UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended September 30, 2008
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1863696
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
624 Simpson Avenue, Hoquiam, Washington 98550
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share The Nasdaq Stock Market LLC
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(Title of Each Class) (Name of Each Exchange on
Which Registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
YES NO X
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Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 of Section 15(d) of the Act.
YES NO X
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
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Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated
filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer Accelerated filer X
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Non-accelerated filer Smaller reporting company
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Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Act). YES NO X
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As of November 30, 2008, the Registrant had 6,980,329 shares of Common
Stock issued and outstanding. The aggregate market value of the Common Stock
held by nonaffiliates of the Registrant, based on the closing sales price of
the Registrant's common stock as quoted on the NASDAQ Global Select Market on
March 31, 2008, was $80.1 million (6,876,653 shares at $11.65). For purposes
of this calculation, Common Stock held by officers and directors of the
Registrant and the Timberland Bank Employee Stock Ownership Plan and Trust are
considered nonaffiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Definitive Proxy Statement for the 2009 Annual Meeting
of Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2008 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I. Page
----
Item 1. Business
General................................................... 1
Market Area............................................... 1
Lending Activities........................................ 3
Investment Activities..................................... 21
Deposit Activities and Other Sources of Funds............. 22
Bank Owned Life Insurance................................. 27
Regulation of the Bank.................................... 27
Regulation of the Company................................. 36
Taxation.................................................. 38
Competition............................................... 39
Subsidiary Activities..................................... 39
Personnel................................................. 40
Executive Officers of the Registrant...................... 40
Item 1A. Risk Factors............................................... 41
Business Risks............................................ 41
Risks Related to the U.S. Financial Industry.............. 46
Item 1B. Unresolved Staff Comments.................................. 48
Item 2. Properties.................................................. 49
Item 3. Legal Proceedings........................................... 51
Item 4. Submission of Matters to a Vote of Security Holders......... 51
PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities........... 51
Item 6. Selected Financial Data..................................... 54
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 56
General................................................... 56
Special Note Regarding Forward-Looking Statements......... 56
Critical Accounting Policies and Estimates................ 56
New Accounting Pronouncements............................. 57
Operating Strategy........................................ 57
Market Risk and Asset and Liability Management............ 58
Comparison of Financial Condition at September 30, 2007
and September 30, 2006.................................... 60
Comparison of Operating Results for Years Ended
September 30, 2007 and 2006............................... 61
Comparison of Operating Results for Years Ended
September 30, 2006 and 2005............................... 64
Average Balances, Interest and Average Yields/Cost........ 66
Rate/Volume Analysis...................................... 68
Liquidity and Capital Resources........................... 69
Effect of Inflation and Changing Prices................... 70
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...... 70
Item 8. Financial Statements and Supplementary Data...................... 71
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure............................................. 115
Item 9A. Controls and Procedures......................................... 115
Item 9B. Other Information............................................... 115
i
PART III.
Item 10. Directors, Executive Officers and Corporate Governance..... 115
Item 11. Executive Compensation..................................... 116
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................. 116
Item 13. Certain Relationships and Related Transactions, and
Director Independence...................................... 117
Item 14. Principal Accounting Fees and Services..................... 117
PART IV.
Item 15. Exhibits, Financial Statement Schedules.................... 117
ii
PART I
Item 1. Business
General
Timberland Bancorp, Inc. ("Company"), a Washington corporation, was
organized on September 8, 1997 for the purpose of becoming the holding company
for Timberland Savings Bank, SSB ("Bank") upon the Bank's conversion from a
Washington-chartered mutual savings bank to a Washington-chartered stock
savings bank ("Conversion"). The Conversion was completed on January 12, 1998
through the sale and issuance of 13,225,000 shares of common stock by the
Company. At September 30, 2008, the Company had total assets of $681.9
million, total deposits of $498.6 million and total shareholders' equity of
$74.8 million. The Company's business activities generally are limited to
passive investment activities and oversight of its investment in the Bank.
Accordingly, the information set forth in this report, including consolidated
financial statements and related data, relates primarily to the Bank and its
subsidiary.
The Bank was established in 1915 as "Southwest Washington Savings and
Loan Association." In 1935, the Bank converted from a state-chartered mutual
savings and loan association to a federally chartered mutual savings and loan
association, and in 1972, changed its name to "Timberland Federal Savings and
Loan Association." In 1990, the Bank converted to a federally chartered
mutual savings bank under the name "Timberland Savings Bank, FSB." In 1991,
the Bank converted to a Washington-chartered mutual savings bank and changed
its name to "Timberland Savings Bank, SSB." On December 29, 2000, the Bank
changed its name to "Timberland Bank." The Bank's deposits are insured up to
applicable legal limits by the Federal Deposit Insurance Corporation ("FDIC").
The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since
1937. The Bank is regulated by the Washington Department of Financial
Institutions, Division of Banks ("Division") and the FDIC.
The Bank is a community-oriented bank which has traditionally offered a
variety of savings products to its retail customers while concentrating its
lending activities on real estate mortgage loans. Lending activities have
been focused primarily on the origination of loans secured by real estate,
including an emphasis on construction loans, one- to four-family residential
loans, multi-family loans, commercial real estate loans and land loans. The
Bank originates adjustable-rate residential mortgage loans that do not qualify
for sale in the secondary market under Federal Home Loan Mortgage Corporation
("FHLMC") guidelines. The Bank also originates commercial business loans and
in 1998 established a business banking division to increase the origination of
these loans.
The Company maintains a website at www.timberlandbank.com. The
information contained on that website is not included as a part of, or
incorporated by reference into, this Annual Report on Form 10-K. Other than
an investor's own internet access charges, the Company makes available free of
charge through that website the Company's Annual Report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments
to these reports, as soon as reasonably practicable after these materials have
been electronically filed with, or furnished to, the Securities and Exchange
Commission ("SEC").
Market Area
The Bank considers Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis
Counties as its primary market areas. The Bank conducts operations from:
* its main office in Hoquiam (Grays Harbor County);
* five branch offices in Grays Harbor County (Ocean Shores,
Montesano, Elma, and two branches in Aberdeen);
* a branch office in King County (Auburn);
* five branch offices in Pierce County (Edgewood, Puyallup, Spanaway,
Tacoma, and Gig Harbor);
1
* five branch offices in Thurston County (Olympia, Yelm, Tumwater,
and two branches in Lacey);
* two branch offices in Kitsap County (Poulsbo and Silverdale); and
* two branch offices and a loan production office in Lewis County
(Winlock, Toledo and Centralia).
See "Item 2. Properties."
Hoquiam, with a population of approximately 9,000, is located in Grays
Harbor County which is situated along Washington State's central Pacific
coast. Hoquiam is located approximately 110 miles southwest of Seattle and
145 miles northwest of Portland, Oregon.
The Bank considers its primary market area to include six submarkets:
primarily rural Grays Harbor County with its historical dependence on the
timber and fishing industries; Pierce, Thurston and Kitsap Counties with their
dependence on state and federal government; King County with its broadly
diversified economic base; and Lewis County with its dependence on retail
trade, manufacturing, industrial services and local government. Each of these
markets presents operating risks to the Bank. The Bank's expansion into
Pierce, Thurston, King, Kitsap and Lewis Counties represents the Bank's
strategy to diversify its primary market area to become less reliant on the
economy of Grays Harbor County.
Grays Harbor County has a population of 71,000 according to the U.S.
Census Bureau 2007 estimates and a median family income of $52,600 according
to 2008 HUD estimates. The economic base in Grays Harbor has been
historically dependent on the timber and fishing industries. Other industries
that support the economic base are tourism, agriculture, shipping,
transportation and technology. According to the Washington State Employment
Security Department, the unemployment rate in Grays Harbor County increased to
7.5% at September 30, 2008 from 6.2% at September 30, 2007. The median price
of a resale home in Grays Harbor County for the quarter ended September 30,
2008 decreased 13.9% to $155,000 as compared to the quarter one year prior.
The number of home sales decreased 13.0% for the quarter ended September 30,
2008 compared the same quarter one year earlier. The Bank has six branches
(including its home office) located throughout the county. The recent
slowdown in Grays Harbor County's real estate activity has had a negative
effect on the Bank's profitability.
Pierce County is the second most populous county in the state and has a
population of 773,000 according to the U.S. Census Bureau 2007 estimates. The
county's median family income is $66,200 according to 2008 HUD estimates. The
economy in Pierce County is diversified with the presence of military related
government employment (Fort Lewis Army Base and McChord Air Force Base),
transportation and shipping employment (Port of Tacoma), and aerospace related
employment (Boeing). According to the Washington State Employment Security
Department, the unemployment rate for the Pierce County area increased to 5.9%
at September 30, 2008 from 4.6% at September 30, 2007. The median price of a
resale home in Pierce County for the quarter ended September 30, 2008
decreased 11.9% to $254,000 as compared to the quarter one year prior. The
number of home sales decreased 24.0% for the quarter ended September 30, 2008
compared to the same quarter one year earlier. The Bank has five branches in
Pierce County and these branches have historically been responsible for a
substantial portion of the Bank's construction lending activities. The recent
slowdown in Pierce County's real estate activity has had a negative effect on
the Bank's construction lending opportunities and on the Bank's profitability.
