10-Q
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 March 31, 2016

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 incorporation or organization) 
(IRS Employer 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 MAY 5, 2016
 
Common stock, $.01 par value
6,936,068
 



INDEX

 
 
Page
 
 
 
 
  Item 1.    
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Item 2.     
 
 
 
 
 
  Item 3.    
 
 
 
 
 
  Item 4.     
 
 
 
 
 
 
 
 
 
 
 
  Item 1.     
 
  
 
 
 
  Item 1A.     
 
 
 
 
 
  Item 2.     
 
 
 
 
 
  Item 3.     
 
 
 
 
 
  Item 4.
 
 
 
 
 
  Item 5.     
 
51 
 
 
 
 
  Item 6.     
 
 
 
 
 
 
Certifications 
 
 
 
Exhibit 31.1
 
 
 
Exhibit 31.2
 
 
 
Exhibit 32
 
 
 
Exhibit 101
 


2


PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements (unaudited)
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
March 31, 2016 and September 30, 2015
(Dollars in thousands, except per share amounts)
 
 
March 31,
2016

 
September 30,
2015

 
(Unaudited)
 
*

Assets
 
 
 
Cash and cash equivalents:
 
 
 
Cash and due from financial institutions
$
17,121

 
$
14,014

Interest-bearing deposits in banks
92,908

 
78,275

Total cash and cash equivalents
110,029

 
92,289

 
 
 
 
Certificates of deposit (“CDs”) held for investment (at cost, which
     approximates fair value)
52,524

 
48,611

Investment securities held to maturity, at amortized cost
     (estimated fair value $8,628 and $8,894)
7,743

 
7,913

Investment securities available for sale
1,365

 
1,392

Federal Home Loan Bank (“FHLB”) stock
2,804

 
2,699

Loans held for sale
1,584

 
3,051

 
 
 
 
Loans receivable
632,894

 
614,201

Less: Allowance for loan losses
(10,043
)
 
(9,924
)
Net loans receivable
622,851

 
604,277

 
 
 
 
Premises and equipment, net
16,355

 
16,854

Other real estate owned (“OREO”) and other repossessed assets, net
5,458

 
7,854

Accrued interest receivable
2,232

 
2,170

Bank owned life insurance (“BOLI”)
18,443

 
18,170

Goodwill
5,650

 
5,650

Mortgage servicing rights (“MSRs”), net
1,488

 
1,478

Other assets
3,436

 
3,407

Total assets
$
851,962

 
$
815,815

 
 
 
 
Liabilities and shareholders’ equity
 

 
 

Liabilities
 

 
 

Deposits:
 
 
 
     Non-interest-bearing demand
$
148,980

 
$
141,388

     Interest-bearing
563,058

 
537,524

Total deposits
712,038

 
678,912

 
 
 
 
FHLB advances
45,000

 
45,000

Other liabilities and accrued expenses
2,662

 
2,716

Total liabilities
759,700

 
726,628

* Derived from audited consolidated financial statements.

See notes to unaudited consolidated financial statements

3


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (continued)
March 31, 2016 and September 30, 2015
(Dollars in thousands, except per share amounts)
 
 
March 31,
2016

 
September 30,
2015

 
(Unaudited)
 
*

Shareholders’ equity
 
 
 
Preferred stock, $.01 par value; 1,000,000 shares authorized; none issued
$

 
$

Common stock, $.01 par value; 50,000,000 shares authorized;
6,933,068 shares issued and outstanding - March 31, 2016 6,988,848 shares issued and outstanding - September 30, 2015
9,698

 
10,293

Unearned shares issued to Employee Stock Ownership Plan (“ESOP”)
(793
)
 
(926
)
Retained earnings
83,643

 
80,133

Accumulated other comprehensive loss
(286
)
 
(313
)
Total shareholders’ equity
92,262

 
89,187

Total liabilities and shareholders’ equity
$
851,962

 
$
815,815

* Derived from audited consolidated financial statements.


See notes to unaudited consolidated financial statements


4


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the three and six months ended March 31, 2016 and 2015
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Three Months Ended 
 March 31,
 
Six Months Ended March 31,
 
2016

 
2015

 
2016

 
2015

Interest and dividend income
 
 
 
 
 
 
 
Loans receivable and loans held for sale
$
8,306

 
$
7,352

 
$
16,735

 
$
14,861

Investment securities
74

 
55

 
143

 
120

Dividends from mutual funds and FHLB stock
39

 
6

 
61

 
13

Interest-bearing deposits in banks and CDs
231

 
114

 
402

 
219

Total interest and dividend income
8,650

 
7,527

 
17,341

 
15,213

 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
 
Deposits
507

 
495

 
1,012

 
1,004

FHLB advances
472

 
465

 
948

 
940

Total interest expense
979

 
960

 
1,960

 
1,944

 
 
 
 
 
 
 
 
Net interest income
7,671

 
6,567

 
15,381

 
13,269

 
 
 
 
 
 
 
 
Provision for loan losses

 

 

 

 
 
 
 
 
 
 
 
Net interest income after provision for loan losses
7,671

 
6,567

 
15,381

 
13,269

 
 
 
 
 
 
 
 
Non-interest income
 
 
 
 
 
 
 
Other than temporary impairment (“OTTI”) on investment securities
(24
)
 

 
(24
)
 

Adjustment for portion of OTTI (transferred from) recorded as other comprehensive income (loss) before income taxes
1

 
(1
)
 
1

 
(1
)
Net OTTI on investment securities
(23
)
 
(1
)
 
(23
)
 
(1
)
Gain on sale of investment securities available for sale, net

 

 

 
45

Service charges on deposits
937

 
852

 
1,909

 
1,737

ATM and debit card interchange transaction fees
710

 
643

 
1,409

 
1,273

BOLI net earnings
137

 
131

 
273

 
268

Gain on sales of loans, net
393

 
348

 
787

 
584

Escrow fees
49

 
56

 
89

 
98

Servicing income (loss) on loans sold
55

 
(12
)
 
120

 
(40
)
Other, net
255

 
197

 
467

 
374

Total non-interest income, net
2,513

 
2,214

 
5,031

 
4,338








 See notes to unaudited consolidated financial statements

5


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (continued)
For the three and six months ended March 31, 2016 and 2015
(Dollars in thousands, except per share amounts)
(Unaudited)
 
Three Months Ended 
 March 31,
 
Six Months Ended March 31,
 
2016

 
2015

 
2016

 
2015

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
3,466

 
$
3,284

 
$
6,936

 
$
6,680

Premises and equipment
771

 
751

 
1,531

 
1,476

Advertising
193

 
173

 
398

 
361

OREO and other repossessed assets, net
195

 
349

 
438

 
425

ATM and debit card interchange transaction fees
331

 
255

 
653

 
593

Postage and courier
110

 
114

 
211

 
218

State and local taxes
138

 
119

 
270

 
236

Professional fees
117

 
223

 
247

 
399

Federal Deposit Insurance Corporation ("FDIC") insurance
127

 
148

 
234

 
308

Loan administration and foreclosure
95

 
76

 
124

 
119

Data processing and telecommunications
474

 
471

 
924

 
850

Deposit operations
234

 
219

 
406

 
395

Other
378

 
472

 
735

 
868

Total non-interest expense
6,629

 
6,654

 
13,107

 
12,928

 
 
 
 
 
 
 
 
Income before federal income taxes
3,555

 
2,127

 
7,305

 
4,679

 
 
 
 
 
 
 
 
Provision for federal income taxes
1,175

 
676

 
2,397

 
1,501

 
 
 
 
 
 
 
 
     Net income
$
2,380

 
$
1,451

 
$
4,908

 
$
3,178

 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
Basic
$
0.35

 
$
0.21

 
$
0.72

 
$
0.46

Diluted
$
0.34

 
$
0.21

 
$
0.69

 
$
0.45

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
6,846,527

 
6,898,192

 
6,858,190

 
6,895,038

Diluted
7,080,005

 
7,071,792

 
7,081,945

 
7,067,621

 
 
 
 
 
 
 
 
Dividends paid per common share
$
0.08

 
$
0.06

 
$
0.20

 
$
0.11




See notes to unaudited consolidated financial statements

6


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and six months ended March 31, 2016 and 2015
(Dollars in thousands)
(Unaudited) 
 
Three Months Ended 
 March 31,
 
Six Months Ended 
 March 31,
 
2016

 
2015

 
2016

 
2015

Comprehensive income
 
 
 
 
 
 
 
Net income
$
2,380

 
$
1,451

 
$
4,908

 
$
3,178

Unrealized holding gain (loss) on investment securities available for sale, net of income taxes of $6, $4, ($1) and $2, respectively
11

 
8

 
(1
)
 
5

Reclassification adjustment for gain on sale of investment securities available for sale included in net income, net of income taxes of $0, $0, $0 and ($15), respectively.

 

 

 
(30
)
Change in OTTI on investment securities held to maturity, net of income taxes:
 
 
 
 
 
 
 
Additional amount recovered related to credit loss for which OTTI was previously recognized, net of income taxes of $6, $1, $7 and $1, respectively
12

 
1

 
12

 
1

Amount reclassified to credit loss for previously recorded market loss, net of income taxes of ($1), $1, ($1) and $1, respectively
(1
)
 
1

 
(1
)
 
1

Accretion of OTTI on investment securities held to maturity, net of income taxes of $4, $4, $9, and $8, respectively
7

 
7

 
17

 
15

Total other comprehensive income (loss), net of income taxes
$
29

 
$
17

 
$
27

 
$
(8
)
 
 
 
 
 
 
 
 
Total comprehensive income
$
2,409

 
$
1,468

 
$
4,935


$
3,170




See notes to unaudited consolidated financial statements

7


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the six months ended March 31, 2016 and 2015
(Dollars in thousands, except per share amounts)
(Unaudited)

 
 
Number of Shares
 
Amount
 
Unearned
 Shares Issued to
ESOP

 
 
 
Accumulated
Other
Compre-
hensive
Loss

 
 
 
 
Common
Stock
 
Common
Stock
 
 
Retained
Earnings
 
 
Total
Balance, September 30, 2014
 
7,047,336

 
$
10,773

 
$
(1,190
)
 
$
73,534

 
$
(339
)
 
$
82,778

Net income
 

 

 

 
3,178

 

 
3,178

Other comprehensive loss
 

 

 

 

 
(8
)
 
(8
)
Exercise of stock options
 
5,300

 
25

 

 

 

 
25

Common stock dividends ($0.11 per common share)
 

 

 

 
(775
)
 

 
(775
)
Earned ESOP shares, net of income taxes
 

 
36

 
132

 

 

 
168

Stock option compensation expense
 

 
58

 

 

 

 
58

Balance, March 31, 2015
 
7,052,636

 
10,892

 
(1,058
)
 
75,937

 
(347
)
 
85,424

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2015
 
6,988,848

 
10,293

 
(926
)
 
80,133

 
(313
)
 
89,187

Repurchase of common stock
 
(66,000
)
 
(820
)
 

 

 

 
(820
)
Net income
 

 

 

 
4,908

 

 
4,908

Other comprehensive income
 

 

 

 

 
27

 
27

Exercise of stock options
 
10,220

 
86

 

 

 

 
86

Common stock dividends ($0.20 per common share)
 

 

 

 
(1,398
)
 

 
(1,398
)
Earned ESOP shares, net of income taxes
 

 
55

 
133

 

 

 
188

Stock option compensation expense
 

 
84

 

 

 

 
84

Balance, March 31, 2016
 
6,933,068

 
$
9,698

 
$
(793
)
 
$
83,643

 
$
(286
)
 
$
92,262





See notes to unaudited consolidated financial statements

8


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended March 31, 2016 and 2015
(In thousands)
(Unaudited)

 
Six Months Ended
March 31,
 
2016

 
2015

Cash flows from operating activities
 
 
 
Net income
$
4,908

 
$
3,178

Adjustments to reconcile net income to net cash provided by
   operating activities:
 

 
 

Depreciation
673

 
669

Amortization of core deposit intangible ("CDI")

 
3

Earned ESOP shares
133

 
132

Stock option compensation expense
75

 
56

Stock option tax effect less excess tax benefit
5

 
1

Gain on sales of OREO and other repossessed assets, net
(13
)
 
(127
)
Provision for OREO losses
301

 
405

Loss on sales/dispositions of premises and equipment, net
3

 

BOLI net earnings
(273
)
 
(268
)
Gain on sales of loans, net
(787
)
 
(584
)
Increase (decrease) in deferred loan origination fees
(145
)
 
147

Net OTTI on investment securities
23

 
1

Gain on sale of investment securities available for sale, net

 
(45
)
Amortization of MSRs
295

 
40

Loans originated for sale
(24,305
)
 
(21,696
)
Proceeds from sales of loans
26,559

 
20,927

Net change in accrued interest receivable and other assets, and other liabilities and accrued expenses
(514
)
 
524

Net cash provided by operating activities
6,938

 
3,363

 
 
 
 
Cash flows from investing activities
 

 
 

Net increase in CDs held for investment
(3,913
)
 
