UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2011 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From _____ to _____. Commission file number 0-23333 TIMBERLAND BANCORP, INC. (Exact name of registrant as specified in its charter) Washington 91-1863696 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 624 Simpson Avenue, Hoquiam, Washington 98550 (Address of principal executive offices) (Zip Code) (360) 533-4747 (Registrant's telephone number, including area code) 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 ----- ----- 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 X No ----- ----- 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 definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated Filer ----- ----- Non-accelerated filer Smaller reporting company X ----- ----- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS SHARES OUTSTANDING AT JANUARY 31, 2012 ----- -------------------------------------- Common stock, $.01 par value 7,045,036 INDEX Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Income 4-5 Condensed Consolidated Statements of Comprehensive Income 6 Condensed Consolidated Statements of Shareholders' Equity 7 Condensed Consolidated Statements of Cash Flows 8-9 Notes to Unaudited Condensed Consolidated Financial Statements 10-33 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 33-48 Item 3. Quantitative and Qualitative Disclosures About Market Risk 49 Item 4. Controls and Procedures 49 PART II. OTHER INFORMATION Item 1. Legal Proceedings 49 Item 1A. Risk Factors 49 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50 Item 3. Defaults Upon Senior Securities 50 Item 4. (Removed and Reserved) 50 Item 5. Other Information 50 Item 6. Exhibits 50-51 SIGNATURES 52 Certifications Exhibit 31.1 Exhibit 31.2 Exhibit 32 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements ------------------------------ TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS December 31, 2011 and September 30, 2011 (Dollars in thousands, except per share amounts) (Unaudited) December 31, September 30, 2011 2011 ----------------------- Assets Cash and cash equivalents: Cash and due from financial institutions $ 12,671 $ 11,455 Interest-bearing deposits in banks 98,876 100,610 ----------------------- Total cash and cash equivalents 111,547 112,065 ----------------------- Certificates of deposit ("CDs") held for investment (at cost) 19,810 18,659 Mortgage-backed securities ("MBS") and other investments - held to maturity, at amortized cost 3,941 4,145 (estimated fair value $4,006 and $4,229) MBS and other investments - available for sale 6,284 6,717 Federal Home Loan Bank of Seattle ("FHLB") stock 5,705 5,705 Loans receivable 537,904 535,926 Loans held for sale 3,110 4,044 Less: Allowance for loan losses (11,972) (11,946) ----------------------- Net loans receivable 529,042 528,024 ----------------------- Premises and equipment, net 17,353 17,390 Other real estate owned ("OREO") and other repossessed assets, net 7,714 10,811 Accrued interest receivable 2,388 2,411 Bank owned life insurance ("BOLI") 16,074 15,917 Goodwill 5,650 5,650 Core deposit intangible ("CDI") 360 397 Mortgage servicing rights ("MSRs"), net 2,169 2,108 Prepaid Federal Deposit Insurance Corporation ("FDIC") insurance assessment 1,873 2,103 Other assets 5,939 6,122 ----------------------- Total assets $735,849 $738,224 ======================= Liabilities and shareholders' equity Liabilities: Deposits: Non-interest-bearing demand $ 61,178 $ 64,494 Deposits: Interest-bearing 527,997 528,184 ----------------------- Total deposits 589,175 592,678 ----------------------- FHLB advances 55,000 55,000 Repurchase agreements 538 729 Other liabilities and accrued expenses 3,806 3,612 ----------------------- Total liabilities 648,519 652,019 ----------------------- Shareholders' equity Preferred stock, $.01 par value; 1,000,000 shares authorized; 16,048 15,989 16,641 shares, Series A, issued and outstanding; $1,000 per share liquidation value Common stock, $.01 par value; 50,000,000 shares authorized; 10,464 10,457 7,045,036 shares issued and outstanding Unearned shares - Employee Stock Ownership Plan ("ESOP") (1,917) (1,983) Retained earnings 63,286 62,270 Accumulated other comprehensive loss (551) (528) ----------------------- Total shareholders' equity 87,330 86,205 ----------------------- Total liabilities and shareholders' equity $735,849 $738,224 ======================= See notes to unaudited condensed consolidated financial statements 3 TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF INCOME For the three months ended December 31, 2011 and 2010 (Dollars in thousands, except per share amounts) (Unaudited) Three Months Ended December 31, 2011 2010 ------------------- Interest and dividend income Loans receivable $7,805 $8,534 MBS and other investments 125 182 Dividends from mutual funds and FHLB stock 13 8 Interest-bearing deposits in banks 89 87 ------------------- Total interest and dividend income 8,032 8,811 ------------------- Interest expense Deposits 1,169 1,751 FHLB advances - long term 562 729 ------------------- Total interest expense 1,731 2,480 ------------------- Net interest income 6,301 6,331 Provision for loan losses 650 900 ------------------- Net interest income after provision for loan losses 5,651 5,431 ------------------- Non-interest income Other than temporary impairment ("OTTI") on MBS and other investments (90) (145) Adjustment for portion recorded as other comprehensive loss (before taxes) 30 9 ------------------- Net OTTI on MBS and other investments (60) (136) ------------------- Gain on sales of MBS and other investments - - 79 Service charges on deposits 970 984 ATM transaction fees 517 411 BOLI net earnings 157 122 Gain on sales of loans, net 560 701 Servicing income (expense) on loans sold 9 (36) Escrow fees 27 21 Valuation recovery on MSRs 84 634 Fee income from non-deposit investment sales 12 31 Other 168 140 ------------------- Total non-interest income, net 2,444 2,951 ------------------- See notes to unaudited condensed consolidated financial statements 4 TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (continued) For the three months ended December 31, 2011 and 2010 (Dollars in thousands, except per share amounts) (Unaudited) Three Months Ended December 31, 2011 2010 ------------------- Non-interest expense Salaries and employee benefits $2,929 $3,127 Premises and equipment 673 694 Advertising 208 167 OREO and other repossessed items expense, net 502 428 ATM expenses 194 175 Postage and courier 118 115 Amortization of CDI 37 42 State and local taxes 149 166 Professional fees 178 182 FDIC insurance 225 340 Other insurance 56 154 Loan administration and foreclosure 161 98 Data processing and telecommunications 257 234 Deposit operations 223 106 Other 311 348 ------------------- Total non-interest expense 6,221 6,376 ------------------- Income before federal and state income taxes 1,874 2,006 Provision for federal and state income taxes 591 647 ------------------- Net income 1,283 1,359 Preferred stock dividends (208) (208) Preferred stock discount accretion (59) (54) ------------------- Net income to common shareholders $1,016 $1,097 =================== Net income per common share Basic $ 0.15 $ 0.16 Diluted $ 0.15 $ 0.16 Weighted average common shares outstanding Basic 6,780,516 6,745,250 Diluted 6,780,516 6,745,250 See notes to unaudited condensed consolidated financial statements 5 TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the three months ended December 31, 2011 and 2010 (In thousands) (Unaudited) Three Months Ended December 31, 2011 2010 ------------------- Comprehensive income: Net income $1,283 $1,359 Unrealized holding loss on securities available for sale, net of tax (14) (75) Change in OTTI on securities held-to-maturity, net of tax: Additions (14) (47) Additional amount recognized related to credit loss for which OTTI was previously recognized (13) (4) Amount reclassified to credit loss for previously recorded market loss 7 45 Accretion of OTTI securities held-to-maturity, net of tax 11 6 ------ ------ Total comprehensive income $1,260 $1,284 ====== ====== See notes to unaudited condensed consolidated financial statements 6 TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the three months ended December 31, 2011 and the year ended September 30, 2011 (Dollars in thousands, except per share amounts) (Unaudited) Accumu- lated Number of Shares Amount Other ------------------- ------------------ Unearned Compre- Preferred Common Preferred Common Shares - Retained hensive Stock Stock Stock Stock ESOP Earnings Loss Total ------ ------ ------- ------ --------- -------- --------- ----- Balance, September 30, 2010 16,641 7,045,036 $15,764 $10,377 $(2,247) $62,238 $ (724) $85,408 Net income - - - - - - - - - - 1,089 - - 1,089 Accretion of preferred stock discount - - - - 225 - - - - (225) - - - - 5% preferred stock dividend - - - - - - - - - - (832) - - (832) Earned ESOP shares - - - - - - (61) 264 - - - - 203 MRDP (1) compensation expense - - - - - - 134 - - - - - - 134 Stock option compensation expense - - - - - - 7 - - - - - - 7 Unrealized holding gain on securities available for sale, net of tax - - - - - - - - - - - - 14 14 Change in OTTI on securities held to maturity, net of tax - - - - - - - - - - - - 139 139 Accretion of OTTI on securities held to maturity, net of tax - - - - - - - - - - - - 43 43 ------ --------- ------- ------- ------- ------- ----- ------- Balance, September 30, 2011 16,641 7,045,036 15,989 10,457 (1,983) 62,270 (528) 86,205 Net income - - - - - - - - - - 1,283 - - 1,283 Accretion of preferred stock discount - - - - 59 - - - - (59) - - - - 5% preferred stock dividend - - - - - - - - - - (208) - - (208) Earned ESOP shares - - - - - - (20) 66 - - - - 46 MRDP (1) compensation expense - - - - - - 25 - - - - - - 25 Stock option compensation expense - - - - - - 2 - - - - - - 2 Unrealized holding loss on securities available for sale, net of tax - - - - - - - - - - - - (14) (14) Change in OTTI on securities held to maturity, net of tax - - - - - - - - - - - - (20) (20) Accretion of OTTI on securities held to maturity, net of tax - - - - - - - - - - - - 11 11 ------ --------- ------- ------- ------- ------- ----- ------- Balance, December 31, 2011 16,641 7,045,036 $16,048 $10,464 $(1,917) $63,286 $(551) $87,330 ====== ========= ======= ======= ======= ======= ===== ======= ---------------- (1) 1998 Management Recognition and Development Plan ("MRDP"). See notes to unaudited condensed consolidated financial statements TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the three months ended December 31, 2011 and 2010 (Dollars in thousands) (Unaudited) Three Months Ended December 31, 2011 2010 ------------------------------ Cash flow from operating activities Net income $ 1,283 $ 1,359 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 650 900 Depreciation 234 253 Deferred federal income taxes (12) - - Amortization of CDI 37 42 Earned ESOP shares 66 66 MRDP compensation expense 25 44 Stock option compensation expense 2 1 Loss (gain) on sales of OREO and other repossessed assets, net 271 (14) Provision for OREO losses 57 251 Loss on disposition of premises and equipment - - 5 BOLI net earnings (157) (122) Gain on sales of loans, net (560) (701) Decrease in deferred loan origination fees (58) (83) Net OTTI on MBS and other investments 60 136 Gain on sales of MBS and other investments - - (79) Valuations recovery on MSR's (84) (634) Loans originated for sale (22,203) (25,045) Proceeds from sales of loans 23,697 26,863 Decrease in other assets, net 463 874 Decrease in other liabilities and accrued expenses, net (14) (109) --------------------- Net cash provided by operating activities 3,757 4,007 Cash flow from investing activities Net increase in CDs held for investment (1,151) (454) Proceeds from maturities and prepayments of securities available for sale 378 632 Proceeds from maturities and prepayments of securities held to maturity 184 252 Proceeds from sales of MBS and other investments - - 2,271 (Increase) decrease in loans receivable, net (9) 207 Additions to premises and equipment (197) (112) Proceeds from sales of OREO and other repossessed assets 234 370 --------------------- Net cash (used in) provided by investing activities (561) 3,166 Cash flow from financing activities Decrease in deposits, net (3,503) (1,475) Repayment of FHLB advances - - (20,000) (Decrease) increase in repurchase agreements (191) 20 ESOP tax effect (20) (33) --------------------- Net cash used in financing activities (3,714) (21,488) --------------------- See notes to unaudited condensed consolidated financial statements 8 TIMBERLAND BANCORP, INC. AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) For the three months ended December 31, 2011 and 2010 (Dollars in thousands) (Unaudited) Three Months Ended December 31, 2011 2010 ------------------------------ Net decrease in cash and cash equivalents $ (518) $(14,315) Cash and cash equivalents Beginning of period 112,065 111,786 --------------------- End of period $111,547 $ 97,471 ===================== Supplemental disclosure of cash flow information Income taxes paid $ - - $ 137 Interest paid 1,752 2,558 Supplemental disclosure of non-cash investing activities Loans transferred to OREO and other repossessed assets $ 669 $ 1,700 Loan originated to facilitate the sale of OREO 3,204 - - See notes to unaudited condensed consolidated financial statements 9 Timberland Bancorp, Inc. and Subsidiary Notes to Unaudited Condensed Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation: The accompanying unaudited condensed consolidated financial statements for Timberland Bancorp, Inc. ("Company") were prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with GAAP. However, all adjustments which are in the opinion of management, necessary for a fair presentation of the interim condensed consolidated financial statements have been included. All such adjustments are of a normal recurring nature. