======= ======
Weighted average rate at end of period:
FHLB advances................................ --% % --%
Repurchase agreements........................ 0.05 0.05 1.05
PCBB borrowings.............................. -- -- --
FRB borrowings............................... -- 0.50 --
Total weighted average rate at end of period.. 0.05 0.50 1.05
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, 2010, the Bank had $13.4 million in bank owned life insurance.
Regulation of the Bank
General. The Bank, as a state-chartered savings bank, is subject to
regulation and oversight by the Division and the applicable provisions of
Washington law and regulations of the Division adopted thereunder. The Bank
also is subject to regulation and examination by the FDIC, which insures the
deposits of the Bank to the maximum extent permitted by law, and requirements
established by the Federal Reserve. State law and regulations govern the
Bank's ability to take deposits and pay interest thereon, to make loans on or
invest in residential and other real estate, to make consumer loans, to invest
in securities, to offer various banking services to its customers, and to
establish branch offices. Under state law, savings banks in Washington also
generally have all of the powers that federal savings banks have under federal
laws and regulations. The Bank is subject to periodic examination and
reporting requirements by and of the Division and the FDIC.
In December 2009, the FDIC and the Division agreed to terms on an
informal supervisory agreement the Bank MOU. 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 payments due May 15, 2010, August
15, 2010 and November 15, 2010. 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 of understanding issued by their respective regulators and lack of
compliance could result in additional regulatory actions."
27
Recent Legislative and Regulatory Initiatives to Address Financial and
Economic Crises. Legislation is introduced from time to time in the United
States Congress that may affect the Company's and the Bank's operations. In
addition, the regulations governing the Company and the Bank may be amended
from time to time by the FDIC. Any such legislation or regulatory changes
could adversely affect the Company and the Bank and no prediction can be made
as to whether any such changes may occur.
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, 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.
* Change the assessment base for federal deposit insurance from
deposits to average total assets minus tangible equity.
* 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, repeal 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.
Temporary Liquidity Guaranty Program. Following a systemic risk
determination, the FDIC established a Temporary Liquidity Guarantee Program
("TLGP") on October 14, 2008. The TLGP includes the Transaction Account
Guarantee Program, which provides unlimited deposit insurance coverage through
December 31, 2010 for noninterest-bearing transaction accounts (typically
business checking accounts) and certain funds swept into noninterest-bearing
savings accounts ("TAGP"). Institutions participating in the TAGP pay a 10
basis point fee (annualized) on the balance of each covered account in excess
of $250,000, while the extra deposit insurance is in place. The TLGP also
includes the Debt Guarantee Program ("DGP"), under which the FDIC guarantees
certain senior unsecured debt of FDIC-insured institutions and their holding
companies. The TAGP and DGP are in effect for all eligible entities, unless
the entity opted out on or before December 5, 2008. The Company did not opt
out of the program. At September 30, 2010, the DGP
28
coverage limit is equal to 2% of the Bank's liabilities; however, the Bank did
not have any senior unsecured debt which was being guaranteed under the DGP at
that time.
Insurance of Accounts and Regulation by the FDIC. The Bank's deposits
are insured up to applicable limits by the Deposit Insurance Fund ("DIF") of
the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC insured
institutions. It also may prohibit any FDIC insured institution from engaging
in any activity the FDIC determines by regulation or order to pose a serious
risk to the insurance fund.
The FDIC currently assesses deposit insurance premiums on each
FDIC-insured institution quarterly based on annualized rates for one of four
risk categories applied to its deposits subject to certain adjustments. Each
institution is assigned to one of four risk categories based on its capital,
supervisory ratings and other factors. Well capitalized institutions that are
financially sound with only a few minor weaknesses are assigned to Risk
Category I. Risk Categories II, III and IV present progressively greater
risks to the DIF. Under FDIC's current risk-based assessment rules, the
initial base assessment rates prior to adjustments range from 12 to 16 basis
points for Risk Category I, 22 basis points for Risk Category II, 32 basis
points for Risk Category III, and 45 basis points for Risk Category IV.
Initial base assessment rates are subject to adjustments based on an
institution's unsecured debt, secured liabilities and brokered deposits, such
that the total base assessment rates after adjustments range from 7 to 24
basis points for Risk Category I, 17 to 43 basis points for Risk Category II,
27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for
Risk Category IV. The FDIC's regulations include authority for the FDIC to
increase or decrease total base assessment rates in the future by as much as
three basis points without a formal rulemaking proceeding. No institution may
pay a dividend if in default of the FDIC assessment.
The Dodd-Frank Act requires the FDIC to amend its regulations to define
the assessment base against which deposit insurance premiums are calculated as
a depository institution's average total consolidated assets minus the
institution's average tangible equity. In November 2009, the FDIC issued a
proposed rule under which, effective in the second calendar quarter of 2011,
the assessment base would be average consolidated assets minus Tier 1 capital.
The FDIC has stated that it set rates using the new assessment base such that
the revenues it receives will be approximately the same as under the current
assessment base. Under the proposal, initial base assessment rates for
institutions with less than $10 billion in assets would be from 5-9 basis
points for Risk Category I, 14 basis points for Risk Category II, 23 basis
points for Risk Category III and 35 basis points for Risk Category IV. After
a downward adjustment for certain long-term, unsecured debt issued by an
institution and an upward adjustment for brokered deposits (except in Risk
Category I), total assessments rates would range from 2.5-9 basis points for
Risk Category I, 9-24 basis points for Risk Category II, 18-33 basis points
for Risk Category III, and 30-45 basis points for Risk Category IV, subject to
further increase in the case of an institution that holds unsecured debt
issued by another FDIC-insured institution. The Bank is currently classified
as a Risk Category II institution.
The Dodd-Frank Act increased the minimum designated reserve ratio or DRR
(the ratio of the net worth of the DIF to estimated insured deposits) from
1.15% of estimated deposits to 1.35% of estimated deposits (or a comparable
percentage of the asset-based assessment base described above). The
Dodd-Frank Act requires the FDIC to offset the effect of the increase in the
DRR when setting assessments for insured depository institutions with less
than $10 billion in total consolidated assets, including the Bank. The FDIC
has until September 30, 2020 to achieve the new DRR of 1.35%.
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.
On November 12, 2009, the FDIC required insured depository institutions
to prepay their quarterly risk-based assessments for the quarter ended
December 31, 2009 and for all of calendar 2010, 2011, and 2012, on December
30,
29
2009, along with each institution's risk-based assessment for the third
quarter of 2009. In December 2009, the Bank paid the prepaid assessment of
$4.4 million; and as of September 30, 2010, the remaining prepaid balance was
$3.3 million.
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
wellcapitalized 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, 2010, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC. For additional
information on capital requirements, see Note 19 of the Notes to the
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
Standards for Safety and Soundness. The federal banking regulatory
agencies have prescribed, by regulation, guidelines for all insured depository
institutions relating to: internal controls, information systems and internal
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, asset quality, earnings, and compensation, fees and
benefits. The guidelines set forth the safety and soundness standards that
the federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. Each insured
depository institution must implement a comprehensive written information
security program that includes administrative, technical, and physical
safeguards appropriate to the institution's size and complexity and the nature
and scope of its activities. The information security program also must be
designed to ensure the security and confidentiality of customer information,
protect against any unanticipated threats or hazards to the security or
integrity of such information, protect against unauthorized access to or use
of such information that could result in substantial harm or inconvenience to
any customer, and ensure the proper disposal of customer and consumer
information. Each insured depository institution must also develop and
implement a risk-based response program to address incidents of unauthorized
access to customer information in customer information systems. If the FDIC
determines that the Bank fails to meet any standard prescribed by the
guidelines, the agency may require the Bank to submit to the agency an
acceptable plan to achieve compliance with the standard. FDIC regulations
establish deadlines for the submission and review of such safety and soundness
compliance plans. Management of the Bank is not aware of any conditions
relating to these safety and soundness standards which would require
submission of a plan of compliance.
Capital Requirements. Federally insured savings institutions, such as
the Bank, are required to maintain a minimum level of regulatory capital.
FDIC regulations recognize two types, or tiers, of capital: core ("Tier 1")
capital and supplementary ("Tier 2") capital. Tier 1 capital generally
includes common shareholders' equity and noncumulative perpetual preferred
stock, less most intangible assets. Tier 2 capital, which is limited to 100%
of Tier 1 capital, includes such items as qualifying general loan loss
reserves, cumulative perpetual preferred stock, mandatory convertible debt,
term subordinated debt and limited life preferred stock; however, the amount
of term subordinated debt and intermediate
30
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, 2010, the Bank had a Tier
1 leverage capital ratio of 10.0%. 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, 2010, the
Bank's ratio of total capital to risk-weighted assets was 14.9% and the ratio
of Tier 1 capital to risk-weighted assets was 13.6%.
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, 2010, the Bank had a net
worth of 9.7% of total assets.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2010. 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, 2010
------------------------------
Percent of Adjusted
Amount Total Assets (1)
-------- -------------------
(Dollars in thousands)
Tier 1 (leverage) capital................... $72,784 10.0%
Tier 1 (leverage) capital requirement (2)... 72,809 10.0
------- ----
Deficit..................................... $ (25) --%
======= ====
Tier 1 risk adjusted capital................ $72,784 13.6%
Tier 1 risk adjusted capital requirement.... 32,036 6.0
------- ----
Excess...................................... $40,748 7.6%
======= ====
Total risk-based capital.................... $79,515 14.9%
Total risk-based capital requirement........ 53,393 10.0
------- ----
Excess...................................... $26,122 4.9%
======= ====
(Footnotes on following page)
31
-------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $728.1 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $533.9 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.
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."
Real Estate Lending Standards. FDIC regulations require the Bank to
adopt and maintain written policies that establish appropriate limits and
standards for real estate loans. These standards, which must be consistent
with safe and sound banking practices, must establish loan portfolio
diversification standards, prudent underwriting standards (including
loan-to-value ratio limits) that are clear and measurable, loan administration
procedures, and documentation, approval and reporting requirements. The Bank
is obligated to monitor conditions in its real estate markets to ensure that
its standards continue to be appropriate for current market conditions. The
Bank's Board of Directors is required to review and approve the Bank's
standards at least annually. The FDIC has published guidelines for compliance
with these regulations, including supervisory limitations on loan-to-value
ratios for different categories of real estate loans. Under the guidelines,
the aggregate amount of all loans in excess of the supervisory loan-to-value
ratios should not exceed 100% of total capital, and the total of all loans for
commercial, agricultural, multifamily or other non-one- to four-family
residential properties should not exceed 30% of total capital. Loans in
excess of the supervisory loan-to-value 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, 2010, the Bank's aggregate loans in excess
of the supervisory loan-to-value ratios were 2.0% 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 15% 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. The law also provides that Washington-chartered savings
banks may exercise any of the powers of Washington-chartered commercial banks,
national banks and federally-chartered savings banks, subject to the approval
of the Director in certain situations. Finally, the law provides additional
flexibility for Washington-chartered commercial and savings banks with
32
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, 2010, 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.
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.
33
Privacy Standards. The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA") modernized the financial services industry
by establishing a comprehensive framework to permit affiliations among
commercial banks, insurance companies, securities firms and other financial
service providers. The Bank is subject to FDIC regulations implementing the
privacy protection provisions of the GLBA. These regulations require the Bank
to disclose its privacy policy, including informing consumers of its
information sharing practices and informing consumers of their rights to opt
out of certain practices.
Other Consumer Protection Laws and Regulations. The Bank is subject to a
broad array of federal and state consumer protection laws and regulations that
govern almost every aspect of its business relationships with consumers.
While the list set forth below is not exhaustive, these include the
Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer
Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act,
the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt
Collection Practices Act, the Right to Financial Privacy Act, the Home
Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit
Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st
Century Act, laws governing flood insurance, laws governing consumer
protections in connection with the sale of insurance, federal and state laws
prohibiting unfair and deceptive business practices, and various regulations
that implement some or all of the foregoing. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits, making
loans, collecting loans, and providing other services. Failure to comply with
these laws and regulations can subject the Bank to various penalties,
including but not limited to, enforcement actions, injunctions, fines, civil
liability, criminal penalties, punitive damages, and the loss of certain
contractual rights.
The Americans with Disabilities Act requires employers with 15 or more
employees and all businesses operating "commercial facilities" or "public
accommodations" to accommodate disabled employees and customers. The
Americans with Disabilities Act has two major objectives: (i) to prevent
discrimination against disabled job applicants, job candidates and employees,
and (ii) to provide disabled persons with ready access to commercial
facilities and public accommodations. Commercial facilities, such as the
Bank, must ensure that all new facilities are accessible to disabled persons,
and in some instances may be required to adapt existing facilities to make
them accessible.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"), and
the regulations of the Federal Reserve. As a bank holding company, the
Company is required to file with the Federal Reserve annual reports and such
additional information as the Federal Reserve may require and will be subject
to regular examinations by the Federal Reserve. The Federal Reserve also has
extensive enforcement authority over bank holding companies, including, among
other things, the ability to assess civil money penalties, to issue cease and
desist or removal orders and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices.
The Bank Holding Company Act. Under the Bank Holding Company Act, the
Company is supervised by the Federal Reserve. The Federal Reserve has a
policy that a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and may not conduct
its operations in an unsafe or unsound manner. In addition, the Federal
Reserve provides that bank holding companies should serve as a source of
strength to its subsidiary banks by being prepared to use available resources
to provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity, and should maintain the financial flexibility
and capital raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligation to
serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
34
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 the Division. In addition, in May and August
2010, the FRB denied the Company's request to pay cash dividends on its common
stock. 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.
35
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, 2010, the Company's total risk based capital was 16.3% of risk-weighted
assets, its risk based capital of Tier 1 (core) capital was 15.0% of
risk-weighted assets and its Tier 1 (core) capital was 11.0% 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.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." These
rules required that all institutions recapture all or a portion of their
allowance for loan losses added since the base year (last taxable year
beginning before January 1, 1988). The Bank had previously recorded deferred
taxes equal to the bad debt recapture and as such the new rules had no effect
on the net income or federal income tax expense. For taxable years beginning
after December 31, 1995, the Bank's bad debt deduction is determined under the
experience method using a formula based on actual bad debt experience over a
period
36
of years or, if the Bank is a "large" association (assets in excess of $500
million) on the basis of net charge-offs during the taxable year. The
unrecaptured base year reserves will not be subject to recapture as long as
the institution continues to carry on the business of banking. In addition,
the balance of the pre-1988 bad debt reserves continue to be subject to
provisions of present law referred to below that require recapture in the case
of certain excess distributions to shareholders. The Bank has recaptured all
federal tax bad debt reserves that had been accumulated since October 1, 1988.
Distributions. To the extent that the Bank makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its 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 35% corporate income tax rate (exclusive of state and
local taxes). See "- Regulation of the Bank - Dividends" for limits on the
payment of dividends by the Bank. The Bank does not intend to pay dividends
that would result in a recapture of any portion of its tax 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,
2006.
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.
37
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, 2010, the Bank had 250 full-time employees and 33
part-time and on-call employees. The employees are not represented by a
collective bargaining unit and the Bank believes its relationship with its
employees is good.
Executive Officers of the Registrant
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.
Executive Officers of the Company and Bank
Age at Position
September -------------------------------------------------
Name 30, 2010 Company Bank
----------------- --------- ------------------------- ----------------------
Michael R. Sand 56 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 43 Executive Vice President, Executive Vice
Chief Financial Officer President, Chief
and Secretary Financial Officer and
Secretary
Robert A. Drugge 59 Executive Vice President Executive Vice
President and
Business Banking
Division Manager
John P. Norawong 45 Executive Vice President Executive Vice
President and
Community Banking
Division Manager
Marci A. Basich 41 Senior Vice President Senior Vice President
and Treasurer and Treasurer
Kathie M. Bailey 59 Senior Vice President Senior Vice President
and Chief Operations
Officer
Michael J. Scott 64 Senior Vice President
and Chief Credit
Administrator
Biographical Information.
Michael R. Sand has been affiliated with the Bank since 1977 and has
served as President of the Bank and the Company since January 23, 2003. On
September 30, 2003, he was appointed as Chief Executive Officer of the Bank
and Company. Prior to appointment as President and Chief Executive Officer,
Mr. Sand had served as Executive Vice President and Secretary of the Bank
since 1993 and as Executive Vice President and Secretary of the Company since
its formation in 1997.
38
Dean J. Brydon has been affiliated with the Bank since 1994 and has
served as the Chief Financial Officer of the Company and the Bank since
January 2000 and Secretary of the Company and Bank since January 2004. Mr.
Brydon is a Certified Public Accountant.
Robert A. Drugge has been affiliated with the Bank since April 2006 and
has served as Executive Vice President and Business Banking Manager since
September 2006. Prior to joining Timberland, Mr. Drugge was employed at Bank
of America as an executive officer and most recently served as Senior Vice
President. Mr. Drugge began his banking career at Seafirst in 1974, which was
acquired by Bank America Corp. and became known as Bank of America.
John P. Norawong has been affiliated with the Bank since July 2006 and
has served as Executive Vice President and Community Banking Division Manager
since September 2006. Prior to joining Timberland, Mr. Norawong served as
Senior Vice President and Commercial Bank Manager at United Commercial Bank
from February 2006 to July 2006, and as Vice President and Senior Vice
President at Key Bank from 1999 through 2006.
Marci A. Basich has been affiliated with the Bank since 1999 and has
served as Treasurer of the Company and the Bank since January 2002. Ms.
Basich is a Certified Public Accountant.