(6,023
)
Proceeds from sale of investment securities available for sale

 
1,220

Proceeds from maturities and prepayments of investment securities available for sale
27

 
159

Proceeds from maturities and prepayments of investment securities held to maturity
238

 
243

Purchase of FHLB stock
(105
)
 

Redemption of FHLB stock

 
111

Increase in loans receivable, net
(18,505
)
 
(17,955
)
Additions to premises and equipment
(177
)
 
(412
)
Capitalized improvements to OREO
(142
)
 

Proceeds from sales of OREO and other repossessed assets
2,326

 
1,589

Net cash used in investing activities
(20,251
)
 
(21,068
)
 
 
 
 
See notes to unaudited consolidated financial statements

9


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the six months ended March 31, 2016 and 2015
(In thousands)
(Unaudited)

 
Six Months Ended
March 31,
 
2016

 
2015

Cash flows from financing activities
 

 
 

Net increase in deposits
$
33,126

 
$
28,157

ESOP tax effect
55

 
36

Proceeds from exercise of stock options
86

 
24

Stock option excess tax benefit
4

 
1

Issuance of common stock

 
1

Repurchase of common stock
(820
)
 

Payment of dividends
(1,398
)
 
(775
)
Net cash provided by financing activities
31,053

 
27,444

 
 

 
 

Net increase in cash and cash equivalents
17,740

 
9,739

Cash and cash equivalents
 

 
 

Beginning of period
92,289

 
72,354

End of period
$
110,029

 
$
82,093

 
 
 
 
Supplemental disclosure of cash flow information
 

 
 

Income taxes paid
$
2,280

 
$
1,560

Interest paid
1,938

 
1,937

 
 
 
 
Supplemental disclosure of non-cash investing activities
 

 
 

Loans transferred to OREO and other repossessed assets
$
76

 
$
641

Other comprehensive loss related to investment securities
27

 
(8
)


 


See notes to unaudited consolidated financial statements

10


Timberland Bancorp, Inc. and Subsidiary
Notes to Unaudited Consolidated Financial Statements

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)  Basis of Presentation:  The accompanying unaudited 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 consolidated 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 consolidated financial statements have been included.  All such adjustments are of a normal recurring nature. The unaudited 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, 2015 (“2015 Form 10-K”).  The unaudited consolidated results of operations for the six months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the entire fiscal year ending September 30, 2016.

(b)  Principles of Consolidation:  The unaudited 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 Corporation.   All significant intercompany transactions and 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 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 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 March 31, 2016 presentation with no change to net income or total shareholders’ equity as previously reported.































11


(2) INVESTMENT SECURITIES

Held to maturity and available for sale investment securities have been classified according to management’s intent and were as follows as of March 31, 2016 and September 30, 2015 (dollars in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
March 31, 2016
 
 
 
 
 
 
 
Held to maturity
 
 
 
 
 
 
 
Mortgage-backed securities ("MBS"):
 
 
 
 
 
 
 
U.S. government agencies
$
745

 
$
21

 
$
(1
)
 
$
765

Private label residential
993

 
799

 
(6
)
 
1,786

U.S. Treasury and U.S government agency securities
6,005

 
72

 

 
6,077

Total
$
7,743

 
$
892

 
$
(7
)
 
$
8,628

 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

U.S. government agencies
$
361

 
$
30

 
$

 
$
391

Mutual funds
1,000

 

 
(26
)
 
974

Total
$
1,361

 
$
30

 
$
(26
)
 
$
1,365

 
 
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
 
 
Held to maturity
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

U.S. government agencies
$
828

 
$
23

 
$
(1
)
 
$
850

Private label residential
1,081

 
894

 
(12
)
 
1,963

U.S. Treasury and U.S. government agency securities
6,004

 
77

 

 
6,081

Total
$
7,913

 
$
994

 
$
(13
)
 
$
8,894

 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

U.S. government agencies
$
387

 
$
34

 
$

 
$
421

Mutual funds
1,000

 

 
(29
)
 
971

Total
$
1,387

 
$
34

 
$
(29
)
 
$
1,392



12


The following table summarizes the estimated fair value and gross unrealized losses for all securities and the length of time these unrealized losses existed as of March 31, 2016 (dollars in thousands):
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Estimated
 Fair
 Value
 
Gross
Unrealized
Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized
Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized
Losses
Held to maturity
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government agencies
$
91

 
$

 
2

 
$
59

 
$
(1
)
 
4

 
$
150

 
$
(1
)
Private label residential
40

 
(1
)
 
3

 
163

 
(5
)
 
12

 
203

 
(6
)
     Total
$
131

 
$
(1
)
 
5

 
$
222

 
$
(6
)
 
16

 
$
353

 
$
(7
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Mutual funds
$

 
$

 

 
$
974

 
$
(26
)
 
1

 
$
974

 
$
(26
)
     Total
$

 
$

 

 
$
974

 
$
(26
)
 
1

 
$
974

 
$
(26
)

The following table summarizes the estimated fair value and gross unrealized losses for all securities and the length of time these unrealized losses existed as of September 30, 2015 (dollars in thousands):
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Estimated
 Fair
 Value
 
Gross
Unrealized Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized Losses
Held to maturity
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government agencies
$
49

 
$

 
4

 
$
63

 
$
(1
)
 
5

 
$
112

 
$
(1
)
Private label residential
1

 

 
1

 
157

 
(12
)
 
11

 
158

 
(12
)
     Total
$
50

 
$

 
5

 
$
220

 
$
(13
)
 
16

 
$
270

 
$
(13
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government agencies
$
1

 
$

 
1

 
$
48

 
$

 
2

 
$
49

 
$

Mutual funds

 

 

 
971

 
(29
)
 
1

 
971

 
(29
)
     Total
$
1

 
$

 
1

 
$
1,019

 
$
(29
)
 
3

 
$
1,020

 
$
(29
)

The Company has evaluated these securities and has determined that the decline in their value is temporary.  The unrealized losses are primarily due to changes in market interest rates and spreads in the market for mortgage-related products. The fair value of these securities is expected to recover as the securities approach their maturity dates and/or as the pricing spreads narrow on mortgage-related securities.  The Company has the ability and the intent to hold the investments until the market value recovers.  Furthermore, as of March 31, 2016, management does not have the intent to sell any of the securities classified as available for sale where the estimated fair value is below the recorded value and believes that it is more likely than not that the Company will not have to sell such securities before a recovery of cost or recorded value if previously written down.

In accordance with GAAP, the Company bifurcates OTTI into (1) amounts related to credit losses which are recognized through earnings and (2) 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 the OTTI security to the present value of its revised expected cash flows, discounted using its pre-impairment yield.  The revised expected cash flow estimates for individual securities are based primarily on an analysis of default rates, prepayment speeds and

13


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 March 31, 2016 and September 30, 2015:
 
Range
 
Weighted
 
Minimum 
 
Maximum 
 
Average 
March 31, 2016
 
 
 
 
 
Constant prepayment rate
6.00
%
 
15.00
%
 
9.16
%
Collateral default rate
0.24
%
 
17.64
%
 
5.70
%
Loss severity rate
7.00
%
 
77.00
%
 
41.97
%
 
 
 
 
 
 
September 30, 2015
 
 
 
 
 
Constant prepayment rate
6.00
%
 
15.00
%
 
11.49
%
Collateral default rate
0.16
%
 
14.65
%
 
6.08
%
Loss severity rate
3.92
%
 
65.00
%
 
39.83
%

The following table presents the OTTI for the three and six months ended March 31, 2016 and 2015 (dollars in thousands):
 
Three Months Ended March 31, 2016
 
Three Months Ended
March 31, 2015
 
Held To
Maturity
 
Available
For Sale
 
Held To
Maturity
 
Available
For Sale
Total OTTI
$
(24
)
 
$

 
$

 
$

Adjustment for portion of OTTI recorded as (transfered from)
       other comprehensive income (loss) before income taxes (1)
1

 

 
(1
)
 

Net OTTI recognized in earnings (2)
$
(23
)
 
$

 
$
(1
)
 
$

    
 
Six Months Ended March 31, 2016
 
Six Months Ended
March 31, 2015
 
Held To
Maturity
 
Available
For Sale
 
Held To
Maturity
 
Available
For Sale
Total OTTI
$
(24
)
 
$

 
$

 
$

Adjustment for portion recorded as (transferred from)
       other comprehensive income (loss) before income taxes (1)
1

 

 
(1
)
 

Net OTTI recognized in earnings (2)
$
(23
)
 
$

 
$
(1
)
 
$

 
 
 
 
 
 
 
 
________________________
(1)
Represents OTTI related to all other factors.
(2)
Represents OTTI related to credit losses.



14


The following table presents a roll forward of the credit loss component of held to maturity and available for sale debt securities that have been written down for OTTI with the credit loss component recognized in earnings for the six months ended March 31, 2016 and 2015 (dollars in thousands):
 
Six Months Ended March 31,
 
2016

 
2015

Beginning balance of credit loss
$
1,576

 
$
1,654

Additions:
 

 
 

Credit losses for which OTTI was
not previously recognized

 
1

Additional increases to the amount
related to credit loss for which OTTI
was previously recognized
20

 

Subtractions:
 
 
 

Realized losses previously recorded
as credit losses
(59
)
 
(38
)
Ending balance of credit loss
$
1,537

 
$
1,617


There was no realized gain on the sale of investment securities for the three and six months ended March 31, 2016. There was no realized gain on the sale of investment securities for the three months ended March 31, 2015 and there was a $45,000 realized gain on the sale of investment securities for the six months ended March 31, 2015. During the three months ended March 31, 2016, the Company recorded a $35,000 net realized loss (as a result of the securities being deemed worthless) on 12 held to maturity residential MBS, of which $32,000 had been recognized previously as a credit loss. During the six months ended March 31, 2016 the Company recorded a $63,000 net realized loss (as a result of securities being deemed worthless) on 15 held to maturity residential MBS, of which $59,000 had been previously recognized as a credit loss. During the three months ended March 31, 2015, the Company recorded a $21,000 net realized loss (as a result of the securities being deemed worthless) on 12 held to maturity residential MBS, of which the entire amount had been recognized previously as a credit loss. During the six months ended March 31, 2015, the Company recorded a $38,000 net realized loss (as a result of securities being deemed worthless) on 14 held to maturity residential MBS, of which the entire amount had been recognized previously as a credit loss.

The recorded amount of residential MBS, treasury and agency securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits, FHLB collateral and other non-profit organization deposits totaled $7.14 million and $7.25 million at March 31, 2016 and September 30, 2015, respectively.

The contractual maturities of debt securities at March 31, 2016 were 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
 
Amortized
Cost
 
Estimated
Fair
Value
 
Amortized
Cost
 
Estimated
Fair
Value
Due within one year
$

 
$

 
$
5

 
$
6

Due after one year to five years
6,005

 
6,077

 

 

Due after five to ten years
22

 
23

 

 

Due after ten years
1,716

 
2,528

 
356

 
385

Total
$
7,743

 
$
8,628

 
$
361

 
$
391



(3) GOODWILL

Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired.  Goodwill is presumed to have an indefinite useful life and is analyzed annually for impairment.  The Company performs an annual review 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.


15


The goodwill impairment test involves a two-step process. Step one estimates the fair value of the reporting unit. If the estimated fair value of the Company's sole reporting unit, the Bank, under step one exceeds the recorded value of the reporting unit, goodwill is not considered impaired and no further analysis is necessary. If the estimated fair value of the Company's sole reporting unit is less than the recorded value, then a step two test, which calculates the fair value of assets and liabilities to calculate an implied value of goodwill, is performed.

The Company performed its fiscal year 2015 goodwill impairment test during the quarter ended June 30, 2015 with the assistance of an independent third-party firm specializing in goodwill impairment valuations for financial institutions. The third-party analysis was conducted as of May 31, 2015 and the step one test concluded that the reporting unit's fair value was more than its recorded value and, therefore, step two of the analysis was not necessary. Accordingly, the recorded value of goodwill as of May 31, 2015 was not impaired.

Step one of the goodwill impairment test estimates the fair value of the reporting unit utilizing a discounted cash flow income approach analysis, a public company market approach analysis, a merger and acquisition market approach analysis and a trading price market approach analysis in order to derive an enterprise value for the Company.

The discounted cash flow income approach analysis uses a reporting unit's projection of estimated operating results and cash flows and discounts them using a rate that reflects current market conditions. The projection uses management's estimates of economic and market conditions over the projected period including growth rates in loans and deposits, estimates of future expected changes in net interest margins and cash expenditures. Key assumptions used by the Company in its discounted cash flow model (income approach) included an annual loan growth rate that ranged from 3.00% to 3.60%, an annual deposit growth rate that ranged from 2.20% to 3.20% and a return on assets that ranged from 0.80% to 1.00%. In addition to the above projections of estimated operating results, key assumptions used to determine the fair value estimate under the income approach were the discount rate of 12.2% and the residual capitalization rate of 9.2%. The discount rate used was the cost of equity capital. The cost of equity capital was based on the capital asset pricing model ("CAPM"), modified to account for a small stock premium. The small stock premium represents the additional return required by investors for small stocks based on the 2015 Valuation Handbook - Guide to Cost of Capital. Beyond the approximate five-year forecast period, residual free cash flows were estimated to increase at a constant rate into perpetuity. These cash flows were converted to a residual value using an appropriate residual capitalization rate. The residual capitalization rate was equal to the discount rate minus the expected long-term growth rate of cash flows. Based on historical results, the economic climate, the outlook for the industry and management's expectations, a long-term growth rate of 3.0% was estimated.