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended September 30, 2011 ("2011 Form 10-K"). The unaudited condensed consolidated results of operations for the three months ended December 31, 2011 are not necessarily indicative of the results that may be expected for the entire fiscal year. (b) Principles of Consolidation: The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Timberland Bank ("Bank"), and the Bank's wholly-owned subsidiary, Timberland Service Corp. All significant inter-company balances have been eliminated in consolidation. (c) Operating Segment: The Company has one reportable operating segment which is defined as community banking in western Washington under the operating name, "Timberland Bank." (d) The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. (e) Certain prior period amounts have been reclassified to conform to the December 31, 2011 presentation with no change to net income or total shareholders' equity previously reported. (2) REGULATORY MATTERS 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 an agreement on a Memorandum of Understanding with the Bank ("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 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 ("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 10 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 U.S. Treasury Department's Capital Purchase Program ("CPP") for quarterly payments due for the last seven quarters commencing with the payments due May 15, 2010. For additional information on the CPP, see Note 3 below entitled "U.S Treasury Department's Capital Purchase Program." (3) 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 a part of the Treasury's 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 pays a 5.0% dividend for the first five years, after which the rate increases to 9.0% if the preferred shares are not redeemed by the Company. Preferred stock 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 net income for computing income available to common shareholders and net income per share computations. 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. The FRB has denied the Company's requests to pay dividends on its Series A Preferred Stock issued under the CPP for quarterly payments due for the last seven quarters commencing with the payment due May 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. Since dividends on the Series A Preferred Stock have not been paid for at least six quarters, the Treasury has the right to appoint two members to the Company's Board of Directors. 11 (4) MBS AND OTHER INVESTMENTS MBS and other investments have been classified according to management's intent and are as follows as of December 31, 2011 and September 30, 2011 (dollars in thousands): Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ------- December 31, 2011 ---------------- Held to Maturity MBS: U.S. government agencies $ 1,770 $ 47 $ (4) $ 1,813 Private label residential 2,144 207 (188) 2,163 U.S. agency securities 27 3 - - 30 ------- ------- ------ ------- Total $ 3,941 $ 257 $ (192) $ 4,006 ======= ======= ====== ======= Available for Sale MBS: U.S. government agencies $ 4,062 $ 163 $ - - $ 4,225 Private label residential 1,148 60 (144) 1,064 Mutual funds 1,000 - - (5) 995 ------- ------- ------ ------- Total $ 6,210 $ 223 $ (149) $ 6,284 ======= ======= ====== ======= September 30, 2011 ------------------ Held to Maturity MBS: U.S. government agencies $ 1,831 $ 45 $ (4) $ 1,872 Private label residential 2,287 311 (271) 2,327 U.S. agency securities 27 3 - - 30 ------- ------- ------ ------- Total $ 4,145 $ 359 $ (275) $ 4,229 ======= ======= ====== ======= Available for Sale MBS: U.S. government agencies $ 4,395 $ 188 $ - - $ 4,583 Private label residential 1,227 59 (152) 1,134 Mutual funds 1,000 - - - - 1,000 ------- ------- ------ ------- Total $ 6,622 $ 247 $ (152) $ 6,717 ======= ======= ====== ======= 12 The estimated fair value of temporarily impaired securities, the amount of unrealized losses and the length of time these unrealized losses existed as of December 31, 2011 are as follows (dollars in thousands): Less Than 12 Months 12 Months or Longer ------------------- ------------------- Total Esti- Esti- Esti- mated Gross mated Gross mated Gross Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----- ------ ----- ------ ----- ------ Held to Maturity MBS: U.S. government agencies $ 106 $ (1) $ 348 $ (3) $ 454 $ (4) Private label residential 76 (3) 1,118 (185) 1,194 (188) ----- ----- ------ ------ ------ ----- Total $ 182 $ (4) $1,466 $ (188) $1,648 $(192) ===== ===== ====== ====== ====== ====== Available for Sale MBS: U.S. government agencies $ - - $ - - $ - - $ - - $ - - $ - - Private label residential - - - - 724 (144) 724 (144) Mutual funds - - - - 995 (5) 995 (5) ----- ----- ------ ------ ------ ----- Total $ - - $ - - $1,719 $ (149) $1,719 $(149) ===== ===== ====== ====== ====== ====== During the three months ended December 31, 2011 and 2010, the Company recorded net OTTI charges through earnings on residential MBS of $60,000 and $136,000, respectively. The Company provides for the bifurcation of OTTI into (i) amounts related to credit losses which are recognized through earnings, and (ii) amounts related to all other factors which are recognized as a component of other comprehensive income (loss). To determine the component of the gross OTTI related to credit losses, the Company compared the amortized cost basis of each OTTI security to the present value of its revised expected cash flows, 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 by 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 estimate of the credit loss component on OTTI securities as of December 31, 2011 and September 30, 2011: Range --------------------- Weighted Minimum Maximum Average ------- ------- -------- At December 31, 2011 -------------------- Constant prepayment rate 6.00% 15.00% 8.45% Collateral default rate 0.71% 30.03% 10.00% Loss severity rate 25.92% 74.02% 49.39% At September 30, 2011 --------------------- Constant prepayment rate 6.00% 15.00% 10.71% Collateral default rate 0.43% 24.23% 8.03% Loss severity rate 11.93% 64.54% 39.22% 13 The following tables present the OTTI for the three months ended December 31, 2011 and 2010 (dollars in thousands): Three months ended Three months ended December 31, 2011 December 31, 2010 ------------------- -------------------- Held To Available Held To Available Maturity For Sale Maturity For Sale -------- --------- -------- --------- Total OTTI $ 52 $ 38 $ 145 $ - - Portion of OTTI recognized in other comprehensive loss (before income taxes) (1) (30) - - (9) - - ------- ------ ------ ------ Net OTTI recognized in earnings (2) $ 22 $ 38 $ 136 $ - - ======= ====== ====== ====== ------------- (1) Represents OTTI related to all other factors. (2) Represents OTTI related to credit losses. 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 income for the three months ended December 31, 2011 and 2010 (in thousands): Three months ended December 31, 2011 2010 ------ ------ Beginning balance of credit loss $3,361 $4,725 Additions: Credit losses for which OTTI was not previously recognized 1 46 Additional increases to the amount related to credit loss for which OTTI was previously recognized 59 90 Subtractions: Realized losses previously recorded as credit losses (196) (496) ------ ------ Ending balance of credit loss $3,225 $4,365 ====== ====== There were no gross realized gains on sale of securities for the three months ended December 31, 2011. There was a gross realized gain on sale of securities for the three months ended December 31, 2010 of $79,000. During the three months ended December 31, 2011, the Company recorded a $196,000 realized loss (as a result of the securities being deemed worthless) on 21 held to maturity residential MBS and one available for sale residential MBS, of which the entire amount had been recognized previously as a credit loss. During the three months ended December 31, 2010, the Company recorded a $496,000 realized loss on 16 held to maturity residential MBS which had previously been recognized as a credit loss. The amortized cost of residential mortgage-backed and agency securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits, FHLB collateral, retail repurchase agreements and other non-profit organization deposits totaled $7.36 million and $7.88 million at December 31, 2011 and September 30, 2011, respectively. 14 The contractual maturities of debt securities at December 31, 2011 are as follows (dollars in thousands). Expected maturities may differ from scheduled maturities as a result of 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 $ - - $ - - $ - - $ - - Due after one year to five years 22 23 104 111 Due after five to ten years 37 39 - - - - Due after ten years 3,882 3,944 5,106 5,178 ------- ------- ------- ------- Total $ 3,941 $ 4,006 $ 5,210 $ 5,289 ======= ======= ======= ======= (5) FHLB STOCK 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. On October 25, 2010, the FHLB announced that it had entered into a Consent Agreement with the Federal Housing Finance Agency ("FHFA"), which requires the FHLB to take certain specific actions related to its business and operations. As of its latest regulatory filing, the FHLB reported that it had met all of its regulatory capital requirements, but remained classified as "undercapitalized" by the FHFA. The FHLB will not pay a dividend or repurchase capital stock while it is classified as undercapitalized. While the FHLB was classified as undercapitalized, the Company does not believe that its investment in the FHLB is impaired as of December 31, 2011. However, this estimate could change in the near term if: 1) significant other-than-temporary losses are incurred on the FHLB's MBS causing a significant decline in its regulatory capital status; 2) the economic losses resulting from credit deterioration on the FHLB's MBS increases significantly; or 3) capital preservation strategies being utilized by the FHLB become ineffective. 15 (6) LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES Loans receivable and loans held for sale consisted of the following at December 31, 2011 and September 30, 2011 (dollars in thousands): December 31, September 30, 2011 2011 ------------------- ------------------ Amount Percent Amount Percent ------------------- ------------------ Mortgage loans: One- to four-family (1) $110,502 19.7% $114,680 20.5% Multi-family 30,866 5.5 30,982 5.5 Commercial 245,874 43.9 246,037 43.9 Construction and land development 57,803 10.3 52,484 9.4 Land 46,198 8.3 49,236 8.8 -------- ----- -------- ----- Total mortgage loans 491,243 87.7 493,419 88.1 Consumer loans: Home equity and second mortgage 34,607 6.2 36,008 6.4 Other 6,695 1.2 8,240 1.5 -------- ----- -------- ----- Total consumer loans 41,302 7.4 44,248 7.9 Commercial business loans 27,426 4.9 22,510 4.0 -------- ----- -------- ----- Total loans receivable 559,971 100.0% 560,177 100.0% -------- ===== -------- ===== Less: Undisbursed portion of construction loans in process (17,073) (18,265) Deferred loan origination fees (1,884) (1,942) Allowance for loan losses (11,972) (11,946) -------- -------- Total loans receivable, net $529,042 $528,024 ======== ======== ------------- (1) Includes loans held for sale. Construction and Land Development Loan Portfolio Composition ------------------------------------------------------------ The following table sets forth the composition of the Company's construction and land development loan portfolio at December 31, 2011 and September 30, 2011 (dollars in thousands): December 31, September 30, 2011 2011 ------------------- ------------------ Amount Percent Amount Percent ------------------- ------------------ Custom and owner/builder $ 28,797 49.8% $ 26,205 49.9% Speculative one- to four-family 2,186 3.8 1,919 3.7 Commercial real estate 16,693 28.9 12,863 24.5 Multi-family (including condominiums) 8,320 14.4 9,322 17.8 Land development 1,807 3.1 2,175 4.1 -------- ----- -------- ----- Total construction and land development loans $ 57,803 100.0% $ 52,484 100.0% ======== ===== ======== ===== 16 Allowance for Loan Losses ------------------------- The following tables set forth information for the three months ended December 31, 2011 and December 31, 2010 regarding activity in the allowance for loan losses (dollars in thousands): For the Three Months Ended December 31, 2011 -------------------------------------------- Beginning Ending Allowance Provision Charge-offs Recoveries Allowance --------- --------- ----------- ---------- --------- Mortgage loans: One-to four-family $ 760 $ 92 $ 68 $ 1 $ 785 Multi-family 1,076 233 - - - - 1,309 Commercial 4,035 (18) 508 - - 3,509 Construction - custom and owner / builder 222 38 - - - - 260 Construction - speculative one- to four-family 169 (6) - - 1 164 Construction - commercial 794 13 - - - - 807 Construction - multi-family 354 (414) - - 450 390 Construction - land development 79 247 230 - - 96 Land 2,795 