Kathie M. Bailey has been affiliated with the Bank since 1984 and has
served as Senior Vice President and Chief Operations Officer since 2003.
Michael J. Scott has been affiliated with the Bank since January 2008 and
has served as Senior Vice President and Chief Credit Administrator. Prior to
joining Timberland, Mr. Scott was employed by Bank of America where he was a
Senior Vice President and Senior Credit Products Officer for the past several
years in both Seattle and Tacoma. He began his banking career at Seafirst in
1973, which was acquired by Bank America Corp. and became known as Bank of
America.
Item 1A. Risk Factors
----------------------
We assume and manage a certain degree of risk in order to conduct our
business strategy. In addition to the risk factors described below, other
risks and uncertainties not specifically mentioned, or that are currently
known to, or deemed to be immaterial by management, also may materially and
adversely affect our financial position, results of 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 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:
39
* maintain Tier 1 Capital of not less than 10.0% of the Bank's adjusted
total assets pursuant to Part 325 of the FDIC Rules and Regulations,
and maintain capital ratios above "well capitalized" thresholds as
defined under Section 325.103 of the FDIC Rules and Regulations;
* maintain a fully funded allowance for loan and lease losses, the
adequacy of which shall be deemed to be satisfactory to the FDIC and
the DFI;
* formulate and implement a written profit plan acceptable to the FDIC
and the DFI;
* eliminate from its books all assets classified "Loss" that have not
been previously collected or charged-off;
* reduce the dollar volume by 50% the assets classified "Substandard"
and "Doubtful" at April 30, 2009;
* develop a written plan for reducing the aggregate amount of its
acquisition, development and construction loans; and
* revise, adopt and fully implement a written liquidity and funds
management policy.
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
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, 2010, the FRB has denied the Company's requests to
pay dividends on its Series A Preferred Stock (issued under TARP) for the
payments due May 15, 2010 and August 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 recently 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.
Congress recently enacted 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,
40
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.
Certain provisions of the Dodd-Frank Act are expected to have a near term
impact on the Company. For example, one year after the date of enactment a
provision of the Dodd-Frank Act eliminates 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.
It is difficult to predict at this time what specific impact the
Dodd-Frank Act and the yet to be written implementing rules and regulations
will have on community banks. However, it is expected that at a minimum they
will increase our operating and compliance costs and could increase our
interest expense.
The current economic recession in the market areas we serve may continue to
adversely impact our earnings and could increase the credit risk associated
with our loan portfolio.
Substantially all of our loans are to businesses and individuals in the
state of Washington. A continuing decline in the economies of 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;
* 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 are based upon
estimates of costs and the value of the completed project.
We make real estate construction loans to individuals and builders,
primarily for the construction of residential properties. We originate these
loans whether or not the collateral property underlying the loan is under
contract for sale. At September 30, 2010, construction and land development
loans totaled $69.3 million, or 12.4% of our total loan portfolio, of which
$39.3 million were for residential real estate projects. Approximately $30.9
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 $6.4 million, or 1.2%, of
our total loan portfolio at September 30, 2010. In general, construction and
land development lending involves additional risks because of the inherent
difficulty in estimating a property's value both before and at completion of
the project as well as the estimated cost of the project. Construction costs
may exceed original estimates as a result of increased materials, labor or
other costs. In addition, because of current uncertainties in the residential
real estate market, property values have become more difficult to determine
than they have historically
41
been. Construction loans and land development loans often involve the
disbursement of funds with repayment dependent, in part, on the success of the
project and the ability of the borrower to sell or lease the property or
refinance the indebtedness, rather than the ability of the borrower or
guarantor to repay principal and interest. These loans are also generally
more difficult to monitor. In addition, speculative construction loans to a
builder are often associated with homes that are not pre-sold, and thus pose a
greater potential risk than construction loans to individuals on their
personal residences. At September 30, 2010, $4.8 million of our construction
portfolio was comprised of speculative one- to four-family construction loans.
Approximately $7.6 million, or 11.0%, of our total real estate construction
and land development loans were non-performing at September 30, 2010. 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, 2010, we had $208.0 million commercial real estate
mortgage loans, representing 37.2% 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 Thrift Supervision have
promulgated joint guidance on sound risk management practices for financial
institutions with concentrations in commercial real estate lending. Under this
guidance, a financial institution that, like us, is actively involved in
commercial real estate lending should perform a risk assessment to identify
concentrations. A financial institution may have a concentration in commercial
real estate lending if, among other factors (i) total reported loans for
construction, land development, and other land represent 100% or more of total
capital, or (ii) total reported loans secured by multifamily and non-farm
residential properties, loans for construction, land development and other
land, and loans otherwise sensitive to the general commercial real estate
market, including loans to commercial real estate related entities, represent
300% or more of total capital. The particular focus of the guidance is on
exposure to commercial real estate loans that are dependent on the cash flow
from the real estate held as collateral and that are likely to be at greater
risk to conditions in the commercial real estate market (as
42
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, 2010 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 and an adjustment to our growth strategies.
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, 2010, we had $18.0 million or 3.2% 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, 2010, $159.4 million, or 28.5% 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.
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.
Our provision for loan losses has increased substantially in the years ended
September 30, 2010 and 2009, 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.
43
For the fiscal years ended September 30, 2010 and 2009 we recorded a
provision for loan losses of $10.6 million and $10.7 million, respectively. We
also recorded net loan charge-offs of $13.5 million and $4.4 million for the
fiscal years ended September 30, 2010 and 2009, 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, which represent 30.6% of our non-performing assets at
September 30, 2010. Further, our portfolio is concentrated in construction
and land loans and commercial and commercial real estate loans, all of which
have a higher risk of loss than residential mortgage loans.
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 continuing losses.
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 provision for loan losses and OREO related expenses and write-downs.
We may continue to suffer further losses 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:
* our general reserve, based on our historical default and loss
experience and certain macroeconomic factors based on management's
expectations of future events; and
* our specific reserve, based on our evaluation of impaired loans and
their underlying collateral and cash flows.
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,
44
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 $11.3
million or 2.1% of gross loans held for investment and 45.3% of non-performing
loans at September 30, 2010. In addition, bank regulatory agencies
periodically review our allowance for loan losses and may require an increase
in the provision for possible loan losses or the recognition of further loan
charge-offs, based on judgments different than those of management. If
charge-offs in future periods exceed the allowance for loan losses, we 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 investments in real estate are not properly valued or sufficiently
reserved to cover actual losses, or if we are required to increase our
valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price
opinions when a loan has been foreclosed and the property is taken in as 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 additional charge-offs. Additional material charge-offs to our OREO
could have a material adverse effect on our financial condition and results of
operations.
In addition, bank regulators periodically review our OREO and may require
us to recognize further charge-offs. Any increase in our charge-offs, as
required by such regulators, may have a material adverse effect on our
financial condition and results of operations.
Other-than-temporary impairment charges in our investment securities portfolio
could result in additional losses.
During the year ended September 30, 2010, we recognized a $2.2 million
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, 2010 our remaining private label mortgage backed securities
portfolio totaled $5.0 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 our 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 the FHLMC or
our ability to qualify for their programs may reduce our mortgage revenues,
which would negatively impact our non-interest income.
45
The sale of residential mortgage loans to the FHLMC provides a
significant portion of our non-interest income. Any future changes in their
program, our eligibility to participate in such program, the criteria for
loans to be accepted or laws that significantly affect the activity of the
FHLMC could, in turn, materially adversely affect our results of operations if
we could not find other purchasers. Further, in a rising or higher interest
rate environment, our originations of mortgage loans may decrease, resulting
in fewer loans that are available to be sold. This would result in a decrease
in mortgage revenues and a corresponding decrease in non-interest income. In
addition, our results of operations are affected by the amount of non-interest
expense associated with our loan sale activities, such as salaries and
employee benefits, occupancy, equipment and data processing expense and other
operating costs. During periods of reduced loan demand, our results of
operations may be adversely affected to the extent that we are unable to
reduce expenses commensurate with the decline in loan originations.
Our real estate lending also exposes us to the risk of environmental
liabilities.
In the course of our business, we may foreclose and take title to real
estate, and we could be subject to environmental liabilities with respect to
these properties. We may be held liable to a governmental entity or to third
persons for property damage, personal injury, investigation, and clean-up
costs incurred by these parties in connection with environmental
contamination, or may be required to investigate or clean up hazardous or
toxic substances, or chemical releases at a property. The costs associated
with investigation or remediation activities could be substantial. In
addition, as the owner or former owner of a contaminated site, we may be
subject to common law claims by third parties based on damages and costs
resulting from environmental contamination emanating from the property. If we
ever become subject to significant environmental liabilities, our business,
financial condition and results of operations could be materially and
adversely affected.
Fluctuating interest rates can adversely affect our profitability.
Our profitability is dependent to a large extent upon net interest
income, which is the difference, or spread, between the interest earned on
loans, securities and other interest-earning assets and the interest paid on
deposits, borrowings, and other interest-bearing liabilities. Because of the
differences in maturities and repricing characteristics of our
interest-earning assets and interest-bearing liabilities, changes in interest
rates do not produce equivalent changes in interest income earned on
interest-earning assets and interest paid on interest-bearing liabilities. We
principally manage interest rate risk by managing our volume and mix of our
earning assets and funding liabilities. In a changing interest rate
environment, we may not be able to manage this risk effectively. Changes in
interest rates also can affect: (1) our ability to originate and/or sell
loans; (2) the value of our interest-earning assets, which would negatively
impact shareholders' equity, and our ability to realize gains from the sale of
such assets; (3) our ability to obtain and retain deposits in competition with
other available investment alternatives; and (4) the ability of our borrowers
to repay adjustable or variable rate loans. Interest rates are highly
sensitive to many factors, including government monetary policies, domestic
and international economic and political conditions and other factors beyond
our control. If we are unable to manage interest rate risk effectively, our
business, financial condition and results of operations could be materially
harmed.
Our loan portfolio possesses increased risk due to our level of adjustable
rate loans.
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.
Beginning in late 2008, the economic environment caused higher levels of
bank failures, which dramatically increased FDIC resolution costs and led to a
significant reduction in the Deposit Insurance Fund. As a result, the FDIC has
significantly increased the initial base assessment rates paid by financial
institutions for deposit insurance. The base assessment rate was increased by
seven basis points (seven cents for every $100 of deposits) for the first
quarter of 2009. Effective April 1, 2009, initial base assessment rates were
changed to range from 12 basis points to 45 basis points across
46
all risk categories with possible adjustments to these rates based on certain
debt-related components. These increases in the base assessment rate have
increased our deposit insurance costs and negatively impacted our earnings. In
addition, in May 2009, the FDIC imposed a special assessment on all insured
institutions due to recent bank and savings association failures. The
emergency assessment amounts to five basis points on each institution's assets
minus Tier 1 capital as of June 30, 2009, subject to a maximum equal to 10
basis points times the institution's assessment base. Our FDIC deposit
insurance expense for the years ended September 30, 2010 and 2009 was $1.7
million and $778,000, respectively.
Additionally, in November 2009, the FDIC announced that financial
institutions are required to prepay their estimated quarterly risk-based
assessment for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.
In December 2009, we prepaid $4.4 million, which will be expensed over this
three-year period. This prepayment did not immediately impact our earnings as
the payment will be expensed over time, however, any additional emergency
special assessment imposed by the FDIC will adversely affect our earnings.
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 the terms of which are acceptable could be impaired
by factors that affect us specifically or the financial services industry or
economy in general - such as a disruption in the financial markets or negative
views and expectations about the prospects for the financial services industry
in light of the recent turmoil faced by banking organizations and the
continued deterioration in credit markets. Factors that could detrimentally
impact our access to liquidity sources include a decrease in the level of our
business activity as a result of a downturn in the Washington markets where
our loans are concentrated or adverse regulatory action against us.
Our financial flexibility will be severely constrained if we are unable
to maintain our access to funding or if adequate financing is not available to
accommodate future growth at acceptable interest rates. Although we consider
our sources of funds adequate for our liquidity needs, we may seek additional
debt in the future to achieve our long-term business objectives. Additional
borrowings, if sought, may not be available to us or, if available, may not be
available on reasonable terms. If additional financing sources are
unavailable, or are not available on reasonable terms, our financial
condition, results of operations, growth and future prospects could be
materially adversely affected. Finally, if we are required to rely more
heavily on more expensive funding sources to support future growth, our
revenues may not increase proportionately to cover our costs.
Our growth or future losses may require us to raise additional capital in the
future, but that capital may not be available when it is needed or the cost of
that capital may be very high.
We are required by federal regulatory authorities to maintain adequate
levels of capital to support our operations. At some point, we may need to
raise additional capital to support continued growth. Our ability to raise
additional capital, if needed, will depend on conditions in the capital
markets at that time, which are outside our control, and on our financial
condition and performance. 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."
47
We operate in a highly regulated environment and may be adversely affected by
changes in federal and state laws and regulations, including changes that may
restrict our ability to foreclose on single-family home loans and offer
overdraft protection.
We are subject to extensive examination, supervision and comprehensive
regulation by the FDIC and the Washington Department of Financial
Institutions. Banking regulations are primarily intended to protect
depositors' funds, federal deposit insurance funds, and the banking system as
a whole, and not holders of our common stock. These regulations affect our
lending practices, capital structure, investment practices, dividend policy,
and growth, among other things. Congress and federal and state regulatory
agencies continually review banking laws, regulations, and policies for
possible changes. Changes to statutes, regulations, or regulatory policies,
including changes in interpretation or implementation of statutes,
regulations, or policies, could affect us in substantial and unpredictable
ways. Such changes could subject us to additional costs, limit the types of
financial services and products we may offer, restrict mergers and
acquisitions, investments, access to capital, the location of banking offices,
and/or increase the ability of non-banks to offer competing financial services
and products, among other things. Failure to comply with laws, regulations or
policies could result in sanctions by regulatory agencies, civil money
penalties and/or reputational damage, which could have a material adverse
effect on our business, financial condition and results of operations. While
we have policies and procedures designed to prevent any such violations, there
can be no assurance that such violations will not occur.
Further, our regulators have significant discretion and authority to
prevent or remedy unsafe or unsound practices or violations of laws by
financial institutions and holding companies in the performance of their
supervisory and enforcement duties. Congress and federal regulatory agencies
continually review banking laws, regulations and policies for possible
changes. Changes to statutes, regulations or regulatory policies, including
changes in interpretation or implementation of statutes, regulations or
policies, could affect us in substantial and unpredictable ways. Such changes
could subject us to additional costs, limit the types of financial services
and products we may offer and/or increase the ability of non banks to offer
competing financial services and products, among other things.
We may experience future goodwill impairment, which could reduce our earnings.
We performed our test for goodwill impairment for fiscal year 2010, 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 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, 2010, 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 announed that it had entered
into a Consent Agreement with the FHFA, which requires the FHLB to take
certain specified actions related to
48
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. We periodically evaluate the fair value 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 an $890,000 valuation allowance to our MSRs during the year ended
September 30, 2010, which reduced our earnings. Future decreases in mortgage
interest rates could further decrease the fair value of our MSRs, which would
decrease our earnings.
Our assets as of September 30, 2010 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, 2010, the net deferred tax asset was
approximately $3.4 million, a decrease from a balance of approximately $4.5
million at September 30, 2009. 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. 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, 2010 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.
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 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.
49
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. As of September 30, 2010, the FRB has denied the Company's request to
pay dividends on its Series A Preferred Stock (issued under TARP) for the
payments due May 15, 2010 and August 15, 2010. 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.
Moreover, holders of our common stock are entitled to receive dividends only
when, as and if declared by our Board of Directors. Although we have
historically paid cash dividends on our common stock, we are not required to
do so and our Board of Directors could reduce or eliminate our common stock
dividend in the future.
The Series A Preferred Stock impacts net income (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, 2010
(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.
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.
50
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.
Item 1B. Unresolved Staff Comments
-----------------------------------
Not applicable.
Item 2. Properties
-------------------
At September 30, 2010 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, 2010
--------------------------- ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $82,308
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 33,316
Aberdeen, Washington 98520
201 Main Street South 2004 3200 31,472
Montesano, Washington 98563
361 Damon Road 1977 2,100 23,210
Ocean Shores, Washington 98569
2418 Meridian East 1980 2400 39,581
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 28,345
Auburn, Washington 98002
12814 Meridian East (South Hill) 1996 4,200 31,014
Puyallup, Washington 98373
1201 Marvin Road, N.E. 1997 4,400 18,673
Lacey, Washington 98516
101 Yelm Avenue W. 1999 1,800 17,704
Yelm, Washington 98597
51
Approximate Deposits at
Location Year Opened Square Footage September 30, 2010
--------------------------- ----------- -------------- ------------------
(In thousands)
20464 Viking Way NW 1999 3,400 12,738
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,900 26,534
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 28,032
Tumwater, Washington 98512
7805 South Hosmer Street 2001 5,000 25,886
Tacoma, Washington 98408
2401 Bucklin Hill Road 2003 4,000 37,140
Silverdale, Washington 98383
423 Washington Street SE 2003 3,000 16,439
Olympia, Washington 98501
3105 Judson St 2004 2,700 22,904
Gig Harbor, Washington 98335
117 N. Broadway 2004 3,700 19,260
Aberdeen, Washington 98520
313 West Waldrip 2004 5,900 21,422
Elma, Washington 98541
1751 Circle Lane SE 2004 900 15,306
Lacey, Washington 98503
101 2nd Street 2004 1,800 20,617
Toledo, Washington 98591
209 NE 1st Street 2004 3,400 15,622
Winlock, Washington 98586
714 W. Main Street 2009 4,600 11,346
Chehalis, Washington 98532
Loan Center/Data Center:
120 Lincoln Street 2003 6,000 --
Hoquiam, Washington 98550
Other Properties:
305 8th Street(1)
Hoquiam, Washington 98550 2004 4,100 --
------------
(1) Office at 305 8th Street, Hoquiam, Washington was consolidated into the
office at 624 Simpson Avenue, Hoquiam, Washington on November 15, 2004.