The public company market approach analysis estimates the fair value by applying cash flow multiples to the reporting unit's operating performance. The multiples are derived from comparable publicly traded companies with operating and investment characteristics similar to those of the Company. Key assumptions used by the Company included the selection of comparable public companies and performance ratios. In applying the public company analysis, the Company selected nine publicly traded institutions based on similar lines of business, markets, growth prospects, risks and firm size. The performance ratios included price to earnings (last twelve months), price to earnings (current year to date), price to book value, price to tangible book value and price to deposits.

The merger and acquisition market approach analysis estimates the fair value by using merger and acquisition transactions involving companies that are similar in nature to the Company. Key assumptions used by the Company included the selection of comparable merger and acquisition transactions and the valuation ratios to be used. The analysis used banks located in Washington or Oregon that were acquired after January 1, 2013. The valuation ratios from these transactions for price to earnings and price to tangible book value were then used to derive an estimated fair value of the Company.

The trading price market approach analysis used the closing market price at May 29, 2015 of the Company's common stock, traded on the NASDAQ Global Market to determine the market value of total equity capital.

A key assumption used by the Company in the public company market approach analysis and the trading price market approach analysis was the application of a control premium. The Company's common stock is thinly traded and, therefore, management believes reflects a discount for illiquidity. In addition, the trading price of the Company's common stock reflects a minority interest value. To determine the fair market value of a majority interest in the Company's stock, premiums were calculated and applied to the indicated values. Therefore, a control premium was applied to the results of the discounted cash flow income approach analysis, the public company market approach analysis and the trading price market approach analysis because the initial value conclusion was based on minority interest transactions. Merger and acquisition studies were analyzed to conclude that the difference between the acquisition price and a company's stock price prior to acquisition indicates, in part, the price effect of a controlling interest. Based on the evaluation of mergers and acquisition studies, a control premium of 25% was used.

16



A significant amount of judgment is involved in determining if an indicator of goodwill impairment has occurred. Such indicators may include, among others: a significant decline in the expected future cash flows; a sustained, significant decline in the Company's stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse assessment or action by a regulator; and unanticipated competition. Key assumptions used in the annual goodwill impairment test are highly judgmental and include: selection of comparable companies, amount of control premium, projected cash flows and discount rate applied to projected cash flows. Any change in these indicators or key assumptions could have a significant negative impact on the Company's financial condition, impact the goodwill impairment analysis or cause the Company to perform a goodwill impairment analysis more frequently than once per year.

As of March 31, 2016, management believed that there had been no events or changes in the circumstances since May 31, 2015 that would indicate a potential impairment of goodwill. No assurances can be given, however, that the Company will not record an impairment loss on goodwill in the future.

17


(4) LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans receivable and loans held for sale by portfolio segment consisted of the following at March 31, 2016 and September 30, 2015 (dollars in thousands):
 
March 31,
2016
 
September 30,
2015
 
Amount
 
Percent
 
Amount
 
Percent
Mortgage loans:
 
 
 
 
 
 
 
One- to four-family
$
117,465

 
17.3
%
 
$
116,664

 
17.4
%
Multi-family
42,666

 
6.3

 
52,322

 
7.8

Commercial
290,817

 
42.8

 
291,216

 
43.5

Construction - custom and owner/builder
69,817

 
10.3

 
62,954

 
9.4

Construction - speculative one- to four-family
6,384

 
0.9

 
6,668

 
1.0

Construction - commercial
22,487

 
3.3

 
20,728

 
3.1

Construction - multi-family
20,570

 
3.0

 
20,570

 
3.1

Land
24,322

 
3.6

 
26,140

 
3.9

Total mortgage loans
594,528

 
87.5

 
597,262

 
89.2

 
 
 
 
 
 
 
 
Consumer loans:
 

 
 

 
 

 
 

Home equity and second mortgage
37,144

 
5.5

 
34,157

 
5.1

Other
4,380

 
0.6

 
4,669

 
0.7

Total consumer loans
41,524

 
6.1

 
38,826

 
5.8

 
 
 
 
 
 
 
 
Commercial business loans
43,355

 
6.4

 
33,763

 
5.0

 
 
 
 
 
 
 
 
Total loans receivable
679,407

 
100.0
%
 
669,851

 
100.0
%
Less:
 

 
 

 
 

 
 

Undisbursed portion of construction 
loans in process
44,465

 
 

 
53,457

 
 

Deferred loan origination fees
2,048

 
 

 
2,193

 
 

Allowance for loan losses
10,043

 
 

 
9,924

 
 

 
56,556

 
 
 
65,574

 
 
Loans receivable, net
622,851

 
 

 
604,277

 
 

Loans held for sale (one- to four-family)
1,584

 
 
 
3,051

 
 
Total loans receivable and loans held for sale, net
$
624,435

 
 
 
$
607,328

 
 



















18


Allowance for Loan Losses
The following tables set forth information for the three and six months ended March 31, 2016 and 2015 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):

 
Three Months Ended March 31, 2016
 
Beginning
Allowance
 
Provision for
/(Recapture of)
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
One-to four-family
$
1,420

 
$
(147
)
 
$
(2
)
 
$
52

 
$
1,323

Multi-family
373

 
(58
)
 

 

 
315

Commercial
3,898

 
239

 
(54
)
 

 
4,083

Construction – custom and owner/builder
555

 
(13
)
 

 

 
542

Construction – speculative one- to four-family
122

 
(28
)
 

 
2

 
96

Construction – commercial
486

 
131

 

 

 
617

Construction – multi-family
336

 
(77
)
 

 
150

 
409

Land
923

 
24

 

 
7

 
954

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
1,102

 
(81
)
 

 

 
1,021

Other
161

 
3

 
(2
)
 

 
162

Commercial business loans
513

 
7

 

 
1

 
521

Total
$
9,889

 
$

 
$
(58
)
 
$
212

 
$
10,043


 
Six Months Ended March 31, 2016
 
Beginning
Allowance
 
Provision for
/(Recapture of)
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
One-to four-family
$
1,480

 
$
(184
)
 
$
(28
)
 
$
55

 
$
1,323

Multi-family
392

 
(77
)
 

 

 
315

Commercial
4,065

 
99

 
(81
)
 

 
4,083

Construction – custom and owner/builder
451

 
91

 

 

 
542

Construction – speculative one- to four-family
123

 
(29
)
 

 
2

 
96

Construction – commercial
426

 
191

 

 

 
617

Construction – multi-family
283

 
(55
)
 

 
181

 
409

Land
1,021

 
(72
)
 
(8
)
 
13

 
954

Consumer loans:
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
1,073

 
(39
)
 
(13
)
 

 
1,021

Other
187

 
(21
)
 
(5
)
 
1

 
162

Commercial business loans
423

 
96

 

 
2

 
521

Total
$
9,924

 
$

 
$
(135
)
 
$
254

 
$
10,043

 
 
 
 
 
 
 
 
 
 


19


 
Three Months Ended March 31, 2015
 
Beginning
Allowance
 
Provision for
/(Recapture of)
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
  One-to four-family
$
1,504

 
$
24

 
$
(39
)
 
$
107

 
$
1,596

  Multi-family
368

 
(66)

 

 

 
302
  Commercial
3,646

 
(45)

 

 

 
3,601
  Construction – custom and owner/builder
460

 
15

 

 

 
475
  Construction – speculative one- to four-family
50

 
14

 

 

 
64
  Construction – commercial
28

 
9

 

 

 
37
Construction – multi-family
75

 
54

 

 

 
129

  Land
2,817

 
(67
)
 

 
3

 
2,753
Consumer loans:
 
 
 
 
 
 
 
 
 
  Home equity and second mortgage
801

 
5

 
(9
)
 

 
797
  Other
159

 
34

 
(4
)
 
1

 
190
Commercial business loans
414

 
23

 

 
1

 
438
Total
$
10,322

 
$

 
$
(52
)
 
$
112

 
$
10,382



 
Six Months Ended March 31, 2015
 
Beginning
Allowance
 
Provision for
/(Recapture of)
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
  One-to four-family
$
1,650

 
$
(23
)
 
$
(157
)
 
$
126

 
$
1,596

  Multi-family
387

 
(85)

 

 

 
302
  Commercial
4,836

 
(1,235)

 

 

 
3,601
  Construction – custom and owner/builder
450

 
25

 

 

 
475
  Construction – speculative one- to four-family
52

 
12

 

 

 
64
  Construction – commercial
78

 
(41)

 

 

 
37
Construction – multi-family
25

 
104

 

 

 
129

  Land
1,434

 
1,312

 
(4
)
 
11

 
2,753
Consumer loans:
 
 
 
 
 
 
 
 
 
  Home equity and second mortgage
879

 
(62)

 
(20
)
 

 
797
  Other
176

 
17

 
(5
)
 
2

 
190
Commercial business loans
460

 
(24)

 

 
2

 
438
Total
$
10,427

 
$

 
$
(186
)
 
$
141

 
$
10,382



20


The following tables present information on the loans evaluated individually and collectively for impairment in the allowance for loan losses by portfolio segment at March 31, 2016 and September 30, 2015 (dollars in thousands):

 
Allowance for Loan Losses
 
Recorded Investment in Loans
 
Individually
Evaluated for
Impairment
 
Collectively
Evaluated for
Impairment
 
Total
 
Individually
Evaluated for
Impairment
 
Collectively
Evaluated for
Impairment
 
Total
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
120

 
$
1,203

 
$
1,323

 
$
2,930

 
$
114,535

 
$
117,465

Multi-family

 
315

 
315

 

 
42,666

 
42,666

Commercial
412

 
3,671

 
4,083

 
11,977

 
278,840

 
290,817

Construction – custom and owner/builder

 
542

 
542

 

 
41,312

 
41,312

Construction – speculative one- to four-family

 
96

 
96

 

 
2,956

 
2,956

Construction – commercial

 
617

 
617

 

 
16,902

 
16,902

Construction –  multi-family

 
409

 
409

 

 
13,623

 
13,623

Land
57

 
897

 
954

 
1,185

 
23,137

 
24,322

Consumer loans:
 

 
 
 
 

 
 

 
 

 
 

Home equity and second mortgage
259

 
762

 
1,021

 
1,015

 
36,129

 
37,144

Other
16

 
146

 
162

 
33

 
4,347

 
4,380

Commercial business loans

 
521

 
521

 

 
43,355

 
43,355

Total
$
864

 
$
9,179

 
$
10,043

 
$
17,140

 
$
617,802

 
$
634,942

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
$
307

 
$
1,173

 
$
1,480

 
$
4,291

 
$
112,373

 
$
116,664

Multi-family
16

 
376

 
392

 
4,037

 
48,285

 
52,322

Commercial
265

 
3,800

 
4,065

 
12,852

 
278,364

 
291,216

Construction – custom and owner/builder

 
451

 
451

 

 
36,192

 
36,192

Construction – speculative one- to four-family

 
123

 
123

 

 
3,781

 
3,781

Construction – commercial

 
426

 
426

 

 
12,200

 
12,200

Construction – multi-family

 
283

 
283

 

 
5,290

 
5,290

Land
37

 
984

 
1,021

 
2,305

 
23,835

 
26,140

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
362

 
711

 
1,073

 
910

 
33,247

 
34,157

Other
24

 
163

 
187

 
36

 
4,633

 
4,669

Commercial business loans

 
423

 
423

 

 
33,763

 
33,763

Total
$
1,011

 
$
8,913

 
$
9,924

 
$
24,431

 
$
591,963

 
$
616,394



21


The following tables present an age analysis of past due status of loans by portfolio segment at March 31, 2016 and September 30, 2015 (dollars in thousands):

 
30–59
Days
Past Due
 
60-89
Days
Past Due
 
Non-
Accrual (1)
 
Past Due
90 Days
or More
and Still
Accruing
 
Total
Past Due
 
Current
 
Total
Loans
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$

 
$

 
$
1,365

 
$

 
$
1,365

 
$
116,100

 
$
117,465

Multi-family

 

 

 

 

 
42,666

 
42,666

Commercial

 

 
1,129

 

 
1,129

 
289,688

 
290,817

Construction – custom and owner/builder

 

 

 

 

 
41,312

 
41,312

Construction – speculative one- to four- family

 

 

 

 

 
2,956

 
2,956

Construction – commercial

 

 

 

 

 
16,902

 
16,902

Construction – multi-family

 

 

 

 

 
13,623

 
13,623

Land
64

 

 
451

 

 
515

 
23,807

 
24,322

Consumer loans:
 

 
 

 
 

 
 

 


 
 
 
 
Home equity and second mortgage
29

 
48

 
413

 
135

 
625

 
36,519

 
37,144

Other

 

 
33

 

 
33

 
4,347

 
4,380

Commercial business loans

 

 

 

 

 
43,355

 
43,355

Total
$
93

 
$
48

 
$
3,391

 
$
135

 
$
3,667

 
$
631,275

 
$
634,942

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 

 
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
$

 
$
425

 
$
2,368

 
$

 
$
2,793

 
$
113,871

 
$
116,664

Multi-family

 

 
760

 

 
760

 
51,562

 
52,322

Commercial

 

 
1,016

 

 
1,016

 
290,200

 
291,216

   Construction – custom and owner/
       builder

 
345

 

 

 
345

 
35,847

 
36,192

Construction – speculative one- to four- family

 

 

 

 

 
3,781

 
3,781

Construction – commercial

 

 

 

 

 
12,200

 
12,200

Construction – multi-family

 

 

 

 

 
5,290

 
5,290

Land
15

 
32

 
1,558

 

 
1,605

 
24,535

 
26,140

Consumer loans:
 

 
 

 
 

 
 

 
 
 
 

 
 
Home equity and second mortgage
146

 
14

 
303

 
151

 
614

 
33,543

 
34,157

Other

 

 
35

 

 
35

 
4,634

 
4,669

Commercial business loans

 

 

 

 

 
33,763

 
33,763

Total
$
161

 
$
816

 
$
6,040

 
$
151

 
$
7,168

 
$
609,226

 
$
616,394

______________________
(1) Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual.

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 ongoing 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 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.