76 285 71 2,657 Consumer loans: Home equity and second mortgage 460 (1) 50 - - 409 Other 415 (24) 1 - - 390 Commercial business loans 787 414 6 1 1,196 ------- ----- ------ ----- ------- Total $11,946 $ 650 $1,148 $ 524 $11,972 ======= ===== ====== ===== ======= Three Months Ended December 31, 2010 ------------------------ Balance at beginning of period $11,264 Provision for loan losses 900 Loans charged off (439) Recoveries of loans previously charged off 24 Net charge-offs (415) ------- Balance at end of period $11,749 ======= 17 The following table presents information on the loans evaluated individually for impairment and collectively evaluated for impairment in the allowance for loan losses at December 31, 2011 and September 30, 2011 (dollars in thousands): Allowance for Loan Losses Recorded Investment in Loans ------------------------- ---------------------------- Individually Collectively Individually Collectively Evaluated for Evaluated for Evaluated for Evaluated for Impairment Impairment Total Impairment Impairment Total ---------- ---------- ----- ---------- ---------- ----- December 31, 2011 ----------------- Mortgage loans: One- to four-family $ 136 $ 649 $ 785 $ 4,335 $106,167 $110,502 Multi-family 976 333 1,309 6,921 23,945 30,866 Commercial 214 3,295 3,509 21,552 224,322 245,874 Construction - custom and owner / builder 9 251 260 318 19,890 20,208 Construction - speculative one- to four-family 24 140 164 700 972 1,672 Construction - commercial 687 120 807 5,413 4,817 10,230 Construction - multi-family - - 390 390 370 6,443 6,813 Construction - land development - - 96 96 1,597 210 1,807 Land 583 2,074 2,657 9,527 36,671 46,198 Consumer loans: Home equity and second mortgage 12 397 409 1,236 33,371 34,607 Other - - 390 390 - - 6,695 6,695 Commercial business loans 276 920 1,196 317 27,109 27,426 ------ ------ ------- ------- -------- -------- $2,917 $9,055 $11,972 $52,286 $490,612 $542,898 ====== ====== ======= ======= ======== ======== September 30, 2011 ------------------ Mortgage loans: One- to four-family $ 45 $ 715 $ 760 $ 3,701 $110,979 $114,680 Multi-family 632 444 1,076 5,482 25,500 30,982 Commercial 255 3,780 4,035 19,322 226,715 246,037 Construction - custom and owner / builder 11 211 222 320 16,777 17,097 Construction - speculative one- to four-family 37 132 169 700 906 1,606 Construction - commercial 738 56 794 5,435 2,479 7,914 Construction - multi-family - - 354 354 632 4,867 5,499 Construction - land development - - 79 79 1,882 221 2,103 Land 560 2,235 2,795 9,997 39,239 49,236 Consumer loans: Home equity and second mortgage 10 450 460 1,014 34,994 36,008 Other 1 414 415 1 8,239 8,240 Commercial business loans - - 787 787 44 22,466 22,510 ------ ------ ------- ------- -------- -------- $2,289 $9,657 $11,946 $48,530 $493,382 $541,912 ====== ====== ======= ======= ======== ======== Credit Quality Indicators ------------------------- The Company uses credit risk grades which reflect the Company's assessment of a loan's risk or loss potential. The Company categorizes loans into risk grade categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors such as the estimated fair value of the collateral. The Company uses the following definitions for credit risk ratings as part of the on-going monitoring of the credit quality of its loan portfolio: Pass: Pass loans are defined as those loans that meet acceptable quality underwriting standards. Watch: Watch loans are defined as those loans that still exhibit marginal acceptable quality, but have some concerns that justify greater attention. If these concerns are not corrected, a potential for further adverse categorization exists. These concerns could relate to a specific condition peculiar to the borrower, its industry segment or the general economic environment. 18 Special Mention: Special mention loans are defined as those loans deemed by management to have some potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the payment prospects of the loan. Assets in this category do not expose the Company to sufficient risk to warrant a substandard classification. Substandard: Substandard loans are defined as those loans that are inadequately protected by the current net worth and paying capacity of the obligor, or of the collateral pledged. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. If the weakness or weaknesses are not corrected, there is the distinct possibility that some loss will be sustained. Loss: Loans in this classification are considered uncollectible and of such little value that continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this loan even though partial recovery may be realized in the future. The following table lists the loan credit risk grades utilized by the Company that serve as credit quality indicators. Each of the credit risk loan grades include high and low factors associated with their classification that are utilized to calculate the aggregate ranges of the allowance for loan losses at December 31, 2011 and September 30, 2011 (dollars in thousands): Credit Risk Profile by Internally Assigned Grades December 31, 2011 Loan Grades ----------------- --------------------------------------- Special Pass Watch Mention Substandard Total ------ ----- ------- ----------- ----- Mortgage loans: One- to four-family $ 96,715 $ 4,708 $ 3,291 $ 5,788 $110,502 Multi-family 18,995 68 4,696 7,107 30,866 Commercial 215,172 696 6,040 23,966 245,874 Construction - custom and owner / builder 19,629 261 - - 318 20,208 Construction - speculative one- to four-family 212 155 - - 1,305 1,672 Construction - commercial 4,817 - - - - 5,413 10,230 Construction - multi-family 6,443 - - - - 370 6,813 Construction - land development - - - - - - 1,807 1,807 Land 25,168 5,947 5,233 9,850 46,198 Consumer loans: Home equity and second mortgage 31,083 931 1,355 1,238 34,607 Other 6,638 48 - - 9 6,695 Commercial business loans 24,080 60 192 3,094 27,426 -------- ------- ------- ------- -------- Total $448,952 $12,874 $20,807 $60,265 $542,898 ======== ======= ======= ======= ======== September 30, 2011 ------------------ Mortgage loans: One- to four-family $100,159 $ 6,131 $ 2,450 $ 5,940 $114,680 Multi-family 19,279 199 10,380 1,124 30,982 Commercial 212,898 1,042 6,320 25,777 246,037 Construction - custom and owner / builder 16,522 255 - - 320 17,097 Construction - speculative one- to four-family 323 - - 700 583 1,606 Construction - commercial 2,479 - - - - 5,435 7,914 Construction - multi-family 4,115 - - 752 632 5,499 Construction - land development 83 - - - - 2,020 2,103 Land 26,825 6,604 5,084 10,723 49,236 Consumer loans: Home equity and second mortgage 32,389 901 1,513 1,205 36,008 Other 8,179 50 - - 11 8,240 Commercial business loans 19,060 20 220 3,210 22,510 -------- ------- ------- ------- -------- Total $442,311 $15,202 $27,419 $56,980 $541,912 ======== ======= ======= ======= ======== 19 The following tables present an age analysis of past due status of loans by category at December 31, 2011 and September 30, 2011 (dollars in thousands): Past Due 90 Days 30-59 Days 60-89 Days Non- or More and Total Total Past Due Past Due Accrual (1) Still Accruing Past due Current Loans -------- -------- ----------- ----------- -------- ------- --------- Mortgage loans: One- to four-family $2,889 $ - - $ 2,788 $ - - $ 5,677 $104,825 $110,502 Multi-family - - - - 1,449 - - 1,449 29,417 30,866 Commercial 8,902 - - 10,445 - - 19,347 226,527 245,874 Construction - custom and owner / builder - - - - 318 - - 318 19,890 20,208 Construction - speculative one- to four-family - - - - - - 201 201 1,471 1,672 Construction - commercial - - - - 666 - - 666 9,564 10,230 Construction - multi-family - - - - 370 - - 370 6,443 6,813 Construction - land development - - - - 1,597 - - 1,597 210 1,807 Land 5,727 82 9,264 1,586 16,659 29,539 46,198 Consumer loans: Home equity and second mortgage 816 39 589 890 2,334 32,273 34,607 Other 83 - - - - - - 83 6,612 6,695 Commercial business loans - - 132 317 - - 449 26,977 27,426 ------- ------ ------- ------ ------- -------- -------- Total $18,417 $ 253 $27,803 $2,677 $49,150 $493,748 $542,898 ======= ====== ======= ====== ======= ======== ======== September 30, 2011 ------------------ Mortgage loans: One- to four-family $ - - $1,822 $ 2,150 $ - - $ 3,972 $110,708 $114,680 Multi-family - - - - - - 1,449 1,449 29,533 30,982 Commercial - - 12,723 6,571 - - 19,294 226,743 246,037 Construction - custom and owner / builder - - - - 320 - - 320 16,777 17,097 Construction - speculative one- to four-family - - - - - - - - - - 1,606 1,606 Construction - commercial - - - - 688 - - 688 7,226 7,914 Construction - multi-family - - 752 632 - - 1,384 4,115 5,499 Construction - land development - - - - 1,882 - - 1,882 221 2,103 Land 1,100 2,558 8,935 29 12,622 36,614 49,236 Consumer loans: Home equity and second mortgage 643 441 366 - - 1,450 34,558 36,008 Other 9 7 1 - - 17 8,223 8,240 Commercial business loans - - 14 44 276 334 22,176 22,510 ------- ------ ------- ------ ------- -------- -------- Total $ 1,752 $18,317 $21,589 $1,754 $43,412 $498,500 $541,912 ======= ======= ======= ====== ======= ======== ======== ------------- (1) Includes non-accrual loans past due 90 days or more and manual non-accrual loans. 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 that are 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 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 delay, payment record, the amount past due and the number of days past due. 20 At December 31, 2011 and September 30, 2011, the Company had impaired loans totaling $52.29 million and $48.53 million, respectively. At December 31, 2011, the Company had loans totaling $2.68 million that were 90 days or more past due and still accruing interest. At September 30, 2011, the Company had loans totaling $1.75 million that were 90 days or more past due and still accruing interest. Interest income recognized on impaired loans for the three months ended December 31, 2011 and 2010 was $419,000 and $322,000, respectively. Interest income recognized on a cash basis on impaired loans for the three months ended December 31, 2011 and 2010, was $294,000 and $246,000, respectively. The average investment in impaired loans for the three months ended December 31, 2011 and 2010 was $48.64 million and $41.44 million, respectively. 21 The following table is a summary of information related to impaired loans as of and for the three months ended December 31, 2011 (dollars in thousands): Unpaid Principal Cash Basis Balance (Loan Average Interest Interest Recorded Balance Plus Related Recorded Income Income Investment Charge Off) Allowance Investment Recognized(1) Recognized(1) ---------- ------------ --------- ---------- ------------ ------------ With no related allowance recorded: Mortgage loans: One- to four-family $ 2,266 $ 2,486 $ - - $ 2,623 $ 6 $ 6 Multi-family - - 982 - - - - - - - - Commercial 17,704 19,354 - - 15,514 190 135 Construction - custom and owner / builder 209 209 - - 345 - - - - Construction - speculative one- to four-family - - - - - - 243 - - - - Construction - multi-family 370 810 - - 1,071 - - - - Construction - land development 1,597 7,124 - - 2,482 5 5 Land 5,214 8,750 - - 7,034 8 4 Consumer loans: Home equity and second mortgage 592 658 - - 534 - - - - Other - - - - - - 8 - - - - Commercial business loans 41 61 - - 43 1 1 ------- ------- ------ ------- ----- ----- Subtotal 27,993 40,434 - - 29,897 210 151 With an allowance recorded: Mortgage loans: One- to four-family 2,069 2,069 136 1,181 22 17 Multi-family 6,921 6,921 976 5,768 73 55 Commercial 3,848 3,848 214 2,179 24 3 Construction - custom and owner / builder 109 109 9 67 - - - - Construction - speculative one- to four-family 700 700 24 1,030 8 6 Construction - commercial 5,413 6,857 687 4,620 63 47 Land 4,313 4,337 583 3,428 8 8 Consumer loans: Home equity and second mortgage 644 644 12 412 11 7 Other - - - - - - 1 - - - - Commercial business loans 276 276 276 55 - - - - ------- ------- ------ ------- ----- ----- Subtotal 24,293 25,761 2,917 18,741 209 143 Total Mortgage loans: One- to four-family 4,335 4,555 136 3,804 28 23 Multi-family 6,921 7,903 976 5,768 73 55 Commercial 21,552 23,202 214 17,693 214 138 Construction - custom and owner / builder 318 318 9 412 - - - - Construction - speculative one- to four-family 700 700 24 1,273 8 6 Construction - commercial 5,413 6,857 687 4,620 63 47 Construction - multi-family 370 810 - - 1,071 5 - - Construction - land development 1,597 7,124 - - 2,482 - - 5 Land 9,527 13,087 583 10,462 16 12 Consumer loans: Home equity and second mortgage 1,236 1,302 12 946 11 7 Other - - - - - - 9 - - - - Commercial business loans 317 337 276 98 1 1 ------- ------- ------ ------- ----- ----- Total $52,286 $66,195 $2,917 $48,638 $ 419 $ 294 ======= ======= ====== ======= ===== ===== ------------- (1) For the three months ended December 31, 2011 22 Following is a summary of information related to impaired loans as of and for the year ended September 30, 2011 (in thousands): Unpaid Principal Cash Basis Balance (Loan Average Interest Interest Recorded Balance Plus Related Recorded Income Income Investment Charge Off) Allowance Investment Recognized(1) Recognized(1) ---------- ------------ --------- ---------- ------------ ------------ With no related allowance recorded: Mortgage loans: One- to four-family $ 2,092 $ 2,387 $ - - $ 2,908 $ 30 $ 22 Multi-family - - 982 - - 681 - - - - Commercial 18,137 19,279 - - 14,623 1,060 573 Construction - custom and owner / builder 209 209 - - 303 