Thurston County has a population of 239,000 according to the U.S. Census
Bureau 2007 estimates and a median family income of $66,300 according to 2008
HUD estimates. Thurston County is home of Washington State's capital
(Olympia) and its economic base is largely driven by state government related
employment. According to the Washington State Employment Security Department,
the unemployment rate for the Thurston County area increased to 5.2% at
September 30, 2008 from 4.2% at September 30, 2007. The median price of a
resale home in Thurston County for the quarter ended September 30, 2008
decreased 7.2% to $251,000 as compared to the same quarter one year earlier.
The number of home sales decreased 23.8% for the quarter ended September 30,
2008 compared to the same quarter one year earlier. The Bank has five
branches in Thurston County. This county has historically had a stable
economic base
2
primarily attributable to the state government presence; however, the recent
slowdown in Thurston County's real estate activity has had a negative effect
on the Bank's construction lending opportunities and the Bank's profitability.
Kitsap County has a population of 237,000 according to the U.S. Census
Bureau 2007 estimates and a median family income of $69,900 according to 2008
HUD estimates. The Bank has two branches in Kitsap County. The economic base
of Kitsap County is largely supported by military related government
employment through the United States Navy. According to the Washington State
Employment Security Department, the unemployment rate for the Kitsap County
area increased to 5.3% at September 30, 2008 from 4.3% at September 30, 2007.
The median price of a resale home in Kitsap County for the quarter ended
September 30, 2008 decreased 10.0% to $270,000, as compared to the same
quarter one year earlier. The number of home sales decreased 23.3% for the
quarter ended September 30, 2008 compared to the same quarter one year
earlier. The recent slowdown in Kitsap County's real estate activity has had
a negative effect on the Bank's lending opportunities.
King County is the most populous county in the state and has a population
of 1.9 million according to the U.S. Census Bureau 2007 estimates. The Bank
has one branch in King County. The county's median family income is $81,400
according to 2008 HUD estimates. King County's economic base is diversified
with many industries including shipping, transportation, aerospace (Boeing),
computer technology and biotech industries. According to the Washington State
Employment Security Department, the unemployment rate for the King County area
increased to 4.6% at September 30, 2008 from 3.9% at September 30, 2007. The
median price of a resale home in King County for the quarter ended September
30, 2008 decreased 9.5% to $427,000, as compared to the same quarter one year
earlier. The number of home sales decreased 30.7% for the quarter ended
September 30, 2008 compared to the same quarter one year earlier. The recent
slowdown in King County's real estate activity has had a negative effect on
the Bank's lending opportunities in this market.
Lewis County has a population of 74,000 according to the U.S. Census
Bureau 2007 estimates and a median family income of $52,600 according to 2008
HUD estimates. The economic base in Lewis County is supported by
manufacturing, retail trade, local government and industrial services.
According to the Washington State Employment Security Department, the
unemployment rate in Lewis County increased to 7.7% at September 30, 2008 from
6.3% at September 30, 2007. The median price of a resale home in Lewis County
for the quarter ended September 30, 2008 decreased 39.2% to $175,000, as
compared to the same quarter one year earlier. The number of home sales
decreased 43.6% for the quarter ended September 30, 2008 compared to the same
quarter one year earlier. The Bank currently has two branches and a loan
production office located in Lewis County. In August 2008, the Bank announced
plans to open an additional full-service branch in Lewis County. The Bank's
existing loan production office in Lewis County will be consolidated into the
new facility, which is expected to open in 2009. The recent slowdown in Lewis
County's real estate activity has had a negative effect on the Bank's lending
opportunities in this market.
Lending Activities
General. Historically, the principal lending activity of the Bank has
consisted of the origination of loans secured by first mortgages on
owner-occupied, one- to four-family residences and loans for the construction
of one- to four-family residences. Since 1998, the Bank has emphasized its
origination of construction and land development loans and commercial real
estate loans. The Bank's net loans receivable, including loans held for sale,
totaled $557.7 million at September 30, 2008, representing 81.8% of
consolidated total assets, and at that date construction and land development
loans (including undisbursed loans in process), and loans secured by
commercial properties were $332.6 million, or 54.4%, of total loans.
Construction and land development loans and commercial real estate loans
typically have higher rates of return than one- to four-family loans; however,
they also present a higher degree of risk. See "- Lending Activities -
Construction and Land Development Lending" and "- Lending Activities -
Commercial Real Estate Lending."
The Bank's internal loan policy limits the maximum amount of loans to one
borrower to 25% of its Tier 1 capital. At September 30, 2008, the maximum
amount which the Bank could have lent to any one borrower and the borrower's
related entities was approximately $15.3 million under this policy. At
September 30, 2008, the largest amount outstanding to any one borrower and the
borrower's related entities was $16.6 million (including $2.4 million
3
in undisbursed loans in process balance). The Board of Directors approved
this exception to the borrowing limit because of the strength of the primary
borrower and the borrower's related entities. These loans represent two
condominium construction projects, several one- to four-family speculative
construction projects, and commercial real estate holdings. All of the loans
are secured by projects located in Grays Harbor County, except for one of the
condominium construction projects which is located in Oregon. These loans
were performing according to the required loan terms at September 30, 2008.
The next largest amount outstanding to any one borrower and the borrower's
related entities was $10.1 million (including $7.4 million in undisbursed
loans in process balance.) These loans were secured by two mini-storage
facilities being constructed in Pierce County and a one- to four-family home,
all of which were performing according to terms at September 30, 2008. The
Bank also had 88 borrowers or related borrowers with total loans outstanding
in excess of $1.0 million at September 30, 2008.
Loan Portfolio Analysis. The following table sets forth the composition
of the Bank's loan portfolio by type of loan as of the dates indicated.
At September 30,
--------------------------------------------------------------------------------------------
2008 2007 2006 2005 2004
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to four-
family(1).... $112,299 18.35% $102,434 17.40% $ 98,709 20.11% $101,763 23.24% $ 99,835 25.25%
Multi-family.. 25,927 4.24 35,157 5.97 17,689 3.60 20,170 4.61 17,160 4.34
Commercial.... 146,223 23.90 127,866 21.72 137,609 28.04 124,849 28.51 108,276 27.39
Construction
and land
development.. 186,344 30.46 186,261 31.64 146,855 29.92 112,470 25.68 106,241 26.88
Land.......... 60,701 9.92 60,706 10.30 29,598 6.03 24,981 5.71 19,895 5.03
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans....... 531,494 86.87 512,424 87.03 430,460 87.70 384,233 87.75 351,407 88.89
Consumer Loans:
Home equity
and second
mortgage..... 48,690 7.96 47,269 8.02 37,435 7.63 32,298 7.38 23,549 5.96
Other......... 10,635 1.73 10,922 1.86 11,127 2.27 9,330 2.13 9,270 2.34
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
59,325 9.69 58,191 9.88 48,562 9.90 41,628 9.51 32,819 8.30
Commercial
business
loans......... 21,018 3.44 18,164 3.09 11,803 2.40 12,013 2.74 11,098 2.81
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans.. 611,837 100.00% 588,779 100.00% 490,825 100.00% 437,874 100.00% 395,324 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
construction
loans in
process...... (43,353) (65,673) (59,260) (42,771) (43,563)
Deferred loan
origination
fees......... (2,747) (2,968) (2,798) (2,895) (3,176)
Allowance for
loan losses.. (8,050) (4,797) (4,122) (4,099) (3,991)
-------- -------- -------- -------- --------
Total loans
receivable,
net........... $557,687 $515,341 $424,645 $388,109 $344,594
======== ======== ======== ======== ========
-----------
(1) Includes loans held-for-sale.
Residential One- to Four-Family Lending. At September 30, 2008, $112.3
million, or 18.4%, of the Bank's loan portfolio consisted of loans secured by
one- to four-family residences. The Bank originates both fixed-rate loans and
adjustable-rate loans.
Generally, one-to-four family fixed-rate loans and five and seven year
balloon reset loans (which are loans that are originated with a fixed interest
rate for the initial five or seven years, and thereafter incur one interest
rate change in which the new rate remains in effect for the remainder of the
loan term) are originated to meet the requirements for sale in the secondary
market to the FHLMC. From time to time, however, a portion of these
fixed-rate loans, which include five and seven year balloon reset loans, may
be retained in the loan portfolio to meet the Bank's asset/liability
management objectives. The Bank periodically retains some fixed rate loans
including five and seven year balloon reset loans in its loan portfolio and
classifies them as held-to-maturity. The Bank uses an automated underwriting
program, which preliminarily qualifies a loan as conforming to FHLMC
underwriting standards when the loan is originated. At
4
September 30, 2008, $61.1 million, or 54.4%, of the Bank's one- to four-family
loan portfolio consisted of fixed-rate mortgage loans.