The building is currently being used for storage and other
administrative purposes.
Management believes that all facilities are appropriately insured and are
adequately equipped for carrying on the business of the Bank.
52
At September 30, 2010 the Bank operated 23 proprietary ATMs that are part
of a nationwide cash exchange network.
Item 3. Legal Proceedings
--------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties
in which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Bank is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Bank.
Item 4. [Removed and Reserved]
------------------------------
53
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, 2010, there were 7,045,036 shares of
common stock issued and approximately 605 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, 2010 and 2009. The high and low price information was provided
by the Nasdaq Stock Market.
High Low Dividends
-------- ------- -----------
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 --
High Low Dividends
-------- ------- -----------
Fiscal 2009
-----------
First Quarter.................. $7.99 $5.10 $0.11
Second Quarter................. 7.93 1.94 0.11
Third Quarter.................. 6.00 3.57 0.11
Fourth Quarter................. 5.63 3.90 0.06
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, 2010, the FRB has denied the
Company's request to pay dividends on its Series A Preferred Stock issued
under the CPP for the payments due on May 15, 2010 and August 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."
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d)
in Part III, Item 12. of this Form 10-K is incorporated herein by reference.
Stock Repurchases
The Company 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
54
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, 2005.
[GRAPH APPEARS HERE]
Period Ending
----------------------------------------------------------
Index 09-30-05 09-30-06 09-30-07 09-30-08 09-30-09 09-30-10
------------------ -------- -------- -------- -------- -------- --------
Timberland Bancorp,
Inc............... $100.00 154.92 141.08 70.87 46.78 41.12
NASDAQ Composite... 100.00 104.96 125.55 97.22 98.64 110.08
SNL $250M-$500 M
Thrift Index...... 100.00 108.82 100.55 85.50 80.16 81.83
SNL $500M-$1 B
Thrift Index...... 100.00 116.17 111.96 83.83 70.18 67.32
* Source: SNL Financial LC, Charlottesville, VA
55
Item 6. Selected Financial Data
--------------------------------
The following table sets forth certain information concerning the
consolidated financial position and results of operations of the Company and
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,
----------------------------------------------
2010 2009 2008 2007 2006
------- ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets................ $742,687 $701,676 $681,883 $644,848 $577,087
Loans receivable and loans
held for sale, net......... 527,591 547,208 557,687 515,341 424,645
Investment securities
available-for-sale......... -- -- -- 50,851 63,805
Investment securities held-
to-maturity................ 28 27 28 -- --
Mortgage-backed securities
held-to-maturity........... 5,038 7,060 14,205 71 75
Mortgage-backed securities
and mutual funds
available-for-sale......... 11,119 13,471 17,098 13,047 17,603
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......... 111,786 66,462 42,874 16,670 22,789
Certificates of deposit
held for investment........ 18,047 3,251 -- -- 100
Deposits.................... 578,869 505,661 498,572 466,735 431,061
FHLB advances............... 75,000 95,000 104,628 99,697 62,761
Federal Reserve Bank
advances................... -- 10,000 -- -- --
Shareholders' equity........ 85,408 87,199 74,841 74,547 79,365
Year Ended September 30,
----------------------------------------------
2010 2009 2008 2007 2006
------- ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income..................... $ 36,596 $38,801 $43,338 $41,944 $35,452
Interest expense............ 10,961 13,504 16,413 15,778 10,814
-------- ------- ------- ------- -------
Net interest income......... 25,635 25,297 26,295 26,166 24,638
Provision for loan losses... 10,550 10,734 3,900 686 --
-------- ------- ------- ------- -------
Net interest income after
provision for loan losses.. 15,085 14,563 23,025 25,480 24,638
Non-interest income......... 5,696 6,949 4,178 5,962 6,244
Non-interest expense........ 24,641 22,739 20,349 19,451 18,896
Income (loss) before income
taxes...................... (3,860) (1,227) 6,854 11,991 11,986
Provision (benefit) for
federal and state income
taxes...................... (1,569) (985) 2,849 3,828 3,829
-------- ------- ------- ------- -------
Net income (loss)........... $ (2,291) $ (242) $ 4,005 $ 8,163 $ 8,157
======== ======= ======= ======= =======
Preferred stock dividends... $ (832) $ (643) $ -- $ -- $ --
Preferred stock accretion... (210) (129) -- --
-------- ------- ------- ------- -------
Net income (loss) to common
shareholders............... $ (3,333) $(1,014) $ 4,005 $ 8,163 $ 8,157
======== ======= ======= ======= =======
Net income (loss) per
common share (1):
Basic..................... $ (0.50) $ (0.15) $ 0.62 $ 1.20 $ 1.16
Diluted................... $ (0.50) $ (0.15) $ 0.61 $ 1.17 $ 1.12
Dividends per common
share (1).................. $ 0.04 $ 0.39 $ 0.43 $ 0.37 $ 0.33
Dividend payout ratio (2)... N/A N/A 74.33% 32.86% 30.55%
-------------
(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.
56
At September 30,
----------------------------------------------
2010 2009 2008 2007 2006
------- ------ ------ ------ ------
OTHER DATA:
Number of real estate loans
outstanding................ 2,919 3,062 3,261 3,295 3,005
Deposit accounts............ 55,598 53,941 53,501 53,166 51,392
Full-service offices........ 22 22 21 21 21
At or For the Year Ended September 30,
----------------------------------------------
2010 2009 2008 2007 2006
------- ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return (loss) on average
assets (1)................ (0.32)% (0.04)% 0.61% 1.34% 1.47%
Return (loss) on average
equity (2)................ (2.65) (0.28) 5.35 10.67 10.59
Interest rate spread (3)... 3.63 3.64 3.98 4.18 4.49
Net interest margin (4).... 3.87 4.01 4.41 4.69 4.91
Average interest-earning
assets to average interest-
bearing liabilities....... 114.51 117.42 115.70 118.01 119.20
Noninterest expense as a
percent of average total
assets.................... 3.43 3.35 3.10 3.20 3.41
Efficiency ratio (5)....... 78.65 70.52 65.42 60.54 61.19
Book value per common
share..................... $ 9.89 10.17 $10.74 $10.72 $10.56
Tangible book value per
common share (6).......... 9.00 9.26 9.79 9.73 9.61
Asset Quality Ratios:
Non-accrual and 90 days or
more past due loans as a
percent of total loans
receivable, net........... 4.86% 5.36% 2.12% 0.29% 0.02%
Non-performing assets as a
percent of total assets
(7)....................... 5.53 5.52 1.83 0.23 0.02
Allowance for loan losses
as a percent of total loans
receivable, net (8)....... 2.09 2.59 1.44 0.92 0.96
Allowance for losses as a
percent of non-performing
loans (9)................. 43.01 47.11 67.14 321.95 5,152.50
Net charge-offs (recoveries)
to average outstanding
loans..................... 2.45 0.79 0.12 -- (0.01)
Capital Ratios:
Total equity-to-assets
ratio (6)................. 11.50% 12.43% 10.98% 11.56% 13.75%
Tangible equity-to-assets
ratio..................... 10.66 11.51 10.00 10.49 12.51
Average equity to average
assets.................... 12.05 12.72 11.47 12.58 13.90
------------------
(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) Calculation subtracts goodwill and core deposit intangible from the
equity component.
(7) 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.
(8) Loans receivable includes loans held for sale and is before the allowance
for loan losses.
(9) 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.
57
Item 7. Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
Results of Operations
---------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results
of Operations is intended to assist in understanding the consolidated
financial condition and results of operations of the Company. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying notes thereto included in Item 8 of this
Annual Report on Form 10-K.
Special Note Regarding Forward-Looking Statements
These forward-looking statements are intended to be covered by the safe
harbor for forward- looking statements provided by the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are not statements
of historical fact and often include the words "believes," "expects,"
"anticipates," "estimates," "forecasts," "intends," "plans," "targets,"
"potentially," "probably," "projects," "outlook" or similar expressions or
future or conditional verbs such as "may," "will," "should," "would" and
"could." Forward-looking statements include statements with respect to our
beliefs, plans, objectives, goals, expectations, assumptions and statements
about future performance. These forward-looking statements are subject to
known and unknown risks, uncertainties and other factors that could cause 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 nonperforming assets in our loan portfolio, and
may result in our allowance for loan losses not being adequate to cover actual
losses, and require us to materially increase our reserves; changes in general
economic conditions, either nationally or in our market areas; changes in the
levels of general interest rates, and the relative differences between short
and long term interest rates, deposit interest rates, our net interest margin
and funding sources; fluctuations in the demand for loans, the number of
unsold homes, land and other properties and fluctuations in real estate values
in our market areas; secondary market conditions for loans and our ability to
sell loans in the secondary market; results of examinations of us by the
Federal Reserve 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, require us to
increase our reserve for loan losses, write-down assets, change our regulatory
capital position or affect our ability to borrow funds or maintain or increase
deposits, which could adversely affect our liquidity and earnings; our
compliance with regulatory enforcement actions, 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; our ability to attract and retain deposits; further
increases in premiums for deposit insurance; our ability to control operating
costs and expenses; the use of estimates in determining fair value of certain
of our assets, which estimates may prove to be incorrect and result in
significant declines in valuation; difficulties in reducing risks associated
with the loans on our balance sheet; staffing fluctuations in response to
product demand or the implementation of corporate strategies that affect our
workforce and potential associated charges; computer systems on which we
depend could fail or experience a security breach; our ability to retain key
members of our senior management team; costs and effects of litigation,
including settlements and judgments; our ability to successfully integrate any
assets, liabilities, customers, systems, and management personnel we may in
the future acquire into our operations and our ability to realize related
revenue synergies and cost savings within expected time frames and any
goodwill charges related thereto; 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 availability of
resources to address changes in laws, rules, or regulations or to respond to
regulatory actions; adverse changes in the securities markets; inability of
key third-party providers to perform their obligations to us; changes in
accounting policies and practices, as may be issued by the financial
institution
58
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 2011 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.
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 September 30, 2010 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.
59
Mortgage Servicing Rights ("MSRs"). 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 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, 2010,
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, 2010, there have been no events or changes in the
circumstances that would indicate a potential impairment. No assurance can be
given, however, that the Company will not record an impairment loss on
goodwill in the future.
Other Real Estate Owned and Other Repossessed 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.
60
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 the latter half of 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.
Portfolio Diversification. 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.
61
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, 2010, an immediate increase in interest rates of 200
basis points would increase the Bank's projected net interest income by
approximately 7.0%, primarily because a larger portion of the Bank's interest
rate sensitive assets than interest rate sensitive liabilities would reprice
within a one year period. Similarly, an immediate 200 basis point decrease in
interest rates would negatively affect net interest income by approximately
4.4%, as repricing would have the opposite effect. See "- Quantitative
Aspects of Market Risk" below for additional information. Management has
sought to sustain the match between asset and liability maturities and rates,
while maintaining an acceptable interest rate spread. Pursuant to this
strategy, the Bank actively originates adjustable-rate loans for retention in
its loan portfolio. Fixed-rate mortgage loans with maturities greater than
seven years generally are originated for the immediate or future resale in
the secondary mortgage market. At September 30, 2010, adjustable-rate
mortgage loans constituted $165.8 million or 37.6%, of the Bank's total
mortgage loan portfolio due after one year. Although the Bank has sought to
originate ARM loans, the
62
ability to originate such loans depends to a great extent on market interest
rates and borrowers' preferences. Particularly in lower interest rate
environments, borrowers often prefer fixed-rate loans.
Consumer loans and construction and land development loans typically have
shorter terms and higher yields than permanent residential mortgage loans, and
accordingly reduce the Bank's exposure to fluctuations in interest rates. At
September 30, 2010, the construction and land development, and consumer loan
portfolios amounted to $69.3 million and $47.5 million, or 12.4% and 8.5% 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, 2010.
Net Interest Income(1)(2) Current Market Value
Hypothetical ------------------------------ -------------------------------
Interest Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario Value from Base from Base Value from Base from Base
------------- --------- --------- --------- --------- --------- ---------
(Basis Points) (Dollars in thousands)
+300 $26,520 $ 2,307 9.53% $ 97,859 $ (113) (0.12)%
+200 25,909 1,696 7.00 98,786 814 0.83
+100 25,070 857 3.54 98,681 709 0.72
BASE 24,213 -- -- 97,972 -- --
-100 24,015 (198) (0.81) 96,961 (1,011) (1.03)
-200 23,141 (1,072) (4.43) 100,879 2,907 2.97
-300 22,030 (2,183) (9.02) 112,618 14,646 14.95
----------
(1) Does not include loan fees.
(2) Includes BOLI income, which is included in non-interest income on the
Consolidated Financial Statements.
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan repayments and deposit decay, and should not be relied
upon as indicative of actual results. Furthermore, the computations do not
reflect any actions management may undertake in response to changes in
interest rates.
In the event of a 200 basis point decrease in interest rates, the Bank
would be expected to experience a 3.0% increase in NPV and a 4.4% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 0.8% increase in NPV and a 7.0% increase in net interest income would
be expected. Based upon the modeling described above, the Bank's asset and
liability structure generally results in decreases in net interest income in a
declining interest rate scenario and increases in net interest income in a
rising rate scenario. This structure also generally results in increases in
NPV when rates increase by 200 basis points or less and a decrease in NPV when
rates decrease by 100 basis points or less.
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,
63
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, 2010 and September 30, 2009
The Company's total assets increased by $41.0 million, or 5.8%, to $742.7
million at September 30, 2010 from $701.7 million at September 30, 2009. The
increase was primarily attributable to an increase in cash and cash
equivalents and short-term certificates of deposit ("CDs") held for
investment. These increases were partially offset by a decrease in net loans
receivable.
Net loans receivable decreased by $19.6 million, or 3.6%, to $527.6
million at September 30, 2010 from $547.2 million at September 30, 2009. The
reduction in the loan portfolio was primarily due to a significant decrease in
construction and land development loan balances during the year ended
September 30, 2010, which was partially offset by increases in commercial real
estate loan balances, one- to four-family loan balances, multi-family loan
balances and commercial business loan balances.
Total deposits increased by $73.2 million, or 14.5%, to $578.9 million at
September 30, 2010 from $505.7 million at September 30, 2009, primarily as a
result of increases in N.O.W. checking account balances and CD account
balances.
Shareholders' equity decreased by $1.8 million, or 2.1%, to $85.4 million
at September 30, 2010 from $87.2 million at September 30, 2009. The decrease
was primarily due to a net loss for the year ended September 30, 2010, which
was partially offset by a reduction in the accumulated other comprehensive
loss equity component, due to a reduction in unrealized losses on investment
securities. The Company remains well capitalized with a total risk based
capital ratio of 16.3% at September 30, 2010.
A more detailed explanation of the changes in significant balance sheet
categories follows:
Cash and Cash Equivalents and CDs Held for Investment: Cash and cash
equivalents and CDs held for investment increased by $60.1 million, or 86.2%,
to $129.8 million at September 30, 2010 from $69.7 million at September 30,
2009. The increase in cash equivalents and short-term CDs was primarily due
to the Company's decision to increase its liquidity position for regulatory
and asset-liability management purposes.
Mortgage-backed Securities and Other Investments: Mortgage-backed
securities and other investments decreased by $4.4 million, or 21.3%, to $16.2
million at September 30, 2010 from $20.6 million at September 30, 2009. The
decrease was primarily as a result of regular amortization and prepayments on
mortgage-backed securities and OTTI charges recorded on private label
residential mortgage-backed securities. 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, decreased by
$19.6 million or 3.6% to $527.6 million at September 30, 2010 from $547.2
million at September 30, 2009. The decrease in the portfolio was primarily a
result of a $57.1 million decrease in construction and land development loan
balances (net of the undisbursed portion of construction loans in process), a
$4.1 million decrease in consumer loan balances and a $2.6 million decrease in
land loan balances. These decreases to net loans receivable were partially
offset by a $19.8 million increase in commercial real estate loan balances, a
$10.5 million increase in one- to four-family loan balances, a $6.6 million
increase multi-family loan balances and a $4.2 million increase in commercial
business loan balances. The decreases in the construction and land
development loan balances were primarily due to loan payoffs, construction
projects being completed and converted to permanent financing, loan
charge-offs and changes in the Company's underwriting standards for these
types of loans, which has decreased the level of construction and land
development loan originations.
64
Loan originations decreased by 38.2% to $182.5 million for the year ended
September 30, 2010 from $295.3 million for the year ended September 30, 2009,
primarily due to a decrease 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
Bank sold $68.3 million in fixed rate one- to four-family mortgage loans
during the year ended September 30, 2010 compared to $162.9 million for the
fiscal year ended September 30, 2009. For additional information on loans,
see "Item 1, Business - Lending Activities" and Note 4 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplementary Data."
Premises and Equipment: Premises and equipment decreased by $663,000, or
3.7%, to $17.4 million at September 30, 2010 from $18.0 million at September
30, 2009. The decrease was primarily as a result of depreciation. 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."