22



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. At March 31, 2016 and September 30, 2015, there were no loans classified as loss.


23


The following tables list the loan credit risk grades utilized by the Company that serve as credit quality indicators by portfolio segment at March 31, 2016 and September 30, 2015 (dollars in thousands):

 
Loan Grades
 
 
March 31, 2016
Pass
 
Watch
 
Special
Mention
 
Substandard
 
Total
Mortgage loans:
 
 
 
 
 
 
 
 
 
One- to four-family
$
113,311

 
$
722

 
$
668

 
$
2,764

 
$
117,465

Multi-family
40,844

 

 
1,822

 

 
42,666

Commercial
271,130

 
8,266

 
5,686

 
5,735

 
290,817

Construction – custom and owner/builder
41,125

 

 

 
187

 
41,312

Construction – speculative one- to four-family
2,956

 

 

 

 
2,956

Construction – commercial
16,902

 

 

 

 
16,902

Construction – multi-family
13,623

 

 

 

 
13,623

Land
20,502

 
1,058

 
1,887

 
875

 
24,322

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
34,796

 
626

 
710

 
1,012

 
37,144

Other
4,347

 

 

 
33

 
4,380

Commercial business loans
43,310

 
45

 

 

 
43,355

Total
$
602,846

 
$
10,717

 
$
10,773

 
$
10,606

 
$
634,942

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 

 
 

 
 

 
 

 
 

Mortgage loans:
 
 
 

 
 

 
 

 
 

One- to four-family
$
111,351

 
$
653

 
$
1,339

 
$
3,321

 
$
116,664

Multi-family
45,249

 

 
6,313

 
760

 
52,322

Commercial
270,685

 
8,040

 
6,803

 
5,688

 
291,216

Construction – custom and owner/builder
36,192

 

 

 

 
36,192

Construction – speculative one- to four-family
3,781

 

 

 

 
3,781

Construction – commercial
12,200

 

 

 

 
12,200

Construction – multi-family
5,290

 

 

 

 
5,290

Land
20,964

 
1,105

 
2,078

 
1,993

 
26,140

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
32,172

 
664

 
404

 
917

 
34,157

Other
4,631

 

 

 
38

 
4,669

Commercial business loans
33,635

 
49

 
79

 

 
33,763

Total
$
576,150

 
$
10,511

 
$
17,016

 
$
12,717

 
$
616,394


Impaired Loans
A loan is considered impaired when (based on current information and events) it is probable that the Company will be unable to collect all contractual principal and interest payments when 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 the 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 identical.  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.

24


The following table is a summary of information related to impaired loans by portfolio segment as of March 31, 2016 and for the three and six months then ended (dollars in thousands):
 
Recorded
Investment
 
Unpaid Principal Balance (Loan Balance Plus Charge Off)
 
Related
Allowance
 
QTD Average Recorded Investment (1)
 
YTD Average Recorded Investment (2)
 
QTD Interest Income Recognized (1)
 
YTD Interest Income Recognized (2)
 
QTD Cash Basis Interest Income Recognized (1)
 
YTD Cash Basis Interest Income Recognized (2)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
1,365

 
$
1,435

 
$

 
$
1,634

 
$
1,531

 
$
6

 
$
18

 
$
6

 
$
18

Multi-family

 

 

 

 
253

 

 

 

 

Commercial
8,207

 
9,348

 

 
8,167

 
7,844

 
112

 
234

 
88

 
184

Land
600

 
1,009

 

 
648

 
970

 
4

 
8

 
3

 
6

Consumer loans:
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
280

 
485

 

 
223

 
204

 

 

 

 

Other

 

 

 

 

 

 

 

 

Commercial business loans

 
3

 

 
37

 
24

 

 

 

 

Subtotal
10,452

 
12,280

 

 
10,709

 
10,826

 
122

 
260

 
97

 
208

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
1,565

 
1,565

 
120

 
1,964

 
2,299

 
31

 
63

 
23

 
47

Multi-family

 

 

 

 
1,092

 

 

 

 

Commercial
3,770

 
3,770

 
412

 
3,877

 
4,469

 
59

 
113

 
46

 
88

Land
585

 
585

 
57

 
588

 
622

 
10

 
20

 
8

 
16

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
735

 
735

 
259

 
737

 
740

 
10

 
21

 
9

 
19

Other 
33

 
33

 
16

 
34

 
34

 

 

 

 

Commercial business loans

 

 

 
 
 

 

 

 

 

Subtotal
6,688

 
6,688

 
864

 
7,200

 
9,256

 
110

 
217

 
86

 
170


25


 
Recorded
Investment
 
Unpaid Principal Balance (Loan Balance Plus Charge Off)
 
Related
Allowance
 
QTD Average Recorded Investment (1)
 
YTD Average Recorded Investment (2)
 
QTD Interest Income Recognized (1)
 
YTD Interest Income Recognized (2)
 
QTD Cash Basis Interest Income Recognized (1)
 
YTD Cash Basis Interest Income Recognized (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
2,930

 
$
3,000

 
$
120

 
$
3,598

 
$
3,830

 
$
37

 
$
81

 
$
29

 
$
65

Multi-family

 

 

 

 
1,345

 

 

 

 

Commercial
11,977

 
13,118

 
412

 
12,044

 
12,313

 
171

 
347

 
134

 
272

Land
1,185

 
1,594

 
57

 
1,236

 
1,592

 
14

 
28

 
11

 
22

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
1,015

 
1,220

 
259

 
960

 
944

 
10

 
21

 
9

 
19

Other
33

 
33

 
16

 
34

 
34

 

 

 

 

Commercial business loans

 
3

 

 
37

 
24

 

 

 

 

Total
$
17,140

 
$
18,968

 
$
864

 
$
17,909

 
$
20,082

 
$
232

 
$
477

 
$
183

 
$
378

________________________________________________
(1)
For the three months ended March 31, 2016.
(2)
For the six months ended March 31, 2016.


26


The following table is a summary of information related to impaired loans by portfolio segment as of and for the year ended September 30, 2015 (dollars in thousands):
 
Recorded
Investment
 
Unpaid Principal Balance (Loan Balance Plus Charge Off)
 
Related
Allowance
 
YTD
Average
Recorded
Investment (1)
 
YTD Interest
Income
Recognized
(1)
 
YTD Cash Basis Interest Income Recognized (1)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
1,321

 
$
1,546

 
$

 
$
1,919

 
$
25

 
$
25

Multi-family
760

 
791

 

 
570

 
3

 
3

Commercial
7,199

 
8,259

 

 
9,078

 
521

 
412

Construction – custom and owner/builder

 

 

 
118

 

 

Land
1,614

 
2,150

 

 
1,028

 
25

 
20

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
165

 
381

 

 
270

 

 

Commercial business loans

 
6

 

 

 

 

Subtotal
11,059

 
13,133

 

 
12,983

 
574

 
460

 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
2,970

 
2,970

 
307

 
3,833

 
149

 
112

Multi-family
3,277

 
3,277

 
16

 
3,291

 
184

 
137

Commercial
5,653

 
5,653

 
265

 
3,475

 
202

 
152

Construction – custom and owner/builder

 

 

 
17

 

 

Land
691

 
691

 
37

 
3,298

 
32

 
27

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
745

 
745

 
362

 
516

 
18

 
15

Other
36

 
36

 
24

 
28

 

 

Subtotal
13,372

 
13,372

 
1,011

 
14,458

 
585

 
443

Total:
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
4,291

 
4,516

 
307

 
5,752

 
174

 
137

Multi-family
4,037

 
4,068

 
16

 
3,861

 
187

 
140

Commercial
12,852

 
13,912

 
265

 
12,553

 
723

 
564

Construction – custom and owner/builder

 

 

 
135

 

 

Land
2,305

 
2,841

 
37

 
4,326

 
57

 
47

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
910

 
1,126

 
362

 
786

 
18

 
15

Other
36

 
36

 
24

 
28

 

 

Commercial business loans

 
6

 

 

 

 

Total
$
24,431

 
$
26,505

 
$
1,011

 
$
27,441

 
$
1,159

 
$
903

______________________________________________
(1) For the year ended September 30, 2015.


A troubled debt restructured loan is a loan for which the Company, for reasons related to a borrower’s financial difficulties, grants a significant concession to the borrower that the Company would not otherwise consider.  Examples of such concessions 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 rates; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-amorizations, extensions, deferrals and renewals.  Troubled debt restructured loans are considered impaired and are individually evaluated for impairment.  Troubled debt restructured loans can be classified as either accrual or non-accrual. Troubled debt restructured loans are classified as non-performing loans unless they have been performing in accordance with their modified terms for a period of at least six months. The Company had $8.46 million and $13.72 million in troubled debt restructured loans included in impaired loans at March 31, 2016 and September 30, 2015, respectively, and had no commitments at these dates to lend additional funds on these loans.  The allowance for loan losses allocated to troubled debt restructured loans at March 31, 2016

27


and September 30, 2015 was $525,000 and $310,000, respectively. There were no troubled debt restructured loans which incurred a payment default within 12 months of the restructure date during the six months ended March 31, 2016.

The following tables set forth information with respect to the Company’s troubled debt restructured loans by interest accrual status as of March 31, 2016 and September 30, 2015 (dollars in thousands):

 
March 31, 2016
 
Accruing
 
Non-
Accrual
 
Total
Mortgage loans:
 
 
 
 
 
One- to four-family
$
1,565

 
$
127

 
$
1,692

Commercial
5,331

 

 
5,331

Land
734

 
253

 
987

Consumer loans:
 

 
 

 
 

Home equity and second mortgage
293

 
152

 
445

Total
$
7,923

 
$
532

 
$
8,455


 
September 30, 2015
 
Accruing
 
Non-
Accrual
 
Total
Mortgage loans:
 
 
 
 
 
One- to four-family
$
1,929

 
$
826

 
$
2,755

Multi-family
3,277

 

 
3,277

Commercial
6,237

 

 
6,237

Land
747

 
255

 
1,002

Consumer loans:
 

 
 

 
 

Home equity and second mortgage
295

 
152

 
447

Total
$
12,485

 
$
1,233

 
$
13,718


The following tables set forth information with respect to the Company’s troubled debt restructured loans by portfolio segment that occurred during the six months ended March 31, 2016 and the year ended September 30, 2015 (dollars in thousands):

March 31, 2016
 
 
 
 
 
 
 
There were no new troubled debt restructured loans during the six months ended March 31, 2016.
September 30, 2015
Number of Contracts
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
 
End of Period Balance
One-to four-family (1)
1

 
$
48

 
$
48

 
$
48

Total
1

 
$
48

 
$
48

 
$
48

___________________________
(1)
Modification was a result of a reduction in the stated interest rate.

28


(5) NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income 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 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.  Shares owned by the Bank’s ESOP that have not been allocated are not considered to be outstanding for the purpose of computing basic and diluted net income per common share. At March 31, 2016 and 2015, there were 114,588 and 152,869 shares, respectively, that had not been allocated under the Bank’s ESOP.