7 1 Construction speculative one- to four-family - - - - - - 502 7 7 Construction - multi-family 632 1,135 - - 1,287 4 4 Construction - land development 1,882 7,179 - - 2,920 5 - - Land 8,198 11,533 - - 7,883 69 42 Consumer loans: Home equity and second mortgage 669 719 - - 430 26 16 Other - - - - - - 13 - - - - Commercial business loans 44 65 - - 44 2 2 ------- ------- ------ ------- ------ ------ Subtotal 31,863 43,488 - - 31,594 1,210 667 With an allowance recorded: Mortgage loans: One- to four-family 1,609 1,609 45 768 47 38 Multi-family 5,482 5,482 632 4,798 298 222 Commercial 1,185 1,185 255 1,409 50 118 Construction - custom and owner / builder 111 111 11 45 2 2 Construction - speculative one- to four-family 700 700 37 1,042 50 37 Construction - commercial 5,435 6,879 738 3,537 273 123 Construction - multi-family - - - - - - 65 - - - - Land 1,799 1,821 560 2,946 114 83 Consumer loans: Home equity and second mortgage 345 345 10 425 10 9 Other 1 1 1 1 - - - - ------- ------- ------ ------- ------ ------ Subtotal 16,667 18,133 2,289 15,036 844 632 Total Mortgage loans: One- to four-family 3,701 3,996 45 3,676 77 60 Multi-family 5,482 6,464 632 5,479 298 222 Commercial 19,322 20,464 255 16,032 1,110 691 Construction - custom and owner / builder 320 320 11 348 9 3 Construction - speculative one- to four-family 700 700 37 1,544 57 44 Construction - commercial 5,435 6,879 738 3,537 273 123 Construction - multi-family 632 1,135 - - 1,352 4 4 Construction - land development 1,882 7,179 - - 2,920 5 - - Land 9,997 13,354 560 10,829 183 125 Consumer loans: Home equity and second mortgage 1,014 1,064 10 855 36 25 Other 1 1 1 14 - - - - Commercial business loans 44 65 - - 44 2 2 ------- ------- ------ ------- ------ ------ Total $48,530 $61,621 $2,289 $46,630 $2,054 $1,299 ======= ======= ====== ======= ====== ====== ------------- (1) For the year ended September 30, 2011 23 The following table sets forth information with respect to the Company's non-performing assets at December 31, 2011 and September 30, 2011 (dollars in thousands): Loans accounted for on a non-accrual basis: December 31, September 30, 2011 2011 -------- -------- Mortgage loans: One- to four-family $ 2,788 $ 2,150 Multi-family 1,449 - - Commercial 10,445 6,571 Construction custom and owner / builder 318 320 Construction speculative one- to four-family - - - - Construction commercial 666 688 Construction multi-family 370 632 Construction land development 1,597 1,882 Land 9,264 8,935 Consumer loans: Home equity and second mortgage 589 367 Commercial business 317 43 -------- -------- Total 27,803 21,589 Accruing loans which are contractually past due 90 days or more 2,677 1,754 -------- -------- Total of non-accrual and 90 days past due loans 30,480 23,343 Non-accrual investment securities 2,650 2,796 OREO and other repossessed assets 7,714 10,811 -------- -------- Total non-performing assets (1) $ 40,844 $ 36,950 ======== ======== Troubled debt restructured loans on accrual status (2) $ 18,297 $ 18,166 Non-accrual and 90 days or more past due loans as a percentage of loans receivable 5.64% 4.32% Non-accrual and 90 days or more past due loans as a percentage of total assets 4.15% 3.16% Non-performing assets as a percentage of total assets 5.55% 5.01% Loans receivable (3) $541,014 $539,970 ======== ======== Total assets $735,849 $738,224 ======== ======== (1) Does not include troubled debt restructured loans on accrual status. (2) Does not include troubled debt restructured loans totaling $7.33 million and $7.38 million reported as non-accrual loans at December 31, 2011 and September 30, 2011, respectively. (3) Includes loans held for sale and is before the allowance for loan losses. 24 Troubled debt restructured loans are loans for which the Company, for economic or legal reasons related to the borrower's financial condition, has granted a significant concession to the borrower that it would otherwise not consider. The loan terms which have been modified or restructured due to a borrower's financial difficulty, include but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-aging, extensions, deferrals and renewals. Troubled debt restructured loans are considered impaired loans and are individually evaluated for impairment. Troubled debt restructured loans can be classified as either accrual or non-accrual. The Company had $25.63 million in troubled debt restructured loans included in impaired loans at December 31, 2011 and had no commitments to lend additional funds on these loans. At December 31, 2011, $7.33 million of the $25.63 million in troubled debt restructured loans were on non-accrual status and included in non-performing loans. The Company had $25.54 million in troubled debt restructured loans included in impaired loans at September 30, 2011 and had $144,000 in commitments to lend additional funds on these loans. At September 30, 2011, $7.38 million of the $25.54 million in troubled debt restructured loans were on non-accrual status and included in non-performing loans. The following table sets forth information with respect to the Company's troubled debt restructurings by portfolio segment at December 31, 2011 and September 30, 2011 (dollars in thousands): December 31, 2011 ----------------- Pre- Post- Modification Modification Outstanding Outstanding End of Number of Recorded Recorded Period Contracts Investment Investment Balance --------- ---------- ---------- ------- One-to four-family 5 $ 1,619 $ 1,619 $1,547 Multi-family 4 6,534 5,482 5,472 Commercial 8 5,903 6,226 5,840 Construction - speculative one-to four-family 1 700 700 700 Construction - commercial 2 6,800 5,451 5,413 Construction - land development 4 5,433 5,433 756 Land 12 7,263 7,051 5,256 Home equity 3 654 654 647 -- ------- ------- ------- Total 39 $34,906 $32,616 $25,631 == ======= ======= ======= September 30, 2011 ------------------ Pre- Post- Modification Modification Outstanding Outstanding End of Number of Recorded Recorded Period Contracts Investment Investment Balance --------- ---------- ---------- ------- One-to four-family 5 $ 1,619 $ 1,619 $1,618 Multi-family 4 6,534 5,482 5,482 Commercial 8 5,903 6,226 5,696 Construction - speculative one-to four-family 1 700 700 700 Construction - commercial 2 6,800 5,451 5,435 Construction - land development 4 5,433 5,433 756 Land 12 7,263 7,051 5,208 Home equity 3 654 654 647 -- ------- ------- ------- Total 39 $34,906 $32,616 $25,542 == ======= ======= ======= There were no new troubled debt restructured loans that were recorded during the three months ended December 31, 2011. There were no troubled debt restructured loans that were recorded in the twelve months prior to December 31, 2011 that subsequently defaulted in the three months ended December 31, 2011. 25 (7) NET INCOME PER COMMON SHARE Basic net income per common share is computed by dividing net income to common shareholders 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 to common shareholders by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method at the average share price for the Company's common stock during the period. Common stock equivalents arise from the assumed conversion of outstanding stock options and the outstanding warrant to purchase common stock. In accordance with the Financial Accounting Standards Board ("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 per common share. At December 31, 2011 and 2010, there were 264,520 and 299,786 shares, respectively, that had not been allocated under the Bank's ESOP. Three Months Ended December 31, 2011 2010 -------------------- (in thousands, except for share and per share data) ---------------------------------------------------------------------------- Basic net income per common share computation --------------------------------------------- Numerator - net income $ 1,283 $ 1,359 Preferred stock dividends (208) (208) Preferred stock discount accretion (59) (54) ------- ------- Net income to common shareholders $ 1,016 $ 1,097 ======= ======= Denominator - weighted average common shares outstanding 6,780,516 6,745,250 Basic net income per common share $ 0.15 $ 0.16 Diluted net income per common share computation ----------------------------------------------- Numerator - net income $ 1,283 $ 1,359 Preferred stock dividend (208) (208) Preferred stock discount accretion (59) (54) ------- ------- Net income to common shareholders $ 1,016 $ 1,097 ======= ======= Denominator - weighted average common shares outstanding 6,780,516 6,745,250 Effect of dilutive stock options (1) - - - - Effect of dilutive stock warrant (2) - - - - ------- ------- Weighted average common shares and common stock equivalents 6,780,516 6,745,250 Diluted net income per common share $ 0.15 $ 0.16 -------------------- (1) For the three months ended December 31, 2011 and 2010, options to purchase 153,376 and 194,864 shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per common share because the options' exercise prices were greater than the average market price of the common stock, and, therefore, their effect would have been anti-dilutive. (2) For the three months ended December 31, 2011 and 2010, a warrant to purchase 370,899 shares of common stock was outstanding but not included in the computation of diluted net income per common share because the warrant's exercise price was greater than the average market price of the common stock, and, therefore, its effect would have been anti-dilutive. 26 (8) STOCK PLANS AND STOCK BASED COMPENSATION Stock Option Plans ------------------ Under the Company's stock option plans (the 1999 Stock Option Plan and the 2003 Stock Option Plan), the Company was able to grant options for up to a combined total of 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 common 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 December 31, 2011, options for 218,938 shares are available for future grant under the 2003 Stock Option Plan and no shares are available for future grant under the 1999 Stock Option Plan. Activity under the plans for the three months ended December 31, 2011 and 2010 is as follows: Three Months Ended Three Months Ended December 31, 2011 December 31, 2010 ------------------ ------------------ Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price ------ -------- ------ -------- Options outstanding, beginning of period 137,726 $ 9.25 194,864 $ 8.71 Granted 33,500 4.01 - - - - Forfeited 2,200 4.55 - - - - ------- ------- Options outstanding, end of period 169,026 $ 8.27 194,864 $ 8.71 ======= ======= Options exercisable, end of period 123,326 174,064 ======= ======= There was no aggregate intrinsic value of options outstanding at December 31, 2011. At December 31, 2011, there were 46,700 unvested options with an aggregate grant date fair value of $69,000, all of which the Company assumes will vest. There was no aggregate intrinsic value of unvested options at December 31, 2011. There were 5,000 options with an aggregate grant date fair value of $6,000 that vested during the three months ended December 31, 2011. At December 31, 2010, there were 20,800 unvested options with an aggregate grant date fair value of $27,000. There were 5,200 options with an aggregate grant date fair value of $7,000 that vested during the three months ended December 31, 2010. 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 33,500 options granted during the three months ended December 31, 2011 with an aggregate grant date fair value of $52,000. There were no options granted during the three months ended December 31, 2010. 27 The Black-Scholes option pricing model was used in estimating the fair value of option grants. The weighted average assumptions used for options granted during the three months ended December 31, 2011 were: Expected Volatility 44% Expected term (in years) 5 Expected dividend yield - -% Risk free interest rate 0.89% Grant date fair value per share $1.56 Stock Grant Plan ---------------- The Company adopted the Management Recognition and Development Plan ("MRDP") in 1998 for the benefit of employees, officers and directors of the Company. The objective of the MRDP is to retain and attract personnel of experience and ability in key positions by providing them with a proprietary interest in the Company. The MRDP allowed for the issuance to participants of up to 529,000 shares of the Company's common stock. Awards under the MRDP are made in the form of 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 is the amount of the fair value of the common stock at the date of the grant to the plan participants and is recognized over a five-year vesting period, with 20% vesting on each of the five anniversaries from the date of the grant. There were no MRDP shares granted to officers or directors during the three months ended December 31, 2011 and 2010. At December 31, 2011, there were a total of 15,161 unvested MRDP shares with an aggregated grant date fair value of $155,000. There were 7,231 MRDP shares that vested during the three months ended December 31, 2011 with an aggregated grant date fair value of $79,000. There were 100 MRDP shares forfeited during the three months ended December 31, 2011 with a grant date fair value of $1,000. At December 31, 2011, there were no shares available for future awards under the MRDP. At December 31, 2010, there were a total of 28,992 unvested MRDP shares with an aggregate grant date fair value of $329,000. There were 7,433 MRDP shares that vested during the three months ended December 31, 2010 with and aggregated grant date fair value of $81,000. Expenses for Stock Compensation Plans ------------------------------------- Compensation expenses for all stock-based plans were as follows: Three Months Ended December 31, ------------------------------ 2011 2010 ---- ---- (Dollars in thousands) Stock Stock Stock Stock Options Grants Options Grants ------- ------ ------- ------ Compensation expense recognized in income $ 2 $ 25 $ 1 $ 44 Related tax benefit recognized - - 9 - - 15 28 As of December 31, 2011, the compensation expense yet to be recognized for stock based awards that have been awarded but not vested for the years ending September 30 is as follows (dollars in thousands): Stock Stock Total Options Grants Awards ------- ------ ------ 2012 $ 13 $ 80 $ 93 2013 17 39 56 2014 17 2 19 2015 11 - - 11 2016 10 - - 10 2017 2 - - 2 ---- ----- ----- Total $ 70 $ 121 $ 191 ==== ===== ===== (9) FAIR VALUE MEASUREMENTS 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 certain 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 December 31, 2011 and September 30, 2011. 