OREO: OREO and other repossessed assets increased by $3.3 million, or
40.7% to $11.5 million at September 30, 2010 from $8.2 million at September
30, 2009 as a result of additional properties being acquired through the loan
foreclosure process. At September 30, 2010, the balance was comprised of 27
individual properties and three other repossessed assets. The OREO properties
consisted of two condominium projects totaling $3.9 million, three land
development projects totaling $3.3 million, eight single family homes totaling
$1.7 million, 11 land parcels totaling $1.4 million and three commercial real
estate properties totaling $1.1 million. The largest OREO property was a
condominium project with a balance of $3.0 million. For additional
information on OREO, see "Item 1, Business Lending Activities Nonperforming
Assets" and Note 7 of the Notes to Consolidated Financial Statements contained
in "Item 8, Financial Statements and Supplementary Data."
Goodwill and Core Deposit Intangible ("CDI"): The recorded value of
goodwill at $5.7 million at September 30, 2010 remained unchanged from
September 30, 2009. The amortized value of CDI decreased by $191,000 to
$564,000 at September 30, 2010 from $755,000 at September 30, 2009 due to
scheduled amortization. The Company recorded goodwill and CDI 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, 2010 and determined that there was no impairment to goodwill. For
additional information of Goodwill and CDI, see Note 1 and Note 8 of the Notes
to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Mortgage Servicing Rights ("MSRs"): MSRs decreased $689,000, or 26.3%,
to $1.9 million at September 30, 2010 from $2.6 million at September 30, 2009,
primarily due to an $890,000 MSR valuation allowance established during the
year ended September 30, 2010. The establishment of a valuation allowance was
primarily a result of lower mortgage interest rates at September 30, 2010
which reduced the expected duration of the cash flows associated with the MSR
portfolio, and therefore reduced the estimated fair value of the MSRs.
Prepaid FDIC Insurance Assessment: The prepaid FDIC insurance assessment
increased to $3.27 million at September 30, 2010 due to the FDIC's new
requirement to prepay three year's worth of estimated insurance fees on
December 31, 2009.
Deposits: Deposits increased by $73.2 million, or 14.5%, to $578.9
million at September 30, 2010 from $505.7 million at September 30, 2009. The
increase was primarily a result of a $35.9 million increase in N.O.W. checking
account balances, a $26.7 million increase in CD account balances, an $8.8
million increase in savings account balances and an $8.5 million increase in
non-interest bearing account balances. These increases were partially offset
by a $6.8 million decrease in money market account balances. The increase in
N.O.W. account balances was primarily a result of the Company's checking
account promotions. The increase in CD account balances was primarily a
result of increased demand for CD accounts by customers in the Company's
market areas. The Company also experienced deposit inflows due to a number of
customers transferring funds from other financial institutions during the year
ended September 30, 2010. 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."
65
FHLB Advances and FRB Borrowings: FHLB advances and FRB borrowings
decreased by $30.0 million, or 27.3%, to $75.0 million at September 30, 2010
from $110.0 million at September 30, 2009 as the Company used a portion of its
liquid assets to repay maturing FHLB advances and FRB borrowings. For
additional information on borrowings, see "Item 1, Business - Deposit
Activities and Other Sources of Funds Borrowings" and Notes 10 of the Notes
to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplementary Data."
Shareholders' Equity: Total shareholders' equity decreased by $1.8
million, or 2.1%, to $85.4 million at September 30, 2010 from $87.2 million at
September 30, 2009. The decrease was primarily due to a net loss of $(2.3
million) and the payment and accrual of $1.1 million in dividends to preferred
and common shareholders and was partially offset by a $1.3 million reduction
in the accumulated other comprehensive loss equity component, due to a
reduction in unrealized losses on investment securities.
The FRB has denied the Company's request to pay cash dividends on its
outstanding Series A Preferred Stock held by the Treasury for the payments due
May 15, 2010 and August 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 had not made the May 15, 2010 or the
August 15, 2010 dividend payment as of September 30, 2010. At September 30,
2010, the Company had unpaid preferred stock dividends in arrears of $416,000.
If the Company does not make six quarterly dividend payments on the Series A
Preferred Stock, whether or not consecutive, the Treasury will have the right
to appoint two directors to the Company's board of directors until all accrued
but unpaid dividends have been paid. In addition, the Company's ability to
pay dividends with respect to common stock is restricted until the dividend
obligations under the Series A Preferred Stock are brought current.
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, 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.
66
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 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.
The Company has established a comprehensive methodology for determining
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. Management's analysis for the years ended September 30, 2010 and
2009, placed a greater emphasis on the Company's construction and land
development portfolio and the effect of various factors such as geographic and
loan type concentrations.
67
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $11.26 million at September 30, 2010 (2.09% of loans
receivable and loans held for sale and 45.3% 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. Impaired loans are subject to an
impairment analysis to determine an appropriate reserve amount to be held
against each loan. The aggregate principal impairment amount determined at
September 30, 2010 was $862,000. 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 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
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
$354,000 increase in the Company's general liability insurance expense (which
is included in the other non-interest expense category), 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
68
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 Income Taxes: The benefit for federal income taxes
increased by $582,000 to $1.57 million for the year ended September 30, 2010
from $982,000 for the year ended September 30, 2009 primarily as a result of
an increased loss before income taxes. The Company's effective federal 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 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.
Comparison of Operating Results for the Years Ended September 30, 2009 and
2008
The Company's net income decreased by $4.25 million, or 106.0%, to a net
loss of $(242,000) for the year ended September 30, 2009 from net income of
$4.01 million for the year ended September 30, 2008. Income available to
common shareholders after adjusting for the preferred stock dividend and the
preferred stock discount accretion was a loss of $(1.01 million) for the year
ended September 30, 2009 compared to income of $4.01 million available to
common shareholders for the year ended September 30, 2008. The decrease was
primarily as a result of increased provision for loan losses, decreased net
interest income, and increased non-interest expenses, which were partially
offset by increased non-interest income. Diluted earnings per common share
decreased by 124.6% to a loss of $(0.15) for the year ended September 30, 2009
from $0.61 for the year ended September 30, 2008.
The increased provision for loan losses was primarily a result of an
increase in net charge-offs, an increase in impaired loans, an increase in the
level of performing loans classified as substandard under the Bank's loan
grading system, and uncertainties in real estate values in the Pacific
Northwest. Net charge-offs totaled $4.44 million during the year ended
September 30, 2009, which was equivalent to 0.79% of the average outstanding
loans.
The decreased net interest income was primarily attributable to an
increase in non-accrual loans and lower overall market interest rates, which
compressed the Company's net interest margin. The net interest margin
decreased 40 basis points to 4.01% for the year ended September 30, 2009 from
4.41% for the year ended September 30, 2008.
The increased non-interest expense was primarily attributable to an
increase in FDIC insurance expense, an increase in OREO related expenses, an
increase in loan monitoring and foreclosure related expenses and increases in
premises and equipment expenses.
The increased non-interest income was primarily a result of increased
gains on sale of loans, increased service charges on deposit accounts and
increased BOLI net earnings partially offset by net OTTI losses on private
label mortgage backed securities. The increased income from loan sales was
primarily a result of an increase in the dollar amount of residential mortgage
loans sold in the secondary market for the year ended September 30, 2009. The
increase
69
in loan sales was primarily attributable to lower interest rates for 30-year
fixed rate loans which increased refinancing activity.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2009 decreased
by $4.25 million, or 106.0%, to a net loss of $(242,000) from net income of
$4.01 million for the year ended September 30, 2008. Income available to
common shareholders after adjusting for preferred stock dividends and
preferred stock discount accretion was a loss of $(1.01 million), or $(0.15)
per diluted common share for the year ended September 30, 2009 compared to net
income of $4.01 million, or $0.61 per diluted common share for the year ended
September 30, 2008.
The $0.76 decrease in diluted earnings per common share for the year
ended September 30, 2009 was primarily the result of a $6.83 million ($4.51
million net of income tax - $0.69 per diluted common share) increase in the
provision for loan losses, a $2.39 million ($1.58 million net of income tax -
$0.24 per diluted common share) increase in non-interest expense, a $1.63
million ($1.07 million net of income tax - $0.16 per diluted common share)
decrease in net interest income and a $772,000 increase in preferred stock
dividends and preferred stock accretion which decreased earnings by
approximately $0.12 per diluted common share. These items were partially
offset by a $2.77 million increase in non-interest income which increased
diluted earnings per common share by approximately $0.45.
Net Interest Income: Net interest income decreased by $1.63 million, or
6.0%, to $25.30 million for the year ended September 30, 2009 from $26.93
million for the year ended September 30, 2008. The decrease in net interest
income was primarily attributable to an increase in non-accrual loans and
lower overall market interest rates.
Total interest and dividend income decreased by $4.54 million to $38.80
million for the year ended September 30, 2009 from $43.34 million for the year
ended September 30, 2008 as the yield on interest earning assets decreased to
6.15% from 7.09%. Total average interest earning assets (including
non-accrual loans) increased by $20.11 million to $631.25 million for the year
ended September 30, 2009 from $611.14 million for the year ended September 30,
2008. Non-accrual loans increased by $17.30 million to $29.29 million at
September 30, 2009 from $11.99 million at September 30, 2008.
Total interest expense decreased by $2.91 million to $13.50 million for
the year ended September 30, 2009 from $16.41 million for the year ended
September 30, 2008 as the average rate paid on interest-bearing liabilities
decreased to 2.51% for the year ended September 30, 2009 from 3.11% for the
year ended September 30, 2008. Total interest bearing liabilities increased
by $9.34 million to $537.54 million for the year ended September 30, 2009 from
$528.20 million for the year ended September 30, 2008.
The net interest margin decreased 40 basis points to 4.01% for the year
ended September 30, 2009 from 4.41% for the year ended September 30, 2008 as
the yield on interest earnings assets decreased at a greater rate than funding
costs decreased. This was primarily a result of the decreasing interest rate
environment which reduced yields on loans at a faster pace than the Bank was
able to reduce deposit and borrowing costs. The reversal of interest income
on loans placed on non-accrual status contributed to the margin compression
and reduced the net interest margin by approximately 18 basis points for the
year ended September 30, 2009.
Provision for Loan Losses: The provision for loan losses increased by
$6.83 million, or 175.2%, to $10.73 million for the year ended September 30,
2009 from $3.90 million for the year ended September 30, 2008. The increased
provision for loan losses was primarily a result of an increase in net
charge-offs, an increase in impaired loans, an increase in the level of
performing loans classified as substandard under the Company's loan grading
system, and uncertainties in the housing market in certain markets of the
Pacific Northwest. The Company had net charge-offs of $4.44 million for the
year ended September 30, 2009 compared to net charge-offs of $647,000 for the
year ended September 30, 2008. The net charge-offs to average outstanding
loans ratio was 0.79% for the year ended September 30, 2009 and 0.12% for the
year ended September 30, 2008.
70
Non-interest Income: Total non-interest income increased by $2.77
million, or 66.3%, to $6.95 million for the year ended September 30, 2009 from
$4.18 million for the year ended September 30, 2008. This increase was
primarily a result of a $2.82 million decrease in loss on the redemption of
mutual funds, $1.82 million increase in gain on sale of loans, an $819,000
increase in service charges on deposit accounts, a $479,000 increase in BOLI
net earnings and $139,000 in income recorded for property easements sold.
These increases to non-interest income were partially offset by a $3.62
million increase in net OTTI losses recorded during the year ended September
30, 2009.
The $2.82 million loss on mutual funds recorded during the year ended
September 30, 2008 was a result of the redemption of investments in the AMF
family of mutual funds for the underlying securities and cash. The net OTTI
charges of $3.62 million recorded during the year ended September 30, 2009
were on private label mortgage backed securities that were acquired from the
in-kind redemption from the AMF family of mutual funds in 2008.
The increased income from loan sales was primarily a result of an
increase in the dollar amount of residential mortgage loans sold in the
secondary market for the year ended September 30, 2009. The sale of one- to
four-family mortgage loans totaled $162.6 million for the year ended September
30, 2009 compared to $45.3 million for the year ended September 30, 2008. The
increase in loan sales was primarily attributable to lower interest rates for
30-year fixed rate loans which increased refinancing activity. The increase
in service charges on deposit accounts was primarily a result of implementing
a new automated overdraft decision system in May 2008 and increasing the fee
charged for overdrafts. The increase in BOLI income was attributable to a
$337,000 death claim benefit and a $134,000 gain from moving a number of the
Company's BOLI policies to a new insurance carrier.
Non-interest Expense: Total non-interest expense increased by $2.39
million, or 11.7%, to $22.74 million for the year ended September 30, 2009
from $20.35 million for the year ended September 30, 2008. The increase was
primarily attributable to a $648,000 increase in FDIC insurance expense
(including a special FDIC assessment of $391,000), a $646,000 increase in OREO
related expenses, a $204,000 increase in loan monitoring and foreclosure
related expenses (which are included in the other non-interest expense
category), a $267,000 increase in premises and equipment expense, a $232,000
increase in salary and benefit expenses, and a $143,000 increase in deposit
related expenses (which are included in the other non-interest expense
category).
The increase in OREO related expenses and foreclosure expenses were
primarily a result of an increase in the number of OREO properties held and an
increase in foreclosure activity. The increase in premises and equipment
expenses was partially attributable to the addition of a full service branch
facility in Chehalis, Washington. Also contributing to the change in premises
and equipment expense was an insurance settlement and the sale of a building
in the prior fiscal year which reduced premises and equipments expenses by a
combined $295,000 for the year ended September 30, 2008. The Company also
recorded a capital gain on the sale of Company owned property which reduced
premises and equipment expenses by $235,000 for the year ended September 30,
2009. The increased salary and benefit expenses were primarily a result of
annual salary adjustments and increased insurance expenses. The increased
deposit related expenses were primarily a result of the expenses associated
with several new deposit related programs.
The Company's efficiency ratio increased to 70.52% for the year ended
September 30, 2009 from 65.42% for the year ended September 30, 2008.
Provision (Benefit) for Federal Income Taxes: The provision for federal
income taxes decreased by $3.81 million to a net benefit of $982,000 for the
year ended September 30, 2009 from $2.82 million for the year ended September
30, 2008 primarily as a result of lower income before taxes. The benefit for
federal income taxes for the year ended September 30, 2009 was impacted by an
increased level of non-taxable income, primarily attributable to the increase
in BOLI net earnings. The income tax benefit for the year ended September 30,
2009 was also increased by approximately $180,000 due to adjustments made to
the Company's deferred tax valuation allowance for a previous non-deductible
capital loss carry forward.
The provision for federal income taxes for the year ended September 30,
2008 was impacted by the $2.82 million loss on the redemption of mutual funds.
The redemption of the mutual funds resulted in a capital loss which can only
be deducted for tax purposes to the extent that capital gains are realized
within a three year carry back period and a five year carry forward period.
The Company estimated that it would have $679,000 in capital gains during the
allowable tax period to offset the capital loss. Therefore $2.14 million of
the $2.82 million loss was treated as non-
71
deductible for tax purposes for the year ended September 30, 2008. The
Company's effective tax rate was 41.35% (or 31.65% exclusive of the mutual
fund redemption loss and associated tax impact) for the year ended September
30, 2008.
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.
72
Year Ended September 30,
--------------------------------------------------------------------------------
2010 2009 2008
-------------------------- ------------------------ -------------------------
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)... $555,050 $35,344 6.43% $564,741 $37,249 6.60% $552,318 $40,924 7.41%
Mortgage-backed securities
and other investments.... 17,513 910 5.20 25,762 1,379 5.35 19,799 1,064 5.37
FHLB stock and equity
securities............... 6,679 35 0.52 6,655 38 0.57 29,201 1,123 3.85
Federal funds sold -- -- -- 9,032 36 0.40 8,318 191 2.30
Interest-bearing
deposits................. 82,455 307 0.37 24,964 99 0.40 1,499 36 2.40
-------- ------- -------- ------- -------- -------
Total interest-earning
assets.................. 661,697 36,596 5.53 631,154 38,801 6.15 611,135 43,338 7.09
Non-interest-earning
assets.................... 56,482 47,851 47,086
-------- -------- --------
Total assets............ $718,179 $679,005 $658,221
======== ======== ========
Interest-bearing liabilities:
Savings accounts.......... $ 63,695 454 0.71% $ 55,814 394 0.71 $ 56,461 398 0.70
Money market accounts..... 59,988 677 1.13 61,777 1,036 1.68 51,943 1,249 2.40
NOW accounts.............. 141,240 1,749 1.24 97,879 1,031 1.05 86,441 774 0.90
Certificates of deposit... 234,550 4,927 2.10 224,673 7,011 3.12 224,493 9,342 4.16
Short-term borrowings(3).. 923 3 0.33 672 1 0.12 14,321 615 4.29
Long-term borrowings (4).. 77,479 3,151 4.07 96,721 4,031 4.17 94,537 4,035 4.27
-------- ------- -------- ------- -------- -------
Total interest bearing
liabilities............ 577,875 10,961 1.90 537,536 13,504 2.51 528,196 16,413 3.11
Non-interest bearing
liabilities............... 53,734 55,086 55,150
-------- -------- --------
Total liabilities....... 631,609 592,622 583,346
Shareholders' equity....... 86,570 86,383 74,875
-------- -------- --------
Total liabilities and
shareholders' equity... $718,179 $679,005 $658,221
======== ======== ========
Net interest income........ $25,635 $25,297 $26,925
======= ======= =======
Interest rate spread....... 3.63% 3.64% 3.98%
====== ====== ======
Net interest margin (5).... 3.87% 4.01% 4.41%
====== ====== ======
Ratio of average interest-
earning assets to
average interest-bearing
liabilities............... 114.51% 117.42% 115.70%
====== ====== ======
----------------
(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 (2010, $829; 2009, $1,229;
and 2008, $1,804) included with interest and dividends.