Information regarding the calculation of basic and diluted net income per common share for the three and six months ended March 31, 2016 and 2015 is as follows (dollars in thousands, except per share amounts):
 
Three Months Ended
March 31,
 
Six Months Ended
March 31,
 
2016

 
2015

 
2016

 
2015

Basic net income per common share computation
 
 
 
 
 
 
 
Numerator – net income
$
2,380

 
$
1,451

 
$
4,908

 
$
3,178

 
 
 
 
 
 
 
 
Denominator – weighted average common
shares outstanding
6,846,527

 
6,898,192

 
6,858,190

 
6,895,038

 
 
 
 
 
 
 
 
Basic net income per common share
$
0.35

 
$
0.21

 
$
0.72

 
$
0.46

 
 
 
 
 
 
 
 
Diluted net income per common share computation
 
 
 
 
 

 
 

Numerator – net income
$
2,380

 
$
1,451

 
$
4,908

 
$
3,178

 
 
 
 
 
 
 
 
Denominator – weighted average
shares outstanding
6,846,527

 
6,898,192

 
6,858,190

 
6,895,038

Effect of dilutive stock options (1)
62,028

 
36,730

 
57,482

 
36,775

Effect of dilutive stock warrant (2)
171,450

 
136,870

 
166,273

 
135,808

Weighted average common shares
and common stock equivalents
7,080,005

 
7,071,792

 
7,081,945

 
7,067,621

 
 
 
 
 
 
 
 
Diluted net income per common share
$
0.34

 
$
0.21

 
$
0.69

 
$
0.45


____________________________________________
(1) For the three and six months ended March 31, 2016, average options to purchase 14,000 and 84,383 shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because their effect would have been anti-dilutive. For both the three and six months ended March 31, 2015, average options to purchase 122,000 shares of common stock were outstanding but not included in the computation of diluted net income per common share because their effect would have been anti-dilutive.

(2) Represents a warrant to purchase 370,899 shares of the Company's common stock at an exercise price of $6.73 per share (subject to anti-dilution adjustments) at any time through December 23, 2018 (the "Warrant"). The Warrant was granted on December 23, 2008 to the U.S. Treasury Department ("Treasury") as part of the Company's participation in the Treasury's Troubled Asset Relief Program ("TARP"). On June 12, 2013, the Treasury sold the Warrant to private investors.


29


(6) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The changes in accumulated other comprehensive income (loss) ("AOCI") by component during the three and six months ended March 31, 2016 and 2015 are as follows (dollars in thousands):
 
Three Months Ended March 31, 2016
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
(9
)
 
$
(306
)
 
$
(315
)
Net change, net of income taxes
11

 
18

 
29

Balance of AOCI at the end of period
$
2

 
$
(288
)
 
$
(286
)

 
Six Months Ended March 31, 2016
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
3

 
$
(316
)
 
$
(313
)
Net change, net of income taxes
(1
)
 
28

 
27

Balance of AOCI at the end of period
$
2

 
$
(288
)
 
$
(286
)

 
Three Months Ended March 31, 2015
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
4

 
$
(368
)
 
$
(364
)
Net change, net of income taxes
8

 
9

 
17

Balance of AOCI at the end of period
$
12

 
$
(359
)
 
$
(347
)

 
Six Months Ended March 31, 2015
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
37

 
$
(376
)
 
$
(339
)
Net change, net of income tax
(25
)
 
17

 
(8
)
Balance of AOCI at the end of period
$
12

 
$
(359
)
 
$
(347
)
__________________________
(1) All amounts are net of income taxes.













30


(7) STOCK COMPENSATION PLANS AND STOCK BASED COMPENSATION

Stock Compensation Plans
Under the Company’s prior stock compensation plans (1999 Stock Option Plan, 2003 Stock Option Plan and 1998 Management Recognition and Development Plan ("MRDP")), the Company was able to grant options and awards for restricted stock for up to a combined total of 2,151,500 shares of common stock to employees, officers, directors and directors emeriti.  Under the Company's 2014 Equity Incentive Plan, which was approved by shareholders on January 27, 2015, the Company is able to grant options and awards of restricted stock (with or without performance measures) for up to 352,366 shares of common stock to employees, officers, directors and directors emeriti.  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 value of the Company’s common stock on the date of grant. Generally, options and restricted stock vest in 20% annual installments on each of the five anniversaries from the date of the grant. At March 31, 2016, there were 226,866 shares of common stock available which may be awarded as options or restricted stock pursuant to future grant under the 2014 Equity Incentive Plan. At March 31, 2016, there were no options or awards for restricted stock available for future grant under the 1999 Stock Option Plan, the 2003 Stock Option Plan, or the MRDP. At March 31, 2016 and 2015, there were no unvested restricted stock grant shares.

Activity under the Plans for the six months ended March 31, 2016 and 2015 is as follows:
 
Six Months Ended
March 31, 2016
 
Six Months Ended
March 31, 2015
 
 Number of Shares

 
Weighted
Average
Exercise
Price

 
 Number of Shares

 
Weighted
Average
Exercise
Price

Options outstanding, beginning of period
341,300

 
$
8.73

 
221,400

 
$
7.49

Exercised
(10,220
)
 
8.37

 
(5,300
)
 
4.62

Forfeited
(2,900
)
 
9.96

 
(200
)
 
4.55

Options outstanding, end of period
328,180

 
$
8.73

 
215,900

 
$
7.57


The aggregate intrinsic value of options outstanding at March 31, 2016 was $1.28 million.

At March 31, 2016, there were 226,100 unvested options with an aggregate grant date fair value of $486,000, all of which the Company assumes will vest. The aggregate intrinsic value of unvested options at March 31, 2016 was $691,000.  There were 33,700 options with an aggregate grant date fair value of $82,000 that vested during the six months ended March 31, 2016.

At March 31, 2015, there were 141,200 unvested options with an aggregate grant date fair value of $348,000. There were 42,900 options with an aggregate grant date fair value of $100,000 that vested during the six months ended March 31, 2015.

 
 
Additional information regarding options outstanding at March 31, 2016 is as follows:
 
 
Options Outstanding
 
Options Exercisable
Range of
Exercise
Prices ($)
 
Number

 
Weighted
Average
Exercise
Price

 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Number

 
Weighted
Average
Exercise
Price

 
Weighted
Average
Remaining
Contractual
Life (Years)
$ 4.01 - 4.55
 
30,200

 
$
4.22

 
4.8
 
26,400

 
$
4.26

 
4.7
   5.86 - 6.00
 
58,000

 
5.92

 
6.5
 
34,400

 
5.92

 
6.5
   9.00
 
91,600

 
9.00

 
7.6
 
34,000

 
9.00

 
7.6
 10.26 - 10.71
 
148,380

 
10.57

 
9.0
 
7,280

 
10.37

 
7.8
 
 
328,180

 
$
8.73

 
7.8
 
102,080

 
$
6.83

 
6.5






31



Expense for Stock Compensation Plans
Compensation expense during the six months ended March 31, 2016 and 2015 for all stock-based plans was as follows (dollars in thousands):
 
Six Months Ended March 31,
 
2016
 
2015
 
Stock
Options
 
Stock
Options
Compensation expense
$
84

 
$
58

Less: related tax benefit recognized
(9
)
 
(2
)
Total
$
75

 
$
56

 
The compensation expense to be recognized in the years ending September 30 for stock options that have been awarded as of March 31, 2016 is as follows (dollars in thousands):
 
Stock
Options
Remainder of 2016
$
77

2017
146

2018
115

2019
58

2020
35

Total
$
431



(8) 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 March 31, 2016 and September 30, 2015.  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.

GAAP defines fair value and establishes a framework for measuring fair value.  Fair value is the 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 three levels for categorizing assets and liabilities under GAAP's fair value measurement requirements are as follows:

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 for similar (as opposed to identical) assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities 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.


32


The Company's assets measured at fair value on a recurring basis consist of investment securities available for sale. The estimated fair value of MBS are based upon market prices of similar securities or observable inputs (Level 2). The estimated fair value of mutual funds are based upon quoted market prices (Level 1).

The Company had no liabilities measured at fair value on a recurring basis at March 31, 2016 and September 30, 2015. The Company's assets measured at estimated fair value on a recurring basis at March 31, 2016 and September 30, 2015 are as follows (dollars in thousands):
March 31, 2016
Estimated Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale investment securities
 
 
 
 
 
 
 
MBS: U.S. government agencies
$

 
$
391

 
$

 
$
391

Mutual funds
974

 

 

 
974

Total
$
974

 
$
391

 
$

 
$
1,365

September 30, 2015
Estimated Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale investment securities
 
 
 
 
 
 
 
MBS: U.S. government agencies
$

 
$
421

 
$

 
$
421

Mutual funds
971

 

 

 
971

Total
$
971

 
$
421

 
$

 
$
1,392


There were no transfers among Level 1, Level 2 and Level 3 during the six months ended March 31, 2016 and the year ended September 30, 2015.

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with GAAP.  These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period.

The Company uses the following methods and significant assumptions to estimate fair value on a non-recurring basis:

Impaired Loans: The estimated fair value of impaired loans is calculated using the collateral value method or on a discounted cash flow basis.  The specific reserve for collateral dependent impaired loans is based on the estimated fair value of the collateral less estimated costs to sell, if applicable.  In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparable collateral included in the appraisal and known changes in the market and in the collateral. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Investment Securities Held to Maturity: The estimated fair value of investment securities held to maturity is based upon the assumptions market participants would use in pricing the investment security.  Such assumptions include quoted market prices (Level 1), market prices of similar securities or observable inputs (Level 2) and unobservable inputs such as dealer quotes, discounted cash flows or similar techniques (Level 3).

OREO and Other Repossessed Assets, net:  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 is 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 are based on standard market factors.  The valuation of OREO and other repossessed assets is subject to significant external and internal judgment (Level 3).







33


The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at March 31, 2016 (dollars in thousands):
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
One-to four-family
$

 
$

 
$
1,445

Commercial

 

 
3,358

Land

 

 
528

Consumer loans:
 

 
 

 
 

Home equity and second mortgage

 

 
476

Other


 


 
17

Total impaired loans

 

 
5,824

Investment securities – held to maturity:
 

 
 

 
 

MBS - private label residential

 
49

 

OREO and other repossessed assets

 

 
5,458

Total
$

 
$
49

 
$
11,282



The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis as of March 31, 2016 (dollars in thousands):
 
 Estimated
Fair Value
 
 
Valuation
Technique(s)
 
 
 
Unobservable Input(s)
 
 
 
Range
Impaired loans
$
5,824

 
Market approach
 
Appraised value less selling costs
 
NA
 
 
 
 
 
 
 
 
OREO and other repossessed assets
$
5,458

 
Market approach
 
Lower of appraised value or listing price less selling costs
 
NA


The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at September 30, 2015 (dollars in thousands):
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
One-to four-family
$

 
$

 
$
2,663

Multi-family

 

 
3,261

Commercial

 

 
5,388

Land

 

 
654

Consumer loans:
 

 
 

 
 

Home equity and second mortgage

 

 
383

Other

 

 
12

Total impaired loans

 

 
12,361

Investment securities – held to maturity:
 

 
 

 
 

MBS - private label residential

 
31

 

OREO and other repossessed assets

 

 
7,854

Total
$

 
$
31

 
$
20,215


34



The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis as of September 30, 2015 (dollars in thousands):
 
 Estimated
Fair Value
 
 
Valuation
Technique(s)
 
 
 
Unobservable Input(s)
 
 
 
Range
Impaired loans
$
12,361

 
Market approach
 
Appraised value less selling costs
 
NA
 
 
 
 
 
 
 
 
OREO and other repossessed assets
$
7,854

 
Market approach
 
Lower of appraised value or listing price less selling costs
 
NA


The following methods and assumptions were used by the Company in estimating fair value of its other financial instruments:

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.

Investment Securities: See descriptions above.

FHLB Stock:  No ready market exists for this stock, and it has no quoted market value.  However, redemption of this stock has historically been at par value.  Accordingly, par value is deemed to be a reasonable estimate of fair value.

Loans Receivable, Net: The fair value of non-impaired loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers for the same remaining maturities. Prepayments are based on the historical experience of the Bank. Fair values for impaired loans are estimated using the methods described above.

Loans Held for Sale:  The estimated fair value is based on quoted market prices obtained from the Federal Home Loan Mortgage Corporation ("Freddie Mac").

Accrued Interest:  The recorded amount of accrued interest approximates the estimated fair value.

Deposits:  The estimated fair value of deposits with no stated maturity date is deemed to be 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.

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.