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 Cash Equivalents ------------------------- 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 December 31, 2011 and September 30, 2011, because of the illiquid market for loan sales, loans were priced using comparable market statistics. The loan portfolio was segregated into various categories and 29 a weighted average valuation discount that approximated similar loan sales was applied to each category. Loans Held for Sale ------------------- The estimated fair value is 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. 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 that they do not have a distinguishable estimated fair value. The estimated fair values of financial instruments were as follows as of December 31, 2011 and September 30, 2011 (dollars in thousands): December 31, 2011 September 30, 2011 ----------------- ------------------ Estimated Estimated Recorded Fair Recorded Fair Amount Value Amount Value ------ ----- ------ ----- Financial Assets Cash and cash equivalents $111,547 $111,547 $112,065 $112,065 CDs held for investment 19,810 19,810 18,659 18,659 MBS and other investments 10,225 10,290 10,862 10,946 FHLB stock 5,705 5,705 5,705 5,705 Loans receivable, net 525,932 481,212 523,980 490,322 Loans held for sale 3,110 3,216 4,044 4,185 Accrued interest receivable 2,388 2,388 2,411 2,411 Financial Liabilities Deposits $589,175 $591,595 $592,678 $595,331 FHLB advances - long term 55,000 60,878 55,000 61,009 Repurchase agreements 538 538 729 729 Accrued interest payable 525 525 545 545 30 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. Accounting guidance regarding fair value measurements defines fair value and establishes a framework for measuring fair value in accordance with GAAP. Fair value is the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. The following definitions describe the levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2: Significant observable inputs other than quoted prices included within Level 1, such as quoted prices in markets that are not active, and inputs other than quoted prices that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a company's own assumptions about the assumptions market participants would use in pricing an asset or liability based on the best information available in the circumstances. The following table summarizes the balances of assets and liabilities measured at estimated fair value on a recurring basis at December 31, 2011, and the total losses resulting from these estimated fair value adjustments for the three months ended December 31, 2011 (dollars in thousands): Estimated Fair Value ----------------------------- Level 1 Level 2 Level 3 Total Losses ------- ------- ------- ------------ Available for Sale Securities Mutual funds $ 995 $ - - $ - - $ - - MBS - - 5,289 - - 38 ----- ------ ------ ------ Total $ 995 $5,289 $ - - $ 38 ===== ====== ====== ====== The following table summarizes the balances of assets and liabilities measured at estimated fair value on a nonrecurring basis at December 31, 2011, and the total losses resulting from these estimated fair value adjustments for the three months ended December 31, 2011 (dollars in thousands): Estimated Fair Value ----------------------------- Level 1 Level 2 Level 3 Total Losses ------- ------- ------- ------------ Impaired loans (1) $ - - $ - - $23,520 $ 1,148 MBS - held to maturity (2) - - 267 - - 22 OREO and other repossessed items (3) - - - - 7,714 369 MSR's (4) - - - - 2,169 - - ------ ----- ------- ------- Total $ - - $ 267 $33,403 $ 1,439 ====== ===== ======= ======= 31 ------------- (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. (2) The loss represents OTTI credit-related charges on held-to-maturity MBS. (3) The Company's OREO and other repossessed assets are initially recorded at estimated fair value less estimated costs to sell. This amount becomes the property's new basis. Estimated fair value was generally determined by management based on a number of factors, including third-party appraisals of estimated fair value in an orderly sale. Estimated costs to sell were based on standard market factors. The valuation of OREO and other repossessed items is subject to significant external and internal judgment. Management periodically reviews the recorded value to determine whether the property continues to be recorded at the lower of its recorded book value or estimated fair value, net of estimated costs to sell. (4) The fair value of the MSRs was determined using a third-party model, which incorporates the expected life of the loans, estimated cost to service the loans, servicing fees received and other factors. The estimated fair value is calculated by stratifying the mortgage servicing rights based on the predominant risk characteristics that include the underlying loan's interest rate, cash flows of the loan, origination date and term. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights exceed their estimated fair value. Impairment, if deemed temporary, is recognized through a valuation allowance to the extent that estimated fair value is less than the recorded amount. (10) RECENT ACCOUNTING PRONOUNCEMENTS In December 2010, the FASB issued updated guidance on goodwill and other intangibles regarding when to perform step two of the goodwill impairment test for reporting units with zero or negative carrying amounts. This guidance became effective for the Company on October 1, 2011. The adoption of this guidance did not have a material effect on the Company's condensed consolidated financial statements. In September 2011, the FASB issued guidance regarding testing goodwill for impairment. The new guidance allows an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of the reporting unit. The guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements. In April 2011, the FASB issued guidance regarding Transfer and Servicing for the Reconsideration of Effective Control for Repurchase Agreements. The guidance removes from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments. The guidance is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements. 32 In May 2011, the FASB issued amended guidance regarding the application of existing fair value measurement guidance. The provisions of the amended guidance clarify the application of existing fair value measurement guidance and revise certain measurement and disclosure requirements to achieve convergence of GAAP and International Financial Reporting Standards. The provisions of this amended guidance are effective for the Company's first reporting period beginning January 1, 2012, with early adoption not permitted. The Company is in the process of evaluating the impact of adoption of this guidance and does not expect it to have a material impact on its condensed consolidated financial statements. In June 2011, the FASB issued amended guidance on the presentation of comprehensive income (loss). The new guidance eliminates the current option to present the components of other comprehensive income (loss) in the statement of changes in equity and requires the presentation of net income (loss) and other comprehensive income (loss) (and their respective components) either in a single continuous statement or in two separate but consecutive statements. The amendments do not alter any current recognition or measurement requirements with respect to the items of other comprehensive income (loss). The provisions of this guidance are effective for the Company's first reporting period beginning on January 1, 2012, with early adoption permitted. The Company does not expect it to have a material impact on its condensed consolidated financial statements. In December 2011, the FASB issued guidance that defers the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income. The deferral is temporary until FASB reconsiders the operational concerns and needs of financial statement users. The FASB has not yet announced a timetable for its reconsideration. The Company does not expect this guidance to have a material impact on its condensed consolidated financial statements. Item 2. Management's Discussion and Analysis of Financial Condition and ------------------------------------------------------------------------- Results of Operations --------------------- The following analysis discusses the material changes in the consolidated financial condition and results of operations of the Company at and for the three months ended December 31, 2011. This analysis as well as other sections of this report contains certain "forward-looking statements." Certain matters discussed in this Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact and often include the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate and projections of 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 or implied by forward-looking statements, 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 which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our loan loss reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; secondary market conditions for loans and our ability to sell loans in the secondary market; results of examinations of us by the Board of Governors of the Federal Reserve System and our bank subsidiary by the Federal Deposit Insurance Corporation, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may require us, among other things, to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits or impose additional requirements or restrictions, which could adversely affect our liquidity and earnings; our compliance with regulatory enforcement actions, including regulatory memoranda of understandings ("MOUs") to which we are subject; legislative or regulatory changes that adversely affect our business including changes in regulatory 33 policies and principles, or 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 impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementation of related rules and regulations; our ability to attract and retain deposits; further increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining the fair values of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our consolidated balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force 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; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common and preferred stock; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services; and other risks detailed in our reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended September 30, 2011. Any of the forward-looking statements that we make in this Form 10-Q 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 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 2012 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of us, and could negatively affect the Company's operations and stock price performance. Overview Timberland Bancorp, Inc., a Washington corporation, is the holding company for Timberland Bank. The Bank opened for business in 1915 and serves consumers and businesses across Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis counties, Washington with a full range of lending and deposit services through its 22 branches (including its main office in Hoquiam). At December 31, 2011, the Company had total assets of $735.85 million and total shareholders' equity of $87.33 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 relates primarily to the Bank's operations. The profitability of the Company's operations depends primarily on its net interest income after provision for loan losses. Net interest income is the difference between interest income, which is the income that the Company earns on interest-earning assets, comprised of primarily loans and investments, and interest expense, the amount the Company pays on its interest-bearing liabilities, which are primarily deposits and borrowings. Net interest income is affected by changes in the volume and mix of interest earning assets, interest earned 34 on those assets, the volume and mix of interest bearing liabilities and interest paid on those interest bearing liabilities. Management strives to match the re-pricing characteristics of the interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve. The provision for loan losses is dependent on changes in the loan portfolio and management's assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. The provision for loan losses reflects the amount