The Bank also offers adjustable-rate mortgage ("ARM") loans. All of the
Bank's ARM loans are retained in its loan portfolio rather than intended for
sale. The Bank offers several ARM products which adjust annually after an
initial period ranging from one to five years subject to a limitation on the
annual increase of 2% and an overall limitation of 6%. These ARM products are
priced utilizing the weekly average yield on one year U.S. Treasury securities
adjusted to a constant maturity of one year plus a margin of 2.875% to 4.00%.
Loans tied to the prime rate or to LIBOR indices typically do not have
periodic, or lifetime adjustment limits. Loans tied to these indices normally
have margins ranging from 0.0% to 3.0%. ARM loans held in the Bank's
portfolio do not permit negative amortization of principal. Borrower demand
for ARM loans versus fixed-rate mortgage loans is a function of the level of
interest rates, the expectations of changes in the level of interest rates and
the difference between the initial interest rates and fees charged for each
type of loan. The relative amount of fixed-rate mortgage loans and ARM loans
that can be originated at any time is largely determined by the demand for
each in a competitive environment. At September 30, 2008, $51.2 million, or
45.6%, of the Bank's one- to four- family loan portfolio consisted of ARM
loans.
A portion of the Bank's ARM loans are "non-conforming" because they do
not satisfy acreage limits, or various other requirements imposed by the
FHLMC. Some of these loans are also originated to meet the needs of borrowers
who cannot otherwise satisfy the FHLMC credit requirements because of personal
and financial reasons (i.e., divorce, bankruptcy, length of time employed,
etc.), and other aspects, which do not conform to the FHLMC's guidelines.
Many of these borrowers have higher debt-to-income ratios, or the loans are
secured by unique properties in rural markets for which there are no sales of
comparable properties to support value according to secondary market
requirements. These loans are known as non-conforming loans and the Bank may
require additional collateral or lower loan-to-value ratios to reduce the risk
of these loans. The Bank believes that these loans satisfy a need in its
local market area. As a result, subject to market conditions, the Bank
intends to continue to originate these types of loans.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased interest
to be paid by the customer as a result of increases in interest rates. It is
possible that during periods of rising interest rates the risk of default on
ARM loans may increase as a result of repricing and the increased costs to the
borrower. Furthermore, because the ARM loans originated by the Bank generally
provide, as a marketing incentive, for initial rates of interest below the
rates which would apply were the adjustment index used for pricing initially,
these loans are subject to increased risks of default or delinquency. The
Bank attempts to reduce the potential for delinquencies and defaults on ARM
loans by qualifying the borrower based on the borrower's ability to repay the
ARM loan assuming that the maximum interest rate that could be charged at the
first adjustment period remains constant during the loan term. Another
consideration is that although ARM loans allow the Bank to increase the
sensitivity of its asset base due to changes in the interest rates, the extent
of this interest sensitivity is limited by the periodic and lifetime interest
rate adjustment limits. Because of these considerations, the Bank has no
assurance that yield increases on ARM loans will be sufficient to offset
increases in the Bank's cost of funds.
While fixed-rate, single-family residential mortgage loans are normally
originated with 15 to 30 year terms, these loans typically remain outstanding
for substantially shorter periods because borrowers often prepay their loans
in full upon sale of the property pledged as security or upon refinancing the
original loan. In addition, substantially all mortgage loans in the Bank's
loan portfolio contain due-on-sale clauses providing that the Bank may declare
the unpaid amount due and payable upon the sale of the property securing the
loan. Typically, the Bank enforces these due-on-sale clauses to the extent
permitted by law and as business judgment dictates. Thus, average loan
maturity is a function of, among other factors, the level of purchase and sale
activity in the real estate market, prevailing interest rates and the interest
rates received on outstanding loans.
The Bank requires that fire and extended coverage casualty insurance be
maintained on all of its real estate secured loans. Loans originated since
1994 also require flood insurance, if appropriate.
5
The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 95% of the
lesser of the appraised value or the purchase price. However, the Bank
usually obtains private mortgage insurance ("PMI") on the portion of the
principal amount that exceeds 80% of the appraised value of the security
property. The maximum loan-to-value ratio on mortgage loans secured by
non-owner-occupied properties is generally 80% (90% for loans originated for
sale in the secondary market to the FHLMC). At September 30, 2008 three
single family loans totaling $300,000 were not performing according to their
terms. See "- Lending Activities - Non-performing Assets and Delinquencies."
Construction and Land Development Lending. Prompted by unfavorable
economic conditions in its primary market area in the 1980s, the Bank sought
to establish a market niche and, as a result, began originating construction
loans outside of Grays Harbor County. In recent periods, construction lending
activities have been primarily in the Pierce, King, Thurston, and Kitsap
County markets.
The Bank currently originates three types of residential construction
loans: (i) speculative construction loans, (ii) custom construction loans and
(iii) owner/builder construction loans. The Bank believes that its computer
tracking system has enabled it to establish processing and disbursement
procedures to meet the needs of these borrowers. The Bank also originates
construction loans for the development of multi-family and commercial
properties.
At September 30, 2008 and 2007, the composition of the Bank's
construction and land development loan portfolio was as follows:
At September 30,
------------------------------------------------
2008 2007
----------------------- -----------------------
Outstanding Percent of Outstanding Percent of
Balance Total Balance Total
----------- ---------- ----------- ----------
(In thousands)
Speculative construction... $ 30,895 16.58% $ 43,012 23.09%
Custom and owner/builder
construction.............. 47,168 25.31 52,375 28.12
Multi-family (including
condominium).............. 40,509 21.74 27,584 14.81
Land development........... 28,152 15.11 22,292 11.97
Commercial real estate..... 39,620 21.26 40,998 22.01
-------- ------ -------- ------
Total.................... $186,344 100.00% $186,261 100.00%
======== ====== ======== ======
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Bank or another lender for the finished
home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to debt service
the speculative construction loan and finance real estate taxes and other
carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified and a sale is
consummated. The Bank lends to approximately 45 builders located in the
Bank's primary market area, each of which generally have one to eight
speculative loans outstanding from the Bank during a 12 month period. Rather
than originating lines of credit to home builders to construct several homes
at once, the Bank generally originates and underwrites a separate loan for
each home. Speculative construction loans are generally originated for a term
of 12 months, with current rates ranging from the prime rate to the prime rate
plus 1.5%, and with a loan-to-value ratio of no more than 80% of the appraised
estimated value of the completed property. During this 12 month period, the
borrower is required to make monthly payments of accrued interest on the
outstanding loan balance, a portion, or all of which may be paid from an
interest reserve. At September 30, 2008, speculative construction loans
totaled $30.9 million, or 16.6%, of the total construction loan portfolio. At
September 30, 2008, the Bank had 14 borrowers each with aggregate outstanding
speculative loan balances of more than $500,000. The largest aggregate
outstanding balance to one borrower for speculative construction loans totaled
$3.2 million (including $668,000 of undisbursed loans in process balance).
The largest outstanding balance for a single speculative loan was $1.5 million
(including $69,000 of undisbursed loans in process balance) and was performing
6
according to its terms. At September 30, 2008, 17 out of 91 speculative
construction loans with an aggregate balance of $5.4 million were not
performing according to their terms. These non-performing loans were located
in Pierce County, Thurston County and Lewis County. See "- Lending
Activities - Non-performing Assets and Delinquencies."
Unlike speculative construction loans, custom construction loans are made
to home builders who, at the time of construction, have a signed contract with
a home buyer who has a commitment to purchase the finished home. Custom
construction loans are generally originated for a term of six to 12 months,
with fixed interest rates currently ranging from 7.0% to 7.5% and with
loan-to-value ratios of 80% of the appraised estimated value of the completed
property or sales price, whichever is less. During the construction period,
the borrower is required to make monthly payments of accrued interest on the
outstanding loan balance, a portion, or all of which may be paid from an
interest reserve.
Owner/builder construction loans are originated to the home owner rather
than the home builder as a single loan that automatically converts to a
permanent loan at the completion of construction. The construction phase of
an owner/builder construction loan generally lasts up to 12 months with fixed
interest rates currently ranging from 7.0% to 7.5%, and with loan-to-value
ratios of 80% (or up to 95% with PMI) of the appraised estimated value of the
completed property. During the construction period, the borrower is required
to make monthly payments of accrued interest on the outstanding loan balance,
a portion, or all of which may be paid from an interest reserve. At the
completion of construction, the loan converts automatically to either a
fixed-rate mortgage loan, which conforms to secondary market standards, or an
ARM loan for retention in the Bank's portfolio. At September 30, 2008, custom
and owner/builder construction loans totaled $47.2 million, or 25.3%, of the
total construction loan portfolio. At September 30, 2008, the largest
outstanding custom and owner/builder construction loan had an outstanding
balance of $1.1 million (including $550,000 of undisbursed loans in process
balance) and was performing according to its terms.