(2) Average balance includes nonaccrual loans.
(3) Includes FHLB, FRB and PCBB advances with original maturities of less than one year and other short-term
borrowings-repurchase agreements.
(4) Includes FHLB advances with original maturities of one year or greater.
(5) Net interest income divided by total average interest earning assets.
73
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,
2010 Compared to Year 2009 Compared to Year
Ended September 30, 2009 Ended September 30, 2008
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------ ------------------------
Net Net
Rate Volume Change Rate Volume Change
---- ------ -------- ---- ------ ------
(In thousands)
Interest-earning assets:
Loans receivable (1).... $(1,273) $(632) $(1,905) $(4,579) $ 903 $(3,676)
Mortgage-backed
securities and other
investments............ (38) (431) (469) (4) 319 315
FHLB stock and equity
securities............. (3) -- (3) (569) (516) (1,085)
Federal funds sold...... -- (36) (36) (170) 15 (155)
Interest-bearing deposits (5) 213 208 (54) 117 63
Total net change in income
on interest-earning
assets................. (1,319) (886) (2,205) (5,376) 838 (4,538)
Interest-bearing
liabilities:
Savings accounts....... 3 57 60 1 (5) (4)
NOW accounts........... 204 514 718 147 110 257
Money market accounts.. (330) (29) (359) (422) 209 (213)
Certificate accounts... (2,408) 324 (2,084) (2,339) 8 (2,331)
Short-term borrowings.. 1 -- 1 (310) (304) (614)
Long-term borrowings... (94) (785) (879) (96) 92 (4)
------- ----- ------- ------- ----- -------
Total net change in
expense on interest-
bearing liabilities.... (2,624) 81 (2,543) (3,019) 110 (2,909)
------- ----- ------- ------- ----- -------
Net change in net
interest income........ $ 1,305 $(967) $ 338 $(2,357) $ 728 $(1,629)
======= ===== ======= ======= ===== =======
----------------
(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,
2010, 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 22.49%. At September 30, 2010, the Bank maintained an uncommitted credit
facility with the FHLB that provided for immediately available advances up to
an aggregate amount
74
equal to 30% of total assets, limited by available collateral, under which
$75.0 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, 2010 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, PCBB and collateral for
repurchase agreements.
The Bank's primary investing activity is the origination of mortgage
loans. During the years ended September 30, 2010, 2009 and 2008, the Bank
originated $154.1 million, $273.6 million and $223.9 million of mortgage
loans, respectively. At September 30, 2010, the Bank had loan commitments
totaling $34.4 million and undisbursed loans in process totaling $18.0
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, 2010 totaled $177.9 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, 2010, 2009 and 2008,
the Bank sold $68.3 million, $162.9 million and $45.3 million in fixed rate,
one- to four-family mortgage loans, respectively. During the years ended
September 30, 2010, 2009 and 2008, the Bank received $150.3 million, $150.7
million and $176.1 million in principal repayments, respectively.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2010, 2009 and 2008, deposits increased
by $73.2 million, $7.1 million and $31.8 million, respectively.
Cash and cash equivalents, certificate of deposits held for investment and
mortgage-backed securities and other investments increased to $146.0 million
at September 30, 2010 from $90.3 million at September 30, 2009.
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, 2010, 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 19 of the Notes to Consolidated Financial Statements
contained in "Item 8. Financial Statements and Supplementary Data" and "Item
1. Business - Regulation of the Bank - Capital Requirements."
75
Contractual obligations. The following table presents, as of September
30, 2010, 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, 2010.
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... $ 622 $ -- $ -- $ -- $ 622
Long-term debt obligations.... 20,000 10,000 -- 45,000 75,000
Operating lease obligations... 198 422 288 -- 908
------- ------- ------- ------- -------
Total contractual
obligations................ $20,820 $10,422 $ 288 $45,000 $76,530
======= ======= ======= ======= =======
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. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls
76
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, 2010.
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Reports of Independent Registered Public Accounting Firms........... 78
Consolidated Balance Sheets as of September 30, 2010 and 2009....... 80
Consolidated Statements of Operations For the Years Ended
September 30, 2010, 2009, and 2008................................ 81
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2010, 2009 and 2008..................... 83
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2010, 2009 and 2008................................. 85
Consolidated Statements of Comprehensive Income (Loss) For the
Years Ended September 30, 2010, 2009 and 2008..................... 87
Notes to Consolidated Financial Statements.......................... 88
77
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 sheet of Timberland
Bancorp, Inc. and Subsidiary (collectively, "the Company") as of September 30,
2010, and the related consolidated statements of operations, shareholders'
equity, cash flows, and comprehensive income (loss) for the year 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 audit. The consolidated financial
statements of the Company as of September 30, 2009, and for the years ended
September 30, 2009 and 2008, were audited by other auditors whose report dated
December 14, 2009, expressed an unqualified opinion on those statements.
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
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 audit provides a reasonable basis for our
opinion.
In our opinion, the 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, 2010, and the results of
their operations and their cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States of America.
/s/ Delap LLP
Lake Oswego, Oregon
December 10, 2010
78
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Timberland Bancorp, Inc.
We have audited the consolidated balance sheet of Timberland Bancorp, Inc. and
Subsidiary as of September 30, 2009, and the related consolidated statements
of operations, shareholders' equity, cash flows and comprehensive income for
each of the two years in the period ended September 30, 2009. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Timberland
Bancorp, Inc. and Subsidiary as of September 30, 2009, and the results of
their operations and their cash flows for each of the two years in the period
ended September 30, 2009, in conformity with U.S. generally accepted
accounting principles.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 14, 2009
79
Consolidated Balance Sheets
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
2010 2009
-------- --------
Assets
Cash and cash equivalents:
Cash and due from financial institutions $ 9,466 $ 10,205
Interest-bearing deposits in banks 102,320 56,257
-------- --------
Total cash and cash equivalents 111,786 66,462
-------- --------
Certificates of deposit ("CDs") held for investment,
(at cost which approximates fair value) 18,047 3,251
Mortgage-backed securities ("MBS") and other
investments - held to maturity, at amortized cost
(estimated fair value $4,842 and $6,215) 5,066 7,087
MBS and other investments - available for sale 11,119 13,471
Federal Home Loan Bank of Seattle ("FHLB") stock 5,705 5,705
Loans receivable, net of allowance for loan losses
of $11,264 and $14,172 524,621 546,578
Loans held for sale 2,970 630
-------- --------
Net loans receivable 527,591 547,208
Premises and equipment, net 17,383 18,046
Other real estate owned ("OREO") and other
repossessed assets 11,519 8,185
Accrued interest receivable 2,630 2,805
Bank owned life insurance ("BOLI") 13,400 12,918
Goodwill 5,650 5,650
Core deposit intangible ("CDI") 564 755
Mortgage servicing rights ("MSRs"), net 1,929 2,618
Prepaid Federal Deposit Insurance Corporation
("FDIC") insurance assessment 3,268 - -
Other assets 7,030 7,515
-------- --------
Total assets $742,687 $701,676
======== ========
Liabilities and shareholders' equity
Liabilities
Deposits:
Non-interest-bearing demand $ 58,755 $ 50,295
Interest-bearing 520,114 455,366
-------- --------
Total deposits 578,869 505,661
-------- --------
FHLB advances 75,000 95,000
Federal Reserve Bank of San Francisco ("FRB")
borrowings - - 10,000
Repurchase agreements 622 777
Other liabilities and accrued expenses 2,788 3,039
-------- --------
Total liabilities 657,279 614,477
-------- --------
Commitments and contingencies (See Note 17) - - - -
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 15,764 15,554
Common stock, $0.01 par value; 50,000,000 shares
authorized; 7,045,036 shares issued and outstanding 10,377 10,315
Unearned shares issued to Employee Stock Ownership
Plan ("ESOP") (2,247) (2,512)
Retained earnings 62,238 65,854
Accumulated other comprehensive loss (724) (2,012)
-------- --------
Total shareholders' equity 85,408 87,199
-------- --------
Total liabilities and shareholders' equity $742,687 $701,676
======== ========
See notes to consolidated financial statements.
80
Consolidated Statements of Operations
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
2010 2009 2008
------- ------- -------
Interest and dividend income
Loans receivable $35,344 $37,249 $40,924
MBS and other investments 910 1,379 1,064
Dividends from mutual funds and FHLB stock 35 38 1,123
Interest-bearing deposits in banks 307 135 227
------- ------- -------
Total interest and dividend income 36,596 38,801 43,338
------- ------- -------
Interest expense
Deposits 7,807 9,472 11,763
FHLB advances - short term - - - - 593
FHLB advances - long term 3,154 4,031 4,035
FRB borrowings and repurchase agreements - - 1 22
------- ------- -------
Total interest expense 10,961 13,504 16,413
------- ------- -------
Net interest income 25,635 25,297 26,925
Provision for loan losses 10,550 10,734 3,900
------- ------- -------
Net interest income after provision for
loan losses 15,085 14,563 23,025
Non-interest income
Other than temporary impairment ("OTTI")
on MBS and other investments (998) (5,820) - -
Adjustment for portion recorded as
(transferred from) other comprehensive
loss before taxes (1,178) 2,274 - -
------- ------- -------
Net OTTI on MBS and other investments (2,176) (3,546) - -
Realized loss on MBS and other investments (20) (76) - -
Service charges on deposits 4,240 4,312 3,493
ATM transaction fees 1,619 1,261 1,251
BOLI net earnings 491 965 486
Gain on sale of loans, net 1,547 2,828 1,011
Loss on sale/redemption of mutual funds, net - - - - (2,822)
Servicing income on loans sold 135 103 90
Escrow fees 74 158 9
Fee income from non-deposit investment sales 84 102 124
Valuation allowance on MSRs (890) - - - -
Other 592 842 536
------- ------- -------
Total non-interest income, net 5,696 6,949 4,178
------- ------- -------
See notes to consolidated financial statements.
81
Consolidated Statements of Operations (continued)
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
2010 2009 2008
------- ------- -------
Non-interest expense
Salaries and employee benefits $12,066 $11,801 $11,569
Premises and equipment 2,768 2,574 2,307
Advertising 829 895 897
OREO and other repossessed assets expense
(income) 882 643 (3)
ATM expenses 698 613 576
Postage and courier 539 549 514
Amortization of CDI 191 217 249
State and local taxes 626 604 622
Professional fees 664 745 678
FDIC Insurance 1,659 778 130
Insurance 435 82 88
Other 3,284 3,238 2,722
------- ------- -------
Total non-interest expense 24,641 22,739 20,349
------- ------- -------
Income (loss) before income taxes (3,860) (1,227) 6,854
Provision (benefit) for federal income taxes (1,564) (982) 2,824
Provision (benefit) for state income taxes (5) (3) 25
------- ------- -------
Net income (loss) (2,291) (242) 4,005
Preferred stock dividends (832) (643) - -
Preferred stock discount accretion (210) (129) - -
------- ------- -------
Net Income (loss) to common shareholders $(3,333) $(1,014) $ 4,005
======= ======= =======
Net income (loss) per common share
Basic $(0.50) $(0.15) $0.62
Diluted (0.50) (0.15) 0.61
See notes to consolidated financial statements.
82
Consolidated Statements of Shareholders' Equity
-----------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
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, 2007 - - 6,953,360 $ - - $ 9,993 $(3,040) $68,378 $(784) $74,547
Net income - - - - - - - - - - 4,005 - - 4,005
Issuance of MRDP(1) shares - - 20,315 - - - - - - - - - - - -
Repurchase of common stock - - (144,950) - - (1,921) - - - - - - (1,921)
Exercise of stock options - - 138,854 - - 857 - - - - - - 857
Cash dividends ($0.43 per
common share) - - - - - - - - - - (2,977) - - (2,977)
Earned ESOP shares - - - - - - (409) 264 - - - - (145)
MRDP compensation expense - - - - - - 147 - - - - - - 147
Stock option compensation
expense - - - - - - 5 - - - - - - 5
Unrealized holding gain on
securities available for
sale, net of tax - - - - - - - - - - - - 323 323
------ --------- ------- ------- ------- ------- ------- -------
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
(1) 1998 Management Recognition and Development Plan ("MRDP").
See notes to consolidated financial statements.
83
Consolidated Statements of Shareholders' Equity (continued)
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
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, 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
====== ========= ======= ======= ======= ======= ===== =======
See notes to consolidated financial statements.
84
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
2010 2009 2008
------- ------- --------
Cash flows from operating activities
Net income (loss) $ (2,291) $ (242) $ 4,005
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation 1,141 1,136 1,100
Deferred federal income taxes 466 (1,813) (1,217)
Amortization of CDI 191 217 249
Earned ESOP shares 265 264 264
MRDP compensation expense 173 169 131
Stock option compensation expense 6 3 5
Stock option tax effect - - 46 15
Less stock option excess tax benefit - - - - (11)
Loss on redemption of mutual funds - - - - 2,600
Loss on sale of mutual funds - - - - 222
OTTI losses on securities 2,196 3,622 - -
Gain on sale of OREO and other
repossessed items, net (291) (60) (47)
Gain on sale of loans (1,547) (2,828) (432)
(Gain) loss on disposition of premises
and equipment 6 (233) (288)
Provision for loan losses 10,550 10,734 3,900
Valuation adjustment for OREO 535 306 14
Loans originated for sale (69,123) (158,942) (45,853)
Proceeds from sale of loans 68,330 162,913 45,269
BOLI net earnings (491) (965) (486)
Decrease in deferred loan origination
fees (210) (308) (221)
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses (3,862) (2,546) 731
------- ------- --------
Net cash provided by operating activities 6,044 11,473 9,950
Cash flows from investing activities
Net increase in CDs held for investment (14,796) (3,251) - -
Activity in securities held to maturity:
Maturities and prepayments 1,222 1,763 579
Activity in securities/mutual funds
available for sale:
Maturities and prepayments 3,062 3,451 22,862
Proceeds from sales - - - - 6,929
(Increase) decrease in loans receivable, net 3,532 (11,158) (46,413)
Additions to premises and equipment (484) (2,347) (1,495)
Proceeds from sale of OREO and other
repossessed items 4,507 2,317 926
Proceeds from the disposition of premises
and equipment - - 282 374
------- ------- --------
Net cash used by investing activities (2,957) (8,943) (16,238)
See notes to consolidated financial statements.
85
Consolidated Statements of Cash Flows (continued)
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
2010 2009 2008
-------- ------- -------
Cash flows from financing activities
Net increase in deposits $ 73,208 $ 7,089 $ 31,837
Proceeds from FHLB advances - long term - - - - 50,000
Repayment of FHLB advances - long term (20,000) (9,628) (15,069)
Net decrease in FHLB advances - short term - - - - (30,000)
Net increase (decrease) in FRB advances -
short term (10,000) 10,000 - -
Net increase (decrease) in repurchase
agreements (155) 19 163
Proceeds from exercise of stock options - - 346 841
ESOP tax effect (78) (47) (409)
MRDP compensation tax effect (39) (32) 16
Stock option excess tax benefit - - - - 11
Repurchase of common stock - - - - (1,921)
Issuance of stock warrants - - 1,158 - -
Issuance of preferred stock - - 15,425 - -
Payment of dividends (699) (3,272) (2,977)
-------- ------- -------
Net cash provided by financing activities 42,237 21,058 32,492
-------- ------- -------
Net increase in cash and cash equivalents 45,324 23,588 26,204
Cash and cash equivalents
Beginning of year 66,462 42,874 16,670
-------- ------- -------
End of year $111,786 $66,462 $42,874
======== ======= =======
Supplemental disclosures of cash flow information
Income taxes paid $ 3 $ 1,452 $ 4,120
Interest paid 11,189 13,674 16,656
Supplemental disclosures of non-cash investing
and financing activities
Loans transferred to OREO and other
repossessed assets $ 9,434 $10,237 $ 1,404
Shares issued to MRDP - - 138 259
Loans originated to facilitate sale of OREO 1,349 1,021 257
Mutual funds redeemed for MBS - - - - 22,188
See notes to consolidated financial statements.
86
Consolidated Statements of Comprehensive Income (Loss)
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2010, 2009 and 2008
2010 2009 2008
-------- ------- -------
Comprehensive income (loss)
Net income (loss) $(2,291) $ (242) $4,005
Cumulative effect of FASB guidance
regarding recognition of OTTI - - (91) - -
Unrealized holding gain on securities
available for sale, net of tax 491 18 323
Change in OTTI on securities held to
maturity, net of tax:
Additions 23 1,804 - -
Additional amount recognized related to
credit loss for which OTTI was
previously recognized 534 (3,034) - -
Amount reclassified to credit loss for
previously recorded market loss 209 (248) - -
Accretion of OTTI securities held to
maturity, net of tax 31 - - - -
------- ------- ------
Total comprehensive income (loss) $(1,003) $(1,793) $4,328
======= ======= ======
See notes to consolidated financial statements.
87
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. ("Company"); its wholly owned subsidiary, Timberland Bank
("Bank"); and the Bank's wholly owned subsidiary, Timberland Service Corp.
All significant intercompany transactions and balances have been eliminated 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, land,
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 practices within the banking industry. The preparation of
consolidated financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
the disclosure of contingent assets and liabilities, as of the date of the
balance sheet, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for loan losses, the
determination of other-than-temporary impairments in the estimated fair value
of mortgage-backed securities and FHLB stock, the valuation of mortgage
servicing rights, the valuation of OREO and the determination of goodwill
impairment.