that the Company believes is adequate to cover potential credit losses in its loan portfolio. Net income is also affected by non-interest income and non-interest expenses. For the three month period ended December 31, 2011, non-interest income consisted primarily of service charges and fees on deposit accounts, gain on sale of loans, ATM transaction fees, an increase in the cash surrender value of life insurance, other operating income and a valuation recovery on MSRs. Non-interest income is reduced by net OTTI losses on MBS and other investments. Non-interest expenses consisted primarily of salaries and employee benefits, premises and equipment, advertising, ATM expenses, OREO expenses, postage and courier expenses, professional fees, deposit insurance premiums, other insurance premiums, state and local taxes, loan administration expenses, deposit operation expenses, data processing expenses and telecommunication expenses. Non-interest income and non-interest expenses are affected by the growth of our operations and growth in the number of loan and deposit accounts. Results of operations may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities. The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail customers while concentrating its lending activities on real estate mortgage loans. Lending activities have been focused primarily on the origination of loans secured by real estate, including residential construction loans, one- to four-family residential loans, multi-family loans, commercial real estate loans and land loans. The Bank originates adjustable-rate residential mortgage loans that do not qualify for sale in the secondary market. The Bank also originates commercial business loans. Critical Accounting Policies and Estimates The Company has identified several accounting policies that as a result of judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company's Condensed Consolidated Financial Statements. Allowance for Loan Losses The allowance for loan losses is maintained at a level believed to be 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 the full collectability may not be assured. The detailed analysis includes methods to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific and general components. The specific component relates to loans that are deemed impaired. For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the recorded value of that loan. The general component covers 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 loan losses is estimated 35 based upon these factors and trends identified by management at the time consolidated financial statements are prepared. In accordance with the FASB guidance for receivables, a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts (principal and interest) due according to the contractual terms of the loan agreement. Troubled debt restructured loans are considered impaired loans. 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 and other factors beyond the Company's control. These factors may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. The Company has experienced a significant decline in valuations for some real estate collateral since October 2008. If real estate values continue to decline and as updated appraisals are received on collateral for impaired loans, the Company may need to increase the allowance for loan losses appropriately. In addition, bank 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. MSRs (Mortgage Servicing Rights) MSRs are capitalized when acquired through the origination of loans that are subsequently sold with servicing rights retained and are amortized to servicing income on loans sold in proportion to and over the period of estimated net servicing income. The value of MSRs at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans. The estimated fair value is evaluated at least annually by a third party firm for impairment by comparing actual cash flows and estimated cash flows from the servicing assets to those estimated at the time the 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 36 appropriate if they are applied at different times. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized MSRs based on product type, 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. OTTIs (Other-Than-Temporary Impairments) in the Estimated Fair Value of Investment Securities Unrealized losses on available for sale and held to maturity investment 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 it is more likely than not the Company will not have to sell the security before recovery of its cost basis. An unrealized loss in the value of an equity security is generally considered temporary when the estimated fair value of the security is less than 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, goodwill is not considered impaired and no additional analysis is necessary. One of the circumstances evaluated when determining if an impairment test of goodwill is needed more frequently than annually is the extent and duration that the Company's market capitalization (total common shares outstanding multiplied by current stock price) is less than the total equity applicable to common shareholders. During the quarter ended June 30, 2011, the Company engaged a third party firm to perform the annual test for goodwill impairment. The test concluded that recorded goodwill was not impaired. As of December 31, 2011, there have been no events or changes in 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. OREO (Other Real Estate Owned) and Other Repossessed Assets OREO and other repossessed assets consist of properties or assets acquired through or by deed in lieu of foreclosure, and are recorded initially at the estimated fair value of the properties less estimated costs of disposal. Costs relating to the 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 is subjective in nature and may be adjusted in future periods because of changes in economic conditions. Management periodically obtains updated valuations from third party appraisals, as well as independent fair market value 37 assessments from realtors or persons involved in the selling of real estate in determining the estimated fair value of particular properties. A charge to earnings is recorded if the recorded value of a property exceeds its estimated net realizable value. Comparison of Financial Condition at December 31, 2011 and September 30, 2011 The Company's total assets decreased by $2.37 million, or 0.3%, to $735.85 million at December 31, 2011 from $738.22 million at September 30, 2011. The decrease was primarily the result of a decrease in OREO and other repossessed assets. Net loans receivable increased by $1.02 million, or 0.2%, to $529.04 million at December 31, 2011 from $528.02 million at September 30, 2011. The increase was primarily due to an increase in commercial business loan balances, commercial real estate construction loan balances and custom and owner/builder construction loan balances. These increases were partially offset by decreases in one-to four-family loan balances, land loan balances and consumer loan balances. Total deposits decreased by $3.50 million, or 0.6%, to $589.18 million at December 31, 2011 from $592.68 million at September 30, 2011, primarily as a result of decreases in certificates of deposit account balances and non-interest bearing account balances. These decreases were partially offset by increases in money market account balances, savings account balances and N.O.W. checking account balances. Shareholders' equity increased by $1.13 million, or 1.3%, to $87.33 million at December 31, 2011 from $86.21 million at September 30, 2011.The increase in shareholders' equity was primarily a result of net income for the quarter. 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 $633,000, or 0.5%, to $131.36 million at December 31, 2011 from $130.72 million at September 30, 2011. The increase was primarily due to a $1.15 million increase in CDs held for investment, which was partially offset by a $518,000 decrease in cash and cash equivalents. MBS (Mortgage-backed Securities) and Other Investments: Mortgage-backed securities and other investments decreased by $637,000, or 5.9%, to $10.23 million at December 31, 2011 from $10.86 million at September 30, 2011. The decrease was primarily a result of scheduled amortization and prepayments on MBS and OTTI charges recorded on private label residential MBS. The securities on which the OTTI charges were recognized were acquired from the in-kind redemption of the Company's investment in the AMF family of mutual funds in June 2008. For additional information on MBS and other investments, see Note 4 of the Notes to Condensed Consolidated Financial Statements contained in "Item 1, Financial Statements." Loans: Net loans receivable increased by $1.02 million, or 0.2%, to $529.04 million at December 31, 2011 from $528.02 million at September 30, 2011. The increase in the portfolio was primarily a result of a $4.92 million increase in commercial business loan balances, a $3.83 million increase in commercial real estate construction loan balances and a $2.59 million increase in custom and owner/builder construction loan balances. These increases to net loans receivable were partially offset by a $4.18 million decrease in one-to four-family loan balances and a $3.04 million decrease in land loan balances. Loan originations increased to $51.63 million for the three months ended December 31, 2011 from $49.15 million for the three months ended December 31, 2010. The Company continued to sell longer-term fixed rate loans for asset liability management purposes and to generate non-interest income. The Company sold fixed 38 rate one- to four-family mortgage loans totaling $22.92 million for the three months ended December 31, 2011 compared to $26.86 million for the three months ended December 31, 2010. For additional information, see Note 6 of the Notes to Condensed Consolidated Financial Statements contained in "Item 1, Financial Statements." Premises and Equipment: Premises and equipment decreased by $36,000, or 0.2%, to $17.35 million at December 31, 2011 from $17.39 million at September 30, 2011. The decrease was primarily a result of depreciation. OREO (Other Real Estate Owned): OREO and other repossessed assets decreased by $3.10 million, or 28.6%, to $7.71 million at December 31, 2011 from $10.81 million at September 30, 2011, primarily due to the sale of OREO properties. During the three months ended December 31, 2011, 12 OREO properties and other repossessed assets totaling $3.70 million were sold for a net loss of $271,000. At December 31, 2011, OREO consisted of 52 individual properties and three other repossessed assets. The properties consisted of 37 land parcels totaling $3.50 million, ten single family homes totaling $1.60 million, three commercial real estate properties totaling $1.23 million, a condominium project of $842,000, and a land development project of $469,000. The three other repossessed assets totaled $73,000. Goodwill and CDI: The recorded value of goodwill of $5.65 million at December 31, 2011 remained unchanged from September 30, 2011. The amortized value of the CDI decreased $37,000, or 9.3%, to $360,000 at December 31, 2011 from $397,000 at September 30, 2011. The decrease was attributable to scheduled amortization of the CDI. Prepaid FDIC Insurance Assessment: The prepaid FDIC insurance assessment decreased $230,000, or 10.9%, to $1.87 million at December 31, 2011 from $2.10 million at September 30, 2011 as a portion of the prepaid amount was expensed. Deposits: Deposits decreased by $3.50 million, or 0.6%, to $589.18 million at December 31, 2011 from $592.68 million at September 30, 2011. The decrease was primarily a result of an $8.62 million decrease in certificates of deposit account balances and a $3.32 million decrease in non-interest bearing deposit account balances. These decreases were partially offset by a $5.24 million increase in money market account balances, a $1.70 million increase in savings account balances and a $1.50 million increase in N.O.W. checking account balances. See the "Deposit Breakdown" schedule below for additional information. FHLB Advances: FHLB advances were $55.00 million at December 31, 2011 and September 30, 2011. For additional information, see the "Borrowing Maturity Schedule" set forth below. Shareholders' Equity: Total shareholders' equity increased by $1.13 million, or 1.3%, to $87.33 million at December 31, 2011 from $86.21 million at September 30, 2011. The increase was primarily due to net income of $1.02 million for the three months ended December 31, 2011. The FRB has denied the Company's requests to pay cash dividends on its outstanding Series A Preferred Stock held by the Treasury for the quarterly dividend payments due for the last seven quarters commencing with the payment due May 15, 2010. Cash dividends on the Series A Preferred Stock are cumulative and accrue and compound on each subsequent date. Accordingly, during the deferral period, the Company will continue to accrue, and reflect in the consolidated financial statements, the deferred dividends on the outstanding Series A Preferred Stock. As a result of not receiving permission from the FRB to pay these dividends, the Company had not made seven quarterly dividend payments as of December 31, 2011. At December 31, 2011, the Company had accrued preferred stock dividends in arrears of $1.46 million. 