The Bank originates loans to real estate developers with whom it has
established relationships for the purpose of developing residential
subdivisions (i.e., installing roads, sewers, water and other utilities)
(generally with ten to 50 lots). At September 30, 2008, the Bank had 24 land
development loans totaling $28.2 million, or 15.1% of construction and land
development loans receivable. Land development loans are secured by a lien on
the property and typically made for a period of two to five years with fixed
or variable interest rates, and are made with loan-to-value ratios generally
not exceeding 75%. Monthly interest payments are required during the term of
the loan. Land development loans are generally structured so that the Bank is
repaid in full upon the sale by the borrower of approximately 80% of the
subdivision lots. A majority of the Bank's land development loans are secured
by property located in its primary market area. In addition, in the case of a
corporate borrower, the Bank also generally obtains personal guarantees from
corporate principals and reviews their personal financial statements. At
September 30, 2008, the Bank had two land development loans totaling $4.5
million that were non-performing. The non-performing loans consisted of a
3.1 million loan secured by a land development project in Richland, Washington
and a $1.4 million participation interest in a loan secured by a land
development project in Clark County.
Land development loans secured by land under development involve greater
risks than one- to four-family residential mortgage loans because these loans
are advanced upon the predicted future value of the developed property upon
completion. If the estimate of the future value proves to be inaccurate, in
the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75% of the estimated developed value of
the secured property.
The Bank also provides construction financing for multi-family and
commercial properties. At September 30, 2008, these loans amounted to $80.1
million, or 43.0% of construction loans. These loans are secured by
condominiums, apartment buildings, mini-storage facilities, office buildings
and retail rental space predominantly located in the Bank's primary market
area. At September 30, 2008, the largest outstanding multi-family
construction loan was secured by a condominium project and had a balance of
$6.0 million (including $123,000 of undisbursed loans in process balance) and
was performing according to its terms. At September 30, 2008, the largest
outstanding commercial real estate construction loan had a balance of $12.0
million (including $6.2 million of undisbursed loans in process balance). This
loan was secured by two mini-storage facilities being constructed in Pierce
County and was performing according to its terms.
7
All construction loans must be approved by a member of one of the Bank's
Loan Committees or the Bank's Board of Directors, or in the case of one- to
four-family construction loans meeting FHLMC guidelines, by a qualified
underwriter. See "- Lending Activities - Loan Solicitation and Processing."
Prior to preliminary approval of any construction loan application, an
independent fee appraiser inspects the site and the Bank reviews the existing
or proposed improvements, identifies the market for the proposed project and
analyzes the pro forma data and assumptions on the project. In the case of a
speculative or custom construction loan, the Bank reviews the experience and
expertise of the builder. After preliminary approval has been given, the
application is processed, which includes obtaining credit reports, financial
statements and tax returns on the borrowers and guarantors, an independent
appraisal of the project, and any other expert reports necessary to evaluate
the proposed project. In the event of cost overruns, the Bank generally
requires that the borrower increase the funds available for construction by
depositing its own funds into a secured savings account, the proceeds of which
are used to pay construction costs.
Loan disbursements during the construction period are made to the
builder, materials' supplier or subcontractor, based on a line item budget.
Periodic on-site inspections are made by qualified inspectors to document the
reasonableness of draw requests. For most builders, the Bank disburses loan
funds by providing vouchers to suppliers, which when used by the builder to
purchase supplies are submitted by the supplier to the Bank for payment.
The Bank regularly monitors the construction loan disbursements using an
internal monitoring system which the Bank believes reduces many of the risks
inherent with construction lending.
The Bank originates construction loan applications primarily through
customer referrals, contacts in the business community and occasionally real
estate brokers seeking financing for their clients.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost of
the project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the
estimate of value upon completion proves to be inaccurate, the Bank may be
confronted with a project whose value is insufficient to assure full repayment
and it may incur a loss. Projects may also be jeopardized by disagreements
between borrowers and builders and by the failure of builders to pay
subcontractors. Loans to builders to construct homes for which no purchaser
has been identified carry more risk because the payoff for the loan depends on
the builder's ability to sell the property prior to the time that the
construction loan is due. The Bank has sought to address these risks by
adhering to strict underwriting policies, disbursement procedures, and
monitoring practices. The Bank's construction lending is primarily secured by
properties in its primary market area, and changes in the local and state
economies and real estate markets have adversely affected the Bank's
construction loan portfolio.
Multi-Family Lending. At September 30, 2008, the Bank had $25.9 million,
or 4.2% of the Bank's total loan portfolio, secured by multi-family dwelling
units (more than four units) located primarily in the Bank's primary market
area. Multi-family loans are generally originated with variable rates of
interest ranging from 2.00% to 3.50% over the one-year constant maturity U.S.
Treasury Bill Index or a matched term FHLB advance, with principal and
interest payments fully amortizing over terms of up to 30 years. At September
30, 2008, the largest multi-family loan had an outstanding principal balance
of $5.1 million and was secured by an apartment building located in the Bank's
primary market area. At September 30, 2008, this loan was performing
according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally up to
80%. The Bank generally requests its multi-family loan borrowers with loan
balances in excess of $750,000 to submit financial statements and rent rolls
on the subject property annually. The Bank also inspects the subject property
annually. The Bank generally imposes a minimum debt coverage ratio of
approximately 1.20 times for loans secured by multi-family properties.
Multi-family mortgage lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to four-
family residential lending. However, loans secured by multi-family properties
8
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family
properties are often dependent on the successful operation and management of
the properties, repayment of such loans may be affected by adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these
risks by strictly scrutinizing the financial condition of the borrower, the
quality of the collateral and the management of the property securing the
loan. If the borrower is other than an individual, the Bank also generally
obtains personal guarantees from the principals based on a review of personal
financial statements.
Commercial Real Estate Lending. Commercial real estate loans totaled
$146.2 million, or 23.9% of the total loan portfolio at September 30, 2008,
and consisted of 338 loans. The Bank originated $29.3 million of commercial
real-estate loans during the year ended September 30, 2008 compared to $35.9
million originated during the year ended September 30, 2007. The Bank
originates commercial real estate loans generally at variable interest rates
and these loans are secured by properties, such as restaurants, motels,
mini-storage facilities, office buildings and retail/wholesale facilities,
located in the Bank's primary market area. At September 30, 2008, the largest
commercial real estate loan was secured by a commercial property located in
Olympia, Washington, had a balance of $4.6 million and was performing
according to its terms. At September 30, 2008, one commercial real estate
loan with a balance of $714,000 was not performing according to its terms.
See "- Lending Activities - Non-performing Assets and Delinquencies."
The Bank typically requires appraisals of properties securing commercial
real estate loans. For loans that are less than $250,000, the Bank may use
the tax assessed value and a property inspection in lieu of an appraisal.
Appraisals are performed by independent appraisers designated by the Bank, all
of which are reviewed by management. The Bank considers the quality and
location of the real estate, the credit history of the borrower, the cash flow
of the project and the quality of management involved with the property. The
Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for
originated loans secured by income producing commercial properties.
Loan-to-value ratios on commercial real estate loans are generally limited to
not more than 80%. The Bank generally obtains loan guarantees from
financially capable parties and reviews their personal financial statements.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to
four-family residential lending. However, loans secured by such properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by commercial
properties often depend upon the successful operation and management of the
properties, repayment of these loans may be affected by adverse conditions in
the real estate market or the economy. The Bank seeks to minimize these risks
by generally limiting the maximum loan-to-value ratio to 80% and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank
also requests annual financial information and rent rolls on the subject
property from the borrowers on loans over $750,000.
Land Lending. The Bank originates loans for the acquisition of land upon
which the purchaser can then build or make improvements necessary to build or
to sell as improved lots. At September 30, 2008, land loans totaled $60.7
million, or 9.9% of the Bank's total loan portfolio as compared to $60.7
million, or 10.3% of the Bank's total loan portfolio at September 30, 2007.
Land loans originated by the Bank are generally fixed-rate loans and have
maturities of five to ten years. The largest land loan had an outstanding
balance of $3.0 million at September 30, 2008 and was performing according to
its terms. At September 30, 2008, seven land loans totaling $726,000 were not
performing according to their terms. See "- Lending Activities -
Non-performing Assets and Delinquencies."