Certain prior year amounts have been reclassified to conform to the fiscal
2010 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)
88
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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 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. (See Note 19.) The FRB has denied the Company's requests to pay
dividends on its Series A Preferred Stock issued under the CPP for the
payments due May 15, 2010, August 15, 2010 and November 15, 2010. There can
be no assurances 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. 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.
Mortgage-Backed Securities and Other Investments
Mortgage-backed securities 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 by the interest method over the contractual life of the securities.
Gains and losses on sale of securities are recognized on the trade date and
determined using the specific identification method.
In estimating whether there are any other than temporary impairment losses,
management considers 1) the length of time and the extent to which the fair
value has been less than amortized cost, 2) the financial condition and near
term prospects of the issuer, 3) the impact of changes in market interest
rates and 4) the intent and ability of the Company to retain its investment
for a period of time sufficient to allow for any anticipated recovery in fair
value.
(continued)
89
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 1 - Summary of Significant Accounting Policies (continued)
Mortgage-Backed Securities 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 where the Company does not intend to sell the
security and it is not more likely than not that the Company will be required
to sell the security before recovery of its amortized cost basis, the other
than temporary decline in the fair value of the security related to 1) credit
loss is recognized in earnings and 2) market or other factors is recognized in
other comprehensive income or loss. Credit loss is recorded if the present
value of cash flows is less than the amortized cost. For individual
securities where the Company intends to sell the security or more likely than
not will not recover all of its amortized cost, the other than temporary
impairment is recognized in earnings equal to the entire difference between
the 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.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank of Seattle ("FHLB"), is
required to maintain an investment in capital stock of the FHLB in an amount
equal to the greater of 1% of its outstanding home loans or 5% of advances
from the FHLB. The recorded amount of FHLB stock equals its 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, 2010, the FHLB of Seattle reported that it had met all of its
regulatory capital requirements, but remained classified as "undercapitalized"
by its regulator, the Federal Housing Finance Agency ("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, 2010, 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.
(continued)
90
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 1 - Summary of Significant Accounting Policies (continued)
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
stated in the aggregate at the lower of cost or estimated fair value. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income. Gains or losses on sales of loans are recognized at the
time of sale. The gain or loss is the difference between the net sales
proceeds and the recorded value of the loans, including any remaining
unamortized deferred loan origination fees.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed
portion of construction loans in process, deferred loan origination fees and
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. A troubled
debt restructured loan is generally considered impaired.
Impaired Loans
A loan is 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 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 detailed analysis of individual loans for
which full collectability may not be assured. The detailed analysis includes
methods to
(continued)
91
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (continued)
estimate the fair value of loan collateral and the existence of potential
alternative sources of repayment. The allowance consists of specific and
general components. The specific component relates to loans that are deemed
impaired. For such loans that are classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the recorded value of that
loan. The general component covers non-classified loans and classified loans
that are not evaluated individually for impairment and is based on historical
loss experience adjusted for qualitative factors. The appropriateness of the
allowance for losses on loans is estimated based upon these factors and trends
identified by management at the time financial statements are prepared.
In accordance with the 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 Bank experienced significant declines in current valuations
for real estate collateral for the years ended September 30, 2009 and 2010.
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)
92
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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.
Mortgage Servicing Rights
The Bank holds rights to service loans that it has originated and sold to the
Federal Home Loan Mortgage Corporation. Mortgage servicing rights are
capitalized at estimated fair value when acquired through the origination of
loans that are subsequently sold with the servicing rights retained and are
amortized to servicing income on loans sold in proportion to and over the
period of estimated net servicing income. The value of mortgage servicing
rights at the date of the sale of loans is 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 mortgage servicing rights based on product
type, interest rate and term of the underlying loans. The amount of
impairment recognized is the amount, if any, by which the amortized cost of
the rights for each stratum exceed their fair value. Impairment, if deemed
temporary, is recognized through a valuation allowance to the extent that fair
value is less than the recorded amount.
Bank Owned Life Insurance ("BOLI")
BOLI policies are recorded at their cash surrender value less applicable cash
surrender charges. Income from BOLI is recognized when earned.
(continued)
93
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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, 2010, 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, 2010, there have been
no events or changes in the circumstances that would indicate a potential
impairment. No assurance can be given, however, that the Company will not
record an impairment loss on goodwill in the future.
Core Deposit Intangible
The core deposit intangible is amortized to non-interest expense using an
accelerated method over a ten-year period.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed on the
straight-line method over the following estimated useful lives: buildings and
improvements - up to 40 years; furniture and equipment - three to seven years;
and automobiles - five years. The cost of maintenance and repairs is charged
to expense as incurred. Gains and losses on dispositions are reflected in
earnings.
Impairment of Long-Lived Assets
Long-lived assets, consisting of premises and equipment, are reviewed for
impairment whenever events or changes in circumstances indicate that the
recorded amount of an asset may not be recoverable. Recoverability of assets
to be held and used is measured by a comparison of the recorded amount of an
asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the recorded amount of the assets exceeds the
discounted recovery amount or estimated fair value of the assets. No events
or changes in circumstances have occurred causing management to evaluate the
recoverability of the Company's long-lived assets.
(continued)
94
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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.
The Company adopted guidance issued by the FASB with respect to accounting for
uncertainty in income taxes on October 1, 2007. 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)
95
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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,
2006.
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 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, FHLB
advances short term, FRB borrowings and repurchase agreements are reported
net.
Interest-bearing deposits in banks as of September 30, 2010 and 2009 included
deposits with the Federal Reserve Bank of San Francisco of $88,805,000 and
$26,040,000, 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 accounts for stock based compensation in accordance with FASB
requirements for stock compensation. The guidance requires measurement of the
compensation cost for all stock-based awards based on the grant-date fair
value and recognition of compensation cost over the service period of
stock-based awards.
The fair value of stock options is determined using the Black-Scholes
valuation model. 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)
96
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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,
2009 and 2010 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.
Related Party Transactions
The Chairman of the Board for the Bank and the Company is a member of the law
firm that provides general counsel to the Bank. Legal fees paid to this law
firm for the years ended September 30, 2010, 2009 and 2008 totaled $133,000,
$125,000 and $62,000, respectively.
Recent Accounting Pronouncements
In June 2009, the FASB issued new guidance on the disclosure requirements for
transfers and servicing of financial assets. The new guidance requires more
information about transfers of financial assets, including securitization
transactions, and where entities have continuing exposure to the risks related
to transferred financial assets. It eliminates the concept of a "qualifying
special-purpose entity," changes the requirements for derecognizing financial
assets, and requires additional disclosures. The new authoritative accounting
guidance became effective January 1, 2010 and did not impact the Company's
consolidated financial statements.
In January 2010, the FASB issued updated guidance on fair value measurements
and disclosures. The new guidance requires expanded disclosures related to
fair value measurements including (i) the amounts of significant transfers of
assets or liabilities between Levels 1 and 2 of the fair value hierarchy and
the reasons for the transfers; and (ii) separate presentation of purchases,
sales, issuances, and settlements in the reconciliation for fair value
measurements using significant unobservable inputs (Level 3). The guidance
also further clarifies that (i) fair value instrument disclosures should be
provided for each class of assets and liabilities (rather than major
category), which would generally be a subset of assets or liabilities
(continued)
97
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 1 - Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements (concluded)
within a line item in the statement of financial position and (ii) companies
should provide disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value measurements
for each class of assets and liabilities included in Levels 2 and 3 of the
fair value hierarchy. The new guidance was effective on January 1, 2010 except
for the disclosures about purchases, sales, issuances, and settlements in the
roll forward of activity in Level 3 fair value measurements, which are
effective for the Company on October 1, 2011. The adoption of the guidance
effective on January 1, 2010 was disclosure-related only and did not impact
the Company's consolidated financial statements.
In February 2010, the FASB issued updated guidance on subsequent events and
disclosure requirements. The new guidance removes the requirement for a
Securities and Exchange Commission ("SEC") filer to disclose a date through
which subsequent events have been evaluated in both issued and revised
financial statements. The FASB believes these amendments remove potential
conflicts with the SEC's literature. This guidance was effective upon
issuance and did not have a material impact on the Company's consolidated
financial statements.
In July 2010, the FASB issued updated guidance on disclosure requirements for
the credit quality of financing receivables and the allowance for credit
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 credit 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 credit losses, and class of financing
receivable, which is generally a disaggregration of portfolio segment. The
required disclosures include, among other things, a roll forward of the
allowance for credit losses as well as information about modified, impaired,
non-accrual and past due loans and credit quality indicators. This guidance
will be effective for the Company's consolidated financial statements as of
December 31, 2010, as it relates to disclosures required as of the end of a
reporting period. Disclosures that relate to activity during a reporting
period will be required for the Company's consolidated financial statements
that include periods beginning on or after January 1, 2011. Since this new
guidance is disclosure related only, the Company does not expect it to have an
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, 2010 and 2009 were
approximately $781,000 and $206,000, respectively.
98
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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
--------- ---------- ---------- ---------
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
======= ===== ===== =======
2009
----
Held to Maturity
Mortgage-backed securities:
U.S. government agencies $ 2,455 $ 23 $ (10) $ 2,468
Private label residential 4,605 3 (890) 3,718
U.S. agency securities 27 2 - - 29
------- ----- ----- -------
Total $ 7,087 $ 28 $(900) $ 6,215
======= ===== ===== =======
Available for Sale
Mortgage-backed securities:
U.S. government agencies $10,378 $ 221 $ (5) $10,594
Private label residential 2,774 - - (865) 1,909
Mutual funds 1,000 - - (32) 968
------- ----- ----- -------
Total $14,152 $ 221 $(902) $13,471
======= ===== ===== =======
(continued)
99
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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, 2010 (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 $ 165 $ (1) $ 469 $ (4) $ 634 $ (5)
Private label residential 108 - - 1,907 (411) 2,015 (411)
----- ----- ------ ----- ------ -----
Total $ 273 $ (1) $2,376 $(415) $2,649 $(416)
===== ====== ====== ===== ====== =====
Available for Sale
Mortgage-backed securities:
Private label residential $ - - $ - - $1,574 $(248) $1,574 $(248)
Mutual funds - - - - 988 (12) 988 (12)
----- ----- ------ ----- ------ -----
Total $ - - $ - - $2,562 $(260) $2,562 $(260)
===== ====== ====== ===== ====== =====
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, 2010, 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, 2010, the Company recorded net OTTI
charges through earnings on residential mortgage-backed securities of
$2,176,000. For the year ended September 30, 2009, the Company recorded net
OTTI charges through earnings on residential mortgage-backed securities of
$3,546,000. 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)
100
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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 each 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, assumptions 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, 2010 and 2009:
Range
---------------------- Weighted
Minimum Maximum Average
------- ------- --------
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%
At September 30, 2009
Constant prepayment rate 6.00% 15.00% 10.86%
Collateral default rate 6.78% 59.62% 25.36%
Loss severity rate 14.25% 52.02% 33.99%
The following table presents the OTTI losses for the years ended September 30,
2010 and 2009. There were no similar OTTI losses recorded during the year
ended September 30, 2008 (in thousands).
2010 2009
-------------------- -------------------
Held to Available Held to Available
Maturity For Sale Maturity For Sale
Total OTTI losses $ 895 $ 103 $ 5,593 $ 227
Portion of OTTI losses recognized
in other comprehensive loss
(before taxes) (1) 1,178 (2,274) - -
------ ----- ------- -----
Net impairment losses recognized
in earnings (2) $2,073 $ 103 $ 3,319 $ 227
====== ===== ======= =====
-------------------
(1) Represents OTTI losses related to all other factors.
(2) Represents OTTI losses related to credit losses.
(continued)
101
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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 and the
remaining impairment loss related to all other factors recognized in other
comprehensive loss at September 30, 2010 and 2009 (dollars in thousands).
2010 2009
------- ------
Balance, beginning of year $ 3,551 $ - -
Additions:
Credit losses for which OTTI was
not previously recognized 400 2,511
Additional increases to the amount
related to credit loss for which OTTI
was previously recognized 1,818 1,073
Subtractions:
Realized losses recorded previously
as credit losses (1,044) (33)
------- ------
Balance, end of year $ 4,725 $ 3,551
======= =======
There were no gross realized gains on sales of securities for the years ended
September 30, 2010, 2009 and 2008. 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. During the year ended September 30, 2008 there were gross
realized losses on the sale and redemption of mutual funds classified as
available for sale in the amount of $2,822,000 and gross realized losses on
held to maturity residential mortgage-backed securities of $4,000. During the
year ended September 30, 2008, the Company redeemed its investment in the AMF
family of mutual funds and recognized a $2,822,000 loss on the redemption.
The Company redeemed $29,120,000 in mutual funds and received $22,190,000 in
underlying mortgage-backed securities and $6,930,000 in cash.
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 $12,800,000 and $16,400,000 at September 30,
2010 and 2009, respectively.
(continued)
102
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 3 - Mortgage-Backed Securities and Other Investments (concluded)
The contractual maturities of debt securities at September 30, 2010, 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 $ - - $ - - $ 283 $ 271
Due after one year to five
years 19 20 9 9
Due after five to ten years 40 42 132 141
Due after ten years 5,007 4,780 9,620 9,710
------ ------ ------- -------
Total $5,066 $4,842 $10,044 $10,131
====== ====== ======= =======
103
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable and loans held for sale consisted of the following at
September 30 (in thousands):
2010 2009
-------- --------
Mortgage loans:
One- to four-family $118,044 $109,926
Multi-family 32,267 25,638
Commercial 208,002 188,205
Construction and land development 69,271 139,728
Land 62,999 65,642
-------- --------
Total mortgage loans 490,583 529,139
Consumer loans:
Home equity and second mortgage 38,418 41,746
Other 9,086 9,827
-------- --------
Total consumer loans 47,504 51,573
Commercial business loans 17,979 13,775
-------- --------
Total loans receivable 556,066 594,487
Less:
Undisbursed portion of construction loans in process 17,952 31,298
Deferred loan origination fees 2,229 2,439
Allowance for loan losses 11,264 14,172
-------- --------
31,445 47,909
-------- --------
Loans receivable, net 524,621 546,578
Loans held for sale (one- to four-family) 2,970 630
-------- --------
Total loans receivable and loans held for sale, net $527,591 $547,208
======== ========
Certain related parties of the Bank, principally Bank directors and officers,
were loan customers of the Bank in the ordinary course of business during the
years ended September 30, 2010 and 2009. These loans were performing
according to their terms at September 30, 2010 and 2009. Activity in related
party loans during the years ended September 30 is as follows (in thousands):
2010 2009
------ -------
Balance, beginning of year $1,781 $ 3,051
New loans 1,044 291
Repayments (79) (1,561)
------ -------
Balance, end of year $2,746 $ 1,781
====== =======
(continued)
104
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 4 - Loans Receivable and Loans Held for Sale (continued)
At September 30, 2010, 2009 and 2008, the Bank had impaired loans totaling
approximately $42,245,000, $47,622,000 and $13,647,000 respectively. Interest
income recognized on impaired loans for the years ended September 30, 2010,
2009 and 2008 was $1,296,000, $803,000 and $41,000 respectively. Interest
income recognized on a cash basis on impaired loans for the years ended
September 30, 2010, 2009 and 2008 was $816,000, $647,000 and $21,000,
respectively. The average investment in impaired loans for the years ended
September 30, 2010, 2009 and 2008 was $42,747,000, $32,597,000 and $6,955,000
respectively. The Bank had $16,400,000 in troubled debt restructured loans
included in impaired loans at September 30, 2010. The Bank had $1,055,000 in
commitments to lend additional 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. The Bank had $272,000 in troubled debt restructured loans
included in impaired loans at September 30, 2008 and there were no commitments
to lend additional funds on these loans.
An analysis of the allowance for loan losses for the years ended September 30
is as follows (in thousands):
2010 2009 2008
-------- ------- ------
Balance, beginning of year $ 14,172 $ 8,050 $4,797
Provision for loan losses 10,550 10,734 3,900
Allocated to commitments - - (169) --
Loans charged off (13,820) (4,531) (648)
Recoveries 362 88 1
-------- ------- ------
Net charge-offs (13,458) (4,443) (647)
-------- ------- ------
Balance, end of year $ 11,264 $14,172 $8,050
======== ======= ======
Following is a summary of information related to impaired loans at September
30 (in thousands):
2010 2009 2008
------- ------- -------
Impaired loans without a valuation allowance $36,475 $35,557 $ 8,872
Impaired loans with a valuation allowance 5,770 12,065 4,775
------- ------- -------
Total impaired loans $42,245 $47,622 $13,647
======= ======= =======
(continued)
105
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
An analysis of the valuation allowance related to impaired loans for the years
ended September 30 is as follows (in thousands):
2010 2009 2008
------- ------- -------
Balance, beginning of year $ 3,835 $ 790 $ 75
Additions 2,760 5,648 1,631
Deductions:
Charged off to allowance for loan losses (5,467) (1,838) (647)
Other reductions (266) (765) (269)
------- ------- ------
Balance, end of year $ 862 $ 3,835 $ 790
======= ======= ======
At September 30, 2010, 2009 and 2008, the Bank had non-accruing loans totaling
$24,864,000, $29,287,000 and $11,990,000, respectively. All non-accrual loans
are considered impaired. The Bank had $1,325,000 and $796,000 in loans that
were 90 days or more past due and still accruing interest at September 30,
2010 and 2009, respectively. At September 30, 2008, no loans were 90 days or
more past due and still accruing interest.