39 Non-performing Assets: Non-performing assets consist of non-accrual loans, loans past due 90 days or more and still accruing, non-accrual investment securities, and OREO and other repossessed assets. Non-performing assets increased by $3.89 million, or 10.5%, to $40.84 million at December 31, 2011 from $36.95 million at September 30, 2011. The increase in non-performing assets was primarily a result of a $6.21 million increase in non-accrual loans and a $923,000 increase in loans past due 90 days and still accruing. These increases to non-performing assets were partially offset by a $3.10 million decrease in OREO and other repossessed assets and a $146,000 decrease in non-performing investment securities. The increase in loans past due 90 days or more and still accruing was primarily due to a delay in obtaining final plat approval for a pre-sold residential building plat in King County, Washington. The Company expects the sale to be consummated by February 28, 2012, which will reduce the loans in the past 90 days and still accruing category by $2.32 million. For additional information, see Note 6 of the Notes to Condensed Consolidated Financial Statements contained in "Item 1, Financial Statements." Deposit Breakdown ----------------- The following table sets forth the composition of the Company's deposit balances. At At December 31, 2011 September 30, 2011 ----------------- ------------------ (Dollars in thousands) Non-interest bearing $ 61,178 $ 64,494 N.O.W. checking 156,799 155,299 Savings 85,335 83,636 Money market accounts 66,266 61,028 CDs under $100 136,859 141,899 CDs $100 and over 82,738 86,322 -------- -------- Total deposits $589,175 $592,678 ======== ======== The Company had no brokered deposits at December 31, 2011 or September 30, 2011. Borrowing Maturity Schedule --------------------------- The Company has short- and long-term borrowing lines with the FHLB of Seattle with total credit available on the lines equal to 30% of the Bank's total assets, limited by available collateral. Borrowings are considered short-term when the original maturity is less than one year. FHLB advances consisted of the following: At December 31, At September 30, 2011 2011 ----------------- ----------------- Amount Percent Amount Percent ------ ------- ------ ------- (Dollars in thousands) Short-term $ - - - -% $ - - - -% Long-term 55,000 100.0 55,000 100.0 ------- ----- ------- ----- Total FHLB advances $55,000 100.0% $55,000 100.0% ======= ===== ======= ===== The long-term borrowings mature at various dates through September 2017 and bear interest at rates ranging from 3.49% to 4.34%. The weighted average interest rate on FHLB borrowings at December 31, 2011 was 40 4.01%. Principal reduction amounts due for future years ending September 30 are as follows (dollars in thousands): Remainder of 2012 $10,000 2013 - - 2014 - - 2015 - - 2016 - - 2017 45,000 ------- Total $55,000 ======= A portion of these advances have a putable feature and may be called by the FHLB earlier than the above schedule indicates. As of December 31, 2011, the Company had additional available borrowing capacity of $117.79 million with the FHLB. The Company also maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. As of December 31, 2011, the Company had a borrowing line capacity with the FRB of $50.58 million of which none was outstanding. Comparison of Operating Results for the Three Months Ended December 31, 2011 and 2010 The Company reported net income of $1.28 million for the quarter ended December 31, 2011 compared to net income of $1.36 million for the quarter ended December 31, 2010. Net income to common shareholders after adjusting for the preferred stock dividend and the preferred stock discount accretion was $1.02 million for the quarter ended December 31, 2011 compared to net income of $1.10 million for the quarter ended December 31, 2010. The slight decrease in earnings for the quarter was primarily a result of decreased non-interest income and decreased net interest income, which was partially offset by a decreased provision for loan losses and decreased non-interest expense. Net income per diluted common share was $0.15 for the quarter ended December 31, 2011 compared to net income per diluted common share of $0.16 for the quarter ended December 31, 2010. A more detailed explanation of the income statement categories is presented below. Net Income: The Company reported net income of $1.28 million for the quarter ended December 31, 2011 compared to net income of $1.36 million for the quarter ended December 31, 2010. Net income to common shareholders after adjusting for preferred stock dividends of $208,000 and preferred stock discount accretion of $59,000 was $1.02 million, or $0.15 per diluted common share for the quarter ended December 31, 2011, compared to $1.10 million, or $0.16 per diluted common share for the quarter ended December 31, 2010. The $76,000 decrease in net income for the quarter ended December 31, 2011 was primarily the result of a $507,000 decrease in non-interest income and a $30,000 decrease in net interest income. These decreases to net income were partially offset by a $250,000 decrease in the provision for loan losses, a $155,000 decrease in non-interest expenses and a $56,000 decrease in the provision for federal and state income taxes. Net Interest Income: Net interest income decreased by $30,000, or 0.5%, to $6.30 million for the quarter ended December 31, 2011 from $6.33 million for the quarter ended December 31, 2010. The slight decrease in net interest income was primarily attributable to a decrease in the net interest margin, which was partially offset by an increase in the level of total interest-bearing assets. Total interest and dividend income decreased by $779,000 or 8.8%, to $8.03 million for the quarter ended December 31, 2011 from $8.81 million for the quarter ended December 31, 2010 as the yield on interest bearing 41 assets decreased to 4.76% from 5.31% and average loans receivable declined $1.13 million as compared to the same period last year. The decrease in the weighted average yield on interest bearing assets was primarily a result of decreased market rates for loans and an increase in the amount of lower yielding cash equivalents and other liquid assets. Total interest expense decreased by $749,000, or 30.2%, to $1.73 million for the quarter ended December 31, 2011 from $2.48 million for the quarter ended December 31, 2010 as the average rate paid on interest bearing liabilities decreased to 1.18% for the quarter ended December 31, 2011 from 1.70% for the quarter ended December 31, 2010. The decrease in funding costs was primarily a result of a decrease in overall market rates and a change in the composition of the deposit base as the percentage of certificates of deposit account balances decreased. The net interest margin decreased to 3.73% for the quarter ended December 31, 2011 from 3.82% for the quarter ended December 31, 2010. 42 Average Balances, Interest and Average Yields/Cost The following tables 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. (Dollars in thousands) Three Months Ended December 31, ---------------------------------------------------- 2011 2010 ------------------------ ------------------------- Interest Interest Average and Yield/ Average and Yield/ Balance Dividends Cost Balance Dividends Cost ------- --------- ---- ------- --------- ---- Interest-bearing assets: (1) Loans receivable (2) $537,876 $7,805 5.80% $539,007 $8,534 6.33% MBS and other investments (2) 9,616 125 5.20 13,195 182 5.52 FHLB stock and equity securities 6,704 13 0.78 6,689 8 0.47 Interest-bearing deposits 121,236 89 0.29 104,870 87 0.33 -------- ------ -------- ------ Total interest- bearing assets 675,432 8,032 4.76 663,761 8,811 5.31 Non-interest-bearing assets 60,833 58,246 -------- -------- Total assets $736,265 $722,007 ======== ======== Interest-bearing liabilities: Savings accounts $ 84,511 83 0.39 $ 68,040 123 0.72 Money market accounts 63,708 96 0.60 56,935 134 0.93 N.O.W. accounts 154,319 210 0.54 155,118 420 1.07 Certificates of deposit 223,562 780 1.38 243,128 1,074 1.75 Short-term borrowings (3) 559 - 0.05 546 - 0.05 Long-term borrowings (4) 55,000 562 4.05 55,000 729 5.26 -------- ------ -------- ------ Total interest- bearing liabilities 581,659 1,731 1.18 578,767 2,480 1.70 -------- ------ -------- ------ Non-interest-bearing liabilities 68,072 57,644 -------- -------- Total liabilities 649,731 636,411 Shareholders' equity 86,534 85,596 -------- -------- Total liabilities and shareholders' equity $736,265 $722,007 ======== ======== Net interest income $6,301 $6,331 ====== ====== Interest rate spread 3.58% 3.61% ====== ====== Net interest margin (5) 3.73% 3.82% ====== ====== Ratio of average interest-bearing assets to average interest-bearing liabilities 116.12% 114.69% ====== ====== ----------------- (1) Interest yield on loans and MBS is calculated assuming a 30/360 basis; interest yield on all other categories is based on daily interest basis. (2) Average balances include loans and MBS on non-accrual status. (3) Includes FHLB and FRB 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 bearing assets, annualized. 43 Rate Volume Analysis The following table sets forth the effects of changing rates and volumes on the net interest income of 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 rate/volume have been allocated to rate and volume variances based on the absolute values of each. (In thousands) Three months ended December 31, 2011 compared to three months ended December 31, 2010 increase (decrease) due to ------ Rate Volume Net Change ------ -------- ---------- Interest-bearing assets: Loans receivable (1) $ (712) $ (17) $ (729) MBS and other investments (10) (47) (57) FHLB stock and equity securities 5 - - 5 Interest-bearing deposits (10) 12 2 ------ ----- ------ Total net decrease in income on interest-earning assets (727) (52) (779) Interest-bearing liabilities: Savings accounts (65) 25 (40) N.O.W. accounts (208) (2) (210) Money market accounts (53) 15 (38) CD accounts (212) (82) (294) Long-term borrowings (167) - - (167) ------ ----- ------ Total net decrease in expense on interest bearing liabilities (705) (44) (749) ------ ----- ------ Net decrease in net interest income $ (22) $ (8) $ (30) ====== ===== ====== (1) Excludes interest on loans 90 days or more past due. Includes loans originated for sale. Provision for Loan Losses: The provision for loan losses decreased $250,000, or 27.8%, to $650,000 for the quarter ended December 31, 2011 from $900,000 for the quarter ended December 31, 2010. The decrease in the provision for loan losses was primarily due to $524,000 in allowance for loan loss recoveries for the quarter ended December 31, 2011. Also contributing to the reduction in the provision for loan losses was a change in the composition of the loan portfolio as the level of higher risk loan categories (construction and land development loans and land loans) decreased at December 31, 2011 relative to December 31, 2010. Net charge-offs for the quarter ended December 31, 2011 were $624,000 compared to $1.60 million for the quarter ended September 30, 2011 and $415,000 for the quarter ended December 31, 2010. 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. The factors include changes in the amount and composition of the loan portfolio, historic loss 44 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. Based on its comprehensive analysis, management believes the allowance for loan losses of $11.97 million at December 31, 2011 (2.21% of loans receivable and loans held for sale and 39.3% of non-performing loans) was 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 subjected to an impairment analysis to determine an appropriate reserve amount to be held against each loan. The aggregate principal impairment amount determined at December 31, 2011 was $2.92 million. The allowance for loan losses was $11.75 million (2.19% of loans receivable and loans held for sale and 44.4% of non-performing loans) at December 31, 2010. Non-accrual and loans past due 90 days or more and still accruing increased $7.14 million to $30.48 million at December 31, 2011 from $23.34 million at September 30, 2011. For additional information, see the section entitled "Comparison of Financial Condition at December 31, 2011 and September 30, 2011 - Non-performing Assets" included herein. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact the Company's consolidated financial condition and results of operations. In addition, the determination of the amount of the Bank's allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional reserves based upon their analysis of information available to them at the time of their examination. 