35


The estimated fair values of financial instruments were as follows as of March 31, 2016 and September 30, 2015 (dollars in thousands):
 
March 31, 2016
 
 
 
Fair Value Measurements Using:
 
Recorded
Amount
 
 Estimated Fair Value
 
 
Level 1
 
 
Level 2
 
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
110,029

 
$
110,029

 
$
110,029

 
$

 
$

CDs held for investment
52,524

 
52,524

 
52,524

 

 

Investment securities
9,108

 
9,993

 
3,998

 
5,995

 

FHLB stock
2,804

 
2,804

 
2,804

 

 

Loans receivable, net
622,851

 
630,306

 

 

 
630,306

Loans held for sale
1,584

 
1,631

 
1,631

 

 

Accrued interest receivable
2,232

 
2,232

 
2,232

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 
 
 

Non-interest-bearing demand
148,980

 
148,980

 
148,980

 

 

Interest-bearing
563,058

 
563,459

 
412,062

 

 
151,397

Total deposits
712,038

 
712,439

 
561,042

 

 
151,397

FHLB advances
45,000

 
46,288

 

 
46,288

 

Accrued interest payable
311

 
311

 
311

 

 

 
September 30, 2015
 
 
 
Fair Value Measurements Using:
 
Recorded
Amount
 
 Estimated Fair Value
 
 
Level 1
 
 
Level 2
 
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
92,289

 
$
92,289

 
$
92,289

 
$

 
$

CDs held for investment
48,611

 
48,611

 
48,611

 

 

Investment securities
9,305

 
10,286

 
3,996

 
6,290

 

FHLB stock
2,699

 
2,699

 
2,699

 

 

Loans receivable, net
604,277

 
614,734

 

 

 
614,734

Loans held for sale
3,051

 
3,139

 
3,139

 

 

Accrued interest receivable
2,170

 
2,170

 
2,170

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 
 
 

Non-interest-bearing demand
141,388

 
141,388

 
141,388

 

 

Interest-bearing
537,524

 
538,092

 
383,419

 

 
154,673

Total deposits
678,912

 
679,480

 
524,807

 

 
154,673

FHLB advances
45,000

 
46,742

 

 
46,742

 

Accrued interest payable
289

 
289

 
289

 

 


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 appropriately manage 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

36


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 manage 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.


(9) RECENT ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606), with an effective date for annual reporting periods beginning after December 15, 2016. The core principle of this ASU is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the ASU requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract and estimating the amount of variable consideration to include in the transaction price related to each separate performance obligation. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606), which deferred the effective date of ASU No. 2014-09 to annual periods beginning after December 15, 2017, including interim periods within that reporting period. The adoption of ASU No. 2014-09 is not expected to have a material impact on the Company's consolidated financial statements.

In January 2015, the FASB issued ASU No. 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20). The ASU eliminates the need to separately classify, present and disclose extraordinary events. The disclosure of events or transactions that are unusual or infrequent in nature will be included in other guidance. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The adoption of ASU No. 2015-01 is not expected to have a material impact on the Company's consolidated financial statements.

In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. This ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this ASU require that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this ASU require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in the current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The adoption of ASU No. 2015-16 is not expected to have a material impact on the Company's consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The main provisions of this ASU address the valuation and impairment of certain equity investments along with simplified disclosures about those investments. Equity securities with readily determinable fair values will be treated in the same manner as other financial instruments. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of ASU No. 2016-01 is not expected to have a material impact on the Company's consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements. The principal change required by this ASU relates to lessee accounting, and is that for operating leases, a lessee is required to (1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position, (2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis, and (3) classify all cash payments within operating activities in the statement of cash flows. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. This ASU also changes disclosure requirements related to leasing activities, and requires certain qualitative disclosures along with specific quantitative disclosures. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early application of the amendments in this ASU is permitted. The adoption of ASU No. 2016-02 is being reviewed for any material impact there may be on the Company's consolidated financial statements.

37



In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation - Stock Compensation. This ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The adoption of ASU No. 2016-09 is being reviewed for any material impact there may be on the Company's consolidated financial statements.




Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations


As used in this Form 10-Q, the terms “we,” “our” and “Company” refer to Timberland Bancorp, Inc. and its consolidated subsidiaries, unless the context indicates otherwise.  When we refer to “Bank” in this Form 10-Q, we are referring to Timberland Bank, a wholly-owned subsidiary of Timberland Bancorp, Inc. and the Bank’s wholly-owned subsidiary, Timberland Service Corporation.

The following analysis discusses the material changes in the consolidated financial condition and results of operations of the Company at and for the three and six months ended March 31, 2016.  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 concerning our future operations.  These statements relate to our financial condition, results of operations, plans, objectives, future performance or business.  Forward-looking statements are not statements of historical fact, are based on certain assumptions and often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.”  Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance and projections of financial items.  These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated or implied by our 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 loans 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 ("Federal Reserve") and of our bank subsidiary by the FDIC, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, institute a formal or informal enforcement action against us or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including as a result of Basel III; the impact of the Dodd Frank Wall Street Reform and Consumer Protection Act and implementing regulations; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risks associated with the loans on our consolidated balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; the failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our business strategies; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may 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

38


regulations or to respond to regulatory actions; our ability to pay dividends on our common 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 FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services; and other risks described elsewhere in this Form 10-Q and in the Company's other reports filed with or furnished to the Securities and Exchange Commission, including our 2015 Form 10-K.

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 do not undertake and specifically disclaim any obligation to publicly update or revise any forward-looking statements included in this report to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements 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.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur and we caution readers not to place undue reliance on any forward-looking statements.  These risks could cause our actual results for fiscal 2016 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 consolidated financial condition and results of operations as well as its 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 March 31, 2016, the Company had total assets of $851.96 million and total shareholders’ equity of $92.26 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, which are 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 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 allowance for loan losses reflects the amount that the Company believes is adequate to cover probable credit losses inherent in its loan portfolio.

Net income is also affected by non-interest income and non-interest expenses.  For the three and six month periods ended March 31, 2016, non-interest income consisted primarily of service charges on deposit accounts, gain on sales of loans, ATM and debit card interchange transaction fees, an increase in the cash surrender value of BOLI and other operating income.  Non-interest income is reduced by net OTTI losses on investment securities and losses on the sale of investment securities.  Non-interest expenses consisted primarily of salaries and employee benefits, premises and equipment, advertising, ATM and debit card interchange transaction fees, OREO and other repossessed asset expenses, postage and courier expenses, state and local taxes, professional fees, FDIC insurance premiums, loan administration and foreclosure expenses, deposit operation expenses and data processing and telecommunication expenses.  Non-interest income and non-interest expenses are affected by the growth of the Company's 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-

39


family loans and commercial real estate 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 and other consumer 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 Consolidated Financial Statements. Critical accounting policies and estimates are discussed in the Company’s 2015 Form 10-K under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies and Estimates.” That discussion highlights estimates the Company makes that involve uncertainty or potential for substantial change. There have been no material changes in the Company’s critical accounting policies and estimates as previously disclosed in the Company’s 2015 Form 10-K.

Comparison of Financial Condition at March 31, 2016 and September 30, 2015

The Company’s total assets increased by $36.15 million, or 4.4%, to $851.96 million at March 31, 2016 from $815.82 million at September 30, 2015.  The increase in total assets was primarily due to increases in net loans receivable, cash and cash equivalents and CDs held for investment. The increase in total assets was funded primarily by an increase in total deposits.

Net loans receivable increased by $18.57 million, or 3.1%, to $622.85 million at March 31, 2016 from $604.28 million at September 30, 2015.  The increase was primarily due to increases in commercial business loans, construction loans and consumer loans. These increases to net loans receivable were partially offset by decreases in multi-family loans and land loans.

Total deposits increased by $33.13 million, or 4.9%, to $712.04 million at March 31, 2016 from $678.91 million at September 30, 2015. The increase was primarily a result of increases in money market, non-interest bearing, N.O.W. checking and savings account balances, which were partially offset by a decrease in certificates of deposit account balances.
 
Shareholders’ equity increased by $3.08 million, or 3.4%, to $92.26 million at March 31, 2016 from $89.19 million at September 30, 2015.  The increase in shareholders' equity was primarily due to net income for the six months ended March 31, 2016, which was partially offset by the payment of dividends to common shareholders and the repurchase of common stock.

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 $21.65 million, or 15.4%, to $162.55 million at March 31, 2016 from $140.90 million at September 30, 2015.  The increase was primarily due to a $17.7 million, or 19.2%, increase in cash and cash equivalents and a $3.90 million, or 8.0%, increase in CDs held for investment.

Investment Securities:  Investment securities decreased by $197,000, or 2.1%, to $9.11 million at March 31, 2016 from $9.31 million at September 30, 2015, primarily due to scheduled amortization and prepayments. For additional information on investment securities, see Note 2 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”

FHLB Stock: FHLB stock increased $105,000, or 3.9%, to $2.80 million at March 31, 2016 from $2.70 million at September 30, 2015, as the Bank's stock requirement with the FHLB was increased due to an increase in the Bank's asset size.

Loans: Net loans receivable increased by $18.57 million, or 3.1%, to $622.85 million at March 31, 2016 from $604.28 million at September 30, 2015.  The increase in the portfolio was primarily a result of a $9.60 million increase in commercial business loans, an $8.34 million increase in construction loans (primarily one- to four-family custom and owner/builder loans and commercial construction loans) and a $2.70 million increase in consumer loans. In addition, there was an $8.99 million decrease in the undisbursed portion of construction loans in process. These increases in net loans receivable were partially offset by a $9.66 million decrease in multi-family loans and a $1.81 million decrease in land loans.

Loan originations increased $7.78 million, or 7.4%, to $113.33 million for the six months ended March 31, 2016 from $105.55 million for the six months ended March 31, 2015.  The Company continued to sell longer-term fixed rate one- to four-family mortgage loans for asset liability management purposes and to generate non-interest income.  Sales of fixed rate one- to four-family mortgage loans increased $5.63 million, or 26.9%, to $26.56 million for the six months ended March 31, 2016 compared to $20.93 million for the six months ended March 31, 2015 as more one- to four-family construction loans were completed, converted to permanent financing and then were sold in the secondary market.

40



For additional information, see Note 4 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”

Premises and Equipment:  Premises and equipment decreased by $499,000, or 3.0%, to $16.36 million at March 31, 2016 from $16.85 million at September 30, 2015.  The decrease was primarily due to normal depreciation.

OREO (Other Real Estate Owned): OREO and other repossessed assets decreased by $2.40 million, or 30.5%, to $5.46 million at March 31, 2016 from $7.85 million at September 30, 2015. The decrease was primarily due to the disposition of eight OREO properties.  At March 31, 2016, total OREO and other repossessed assets consisted of 27 individual properties and one other repossessed asset.  The properties consisted of 18 land parcels totaling $3.30 million, two commercial real estate properties totaling $446,000, seven single-family homes totaling $1.65 million and one mobile home with a book value of $67,000.  

Goodwill:  The recorded amount of goodwill of $5.65 million at March 31, 2016 was unchanged from September 30, 2015.  

Deposits: Deposits increased by $33.13 million, or 4.9%, to $712.04 million at March 31, 2016 from $678.91 million at September 30, 2015.  The increase was primarily a result of a $16.02 million increase in money market accounts, a $7.59 million increase in non-interest bearing accounts, a $7.48 million increase in N.O.W. checking accounts and a $5.15 million increase in savings accounts. These increases were partially offset by a $3.11 million decrease in certificates of deposit accounts.

Deposits consisted of the following at March 31, 2016 and September 30, 2015 (dollars in thousands):
 
March 31, 2016
September 30, 2015
 
Amount
 
Percent
Amount
 
Percent
Non-interest-bearing demand
$
148,980

 
21
%
$
141,388

 
21
%
NOW checking
188,108

 
27
%
180,628

 
27
%
Savings
115,461

 
16
%
110,315

 
16
%
Money market
100,903

 
14
%
84,026

 
12
%
Money market - brokered
7,591

 
1
%
8,450

 
1
%
Certificates of deposit under $100
81,350

 
11
%
84,824

 
12
%
Certificates of deposit $100 and over
66,448

 
9
%
66,085

 
10
%
Certificates of deposit - brokered
3,197

 
1
%
3,196

 
1
%
Total
$
712,038

 
100
%
$
678,912

 
100
%

FHLB Advances: The Company has short- and long-term borrowing lines with the FHLB with total credit available on the lines equal to 35% of the Bank’s total assets, limited by available collateral. Borrowings are considered short-term when the original maturity is less than one year. At March 31, 2016, FHLB advances and other borrowings consisted of long-term FHLB advances with scheduled maturities at various dates in fiscal 2017, which bear interest at rates ranging from 3.69% to 4.34%. A portion of these advances may be called by the FHLB at a date earlier than the scheduled maturity date. FHLB advances remained unchanged at $45.00 million at both March 31, 2016 and September 30, 2015.

Shareholders’ Equity:  Total shareholders’ equity increased by $3.08 million, or 3.4%, to $92.26 million at March 31, 2016 from $89.19 million at September 30, 2015.  The increase was primarily due to net income of $4.91 million for the six months ended March 31, 2016, which was partially offset by the payment of $1.40 million in dividends on the Company's common stock and the repurchase of 66,000 shares of the Company's common stock for $820,000 (an average price of $12.42 per share). At March 31, 2016, there were 221,893 shares remaining to be repurchased under the Company's existing stock repurchase plan. For additional information, see Item 2 of Part II of this Form 10-Q.

Asset Quality: The non-performing assets to total assets ratio improved to 1.16% at March 31, 2016 from 1.84% at September 30, 2015 as total non-performing assets decreased by $5.13 million, or 34.2%, to $9.85 million at March 31, 2016 from $14.98 million at September 30, 2015. The decrease was primarily due to a $2.40 million decrease in OREO and other repossessed assets, a $1.11 million decrease in non-accrual land loans and a $1.00 million decrease in non-accrual one- to four-family loans.