Loans secured by undeveloped land or improved lots involve greater risks
than one- to four-family residential mortgage loans because these loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
in the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer loans generally have shorter terms to
maturity and higher interest rates than mortgage loans. Consumer loans
include home equity lines of credit, second mortgage loans, savings account
loans,
9
automobile loans, boat loans, motorcycle loans, recreational vehicle loans and
unsecured loans. Consumer loans are made with both fixed and variable
interest rates and with varying terms. At September 30, 2008, consumer loans
amounted to $59.3 million, or 9.7%, of the total loan portfolio.
At September 30, 2008, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $48.7 million, or 8.0%, of the total loan portfolio. Home
equity lines of credit and second mortgage loans are made for purposes such as
the improvement of residential properties, debt consolidation and education
expenses, among others. The majority of these loans are made to existing
customers and are secured by a first or second mortgage on residential
property. The Bank occasionally solicits these loans. The loan- to-value
ratio is typically 80% or less, when taking into account both the first and
second mortgage loans. Second mortgage loans typically carry fixed interest
rates with a fixed payment over a term between five and 15 years. Home equity
lines of credit are generally made at interest rates tied to the prime rate or
the 26 week Treasury Bill. Second mortgage loans and home equity lines of
credit have greater credit risk than one- to four-family residential mortgage
loans because they are secured by mortgages subordinated to the existing first
mortgage on the property, which may or may not be held by the Bank.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining
deficiency often does not warrant further substantial collection efforts
against the borrower beyond obtaining a deficiency judgment. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and are more likely to be adversely affected by job loss, divorce,
illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount that can be recovered on such loans. The Bank
believes that these risks are not as prevalent in the case of the Bank's
consumer loan portfolio because a large percentage of the portfolio consists
of second mortgage loans and home equity lines of credit that are underwritten
in a manner such that they result in credit risk that is substantially similar
to one- to four-family residential mortgage loans. At September 30, 2008,
three consumer loans totaling $160,000 were delinquent in excess of 90 days.
See "- Lending Activities - Non-performing Assets and Delinquencies."
Commercial Business Lending. Commercial business loans totaled $21.0
million, or 3.4% of the loan portfolio at September 30, 2008, and consisted of
126 loans. Commercial business loans are generally secured by business
equipment, accounts receivable, inventory or other property and are made at
variable rates of interest equal to a negotiated margin above the prime rate.
The Bank also generally obtains personal guarantees from financially capable
applicants based on a review of personal financial statements. The largest
commercial business loan had an outstanding balance of $2.4 million at
September 30, 2008 and was performing according to its terms. At September
30, 2008, one commercial business loan with a balance of $250,000 was not
performing according to its terms. See "- Lending Activities - Non-performing
Assets and Delinquencies."
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral based lending with loan
amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business
loans are often collateralized by equipment, inventory, accounts receivable or
other business assets, the liquidation of collateral in the event of a
borrower default is often an insufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete
or of limited use, among other things. Accordingly, the repayment of a
commercial business loan depends primarily on the creditworthiness of the
borrower (and any guarantors), while liquidation of collateral is a secondary
and often insufficient source of repayment.
10
Loan Maturity. The following table sets forth certain information at
September 30, 2008 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Loans having no stated maturity
and overdrafts are reported as due in one year or less.
After After After
1 Year 3 Years 5 Years
Within Through Through Through After
1 Year 3 Years 5 Years 10 Years 10 Years Total
------ ------- ------- -------- -------- -----
(In thousands)
Mortgage loans:
One- to four-family
(1)................. $ 1,248 $ 3,206 $ 3,461 $ 8,444 $ 95,940 $112,299
Multi-family......... 1,616 -- 1,284 21,905 1,122 25,927
Commercial........... 13,685 4,580 20,082 95,706 12,170 146,223
Construction and land
development(2)..... 175,357 10,934 53 -- -- 186,344
Land................. 22,926 15,959 17,606 2,944 1,266 60,701
Consumer loans:
Home equity and second
mortgage............ 13,394 2,068 1,935 6,899 24,394 48,690
Other................ 2,270 1,222 1,934 824 4,385 10,635
Commercial business
loans................ 12,455 2,554 2,979 2,109 921 21,018
-------- ------- ------- -------- -------- --------
Total................ $242,951 $40,523 $49,334 $138,831 $140,198 $611,837
======== ======= ======= ======== ======== --------
Less:
Undisbursed portion
of construction
loans in process.... (43,353)
Deferred loan
origination fees.... (2,747)
Allowance for loan
losses.............. (8,050)
--------
Loans receivable,
net................. $557,687
========
-------------
(1) Includes loans held-for-sale.
(2) Includes construction/permanent loans that convert to permanent mortgage
loans once construction is completed.
The following table sets forth the dollar amount of all loans due after
one year from September 30, 2008, which have fixed interest rates and have
floating or adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates Total
------- ---------------- ---------
(In thousands)
Mortgage loans:
One- to four-family(1)............... $ 60,142 $ 50,909 $111,051
Multi-family......................... 5,612 18,699 24,311
Commercial........................... 17,147 115,391 132,538
Construction and land development.... 5,819 5,168 10,987
Land................................. 26,493 11,282 37,775
Consumer loans:
Home equity and second mortgage...... 25,408 9,888 35,296
Other................................ 8,213 152 8,365
Commercial business loans............. 4,034 4,529 8,563
-------- -------- --------
Total.............................. $152,868 $216,018 $368,886
======== ======== ========
-----------
(1) Includes loans held-for-sale.
11
Scheduled contractual principal repayments of loans do not reflect the
actual life of these assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase, however, when
current mortgage loan interest rates are substantially higher than interest
rates on existing mortgage loans and, conversely, decrease when interest rates
on existing mortgage loans are substantially higher than current mortgage loan
interest rates.
Loan Solicitation and Processing. Loan originations are obtained from a
variety of sources, including walk-in customers, and referrals from builders
and realtors. Upon receipt of a loan application from a prospective borrower,
a credit report and other data are obtained to verify specific information
relating to the loan applicant's employment, income and credit standing. An
appraisal of the real estate offered as collateral generally is undertaken by
an appraiser retained by the Bank and certified by the State of Washington.
Loan applications are initiated by loan officers and are required to be
approved by an authorized loan underwriter, one of the Bank's Loan Committees
or the Bank's Board of Directors. The Bank's Consumer Loan Committee, which
consists of three underwriters, each of whom can approve one-to four-family
mortgage loans and other consumer loans up to and including the current FHLMC
single-family limit. Certain consumer loans up to and including $25,000 may
be approved by individual loan officers and the Bank's Consumer Lending
Department Manager may approve consumer loans up to and including $75,000.
The Bank's Regional Manager of Commercial Lending has individual lending
authority for loans up to and including $250,000, excluding speculative
construction loans and unsecured loans. The Bank's Commercial Loan Committee,
which consists of the Bank's President, Chief Credit Administrator, Executive
Vice President of Commercial Lending, Executive Vice President of Community
Lending, and Regional Manager of Commercial Lending, may approve commercial
real estate loans and commercial business loans up to and including $1.5
million. The Bank's President, Executive Vice President of Commercial Lending
and Executive Vice President of Community Lending also have individual lending
authority for loans up to and including $750,000. The Bank's Board Loan
Committee, which consists of two rotating non-employee Directors and the
Bank's President, may approve loans up to and including $3.0 million. Loans
in excess of $3.0 million, as well as loans of any amount granted to a single
borrower whose aggregate loans exceed $3.0 million, must be approved by the
Bank's Board of Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 2008 and 2007, the Bank's total gross loan originations were $258.6
million and $279.1 million, respectively. Periodically, the Bank purchases
participation interests in construction and land development loans, commercial
real estate loans, and multi-family loans, secured by properties generally
located in Washington State, from other lenders. These purchases are
underwritten to the Bank's underwriting guidelines and are without recourse to
the seller other than for fraud. During the years ended September 30, 2008
and 2007, the Bank purchased loan participation interests of $2.9 million and
$20.4 million, respectively. See "- Lending Activities - Construction and
Land Development Lending" and "- Lending Activities - Multi-Family Lending."
Consistent with its asset/liability management strategy, the Bank's
policy generally is to retain in its portfolio all ARM loans originated and to
sell fixed rate one-to four-family mortgage loans in the secondary market to
the FHLMC; however, from time to time, a portion of fixed-rate loans may be
retained in the Bank's portfolio to meet its asset-liability objectives.
Loans sold in the secondary market are generally sold on a servicing retained
basis. At September 30, 2008, the Bank's loan servicing portfolio totaled
$175.6 million.
The Bank also periodically sells participation interests in construction
and land development loans, commercial real estate loans, and land loans to
other lenders. These sales are usually made to avoid concentrations in a
particular loan type or concentrations to a particular borrower. The Bank
sold $17.0 million in loan participation interests to other lenders during the
year ended September 30, 2008.