Note 5 - Mortgage Servicing Rights
Loans serviced for the Federal Home Loan Mortgage Corporation are not included
in the accompanying consolidated balance sheets. The principal amounts of
those loans at September 30, 2010, 2009 and 2008 were $280,852,000,
$251,837,000 and $175,807,000, respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (in thousands):
2010 2009 2008
------- ------- -------
Balance, beginning of year $2,618 $1,306 $1,051
Additions 805 1,785 578
Amortization (604) (473) (323)
Valuation allowance (890) (169) - -
Recovery of valuation allowance - - 169 - -
------ ------ ------
Balance, end of year $1,929 $2,618 $1,306
====== ====== ======
At September 30, 2010, 2009 and 2008, the fair value of mortgage servicing
rights totaled $1,929,000, $2,650,000 and $1,820,000, respectively. The fair
values for 2010, 2009, and 2008 were estimated using discounted cash flow
analyses with discount rates of 10.40%, 10.52% and 10.60%, respectively, and
prepayment speed factors of 350, 185 and 214, respectively. At September 30,
2010, there was a mortgage servicing rights valuation allowance of $890,000.
There was no valuation allowance at September 30, 2009 or 2008.
106
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (in
thousands):
2010 2009
------- -------
Land $ 4,291 $ 4,291
Buildings and improvements 16,054 15,860
Furniture and equipment 6,758 6,594
Property held for future expansion 110 110
Construction and purchases in progress 95 71
------- -------
27,308 26,926
Less accumulated depreciation 9,925 8,880
------- -------
Premises and equipment, net $17,383 $18,046
======= =======
The Bank leases premises under operating leases. Rental expense of leased
premises was $228,000, $243,000 and $241,000 for the years ended September 30,
2010, 2009 and 2008, respectively, which is included in premises and equipment
expense.
Minimum net rental commitments under noncancellable leases having an original
or remaining term of more than one year for future years ending September 30
are as follows (in thousands):
2011 $198
2012 211
2013 211
2014 144
2015 144
----
Total minimum payments required $908
====
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
107
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 7 OREO and Other Repossessed Assets
The following table presents the activity related to OREO and other
repossessed assets at September 30 (dollars in thousands):
2010 2009
Amount Number Amount Number
------ ------ ------ ------
Balance, beginning of year $ 8,185 26 $ 511 2
Additions to OREO and other repossessed
assets 9,434 31 10,005 37
Capitalized improvements 288 232
Lower of cost or fair value losses (829) (306)
Disposition of OREO and other
repossessed assets (5,559) (27) (2,257) (13)
------- --- ------- ---
Balance, end of year $11,519 30 $ 8,185 26
======= === ======= ===
At September 30, 2010, OREO and other repossessed assets consisted of 27
properties in Washington, with balances ranging from $5,000 to $3,048,000 and
three other repossessed assets totaling $67,000. At September 30, 2009, OREO
consisted of 26 properties in Washington, with balances ranging from $5,000 to
$2,314,000. The Bank recorded a net gain on sale of OREO and other
repossessed assets for the years ended September 30, 2010, 2009 and 2008 of
$291,000, $60,000 and $47,000, respectively, which is netted against (included
in) OREO and other repossessed assets expense (income) in the accompanying
consolidated statements of operations.
Note 8 - Core Deposit Intangibles ("CDI")
During the year ended September 30, 2005, the Company recorded a core deposit
intangible of $2,201,000 in connection with the October 2004 acquisition of
seven branches and related deposits. Net unamortized core deposit intangible
totaled $564,000 and $755,000 at September 30, 2010 and 2009, respectively.
Amortization expense related to the core deposit intangible for the years
ended September 30, 2010, 2009 and 2008 was $191,000, $217,000 and $249,000,
respectively.
Amortization expense for the core deposit intangible for future years ending
September 30 is estimated to be as follows (in thousands):
2011 $167
2012 147
2013 131
2014 116
2015 3
----
Total $564
====
108
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 9 - Deposits
Deposits consisted of the following at September 30 (in thousands):
2010 2009
-------- --------
Non-interest-bearing demand $ 58,755 $ 50,295
NOW checking 153,304 117,357
Savings 67,448 58,609
Money market accounts 55,723 62,478
Certificates of deposit 243,639 213,168
Certificates of deposit brokered - - 3,754
-------- --------
Total deposits $578,869 $505,661
======== ========
Certificates of deposit of $100,000 or greater totaled $93,006,000 and
$77,926,000 at September 30, 2010 and 2009, respectively.
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (in thousands):
2011 $177,911
2012 43,032
2013 6,244
2014 7,140
2015 9,002
Thereafter 310
--------
Total $243,639
========
Interest expense by account type is as follows for the years ended September
30 (in thousands):
2010 2009 2008
------ ------ -------
NOW checking $1,749 $1,031 $ 774
Savings 454 394 398
Money market accounts 677 1,036 1,250
Certificates of deposit 4,921 6,387 8,480
Certificates of deposit - brokered 6 624 861
------ ------ -------
Total $7,807 $9,472 $11,763
====== ====== =======
109
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 10 - Federal Home Loan Bank ("FHLB") Advances and Federal Reserve Bank of
San Francisco ("FRB") Borrowings
The Bank has long- and short-term borrowing lines with the FHLB of Seattle
with total credit on the lines equal to 30% of the Bank's total assets,
limited by available collateral. Borrowings are considered short-term when
the original maturity is less than one year. The Bank had $75,000,000 and
$95,000,000 of long-term FHLB advances outstanding at September 30, 2010 and
2009, respectively.
The long-term borrowings at September 30, 2010 mature at various dates through
September 2017 and bear interest at rates ranging from 3.49% to 4.66%. Under
the Advances, Security and Deposit Agreement, virtually all of the Bank's
assets, not otherwise encumbered, are pledged as collateral for advances.
Principal reductions due for future years ending September 30 are as follows
(in thousands):
2011 $ 20,000
2012 10,000
2013 - -
2014 - -
2015 - -
Thereafter 45,000
--------
$ 75,000
========
A portion of the long-term advances have a putable feature and may be called
by the FHLB earlier than the scheduled maturities. On October 1, 2010 the
Bank repaid the $20 million in advances due during the 2011 fiscal year.
The Bank also maintains a short-term borrowing line with the FRB with total
credit based on eligible collateral. At September 30, 2010 the Bank had a
borrowing capacity on this line of $41,396,000 with no balance outstanding.
The Bank had borrowings of $10,000,000 outstanding on this line at September
30, 2009.
Information concerning total short-term borrowings as of and for the years
ended at September 30 is summarized as follows (dollars in thousands):
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%
110
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 11 - Repurchase Agreements
Repurchase agreements at September 30, 2010 and 2009 consisted of overnight
repurchase agreements with customers totaling $622,000 and $777,000,
respectively.
Information concerning repurchase agreements as of and for the years ended
September 30 is summarized as follows (dollars in thousands):
2010 2009
------ ------
Average daily balance during the period $ 539 $ 624
Average daily interest rate during the period 0.05% 0.08%
..
Maximum month-end balance during the period $ 750 $ 844
Weighted average rate at end of period 0.05% 0.05%
Securities underlying the agreements at the end of period:
Recorded value $ 690 $ 826
Fair value 695 826
The securities underlying the agreements at September 30, 2010 and 2009 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):
2010 2009
------ ------
Accrued deferred compensation and profit sharing plans
payable $ 81 $ 188
Accrued preferred stock dividend payable 416 - -
Accrued interest payable on deposits, advances,
borrowings and repurchase agreements 737 965
Accounts payable and accrued expenses - other 1,554 1,886
------ ------
Total other liabilities and accrued expenses $2,788 $3,039
====== ======
111
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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):
2010 2009 2008
------- ------- --------
Current $(2,030) $ 831 $ 4,041
Deferred 466 (1,813) (1,217)
------- ------- --------
Provision (benefit) $(1,564) $ (982) $ 2,824
======= ======= ========
At September 30, 2010 and 2009, the Company recorded income taxes receivables
of $2,564,000 and $543,000, respectively, which are included in other assets
in the accompanying consolidated balance sheet.
The components of the Company's deferred tax assets and liabilities at
September 30 were as follows (in thousands):
2010 2009
------ ------
Deferred Tax Assets
Accrued interest on loans $ 479 $ 147
Accrued vacation - - 120
Unearned ESOP shares 439 455
Allowance for loan losses 3,977 5,019
OREO 153 60
CDI 257 250
Unearned MRDP shares 60 111
Net unrealized securities losses 341 1,035
Capital loss carry-forward 680 846
OTTI credit Impairment 111 - -
Other 159 59
------ ------
Total deferred tax assets 6,656 8,102
(continued)
112
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 13 - Federal Income Taxes (concluded)
2010 2009
------ ------
Deferred Tax Liabilities
FHLB stock dividends $ 880 $ 906
Depreciation 319 444
Goodwill 768 659
Mortgage servicing rights 656 916
Prepaid expenses 195 102
Other 17 20
------ ------
Total deferred tax liabilities 2,835 3,047
Valuation allowance for capital loss on sale of
securities (421) (510)
Net deferred tax assets $3,400 $4,545
====== ======
The Company has a capital loss carry forward in the amount of $2,000,000 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):
2010 2009 2008
------- ------ ------
Taxes at statutory rate $(1,312) $ (429) $2,390
BOLI income (167) (337) (170)
Non-deductible capital loss - - - - 750
Dividends on ESOP (12) (121) (136)
Other - net (73) (95) (10)
------- ------ ------
Provision (benefit) for
federal income taxes $(1,564) $ (982) $2,824
======= ====== ======
113
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 14 - Employee Stock Ownership and 401(k) Plan ("KSOP")
Effective October 3, 2007, the Bank established the Timberland Bank Employee
Stock Ownership and 401(k) Plan ("KSOP") by combining the existing Timberland
Bank Employee Stock Ownership Plan (established in 1997) and the Timberland
Bank 401(k) Profit Sharing Plan (established in 1970). The KSOP is comprised
of two components, the Employee Stock Ownership Plan ("ESOP") and the 401(k)
Plan. The KSOP benefits employees with at least one year of service who are
21 years of age or older. It may be funded by Bank contributions in cash or
stock for the ESOP and in cash only for the 401(k) profit sharing. Employee
vesting occurs over six years.
ESOP
----
The amount of the annual contribution is discretionary, except that it must be
sufficient to enable the ESOP to service its debt. All dividends received by
the ESOP are used to pay debt service. Dividends of $35,000, $331,000, and
$389,000 were used to service the debt during the years ended September 30,
2010, 2009 and 2008, respectively. As of September 30, 2010, 192,691 ESOP
shares had been distributed to participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase
1,058,000 shares of common stock of the Company. The term of the loan was
extended by 75 months in December 2006. The extension of the loan reduces the
annual number of shares allocated to participants. The loan is being repaid
primarily from the Bank's contributions to the ESOP and is scheduled to be
fully repaid by March 31, 2019. The interest rate on the loan is 8.5%.
Interest expense on the ESOP debt was $315,000, $337,000, and $359,000 for the
years ended September 30, 2010, 2009 and 2008, respectively. The balance of
the loan at September 30, 2010 was $3,538,000.
Shares held by the ESOP as of September 30 were classified as follows:
2010 2009 2008
------- ------- -------
Unallocated shares 299,786 335,052 370,294
Shares released for allocation 565,523 550,755 523,477
------- ------- -------
Total ESOP shares 865,309 885,807 893,771
======= ======= =======
The approximate fair market value of the Bank's unallocated shares at
September 30, 2010, 2009 and 2008, was $1,211,000, $1,555,000 and $2,796,000,
respectively. Compensation expense recognized under the ESOP for the year
ended September 30, 2010 was $109,000. A compensation benefit of $138,000 was
recognized for the year ended September 30, 2009 and a compensation expense of
$7,000 was recognized for the year ended September 30, 2008.
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
$294,000, $475,000 and $422,000 for the years ended September 30, 2010, 2009
and 2008, respectively.
114
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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, 2010, options for 249,738 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, 2007 412,674 $7.39
Options exercised (138,854) 6.06
-------
Outstanding September 30, 2008 273,820 8.07
=======
Options exercised (57,699) 6.00
Options forfeited (47,257) 6.00
-------
Outstanding September 30, 2009 168,864 9.35
=======
Options granted 26,000 4.55
-------
Outstanding September 30, 2010 194,864 $8.71
=======
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 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
There were no options granted during the years ended September 30, 2009 and
2008.
(continued)
115
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 15 - Stock Compensation Plans (continued)
There were no shares that vested during the year ended September 30, 2010.
The total fair value of shares that vested during the years ended September
30, 2009 and 2008 was $13,000 and $30,000, respectively.
At September 30, 2010 there were 26,000 unvested options with an aggregate
grant date fair value of $34,000, all of which the Company assumes will vest.
There was no aggregate intrinsic value of unvested options at September 30,
2010, as the exercise price was greater than the stock's current market value.
There were no unvested options at September 30, 2009.
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):
2010 2009 2008
------ ------ -------
Proceeds from options exercised $ - - $ 346 $ 842
Related tax benefit recognized - - 46 15
Intrinsic value of options exercised - - 56 531
Additional information regarding options outstanding at September 30, 2010, 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 26,000 $ 4.55 9.1 - - $ - - - -
7.45 56,638 7.45 0.7 56,638 7.45 0.7
7.85 -
7.98 6,000 7.91 1.6 6,000 7.91 1.6
9.52 56,680 9.52 2.4 56,680 9.52 2.4
11.46 -
11.63 49,546 11.51 3.3 49,546 11.51 3.3
------- -------
194,864 $ 8.71 3.0 168,864 $ 9.35 2.1
======= =======
There was no aggregate intrinsic value of options outstanding at September 30,
2010 and 2009, as the exercise price of all options outstanding was greater
than the stock's current market value. The aggregate intrinsic value of all
options outstanding and exercisable at September 30, 2008 was $168,000.
Stock Grant Plan
----------------
The Company adopted the 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)
116
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2009 and 2008
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, 2010, 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:
2010 2009 2008
------ ------ ------
Shares granted - - 19,758 20,315
Weighted average grant date fair value $ - - $ 7.01 $12.76
Shares vested 13,431 9,479 5,416
Aggregate vesting date fair value $ 56,000 $ 46,000 $ 46,000
A summary of unvested MRDP shares as of September 30, 2010 and changes during
the year ended September 30, 2010, were as follows:
Weighted Average
Grant Date
Shares Fair Value
------ ----------
Unvested shares, beginning of period 49,858 $ 11.66
Shares vested (13,431) 12.74
------
Unvested shares, end of period 36,427 $ 11.27
======
At September 30, 2010, there were 36,427 unvested MRDP shares with an
aggregate grant date fair value of $410,000.
Expense for Stock Compensation Plans
------------------------------------
Compensation expense recorded in the consolidated financial statements for all
stock-based plans were as follows for the years ended September 30, (in
thousands):
2010 2009 2008
------ ------ ------
Stock options $ 6 $ 3 $ 5
MRDP stock grants 134 137 147
Less: related tax benefit recognized (49) (49) (53)
----- ----- -----
$ 91 $ 91 $ 99
===== ===== =====
(continued)
117
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
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
------- ------- ------
2011 $ 7 $ 165 $ 172
2012 7 111 118
2013 6 38 44
2014 6 2 8
2015 1 - - 1
---- ----- -----
$ 27 $ 316 $ 343
==== ===== =====
Note 16 - Deferred Compensation Plans
The Bank has a deferred compensation/non-competition arrangement with its
former chief executive officer, which provides for payments of $2,000 per
month. Payments under this agreement began in March 2004 and will continue
until his death, at which time payments will continue to his surviving spouse
until the earlier of her death or for 60 months. The present value of the
payments as of September 30, 2010 and 2009 was $81,000 and $105,000,
respectively, and is included in other liabilities in the accompanying
consolidated balance sheets.
The Company adopted the Timberland Bancorp, Inc. Directors Deferred
Compensation Plan in 2004. This plan allows directors to defer a portion of
their monthly directors' fees until retirement with no income tax payable by
the director until retirement benefits are received. There was no liability
accrued under this plan at September 30, 2010 or 2009.
Note 17 - Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. These instruments
involve, to varying degrees, elements of credit risk not recognized 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.
(continued)
118
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 17 - Commitments and Contingencies (continued)
A summary of the Bank's commitments at September 30, is as follows (in
thousands):
2010 2009
------ ------
Undisbursed portion of construction loans in process
(see Note 4) $17,952 $31,298
Undisbursed lines of credit 26,030 27,609
Commitments to extend credit 8,357 16,513
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.
In March 2007, the Bank adopted the Timberland Bank Employee Severance
Compensation Plan, which replaced the existing employee severance compensation
agreement adopted in 1998. The new plan, which expires in 2017, was adopted
to provide severance pay benefits to eligible employees in the event of a
change in control of the Company or the Bank (as defined in the plan). In
general, all employees (except those who are restricted from receiving golden
parachute payments in any amount under the compensation limitations for
participants in the Treasury's Capital Purchase Program) with two or more
years of service will be eligible to participate in the plan. Under the plan,
in the event of a change in control of the Company or the Bank, eligible
employees who are terminated or who terminate employment (but only upon the
occurrence of events specified in the plan) within 12 months of the effective
date of a change in control would be entitled to a payment based on years of
service or officer rank with the Bank. The maximum payment for any eligible
employee would be equal to 24 months of their current compensation.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these
claims, if any, will not have a material effect on the consolidated financial
position of the Company.