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 Note 6 of the Notes to Condensed Consolidated Financial Statements contained in "Item 1, Financial Statements." Non-interest Income: Total non-interest income decreased $507,000, or 17.2%, to $2.44 million for the quarter ended December 31, 2011 from $2.95 million for the quarter ended December 31, 2010. The decrease was primarily a result of a $550,000 change in the valuation recovery on MSRs and a $141,000 decrease in gain on sale of loans. These decreases to non-interest income were partially offset by a $106,000 increase in ATM transaction fees and a $76,000 reduction in net OTTI on MBS and other investments. The valuation recovery on MSRs is based on a third party valuation of the MSR asset. The Company recorded a valuation recovery on MSRs of $84,000 for the quarter ended December 31, 2011 compared to a recovery of $634,000 for the quarter ended December 31, 2010. At December 31, 2011, the MSR asset had a remaining valuation allowance of $400,000 that is available for future recovery. The decrease in gain on sale of loans was primarily a result of a decreased volume of fixed rate one-to four family loans sold during the quarter ended December 31, 2011. Non-interest Expense: Total non-interest expense decreased by $155,000, or 2.4%, to $6.22 million for the quarter ended December 31, 2011 from $6.38 million for the quarter ended December 31, 2010. The decrease was primarily the result of a $198,000 decrease in salaries and employee benefits expense, a $115,000 decrease in FDIC insurance expense and a $98,000 decrease in other insurance expense. The decrease in salaries and employee benefits expense was primarily a result of increased loan origination fees that offset salary expense and a one-time benefit of $99,000 from changing the Company's employee medical insurance provider. These decreases to non-interest expense were partially offset by increases to deposit operations expense and OREO and other repossessed assets expense. 45 Provision for Federal and State Income Taxes: The provision for federal and state income taxes decreased $56,000, or 8.7%, to $591,000 for the quarter ended December 31, 2011 from $647,000 for the quarter ended December 31, 2010, primarily due to lower income before taxes. The Company's effective tax rate was 31.54% for the quarter ended December 31, 2011 and 32.25% for the quarter ended December 31, 2010. Liquidity --------- The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on loans and MBS, proceeds from the sale of loans, proceeds from maturing securities and maturing CDs held for investment, FHLB advances, and other borrowings. While maturities and the 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. An analysis of liquidity should include a review of the Condensed Consolidated Statement of Cash Flows for the three months ended December 31, 2011. The Condensed Consolidated Statement of Cash Flows includes operating, investing and financing categories. Operating activities include net income, which is adjusted for non-cash items, and increases or decreases in cash due to changes in certain assets and liabilities. Investing activities consist primarily of proceeds from maturities and sales of securities, purchases of securities, the net change in loans and proceeds from the sale of OREO and other repossessed assets. Financing activities present the cash flows associated with the Company's deposit accounts, other borrowings and stock related transactions. The Company's total cash and cash equivalents decreased by $518,000, or 0.5% to $111.55 million at December 31, 2011 from $112.07 million at September 30, 2011. The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds for 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 December 31, 2011, the Bank's regulatory liquidity ratio (net cash, and short-term and marketable assets, as a percentage of net deposits and short-term liabilities) was 22.24%. The Bank maintained an uncommitted credit facility with the FHLB that provided for immediately available advances up to an aggregate amount equal to 30% of total assets, limited by available collateral, under which $55.00 million was outstanding and $117.79 million was available for additional borrowings at December 31, 2011. The Bank also maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. At December 31, 2011, the Bank had $50.58 million available for borrowings with the FRB and there was 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, federal funds sold, and other short-term investments. If the Bank requires funds that exceed its ability to generate them internally, it has additional borrowing capacity with the FHLB and the FRB. The Bank's primary investing activity is the origination of one- to four-family mortgage loans, commercial mortgage loans, construction loans, consumer loans, and commercial business loans. At December 31, 2011, the Bank had loan commitments totaling $33.13 million and undisbursed construction loans in process totaling $17.07 million. The Bank anticipates that it will have sufficient funds available to meet current loan commitments. CDs that are scheduled to mature in less than one year from December 31, 2011 totaled $149.46 million. Historically, the Bank has been able to retain a significant amount of its non-brokered CDs as they mature. At December 31, 2011, the Bank had no brokered deposits. 46 Capital Resources ----------------- 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%. The Bank is currently required to maintain a "well capitalized" status and a Tier 1 leverage capital ratio of at least 10.0% under terms of the Bank MOU. At December 31, 2011, the Bank was in compliance with all applicable capital requirements. The following table compares the Company's and the Bank's actual capital amounts at December 31, 2011 to its minimum regulatory capital requirements at that date (dollars in thousands): To Be Well Capitalized Regulatory Under Prompt Minimum To Corrective Be "Adequately Action Actual Capitalized" Provisions --------------- --------------- -------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- Tier 1 leverage capital: Consolidated $82,250 11.26% $29,226 4.00% N/A N/A Timberland Bank (1) 75,967 10.45 72,676 10.00 $72,676 10.00% Tier 1 risk adjusted capital: Consolidated 82,250 15.39 21,378 4.00 N/A N/A Timberland Bank (1) 75,967 14.25 31,989 6.00 31,989 6.00 Total risk based capital Consolidated 88,996 16.65 42,756 8.00 N/A N/A Timberland Bank (1) 82,967 15.51 53,315 10.00 53,315 10.00 ------------ (1) Reflects the higher Tier 1 leverage capital ratio that the Bank is required to comply with under terms of the Bank MOU with the FDIC and the Division. 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. 47 TIMBERLAND BANCORP, INC. AND SUBSIDIARIES KEY FINANCIAL RATIOS AND DATA (Dollars in thousands, except per share data) Three Months Ended ----------------------------------------- December 31, September 30, December 31, 2011 2011 2010 ----------------------------------------- PERFORMANCE RATIOS: Return (loss) on average assets (1) 0.70% (0.04)% 0.75% Return (loss) on average equity (1) 5.93% (0.34)% 6.35% Net interest margin (1) 3.73% 3.75% 3.82% Efficiency ratio 71.14% 80.83% 68.69% At At At December 31, September 30, December 31, 2011 2011 2010 ----------------------------------------- ASSET QUALITY RATIOS: Non-accrual loans $27,803 $21,589 $26,166 Loans past due 90 days and still accruing 2,677 1,754 305 Non-performing investment securities 2,650 2,796 3,325 OREO & other repossessed assets 7,714 10,811 12,612 ------- ------- ------- Total non-performing assets $40,844 $36,950 $42,408 ======= ======= ======= Non-performing assets to total assets 5.55% 5.01% 5.87% Allowance for loan losses to non-performing loans 39% 51% 44% Troubled debt restructured loans on accrual status (2) $18,297 $18,166 $ 8,841 BOOK VALUES: Book value per common share $ 10.12 $ 9.97 $ 10.04 Tangible book value per common share (3) $ 9.26 $ 9.11 $ 9.17 -------------- (1) Annualized (2) Does not include troubled debt restructured loans totaling $7,334, $7,376 and $6,756 that were included as non-accrual loans at December 31, 2011, September 30, 2011 and December 31, 2010, respectively. (3) Calculation subtracts goodwill and core deposit intangible from the equity component. Three Months Ended ----------------------------------------- December 31, September 30, December 31, 2011 2011 2010 ----------------------------------------- AVERAGE BALANCE SHEET: Average total loans $537,876 $537,612 $539,007 Average total interest-bearing assets (1) 675,432 675,800 663,761 Average total assets 736,265 737,152 722,007 Average total interest-bearing deposits 526,100 526,659 523,221 Average FHLB advances & other borrowings 55,559 55,502 55,546 Average shareholders' equity 86,534 86,465 85,596 ---------------- (1) Includes loans and MBS on non-accrual status 48 Item 3. Quantitative and Qualitative Disclosures About Market Risk ------------------------------------------------------------------- There were no material changes in information concerning market risk from the information provided in the Company's Form 10-K for the fiscal year ended September 30, 2011. Item 4. Controls and Procedures -------------------------------- (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) 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 report. The Company's Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2011 the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner to allow timely decisions regarding required disclosure, 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 December 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The Company continued, however, to implement suggestions from its internal auditor and independent auditors to strengthen existing controls. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors 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 judgments 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; as over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected. PART II. OTHER INFORMATION Item 1. Legal Proceedings -------------------------- Neither the Company nor the Bank is a party to any material legal proceedings at this time. From time to time, the Bank is involved in various claims and legal actions arising in the ordinary course of business. Item 1A. Risk Factors ---------------------- There have been no material changes in the Risk Factors previously disclosed in Item 1A of the Company's 2011 Form 10-K. 49 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds -------------------------------------------------------------------- Not applicable Item 3. Defaults Upon Senior Securities ---------------------------------------- See discussion in Item 2 of Part 1 with respect to cumulative preferred stock dividends in arrears, which discussion is incorporated here by reference. Item 4. (Removed and Reserved) ------------------------------ Item 5. Other Information -------------------------- None to be reported. Item 6. Exhibits ----------------- (a) Exhibits 3.1 Articles of Incorporation of the Registrant (1) 3.2 Certificate of Designation relating to the Company's Fixed Rate Cumulative Perpetual Preferred Stock Series A (2) 3.3 Bylaws of the Registrant (1) 3.4 Amendment to Bylaws (3) 4.1 Warrant to purchase shares of Company's common stock dated December 23, 2008 (2) 4.2 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 (2) 10.1 Employee Severance Compensation Plan, as revised (4) 10.2 Employee Stock Ownership Plan (4) 10.3 1999 Stock Option Plan (5) 10.4 Management Recognition and Development Plan (5) 10.5 2003 Stock Option Plan (6) 10.6 Form of Incentive Stock Option Agreement (7) 10.7 Form of Non-qualified Stock Option Agreement (7) 10.8 Form of Management Recognition and Development Award Agreement (7) 10.9 Form of Compensation Modification Agreements (2) 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 of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes Oxley Act 101 The following materials from Timberland Bancorp Inc.'s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011, formatted on Extensible Business Reporting Language (XBRL) (a) Condensed Consolidated Balance Sheets; (b) Condensed Consolidated Statements of Income; (c) Condensed Consolidated Statements of Shareholders' Equity; (d) Condensed Consolidated Statements of Comprehensive Income; and (e) Notes to Unaudited Condensed Consolidated Financial Statements (8) --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (333- 35817). 50 (2) Incorporated by reference to the Registrant's Current Report on Form 8-K filed on December 23, 2008. (3) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended September 30, 2002. (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, and to the Registrant's Current Report on Form 8-K dated December 18, 2007. (5) Incorporated by reference to the Registrant's 1999 Annual Meeting Proxy Statement dated December 15, 1998. (6) Incorporated by reference to the Registrant's 2004 Annual Meeting Proxy Statement dated December 24, 2003. (7) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended September 30, 2005. (8) Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended And otherwise not subject to liability under those sections. 51 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Timberland Bancorp, Inc. Date: February 8, 2012 By: /s/ Michael R. Sand ----------------------------- Michael R. Sand Chief Executive Officer (Principal Executive Officer) Date: February 8, 2012 By: /s/ Dean J. Brydon ----------------------------- Dean J. Brydon Chief Financial Officer (Principal Financial Officer) 52 EXHIBIT INDEX Exhibit No. Description of Exhibit 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 101 The following materials from Timberland Bancorp Inc.'s Quarterly Report on Form 10-Q for the quarter ended December 31, 2011, formatted on Extensible Business Reporting Language (XBRL) (a) Condensed Consolidated Balance Sheets; (b) Condensed Consolidated Statements of Income; (c) Condensed Consolidated Statements of Shareholders' Equity; (d) Condensed Consolidated Statements of Comprehensive Income; and (e) Notes to Unaudited Condensed Consolidated Financial Statements 53