12
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
----------------------------
2008 2007 2006
------ ----- ------
Loans originated: (In thousands)
Mortgage loans:
One- to four-family...................... $ 45,844 $ 33,252 $ 33,483
Multi-family............................. 4,710 4,397 3,037
Commercial............................... 29,306 35,886 32,174
Construction and land development........ 118,186 127,082 129,623
Land..................................... 25,858 35,066 17,518
Consumer.................................. 22,411 32,354 29,858
Commercial business loans................. 12,268 11,020 10,559
--------- --------- ---------
Total loans originated................... 258,583 279,057 256,252
Loans purchased:
Mortgage loans:
One- to four-family...................... -- -- 48
Multi-family............................. -- 5,200 -
Commercial............................... -- -- 79
Construction and land development........ 2,862 15,175 -
Land..................................... -- -- 28
--------- --------- ---------
Total loans purchased................... 2,862 20,375 155
--------- --------- ---------
Total loans originated and purchased.. 261,445 299,432 256,407
Loans sold:
Whole loans sold.......................... (45,269) (29,893) (26,445)
Participation loans sold.................. (17,035) (6,650) --
--------- --------- ---------
Total loans sold.......................... (62,304) (36,543) (26,445)
Loan principal repayments.................. (176,083) (164,935) (177,011)
Decrease (increase) in other items, net.... 19,288 (7,258) (16,415)
--------- --------- ---------
Net increase in loans receivable........... $ 42,346 $ 90,696 $ 36,536
========= ========= =========
Loan Origination Fees. The Bank receives loan origination fees on a
majority of its mortgage loans and commercial business loans. Loan fees are a
percentage of the loan which are charged to the borrower for funding the loan.
The amount of fees charged by the Bank is generally 0.0% to 2.0% of the loan
amount. Current accounting principles generally accepted in the United States
of America require fees received and certain loan origination costs for
originating loans to be deferred and amortized into interest income over the
contractual life of the loan. Net deferred fees or costs associated with
loans that are prepaid are recognized as income at the time of prepayment.
Deferred loan origination fees totaled $2.7 million at September 30, 2008.
Non-performing Assets and Delinquencies. The Bank assesses late fees or
penalty charges on delinquent loans of approximately 5% of the monthly loan
payment amount. A majority of loan payments are due on the first day of the
month; however, the borrower is given a 15 day grace period to make the loan
payment. When a mortgage loan borrower fails to make a required payment when
due, the Bank institutes collection procedures. A notice is mailed to the
borrower 16 days after the date the payment is due. Attempts to contact the
borrower by telephone generally begin on or before the 30th day of
delinquency. If a satisfactory response is not obtained, continuous follow-up
contacts are attempted until the loan has been brought current. Before the
90th day of delinquency, attempts are made to establish (i) the cause of the
delinquency, (ii) whether the cause is temporary, (iii) the attitude of the
borrower toward the debt, and (iv) a mutually satisfactory arrangement for
curing the default.
13
If the borrower is chronically delinquent and all reasonable means of
obtaining payment on time have been exhausted, foreclosure is initiated
according to the terms of the security instrument and applicable law.
Interest income on loans in foreclosure is reduced by the full amount of
accrued and uncollected interest.
When a consumer loan borrower or commercial business borrower fails to
make a required payment on a loan by the payment due date, the Bank institutes
similar collection procedures as for its mortgage loan borrowers. Loans
becoming 90 days or more past due are placed on non-accrual status, with any
accrued interest reversed against interest income, unless they are well
secured and in the process of collection.
The Bank's Board of Directors is informed monthly as to the status of
loans that are delinquent by more than 30 days, and the status of all
foreclosed and repossessed property owned by the Bank.
The following table sets forth information with respect to the Company's
non-performing assets at the dates indicated.
At September 30,
----------------------------------------------
2008 2007 2006 2005 2004
------ ------ ------ ------ ------
Loans accounted for on a (In thousands)
non-accrual basis:
Mortgage loans:
One- to four-family....... $ 300 $ 252 $ 80 $ 2,208 $ 430
Commercial................ 714 90 -- 261 640
Construction and land
development.............. 9,840 1,000 -- - --
Land...................... 726 28 -- 23 322
Consumer loans............. 160 -- -- 133 23
Commercial business loans.. 250 120 -- 301 27
-------- -------- -------- -------- --------
Total.................... 11,990 1,490 80 2,926 1,442
Accruing loans which are
contractually past due 90
days or more.............. -- -- -- -- --
Total of non-accrual and
90 days past due loans.... 11,990 1,490 80 2,926 1,442
Other real estate owned
and other repossessed
assets.................... 511 -- 15 509 421
-------- -------- -------- -------- --------
Total non-performing
assets (1).............. $ 12,501 $ 1,490 $ 95 $ 3,435 $ 1,863
======== ======== ======== ======== ========
Troubled debt restructured
loans..................... $ 272 $ -- $ -- $ -- $ --
Non-accrual and 90 days
or more past due loans as
a percentage of loans
receivable, net........... 2.12% 0.29% 0.02% 0.75% 0.41%
Non-accrual and 90 days
or more past due loans as
a percentage of total
assets.................... 1.76% 0.23% 0.01% 0.53% 0.31%
Non-performing assets as
a percentage of total
assets.................... 1.83% 0.23% 0.02% 0.62% 0.40%
Loans receivable, net (2).. $565,737 $520,138 $428,767 $392,208 $348,585
======== ======== ======== ======== ========
Total assets............... $681,883 $644,848 $577,087 $552,765 $460,419
======== ======== ======== ======== ========
------------
(1) Includes non-accrual loans, other real estate owned and other repossessed
assets.
(2) Includes loans held-for-sale and is before the allowance for loan losses.
The Bank's non-accrual loans increased by $10.5 million to $12.0 million
at September 30, 2008 from $1.5 million at September 30, 2007, primarily as a
result of a $8.8 million increase in construction and land development loans
on non-accrual status, a $698,000 increase in land loans on non-accrual status
and a $624,000 increase in commercial real estate loans on non-accrual status.
The largest non-performing loan was secured by a land development project in
14
Richland, Washington and had a balance of $3.1 million at September 30, 2008.
Management's evaluation of the collateral determined potential impairment of
$523,000 existed at September 30, 2008, which was factored into the Bank's
allowance for loan loss analysis.
Additional interest income which would have been recorded for the year
ended September 30, 2008 had non-accruing loans been current in accordance
with their original terms totaled $584,000.
Other Real Estate Owned and Other Repossessed Items. Real estate
acquired by the Bank as a result of foreclosure or by deed-in-lieu of
foreclosure is classified as other real estate owned until sold. When
property is acquired, it is recorded at the lower of its cost, which is the
unpaid principal balance of the related loan plus foreclosure costs, or fair
market value. Subsequent to foreclosure, the property is recorded at the
lower of the foreclosed amount or fair value, less estimated selling costs.
At September 30, 2008, the Bank had $511,000 of other real estate owned and
other repossessed items. This consisted of one single-family residence and
two vehicles.
Restructured Loans. Under accounting principles generally accepted in
the United States of America, the Bank is required to account for certain loan
modifications or restructuring as a "troubled debt restructuring." In
general, the modification or restructuring of a debt constitutes a troubled
debt restructuring if the Bank for economic or legal reasons related to the
borrower's financial difficulties grants a concession to the borrowers that
the Bank would not otherwise consider. Debt restructuring or loan
modifications for a borrower does not necessarily always constitute troubled
debt restructuring, however, and troubled debt restructurings do not
necessarily result in non-accrual loans. The Bank had $272,000 in
restructured loans at September 30, 2008.
Other Loans of Concern. Loans not reflected in the table above, but
where known information about possible credit problems of borrowers causes
management to have doubts as to the ability of the borrower to comply with
present repayment terms and that may result in disclosure of such loans and
leases as non-performing assets in the future are commonly referred to as
"other loans of concern" or "potential problem loans." The amount included in
potential problem loans results from an evaluation, on a loan-by-loan basis,
of loans classified as "substandard" and "special mention," as those terms are
defined under "Asset Classification" below. The amount of potential problem
loans and non-performing loans was $42.8 million at September 30, 2008 and
$15.7 million at September 30, 2007. The vast majority of these loans are
collateralized. See "- Asset Classification" below for additional information
regarding our problem loans.
Asset Classification. Applicable regulations require that each insured
institution review and classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, regulatory examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
substandard, doubtful and loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of substandard assets with the additional
characteristic that the weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions and values questionable, and
there is a high possibility of loss. An asset classified as loss is
considered uncollectible and of such little value that continuance as an asset
of the institution is not warranted. When an insured institution classifies
problem assets as either substandard or doubtful, it is required to establish
general allowances for loan losses in an amount deemed prudent by management.
These allowances represent loss allowances which have been established to
recognize the inherent risk associated with lending activities and the risks
associated with particular problem assets. When an insured institution
classifies problem assets as loss, it charges off the balance of the asset
against the allowance for loan losses. Assets which do not currently expose
the insured institution to sufficient risk to warrant classification in one of
the aforementioned categories but possess weaknesses are required to be
designated as special mention. The Bank's determination of the classification
of its assets and the amount of its valuation allowances is subject to review
by the FDIC and the Division which can order the establishment of additional
loss allowances.