Note 18 - Significant Concentrations of Credit Risk
Most of the Bank's lending activity is with customers located in the state of
Washington and involves real estate. At September 30, 2010, the Bank had
$531,971,000 (including $17,952,000 of undisbursed construction loan proceeds)
in loans secured by real estate, which represents 95.2% 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, 2010,
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 $18,047,000 in CDs held for investment at September 30, 2010.
The CDs are held with FDIC insured institutions, and each CD is below the FDIC
insurance limit of $250,000.
119
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 19 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's consolidated financial statements.
Under capital adequacy guidelines of the regulatory framework for prompt
corrective action, the Bank must meet specific capital adequacy guidelines
that involve quantitative measures of the Bank's assets, liabilities and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The capital classifications of the Company and the Bank are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
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, 2010 to its minimum regulatory capital requirements
at that date (dollars in thousands):
(continued)
120
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 19 - Regulatory Matters (concluded)
To be Well
Capitalized
Under Prompt
Capital Adequacy Corrective
Actual Purposes Action Provisions
-------------- ---------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ ------
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
September 30, 2009
Tier 1 leverage
capital:
Consolidated $83,196 12.2% $27,182 4.0% N/A N/A
Timberland Bank 67,780 10.1 26,774 4.0 $33,467 5.0%
Tier 1 risk adjusted
capital:
Consolidated 83,196 14.7 22,683 4.0 N/A N/A
Timberland Bank 67,780 12.0 22,576 4.0 33,864 6.0
Total risk based
capital:
Consolidated 90,372 15.9 45,366 8.0 N/A N/A
Timberland Bank 74,923 13.3 45,152 8.0 56,440 10.0
---------------------
(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. 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.
121
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 20 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(in thousands)
2010 2009
------- -------
Assets
Cash and cash equivalents:
Cash and due from financial institutions $ 641 $ 350
Interest-bearing deposits in banks 3,516 10,603
------- -------
Total cash and cash equivalents 4,157 10,953
Loan receivable from Bank 3,538 3,811
Investment in Bank 77,949 71,784
Other assets 327 798
------- -------
Total assets $85,971 $87,346
======= =======
Liabilities and shareholders' equity
Accrued expenses $ 563 $ 147
Shareholders' equity 85,408 87,199
------- -------
Total liabilities and shareholders' equity $85,971 $87,346
======= =======
Condensed Statements of Operations - Years Ended September 30
(in thousands)
2010 2009 2008
-------- ------- -------
Operating income
Interest on deposits in banks $ 31 $ 25 $ 22
Interest on loan receivable from Bank 315 338 359
Dividends on investments - - - - 65
Loss on sale of investment securities
available for sale - - - - (171)
Dividends from Bank - - 416 3,850
------- ------- -------
Total operating income 346 779 4,125
Non-operating income - - 37 - -
Operating expenses 683 642 589
------- ------- -------
Income (loss) before income taxes and
equity in undistributed income (loss)
of Bank (337) 174 3,536
Benefit for income taxes (127) (200) (193)
------- ------- -------
Income (loss) before equity in
undistributed income (loss) of Bank (210) 374 3,729
Equity in undistributed income (loss)
of bank (dividends in excess of income
of Bank) (2,081) (616) 276
------- ------- -------
Net income (loss) $(2,291) $ (242) $ 4,005
======= ======= =======
Preferred stock dividends $ 832 $ 643 $ - -
Preferred stock accretion 210 129 - -
------- ------- -------
Net income (loss) to common shareholders $(3,333) $(1,014) $ 4,005
======= ======= =======
(continued)
122
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 20 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(in thousands)
2010 2009 2008
------- ------- -------
Cash flows from operating activities
Net income (loss) $(2,291) $ (242) $ 4,005
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 2,081 616 (276)
ESOP shares earned 265 264 264
MRDP compensation expense 173 169 131
Stock option compensation expense 6 3 5
Stock option tax effect - - 46 15
Less stock option excess tax benefit - - - - (11)
Loss on sale of available for sale
securities - - - - 171
Other, net 471 (608) 1,764
------- ------- -------
Net cash provided by operating activities 705 248 6,068
Cash flows from investing activities
Investment in Bank (6,958) (6,308) (562)
Proceeds from sale of available for sale
securities - - - - 1,959
Principal repayments on loan receivable
from Bank 273 252 230
------- ------- -------
Net cash provided by (used in) investing
activities (6,685) (6,056) 1,627
Cash flows from financing activities
Decrease in borrowings from Bank - - - - (1,400)
Proceeds from exercise of stock options - - 346 841
Repurchase of common stock - - - - (1,920)
Payment of dividends (699) (3,272) (2,977)
ESOP tax effect (78) (47) (409)
MRDP compensation tax effect (39) (32) 16
Stock option tax effect - - - - 11
Issuance of preferred stock - - 15,425 - -
Issuance of stock warrants - - 1,158 - -
------- ------- -------
Net cash provided by (used in) financing
activities (816) 13,578 (5,838)
------- ------- -------
Net increase (decrease) in cash (6,796) 7,770 1,857
Cash and cash equivalents
Beginning of year 10,953 3,183 1,326
------- ------- -------
End of year $ 4,157 $10,953 $ 3,183
======= ======= =======
123
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 21 - 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):
2010 2009 2008
------- ------- -------
Basic net income (loss) per common share
computation
Numerator - net income (loss) $(2,291) $ (242) $4,005
Preferred stock dividends (832) (643) - -
Preferred stock discount accretion (210) (129) - -
------- ------- ------
Net income (loss) to common
stockholders $(3,333) $(1,014) $4,005
Denominator - weighted average common
shares outstanding 6,713,766 6,621,399 6,475,385
Basic net income (loss) per common
share $(0.50) $(0.15) $0.62
Diluted net income (loss) per common
share computation
Numerator - net income (loss) $(2,291) $ (242) $4,005
Preferred stock dividends (832) (643) - -
Preferred stock discount accretion (210) (129) - -
------- ------- ------
Net income (loss) to common
stockholders $(3,333) $(1,014) $4,005
Denominator - weighted average common
shares outstanding 6,713,766 6,621,399 6,475,385
Effect of dilutive stock options - - - - 95,107
Weighted average common shares
outstanding-assuming dilution 6,713,766 6,621,399 6,570,492
Diluted net income (loss) per
common share $(0.50) $(0.15) $0.61
For the years ended September 30, 2010, 2009 and 2008, options to purchase
193,083, 176,899 and 40,443 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)
124
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 21 - 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 income (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, 2010 and 2009, a warrant to purchase a
weighted average of 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. There were no warrants to purchase shares of common
stock outstanding during the year ended September 30, 2008.
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 income (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 22 - Accumulated Other Comprehensive Income (Loss)
Net unrealized gains and losses included in accumulated other comprehensive
loss were computed as follows for the years ended September 30 (in thousands):
2010 2009 2008
------ ------- -------
Unrealized gain (loss) on securities:
Net unrealized holding gain (loss) from
available for sale securities $ 755 $ 28 $(2,329)
Cumulative effect of adoption of FASB
guidance regarding recognition of OTTI - - (140) - -
OTTI on held to maturity securities
recognized in other comprehensive income
(loss) 1,178 (2,274) - -
Accretion of OTTI on held to maturity
securities recognized in other comprehensive
income (loss) 48 - - - -
Reclassification adjustment from losses
included in net income (loss) - - - - 2,826
------ ------- -------
Unrealized gain (loss), net of reclassification
adjustment, before income tax provision
(benefit) 1,981 (2,386) 497
Income tax provision (benefit) 693 (835) 174
------ ------- -------
Net unrealized gains (losses) $1,288 $(1,551) $ 323
====== ======= =======
125
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 23 - 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, 2010 and 2009. 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.
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, 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.
Fair value of loans receivable at September 30, 2009 was estimated by using
FDIC portfolio sales for the period of January 1, 2007 through September
30, 2009 which included distressed loan sales.
(continued)
126
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 23 - Fair Value Measurement (continued)
Loans Held for Sale
-------------------
The estimated fair value has been based on quoted market prices obtained
from the Federal Home Loan Mortgage Corporation.
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.
FRB Borrowings
--------------
The recorded value of FRB borrowings approximates the estimated fair value
due to the short-term nature of the borrowings.
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)
127
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 23 - Fair Value Measurement (continued)
The estimated fair value of financial instruments at September 30, were as
follows (in thousands):
2010 2009
------------------- -------------------
Estimated Estimated
Recorded Fair Recorded Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets
Cash and due from financial
institutions and interest-
bearing deposits in banks $111,786 $111,786 $ 66,462 $ 66,462
CDs, held for investment 18,047 18,047 3,251 3,251
MBS and other investments 16,185 15,961 20,558 19,686
FHLB stock 5,705 5,705 5,705 5,705
Loans receivable, net 524,621 473,986 546,578 357,422
Loans held for sale 2,970 3,059 630 648
Accrued interest receivable 2,630 2,630 2,805 2,805
Financial Liabilities
Deposits $578,869 $581,046 $505,661 $507,465
FHLB advances - long term 75,000 81,579 95,000 99,414
FRB borrowings - short term - - - - 10,000 10,000
Repurchase agreements 622 622 777 777
Accrued interest payable 737 737 965 965
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)
128
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 23 - Fair Value Measurement (concluded)
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 and the total losses resulting
from these fair value adjustments for the year ended September 30, 2010 and
2009 (in thousands):
Fair Value
-----------------------------
Level 1 Level 2 Level 3 Total Losses
------- ------- ------- ------------
2010
----
Available for Sale Securities
Mutual funds $ 988 $ - - $ - - $ - -
MBS - - 10,131 - - 103
------ ------- ------ ------
Total $ 988 $10,131 $ - - $ 103
====== ======= ====== ======
2009
----
Available for Sale Securities
Mutual funds $ 968 $ - - $ - - $ - -
MBS - - 12,503 - - 227
------ ------- ------ ------
Total $ 968 $12,503 $ - - $ 227
====== ======= ====== ======
129
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 23 - Fair Value Measurement (concluded)
The following table summarizes the balance of assets and liabilities measured
at fair value on a non-recurring basis and the total losses resulting from
these fair value adjustments for the year ended September 30, 2010 and 2009
(in thousands):
Fair Value
-----------------------------
Level 1 Level 2 Level 3 Total Losses
------- ------- ------- ------------
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
====== ====== ======= =======
2009
----
Impaired Loans (1) $ - - $ - - $ 9,014 $ 4,442
MBS held to maturity (2) - - 1,835 - - 3,395
------ ------ ------- -------
Total $ - - $1,835 $ 9,014 $ 7,837
====== ====== ======= =======
------------------
(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 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 is 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 for each stratum 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.
130
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 24- 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,
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)
(continued)
131
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2010 and 2009
Note 24 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30, June 30, March 31, December 31,
2009 2009 2009 2008
------------ ------- -------- -----------
Interest and dividend income $ 9,364 $ 9,611 $ 9,801 $10,025
Interest expense (3,140) (3,419) (3,384) (3,561)
------- ------- ------- -------
Net interest income 6,224 6,192 6,417 6,464
Provision for loan losses (3,243) (1,000) (5,176) (1,315)
Non-interest income 1,457 2,674 1,912 906
Non-interest expense (5,387) (6,373) (5,442) (5,537)
------- ------- ------- -------
Income (loss) before income
taxes (949) 1,493 (2,289) 518
Provision (benefit) for
income taxes (681) 435 (896) 157
------- ------- ------- -------
Net income (loss) (268) 1,058 (1,393) 361
Preferred stock dividends (207) (210) (208) (18)
Preferred stock discount
accretion (50) (79) - - - -
------- ------- ------- -------
Net income (loss) to common
shareholders $ (525) $ 769 $(1,601) $ 343
======= ======= ======= =======
Net Income (loss) per common
share
Basic $(0.08) $0.12 $(0.24) $0.05
Diluted (0.08) 0.12 (0.24) 0.05
132
Item 9. Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------
On February 25, 2010, the Audit Committee of the Board of Directors of
the Company notified McGladrey & Pullen LLP of its decision not to renew the
engagement of McGladrey & Pullen LLP to serve as the Company's independent
registered public accounting firm. The decision to change certifying
accountants was approved by the Audit Committee of the Board of Directors,
which subsequently advised the Board of Directors of its decision, on February
23, 2010.
During the fiscal year ended September 30, 2009, and the subsequent
interim period through February 23, 2010, there were no: (1) disagreements
with McGladrey & Pullen LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedures,
which disagreements, if not resolved to their satisfaction, would have caused
them to make reference in connection with their opinion to the subject matter
of the disagreement, or (2) reportable events (as defined in Regulation S-K
Item 304 (a)(1)(v)). McGladrey & Pullen LLP issued an unqualified opinion on
the Company's financial statements as of September 30, 2009, and for the two
years then ended.
On February 23, 2010, the Audit Committee engaged the firm of Delap LLP
as the independent registered public accounting firm of the Company and its
subsidiary for the fiscal year ended September 30, 2010. During the fiscal
year ended September 30, 2010, there were no disagreements with Delap LLP and
Delap LLP issued an unqualified opinion on the Company's financial statements
as of September 30, 2010, and for the year then ended.
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, 2010 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, 2010, 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 de detected.
Management's Report on Internal Control Over Financial Reporting is
included in this Form 10-K under Part II, Item 8, "Financial Statements and
Supplementary Data."
133
Item 9B. Other Information
---------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The information required by this item is contained under the section
captioned "Proposal I - Election of Directors" is included in the Company's
Definitive Proxy Statement for the 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."
Compliance with Section 16(a) of the Exchange Act
The information required by this item is contained under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" included
in the Company's Proxy Statement and is incorporated herein by reference.
Audit Committee Financial Expert
The Company has a separately designated standing Audit Committee,
composed of Directors Mason, Robbel, Smith, 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 Mason, 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, 2010. The Code of Ethics requires the
Company's officers, directors and employees to maintain the highest standards
of professional conduct. The Company's Code of Ethics was filed as an exhibit
to its Annual Report on Form 10-K for the year ended September 30, 2003 and is
available on our website at www.timberlandbank.com.
Item 11. Executive Compensation
--------------------------------
The information required by this item is contained under the sections
captioned "Executive Compensation" and "Directors' Compensation" included in
the Company's Proxy Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
----------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
(a) Security Ownership of Certain Beneficial Owners.
The information required by this item is contained under the section
captioned "Security Ownership of Certain Beneficial Owners and Management"
included in the Company's Proxy Statement and is incorporated herein by
reference.
134
(b) Security Ownership of Management.
The information required by this item is contained under the sections
captioned "Security Ownership of Certain Beneficial Owners and Management" and
"Proposal I - Election of Directors" included in the Company's Proxy Statement
and is incorporated herein by reference.
(c) Changes In Control.
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
(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, 2010.
Number of
securities
remaining
available for
future issuance
under equity
Number of securities Weighted-average compensation
to be issued upon exercise price of plans (excluding
exercise of outstanding securities
outstanding options, options, warrants reflected
Plan category warrants and rights and rights in column (a))
----------------- ------------------- ----------------- ----------------
(a) (b) (c)
Equity compensation
plans approved by
security holders:
Management
Recognition
and Development
Plan............. -- $ -- --
1999 Stock Option
Plan............. 156,732 9.18 --
2003 Stock Option
Plan............. 38,132 6.80 249,738
Equity compensation
plans not approved
by security
holders............ -- -- --
------- -------
Total............ 194,864 $ 8.71 249,738
======= =======
Item 13. Certain Relationships and Related Transactions, and Director
------------------------------------------------------------------------
Independence
------------
The information required by this item is contained under the sections
captioned "Meetings and Committees of the Board of Directors And Corporate
Governance Matters - Corporate Governance - Related Party Transactions" and
"Meetings and Committees of the Board of Directors and Corporate Governance
Matters - Corporate Governance - Director Independence" included in the
Company's Proxy Statement and are incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
------------------------------------------------
The information required by this item is contained under the section
captioned "Independent Auditor" included in the Company's Proxy Statement and
is incorporated herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
-------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (1)
3.2 Amended and Restated Bylaws of the Registrant (2)
3.3 Articles of Amendment to Articles of Incorporation of the
Registrant(3)
135
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)
10.8 Form of Management Recognition and Development Award Agreement
(7)
10.10 Employment Agreement with Michael R. Sand (9)
10.11 Employment Agreement with Dean J. Brydon (9)
14 Code of Ethics (10)
21 Subsidiaries of the Registrant
23.1 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, 2010
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, 2010
------------
(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 Current Report on Form 8-K
dated April 13, 2007.
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2003.
136
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 10, 2010 By:/s/ Michael R. Sand
-------------------------------------
Michael R. Sand
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ Michael R. Sand President, Chief Executive Officer December 10, 2010
--------------------- and Director
Michael R. Sand (Principal Executive Officer)
/s/ Jon C. Parker Chairman of the Board December 10, 2010
---------------------
Jon C. Parker
/s/ Dean. J. Brydon Chief Financial Officer December 10, 2010
--------------------- (Principal Financial and Accounting
Dean J. Brydon Officer)
/s/ Andrea M. Clinton Director December 10, 2010
---------------------
Andrea M. Clinton
/s/ Larry D. Goldberg Director December 10, 2010
---------------------
Larry D. Goldberg
/s/ James C. Mason Director December 10, 2010
---------------------
James C. Mason
/s/ Ronald A. Robbel Director December 10, 2010
---------------------
Ronald A. Robbel
/s/ David A. Smith Director December 10, 2010
---------------------
David A. Smith
/s/ Michael J. Stoney Director December 10, 2010
---------------------
Michael J. Stoney
137
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, 2010
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, 2010