Troubled debt restructured loans on accrual status (which are not included in the non-performing asset totals) decreased by $4.56 million, or 36.5%, to $7.92 million at March 31, 2016 from $12.49 million at September 30, 2015.

41




The following table sets forth information with respect to the Company’s non-performing assets at March 31, 2016 and September 30, 2015 (dollars in thousands):
 
March 31,
2016

 
September 30,
2015

Loans accounted for on a non-accrual basis:
 
 
 
Mortgage loans:
 
 
 
    One- to four-family (1)
$
1,365

 
$
2,368

    Multi-family

 
760

    Commercial
1,129

 
1,016

    Land
451

 
1,558

Consumer loans:
 

 
 

    Home equity and second mortgage
413

 
303

Other
33

 
35

       Total loans accounted for on a non-accrual basis
3,391

 
6,040

 
 
 
 
Accruing loans which are contractually
past due 90 days or more
135

 
151

 
 
 
 
Total of non-accrual and 90 days past due loans
3,526

 
6,191

 
 
 
 
Non-accrual investment securities
868

 
932

 
 
 
 
OREO and other repossessed assets, net (2)
5,458

 
7,854

       Total non-performing assets (3)
$
9,852

 
$
14,977

 
 
 
 
Troubled debt restructured loans on accrual status (4)
$
7,923

 
$
12,485

 
 
 
 
Non-accrual and 90 days or more past
due loans as a percentage of loans receivable
0.56
%
 
1.01
%
 
 
 
 
Non-accrual and 90 days or more past
due loans as a percentage of total assets
0.41
%
 
0.76
%
 
 
 
 
Non-performing assets as a percentage of total assets
1.16
%
 
1.84
%
 
 
 
 
Loans receivable (5)
$
632,894

 
$
614,201

 
 
 
 
Total assets
$
851,962

 
$
815,815

___________________________________
(1) As of March 31, 2016, the balance of non-accrual one- to-four family properties includes $276 in the process of foreclosure.
(2) As of March 31, 2016, the balance of OREO includes $1,645 of foreclosed residential real estate property recorded as a result of obtaining physical possession of the property.
(3) Does not include troubled debt restructured loans on accrual status.
(4) Does not include troubled debt restructured loans totaling $532 and $1,233 reported as non-accrual loans at March 31, 2016 and September 30, 2015, respectively.
(5)  Does not include loans held for sale and loan balances are before the allowance for loan losses.
 
 

42





Comparison of Operating Results for the Three and Six Months Ended March 31, 2016 and 2015

Net income increased by $929,000, or 64.0%, to $2.38 million for the quarter ended March 31, 2016 from $1.45 million for the quarter ended March 31, 2015. Net income per diluted common share increased $0.13, or 61.9%, to $0.34 for the quarter ended March 31, 2016 from $0.21 for the quarter ended March 31, 2015. The increase in net income was primarily due to increases in net interest income and non-interest income.

Net income increased by $1.73 million, or 54.4%, to $4.91 million for the six months ended March 31, 2016 from $3.18 million for the six months ended March 31, 2015. Net income per diluted common share increased $0.24, or 53.3%, to $0.69 for the six months ended March 31, 2016 from $0.45 for the six months ended March 31, 2015.

A more detailed explanation of the income statement categories is presented below.

Net Interest Income: Net interest income increased by $1.10 million, or 16.8%, to $7.67 million for the quarter ended March 31, 2016 from $6.57 million for the quarter ended March 31, 2015.  The net interest margin increased to 3.92% for the quarter ended March 31, 2016 from 3.69% for the quarter ended March 31, 2015, primarily due to an increased yield on interest-bearing assets and an increased amount of pre-payment penalties and non-accrual interest collected.

Total interest and dividend income increased by $1.12 million, or 14.9%, to $8.65 million for the quarter ended March 31, 2016 from $7.53 million for the quarter ended March 31, 2015, primarily due to a $71.16 million increase in the average balance of total interest-bearing assets to $783.28 million from $712.12 million, and a $237,000 increase in the amount of pre-payment penalties and non-accrual interest collected. Net interest income was increased during the current quarter by the collection of $193,000 in pre-payment penalties on four loans that paid off (compared to $2,000 collected for the comparable quarter one year ago) and the collection of $46,000 of non-accrual interest. The collection of pre-payment penalties and non-accrual interest added approximately 12 basis points to the net interest margin for the current quarter. The average yield on interest-bearing assets increased to 4.42% for the quarter ended March 31, 2016 from 4.23% for the quarter ended March 31, 2015. Total interest expense increased by $19,000, or 2.0%, to $979,000 for the quarter ended March 31, 2016 from $960,000 for the quarter ended March 31, 2015, as the average balance of interest-bearing liabilities increased by $32.55 million to $598.99 million for the quarter ended March 31, 2016 from $566.44 million for the quarter ended March 31, 2015. The average rate paid on interest-bearing liabilities decreased to 0.66% for the quarter ended March 31, 2016 from 0.69% for the quarter ended March 31, 2015.

Net interest income increased by $2.11 million, or 15.9% , to $15.38 million for the six months ended March 31, 2016 from $13.27 million for the six months ended March 31, 2015. The net interest margin for the six months ended March 31, 2016 increased to 3.96% from 3.78% for the six months ended March 31, 2015.

Total interest and dividend income increased by $2.13 million, or 14.0%, to $17.34 million for the six months ended March 31, 2016 from $15.21 million for the six months ended March 31, 2015, primarily due to a $75.52 million increase in the average balance of interest-bearing assets to $777.18 million from $701.66 million, and a $558,000 increase in the amount of non-accrual interest and pre-payment penalties collected. During the six months ended March 31, 2016 a total of $720,000 in non-accrual interest and pre-payment penalties were collected compared to a total of $162,000 collected during the six months ended March 31, 2015. Total interest expense increased by $16,000, or 0.8%, to $1.96 million for the six months ended March 31, 2016 from $1.94 million for the six months ended March 31, 2015 as the average balance of interest-bearing liabilities increased by $35.72 million to $596.08 million for the six months ended March 31, 2016 from $560.36 million for the six months ended March 31, 2015. The average rate paid on interest-bearing liabilities decreased to 0.66% for the six months ended March 31, 2016 from 0.70% for the six months ended March 31, 2015.




43


Average Balances, Interest and Average Yields/Cost
The following tables set 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-bearing 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 March 31,
 
2016
 
2015
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
Interest-bearing assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable (1)(2)
$
631,708

 
$
8,306

 
5.26
%
 
$
592,000

 
$
7,352

 
4.97
%
Investment securities (2)
8,172

 
74

 
3.62

 
5,679

 
55

 
3.87

Dividends from mutual funds and FHLB stock
3,672

 
39

 
4.27

 
6,144

 
6

 
0.39

Interest-bearing deposits
139,732

 
231

 
0.66

 
108,298

 
114

 
0.42

Total interest-bearing assets
783,284

 
8,650

 
4.42

 
712,121

 
7,527

 
4.23

Non-interest-bearing assets
57,072

 
 

 
 

 
58,224

 
 

 
 

     Total assets
$
840,356

 
 

 
 

 
$
770,345

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Savings accounts
$
112,064

 
15

 
0.05

 
$
100,997

 
13

 
0.05

Money market accounts
105,670

 
79

 
0.30

 
92,683

 
61

 
0.26

N.O.W. checking accounts
184,414

 
112

 
0.24

 
165,314

 
109

 
0.26

Certificates of deposit
151,837

 
301

 
0.80

 
162,446

 
312

 
0.76

Long-term borrowings (3)
45,000

 
472

 
4.22

 
45,000

 
465

 
4.19

Total interest-bearing liabilities
598,985

 
979

 
0.66

 
566,440

 
960

 
0.69

Non-interest-bearing deposits
146,581

 
 
 
 
 
116,177

 
 
 
 
Other liabilities
3,455

 
 

 
 

 
3,092

 
 

 
 

Total liabilities
749,021

 
 

 
 

 
685,709

 
 

 
 

Shareholders' equity
91,335

 
 

 
 

 
84,636

 
 

 
 

Total liabilities and
 
 
 

 
 

 
 
 
 

 
 

shareholders' equity
$
840,356

 
 
 
 
 
$
770,345

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
7,671

 
 
 
 

 
$
6,567

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread
 
 
 
 
3.76
%
 
 

 
 

 
3.54
%
Net interest margin (4)
 
 
 
 
3.92
%
 
 

 
 

 
3.69
%
Ratio of average interest-bearing
   assets to average interest-bearing
   liabilities
 
 
 
 
130.77
%
 
 

 
 

 
125.72
%

44


 
Six Months Ended March 31,
 
2016
 
2015
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
Interest-bearing assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable (1)(2)
$
628,616

 
$
16,735

 
5.32
%
 
$
586,853

 
$
14,861

 
5.06
%
Investment securities (2)
8,230

 
143

 
3.48

 
6,383

 
120

 
3.76

Dividends from mutual funds and FHLB stock
3,670

 
61

 
3.32

 
6,170

 
13

 
0.42

Interest-bearing deposits
136,666

 
402

 
0.59

 
102,258

 
219

 
0.43

Total interest-bearing assets
777,182

 
17,341

 
4.46

 
701,664

 
15,213

 
4.34

Non-interest-bearing assets
57,645

 
 

 
 

 
59,072

 
 

 
 

     Total assets
$
834,827

 
 

 
 

 
$
760,736

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Savings accounts
$
111,205

 
30

 
0.05

 
$
91,455

 
25

 
0.05

Money market accounts
105,020

 
160

 
0.30

 
98,801

 
123

 
0.25

N.O.W. checking accounts
181,999

 
225

 
0.25

 
162,374

 
220

 
0.27

Certificates of deposit
152,858

 
597

 
0.78

 
162,734

 
636

 
0.78

Long-term borrowings (3)
45,000

 
948

 
4.21

 
45,000

 
940

 
4.19

Total interest-bearing liabilities
596,082

 
1,960

 
0.66

 
560,364

 
1,944

 
0.70

Non-interest-bearing deposits
144,544

 
 
 
 
 
113,548

 
 
 
 
Other liabilities
3,616

 
 

 
 

 
2,864

 
 

 
 

Total liabilities
744,242

 
 

 
 

 
676,776

 
 

 
 

Shareholders' equity
90,585

 
 

 
 

 
83,960

 
 

 
 

Total liabilities and
 
 
 

 
 

 
 
 
 

 
 

shareholders' equity
$
834,827

 
 

 
 

 
$
760,736

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
15,381

 
 

 
 

 
$
13,269

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread
 

 
 

 
3.80
%
 
 

 
 

 
3.64
%
Net interest margin (4)
 

 
 

 
3.96
%
 
 

 
 

 
3.78
%
Ratio of average interest-bearing
   assets to average interest-bearing
   liabilities
 

 
 

 
130.38
%
 
 

 
 

 
125.22
%
_______________
(1)
Does not include interest on loans on non-accrual status. Includes loans held for sale. Amortized net deferred loan fees, late fees, extension fees and prepayment penalties are included with interest and dividends.
(2)
Average balances include loans and investment securities on non-accrual status.
(3)
Includes FHLB advances with original maturities of one year or greater.
(4)
Net interest income divided by total average interest-bearing assets, annualized.

45


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), (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 March 31, 2016
compared to three months
ended March 31, 2015
increase (decrease) due to
 
Six months ended March 31, 2016
compared to six months
ended March 31, 2015
increase (decrease) due to
 
Rate
 
Volume
 
Net
Change
 
Rate
 
Volume
 
Net
Change
Interest-bearing assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable and loans held for sale
$
445

 
$
509

 
$
954

 
$
784

 
$
1,090

 
$
1,874

Investment securities
(4
)
 
23

 
19

 

 
23

 
23

  Dividends from mutual funds and FHLB stock
35

 
(2
)
 
33

 
49

 
(1
)
 
48

  Interest-bearing deposits
78

 
39

 
117

 
96

 
87

 
183

Total net increase in income on interest-bearing assets
554

 
569

 
1,123

 
929

 
1,199

 
2,128

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 
 
 
 
 
Savings accounts
1

 
1

 
2

 

 
5

 
5

N.O.W. checking accounts
(10
)
 
13

 
3

 
(8
)
 
13

 
5

Money market accounts
8

 
10

 
18

 
26

 
11

 
37

Certificates of deposit accounts
8

 
(19
)
 
(11
)
 
(2
)
 
(37
)
 
(39
)
   Long term FHLB borrowings
7

 

 
7

 
8

 

 
8

Total net increase (decrease) in expense on interest-bearing liabilities
14

 
5

 
19

 
24

 
(8
)
 
16

 
 
 
 
 
 
 
 
 
 
 
 
Net increase in net interest income
$
540

 
$
564

 
$
1,104

 
$
905

 
$
1,207

 
$
2,112


Provision for Loan Losses:  There was no provision for loan losses for the quarters ended March 31, 2016 and 2015, as improved credit quality measures have been sufficient to cover reserves for changes in the mix of loans. Non-accrual loans decreased 44% to $3.39 million at March 31, 2016, from $6.04 million at September 30, 2015 and decreased 69% from $10.92 million at March 31, 2015. Total delinquent loans (past due 30 days or more) and non-accrual loans decreased 49% to $3.67 million at March 31, 2016, from $7.17 million at September 30, 2015 and decreased 70% from $12.24 million one year ago.  There was a net recovery for the quarter ended March 31, 2016 of $154,000 compared to a net recovery of $60,000 for the quarter ended March 31, 2015.