15
The aggregate amounts of the Bank's classified and special mention loans
(as determined by the Bank), and of the Bank's allowances for loan losses at
the dates indicated, were as follows:
At September 30,
----------------------------
2008 2007 2006
------- ------- -------
(In thousands)
Loss............................. $ -- $ -- $ --
Doubtful......................... -- -- --
Substandard(1)(2)................ 24,603 8,812 3,985
Special mention(1)............... 18,225 6,917 9,015
------- ------- -------
Total classified and special
mention loans.................. $42,828 $15,729 $13,000
======= ======= =======
Allowance for loan losses........ $ 8,050 $ 4,797 $ 4,122
------------
(1) For further information concerning the change in classified assets, see
"- Lending Activities - Non-performing Assets and Delinquencies."
(2) Includes non-performing loans.
The Bank's classified and special mention loans increased by $27.1
million from September 30, 2007 to September 30, 2008, primarily as a result
of a $15.8 million increase in loans classified as substandard and an $11.3
million increase in loans classified as special mention.
Special mention loan are defined as those credits deemed by management to
have some potential weakness that deserve management's close attention. If
left uncorrected these potential weaknesses may result in the deterioration of
the payment prospects of the loan. Assets in this category are not adversely
classified and currently do not expose the Bank to sufficient risk to warrant
a substandard classification. Five individual loans comprise $12.8 million,
or 70.3%, of the $18.2 million in loans classified as special mention. They
include a $3.8 million loan secured by a commercial mixed-use building in
Thurston County, a $3.5 million loan secured by a mini-storage facility in
King County, a $2.4 million loan secured by commercial acreage in Kitsap
County, a $1.6 million loan secured by commercial property in Grays Harbor
County, and a $1.5 million loan secured by a speculative single family
construction home on lake front property in Pierce County. At September 30,
2008 these loans were current and paying in accordance with their required
terms.
Substandard loans are classified as those loans that are inadequately
protected by the current net worth, and paying capacity of the obligor, or of
the collateral pledged. Assets classified as substandard have a well-defined
weakness, or weaknesses that jeopardize the repayment of the debt. If the
weakness, or weaknesses are not corrected there is the distinct possibility
that some loss will be sustained. The aggregate amount of loans classified as
substandard at September 30, 2008 increased by $15.8 million to $24.6 million
from $8.8 million at September 30, 2007. At September 30, 2008, 68 loans were
classified as substandard compared to 26 at September 30, 2007.
Eight credit relationships comprise $19.7 million, or 80.1%, of the $24.6
million in loans classified as substandard (including non-performing loans).
The largest of these eight relationships is with a long-time builder of the
Bank who currently has $4.7 million (including $757,000 in undisbursed
construction loans in process) in loans classified as substandard. These
loans are secured by two land development projects, six single-family
speculative construction homes, and a lien on the borrower's personal
residence. The properties are located in Thurston and King Counties and were
performing according to their terms at September 30, 2008.
The next largest credit relationships classified as substandard are
summarized below.
* $3.3 million in loans secured by a 16-unit condominium project in
Leavenworth, Washington. These loans were performing according to
their terms at September 30, 2008.
16
* $3.1 million loan secured by a land development project in
Richland, Washington. This loan was not performing according to
terms at September 30, 2008 and was on non-accrual status.
Management's evaluation of the collateral determined potential
impairment of $523,000 existed at September 30, 2008, which was
factored into the Bank's allowance for loan loss analysis.
* $2.6 million (including $81,000 of undisbursed construction loans
in process) in loans secured by four completed single-family
speculative homes on acreage, one single family speculative home in
process and four land parcels, all of which are located in Thurston
County. These loans were not performing according to their terms
at September 30, 2008 and were on non-accrual status. Management's
evaluation of the collateral determined potential impairment of
$106,000 existed at September 30, 2008, which was factored into the
Bank's allowance for loan loss analysis.
* $2.0 million (including $127,000 in undisbursed construction loans
in process) in loans secured by two completed single family
speculative homes and four single family speculative homes, all of
which are located in Pierce County. These loans were not
performing according to their terms at September 30, 2008 and were
on non-accrual status. Management's evaluation of the collateral,
including costs to complete construction and market the properties
determined that there was no impairment at September 30, 2008.
* $1.4 million participation interest in a loan secured by a land
development project in Clark County. This loan was not performing
according to its terms at September 30, 2008 and was on non-accrual
status. As part of management's evaluation of the collateral,
$348,000 of the loan was charged off. This reduced the balance to
$1.4 million at September 30, 2008.
* $1.4 million loan secured by a nine-unit condominium project in
Grays Habor County. This loan was 60 days past due at September
30, 2008.
* $1.2 million commercial business loan secured by a mini-storage /
RV facility on leased land in Pierce County. This loan was
performing according to its terms at September 30, 2008.
Allowance for Loan Losses. The allowance for loan losses is maintained
to cover estimated losses in the loan portfolio. The Bank has established a
comprehensive methodology for the determination of provisions for loan losses
that takes into consideration the need for an overall general valuation
allowance. The Bank's methodology for assessing the adequacy of its allowance
for loan losses is based on its historic loss experience for various loan
segments; adjusted for changes in economic conditions, delinquency rates, and
other factors. Using these loss estimate factors, management develops a range
of probable loss for each loan category. Certain individual loans for which
full collectibility may not be assured are evaluated individually with loss
exposure based on estimated discounted cash flows or collateral values. The
total estimated range of loss based on these two components of the analysis is
compared to the loan loss allowance balance. Based on this review, management
will adjust the allowance as necessary to maintain directional consistency
with trends in the loan portfolio.
In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. The Bank increases its allowance for loan losses
by charging provisions for loan losses against the Bank's income.
The Board of Directors reviews the adequacy of the allowance for loan
losses at least quarterly based on management's assessment of current economic
conditions, past loss and collection experience, and risk characteristics of
the loan portfolio.
At September 30, 2008, the Bank's allowance for loan losses totaled $8.1
million. This represents 1.42% of the total loans receivable and 67.14% of
non-performing loans. The Bank's allowance for loan losses as a percentage
17
of total loans receivable has increased to 1.42% at September 30, 2008 from
0.92% at September 30, 2007 primarily due to uncertainties in the housing
market and the economy, and an increased level of charge-offs (which has
translated into higher loss factors assigned to certain loan categories),
increased levels of non-performing loans, and increased levels of classified
loans.
Management believes that the amount maintained in the allowance is
adequate to absorb probable losses in the portfolio. Although management
believes that it uses the best information available to make its
determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.
While the Bank believes it has established its existing allowance for
loan losses in accordance with accounting principles generally accepted in the
United States of America, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future
events affecting borrowers and collateral cannot be predicted with certainty,
there can be no assurance that the existing allowance for loan losses is
adequate or that substantial increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
Any material increase in the allowance for loan losses may adversely affect
the Bank's financial condition and results of operations.
18
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended September 30,
-------------------------------------------
2008 2007 2006 2005 2004
------ ------ ------ ------ ------
(Dollars in thousands)
Allowance at beginning of year... $4,797 $4,122 $4,099 $3,991 $ 3,891
Provision for loan losses........ 3,900 686 -- 141 167
Recoveries:
Mortgage loans:
One- to four-family............. -- -- -- -- 6
Consumer loans:
Home equity and second
mortgage....................... -- -- -- 5 --
Other........................... 1 1 5 3 16
Commercial business loans........ -- -- 20 9 3
------ ------ ------ ------ -------
Total recoveries.............. 1 1 25 17 25
Charge-offs:
Mortgage loans:
One- to four-family............. -- -- -- -- 6
Multi-family.................... -- -- -- 1 --
Construction.................... 648 -- -- -- --
Commercial business loans........ -- -- -- -- 3
Land............................. -- -- -- 1 --
Consumer loans:
Home equity and second
mortgage....................... -- -- -- -- 9
Other........................... -- 12 2 12 68
Commercial business loans........ -- -- -- 36 6
------ ------ ------ ------ -------
Total charge-offs............. 648 12 2 50 92
------ ------ ------ ------ -------
Net charge-offs (recoveries).. 647 11 (23) 33 67
------ ------ ------ ------ -------
Balance at end of year....... $8,050 $4,797 $4,122 $4,099 $3,991
====== ====== ====== ====== ======
Allowance for loan losses as a
percentage of total loans
receivable (net)(1) outstanding
at the end of the year.......... 1.42% 0.92% 0.96% 1.05% 1.14%
Net charge-offs (recoveries) as
a percentage of average loans
outstanding during the year..... 0.12% 0.00% (0.01%) 0.01% 0.02%
Allowance for loan losses as a
percentage of non-performing
loans at end of year excluding
troubled debt restructurings.... 67.14% 321.95% 5,152.50% 140.09% 276.77%
-------------
(1) Total loans receivable (net) includes loans held for sale and is before
the allowance for loan losses.