There was no provision for loan losses for the six months ended March 31, 2016 and 2015. Net recoveries for the six months ended March 31, 2016 were $119,000 compared to a net charge-off of $45,000 for the six months ended March 31, 2015.

The Company has established a comprehensive methodology for determining the allowance 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, historical loss experience for various loan segments, changes in economic conditions, delinquency rates, a detailed analysis of impaired loans, and other factors to determine an appropriate level of allowance for loan losses.  Based on its comprehensive analysis, management believes the allowance for loan losses of $10.04 million at March 31, 2016 (1.59% of loans receivable and 285% of non-performing loans) was adequate to provide for probable losses inherent in the loan portfolio 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 allocated to each loan.  The aggregate principal impairment reserve amount determined at March 31, 2016 was

46


$864,000 compared to $2.68 million at March 31, 2015.  The allowance for loan losses was $10.38 million (1.75% of loans receivable and 95% of non-performing loans) at March 31, 2015.

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 proved 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 Company’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. Any material increase in the allowance for loan losses would adversely affect the Company’s consolidated financial condition and results of operations.  For additional information, see Note 4 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”

Non-interest Income: Total non-interest income increased by $299,000, or 13.5%, to $2.51 million for the quarter ended March 31, 2016 from $2.21 million for the quarter ended March 31, 2015. The increase in non-interest income was primarily due to an $85,000 increase in service charges on deposits, a $67,000 increase in ATM and debit card interchange transaction fees, a $67,000 improvement in servicing income on loans sold and smaller increases several other categories. The increase in service charges on deposits was primarily due to an increase in the amount of service charges collected on checking accounts owned by business associated with the marijuana (or Initiative-502) industry in Washington State. It is permissible in Washington state to handle accounts associated with this industry. The increase in ATM and debit card interchange transaction fees was primarily due to an increase in debit card transactions. The increase in servicing income on loans sold was primarily due to a decrease in the amortization of mortgage servicing rights, which offsets the servicing income received.

Total non-interest income increased by $693,000, or 16.0% , to $5.03 million for the six months ended March 31, 2016 from $4.34 million for the six months ended March 31, 2015. The increase in non-interest income was primarily due to a $203,000 increase in gain on sales of loans, a $172,000 increase in service charges on deposits, a $160,000 improvement in servicing income on loans sold, a $136,000 increase in ATM and debit card interchange transaction fees and smaller increases in several other categories. The increase in gain on sale of loans was primarily due to an increase in the dollar volume of fixed-rate one-to four-family loans sold during the current period.
 
Non-interest Expense:  Total non-interest expense decreased by $25,000, or 0.4%, to $6.63 million for the quarter ended March 31, 2016 from $6.65 million for the quarter ended March 31, 2015.  The decreased expense was primarily due to a $154,000 decrease in OREO and other repossessed assets expense, a $106,000 decrease in professional fees expense and smaller decreases in other expense categories. These decreases were partially offset by a $182,000 increase in salaries and employee benefits expense, a $76,000 increase in ATM and debit card processing expense and smaller increases in other expense categories. The decrease in OREO and other repossessed assets expense was primarily due to a decrease in the level of fair value write-downs on properties. The decrease in professional fees was primarily due to a decrease in legal and consulting fees. The decrease in legal fees was in part due to the recovery of expenses associated with several non-accrual loans that were paid off. The increase in salaries and employee benefits expense was primarily due to annual salary adjustments and the hiring of additional lending personnel. The increase in ATM and debit card processing expense was primarily due to an increase in debit card transactions and an increase in debit card fraud-related expenses.

Total non-interest expense increased $179,000, or 1.4%, to $13.11 million for the six months ended March 31, 2016 from $12.93 million for the six months ended March 31, 2015. The increased expense was primarily due to a $256,000 increase in salaries and employee benefits expense and smaller increases in other expense categories. These increases were partially offset by a $152,000 decrease in professional fees expense and smaller decreases in other expense categories.

Provision for Federal Income Taxes: The provision for federal income taxes increased by $499,000, or 73.8%, to $1.18 million for the quarter ended March 31, 2016 from $676,000 for the quarter ended March 31, 2015, primarily as a result of increased income before federal income taxes. The Company's effective tax rate was 33.05% for the quarter ended March 31, 2016 and 31.78% for the quarter ended March 31, 2015.

The provision for federal income taxes increased by $896,000, or 59.7%, to $2.40 million for the six months ended March 31, 2016 from $1.50 million for the six months ended March 31, 2015, primarily as a result of increased income before federal income taxes. The Company's effective tax rate was 32.81% for the six months ended March 31, 2016 and 32.08% for the six months ended March 31, 2015.




47



Liquidity
The Company’s primary sources of funds are customer deposits, proceeds from principal and interest payments on loans and investment securities, 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.

Liquidity management is both a short and long-term responsibility of the Bank’s management.  The Bank adjusts its investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, and (iv) yields available on interest-bearing deposits.  Excess liquidity is invested generally in interest-bearing overnight deposits and other short-term investments.

The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs.  At March 31, 2016, 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 22.79%.

The Company’s total cash and cash equivalents and CDs held for investment increased by $21.65 million, or 15.4%, to $162.55 million at March 31, 2016 from $140.90 million at September 30, 2015. If the Bank requires funds that exceed its ability to generate them internally, it has additional borrowing capacity with the FHLB, the Federal Reserve Bank of San Francisco ("FRB") and Pacific Coast Bankers' Bank ("PCBB"). At March 31, 2016, the Bank maintained an uncommitted credit facility with the FHLB that provided for immediately available advances up to an aggregate amount equal to 35% of total assets, limited by available collateral. The Bank also has a Letter of Credit ("LOC") of up to $22.0 million with the FHLB for the purpose of collateralizing Washington State public deposits. Any amount pledged for public deposit under the LOC reduces the Bank's available borrowing amount under the FHLB advance agreement. At March 31, 2016, the Bank had $45.00 million in FHLB advances outstanding and $22.00 million pledged under the LOC, which left $199.34 million available for additional borrowings.  The Bank maintains a short-term borrowing line with the FRB with available total credit based on eligible collateral.  At March 31, 2016, the Bank had $45.04 million available for borrowings with the FRB and there was no outstanding balance on this borrowing line. The Bank also maintains a $10.00 million overnight borrowing line with PCBB. At March 31, 2016, the Bank did not have an outstanding balance on this borrowing line.

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 March 31, 2016, the Bank had loan commitments totaling $57.50 million and undisbursed construction loans in process totaling $44.47 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 March 31, 2016 totaled $90.94 million.  Historically, the Bank has been able to retain a significant amount of its non-brokered CDs as they mature.  At March 31, 2016, the Bank had $3.20 million in brokered CDs.

Capital Resources

The Bank, as a state-chartered, federally insured savings bank, is subject to the capital requirements established by the FDIC. Under the FDIC's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.

Based on its capital levels at March 31, 2016, the Bank exceeded all regulatory capital requirements as of that date. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at March 31, 2016, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status.









48


The following table compares the Bank’s actual capital amounts at March 31, 2016 to its minimum regulatory capital requirements at that date (dollars in thousands):
 
 
 
 
 
Actual
 
 
Regulatory
Minimum To
Be “Adequately
Capitalized”
 
To Be “Well Capitalized”
Under Prompt
Corrective Action
Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
 
 
 
 
 
 
 
 
 
 
Leverage Capital Ratio:
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital

$85,747

 
10.26
%
 

$33,419

 
4.00
%
 

$41,773

 
5.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Risk-based Capital Ratios:
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital
85,747

 
13.80
%
 
27,971

 
4.50

 
40,402

 
6.50

 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital
85,747

 
13.80

 
37,294

 
6.00

 
49,726

 
8.00

 
 
 
 
 
 
 
 
 
 
 
 
Total capital
93,547

 
15.05

 
49,726

 
8.00

 
62,157

 
10.00


In addition to the minimum common equity Tier 1 ("CET1"), Tier 1 and total capital ratios, the Bank will have to maintain a capital conservation buffer consisting of additional CET1 capital equal to 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of retained income that could be utilized for such actions. The new capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019.

Timberland Bancorp, Inc. is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary bank to be well capitalized under the prompt corrective action regulations. If Timberland Bancorp, Inc. were subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at March 31, 2016, Timberland Bancorp, Inc. would have exceeded all regulatory requirements.

The following table presents the regulatory capital ratios for Timberland Bancorp, Inc. as of March 31, 2016 (dollars in thousands):
 
Actual
 
Amount
 
Ratio
 
 
 
 
Leverage Capital Ratio:
 
 
 
Tier 1 capital

$88,335

 
10.56
%
 
 
 
 
Risk-based Capital Ratios:
 
 
 
Common equity tier 1 capital
88,335

 
14.21

 
 
 
 
Tier 1 capital
88,335

 
14.21

 

 

Total capital
96,137

 
15.46




49


Key Financial Ratios and Data
(Dollars in thousands, except per share data)

 
Three Months Ended
March 31,
 
Six Months Ended
March 31,
 
2016

 
2015

 
2016

 
2015

PERFORMANCE RATIOS:
 
 
 
 
 
 
 
Return on average assets (1)
1.13
%
 
0.75
%
 
1.18
%
 
0.84
%
Return on average equity (1)
10.42
%
 
6.86
%
 
10.84
%
 
7.57
%
Net interest margin (1)
3.92
%
 
3.69
%
 
3.96
%
 
3.78
%
Efficiency ratio
65.09
%
 
75.78
%
 
64.21
%
 
73.43
%


 
At
March 31,
2016

 
At
September 30,
2015

 
At
March 31,
2015

BOOK VALUES:
 
 
 
 
 
Book value per common share

$13.31

 

$12.76

 

$12.11

Tangible book value per common share (2)
12.49

 
11.95

 
11.31

______________________
(1)
Annualized
(2)
Calculation subtracts goodwill and core deposit intangible from the equity component.

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, 2015.

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 March 31, 2016 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 March 31, 2016, 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

50


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
2015 Form 10-K.

Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds
    
Stock Repurchases

The following table sets forth the shares repurchased by the Company during quarter ended March 31, 2016:
Period
 
Total No. of Shares Repurchased
 
Average Price Paid Per Share
 
Total No. of Shares Purchased as Part of Publicly Announced Plan
 
Maximum No. of Shares that May Yet Be Purchased Under the Plan (1)
1/1/2016 - 1/31/2016
 

 
$

 

 
287,893

2/1/2016 - 2/29/2016
 
66,000

 
12.42

 
66,000

 
221,893

3/1/2016 - 3/31/2016
 

 

 

 
221,893

Total
 
66,000

 
$
12.42

 
66,000

 
221,893


(1) On July 28, 2015 the Company announced a plan to repurchase 352,681 shares of the Company's common stock. As of March 31, 2016, a total of 130,788 shares had been repurchased at an average price of $11.69 per share. All shares were repurchased through open market broker transactions and no shares were directly repurchased from directors or officers of the Company.

Item 3.      Defaults Upon Senior Securities
Not applicable.

Item 4.     Mine Safety Disclosures
Not applicable.

Item 5.     Other Information
None to be reported.


51


Item 6.         Exhibits

(a)   Exhibits
 
3.1
Articles of Incorporation of the Registrant (1) 
 
3.3
Amended and Restated Bylaws of the Registrant (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
Employment Agreement with Michael R. Sand (8)
 
10.10
Employment Agreement with Dean J. Brydon (8)
 
10.11
Timberland Bancorp, Inc. 2014 Equity Incentive Plan (9)
 
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes OxleyAct
 
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 10-Q for the quarter ended March 31, 2016, formatted on Extensible Business Reporting Language (XBRL) (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Shareholders' Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Unaudited Consolidated Financial Statements

_________________
(1)
Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (333- 35817).
(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 Current Report on Form 8-K filed on April 29, 2010.
(4)
Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 1997; and to the Registrant’s Current Report on Form 8-K dated April 13, 2007.
(5)
Incorporated by reference to the Registrant’s 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)
Incorporated by reference to the Registrant's Current Report on Form 8-K filed on March 29, 2013.
(9)
Attached as Appendix A to the Registrant's Annual Meeting Proxy Statement filed on December 19, 2014.

52


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: May 9, 2016
By:  /s/ Michael R. Sand                                   
 
Michael R. Sand 
 
Chief Executive Officer 
 
(Principal Executive Officer) 
 
 
 
 
Date: May 9, 2016
By:  /s/ Dean J. Brydon                                    
 
Dean J. Brydon 
 
Chief Financial Officer
 
(Principal Financial Officer)

53


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 March 31, 2016, formatted on Extensible Business Reporting Language (XBRL) (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Unaudited Consolidated Financial Statements





54