19
The following table sets forth the allocation of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
----------------------------------------------------------------------------------------------
2008 2007 2006 2005 2004
----------------- ------------------ ---------------- ----------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- -------- -------- -------- ------ -------- ------- -------- ------- ---------
(Dollars in thousands)
Mortgage loans:
One- to four-
family....... $ 476 18.35% $ 396 17.40% $ 502 20.11% $ 494 23.24% $ 386 25.25%
Multi-family.. 248 4.24 200 5.97 112 3.60 194 4.61 242 4.34
Commercial.... 1,521 23.90 1,368 21.72 1,222 28.04 1,544 28.51 1,443 27.39
Construction.. 3,254 30.46 1,047 31.64 761 29.92 652 25.68 538 26.88
Land.......... 1,435 9.92 549 10.30 275 6.03 255 5.71 226 5.03
Non-mortgage
loans:
Consumer
loans........ 457 9.69 412 9.88 497 9.90 255 9.51 427 8.30
Commercial
business
loans........ 659 3.44 825 3.09 753 2.40 705 2.74 729 2.81
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total
allowance
for loan
losses...... $8,050 100.00% $4,797 100.00% $4,122 100.00% $4,099 100.00% $3,991 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
20
Investment Activities
The investment policies of the Company are established and monitored by
the Board of Directors. The policies are designed primarily to provide and
maintain liquidity, to generate a favorable return on investments without
incurring undue interest rate and credit risk, and to compliment the Bank's
lending activities. These policies dictate the criteria for classifying
securities as either available-for-sale or held-to-maturity. The policies
permit investment in various types of liquid assets permissible under
applicable regulations, which includes U.S. Treasury obligations, securities
of various federal agencies, certain certificates of deposit of insured banks,
banker's acceptances, federal funds, mortgage-backed securities, and mutual
funds. The Company's investment policy also permits investment in equity
securities in certain financial service companies.
At September 30, 2008, the Company's investment portfolio totaled $31.3
million, primarily consisting of $16.2 million of mortgage-backed securities
available-for-sale, $936,000 of mutual funds available-for-sale, and $14.2
million of mortgaged-backed securities held-to-maturity. The Company does not
maintain a trading account for any investments. This compares with a total
investment portfolio of $64.0 million at September 30, 2007, primarily
consisting of $31.9 million of mutual funds available-for-sale, $13.0 million
of mortgage-backed securities available-for-sale, $19.0 million of U.S. agency
securities available-for-sale, and $71,000 of securities held-to-maturity. In
June 2008, the Company redeemed its $29.1 million investment in the AMF family
of mutual funds and recognized a $2.8 million loss on the redemption. The net
asset value of the mutual funds had declined primarily as a result of the
uncertainty in spreads in the bond market for private label mortgage-related
securities and credit downgrades to a small percentage of the underlying
securities. As a result of the redemption, the Company received $22.2 million
in underlying mortgaged-backed securities and $6.9 million in cash. The
Company also had $19.0 million in U.S. agency securities that matured or were
called during the year ended September 30, 2008. The Company used the
proceeds from the security maturities and redemptions primarily to fund loan
growth. The composition of the portfolios by type of security, at each
respective date is presented in the following table.
At September 30,
--------------------------------------------------------
2008 2007 2006
----------------- ----------------- ------------------
Percent Percent Percent
Recorded of Recorded of Recorded of
Value Total Value Total Value Total
-------- ------- -------- ------- -------- --------
(Dollars in thousands)
Held-to-Maturity:
U.S. agency
securities......... $ 28 0.09% $ -- --% $ -- --%
Mortgage-backed
securities......... 14,205 45.34 71 0.11 75 0.09
Available-for-Sale
(at fair value):
U.S. agency
securities......... -- -- 18,976 29.66 31,718 38.93
Mortgage-backed
securities......... 16,162 51.58 13,047 20.39 17,603 21.60
Mutual funds........ 936 2.99 31,875 49.84 32,087 39.38
------- ------ ------- ------ ------- ------
Total portfolio...... $31,331 100.00% $63,969 100.00% $81,483 100.00%
======= ====== ======= ====== ======= ======
21
The following table sets forth the maturities and weighted average yields
of the investment and mortgage-backed securities in the Company's investment
securities portfolio at September 30, 2008. Mutual funds, which by their
nature do not have maturities, are classified in the one year or less
category.
After One to After Five to After Ten
One Year or Less Five Years Ten Years Years
---------------- ---------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Held-to-Maturity:
U.S. agency securities.. $ -- --% $ 14 3.25% $ 14 3.98% $ -- --%
Mortgage-backed
securities............. -- -- 1 4.60 58 4.71 14,146 6.72
Available-for-Sale:
Mortgage-backed
securities............. -- -- 576 5.03 283 5.93 15,303 4.45
Mutual funds............ 936 4.21 -- -- -- -- -- --
---- ---- ---- ---- ---- ---- ------- ----
Total portfolio......... $936 4.21% $591 4.99% $355 5.68% $29,449 5.52%
==== ==== ==== ==== ==== ==== ======= ====
There were no securities which had an aggregate book value in excess of
10% of the Company's total equity at September 30, 2008.
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the
Bank's funds for lending and other investment purposes. Scheduled loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are influenced significantly by general interest
rates and money market conditions. Borrowings through the FHLB-Seattle and
Pacific Coast Banker's Bank ("PCBB") may be used to compensate for reductions
in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank's depositors are
residents of Washington. Deposits are attracted from within the Bank's market
area through the offering of a broad selection of deposit instruments,
including money market deposit accounts, checking accounts, regular savings
accounts and certificates of deposit. Deposit account terms vary, according
to the minimum balance required, the time periods the funds must remain on
deposit and the interest rate, among other factors. In determining the terms
of its deposit accounts, the Bank considers current market interest rates,
profitability to the Bank, matching deposit and loan products and its customer
preferences and concerns. The Bank actively seeks consumer and commercial
checking accounts through a checking account acquisition marketing program
that was implemented in 2000. At September 30, 2008, the Bank had 28.6% of
total deposits in non-interest bearing accounts and NOW checking accounts.
At September 30, 2008 the Bank had $73.1 million of jumbo certificates of
deposit of $100,000 or more. The Bank also had brokered certificates of
deposits totaling $26.0 million at September 30, 2008. The Bank believes that
its jumbo certificates of deposit and its brokered deposits, which represented
19.9% of total deposits at September 30, 2008, present similar interest rate
risk compared to its other deposits.
22
The following table sets forth information concerning the Bank's deposits
at September 30, 2008.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
---------------------------------------- ------------- --------- ----------
(In thousands)
Non-interest bearing.................... --% $ 51,955 10.42%
Negotiable order of withdrawal ("NOW")
checking............................... 0.90 90,468 18.15
Savings................................. 0.70 56,391 11.31
Money market............................ 2.40 70,379 14.11
-------- ------
Subtotal 1.24 269,193 53.99
Certificates of Deposit(1)
----------------------------------------
Maturing within 1 year.................. 3.72 175,817 35.26
Maturing after 1 year but within 2
years.................................. 3.54 46,407 9.31
Maturing after 2 years but within 5
years.................................. 3.93 6,759 1.36
Maturing after 5 years.................. 3.40 396 0.08
-------- ------
Total certificates of deposit.......... 3.30 229,379 46.01
---- -------- ------
Total deposits........................ 2.19% $498,572 100.00%
==== ======== ======
--------------
(1) Based on remaining maturity of certificates.
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of September 30, 2008. Jumbo
certificates of deposit have principal balances of $100,000 or more and the
rates paid on these accounts are generally negotiable.
Maturity Period Amount
----------------------------------- ------------
(In thousands)
Three months or less............... $26,413
Over three through six months...... 11,504
Over six through twelve months..... 21,472
Over twelve months................. 13,718
-------
Total............................ $73,107
=======
23
Deposit Flow. The following table sets forth the balances of deposits in the various types of accounts
offered by the Bank at the dates indicated.
At September 30,
------------------------------------------------------------------------------------
2008 2007 2006
------------------------------ ----------------------------- -------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- ---------- -------- -------- ---------- ------- --------
(Dollars in thousands)
Non-interest-bearing.... $ 51,955 10.42% $(3,007) $ 54,962 11.77% $(2,943) $ 57,905 13.43%
NOW checking............ 90,468 18.15 10,096 80,372 17.22 (9,137) 89,509 20.77
Savings................. 56,391 11.31 (21) 56,412 12.09 (3,823) 60,235 13.97
Money market............ 70,379 14.11 22,311 48,068 10.30 5,690 42,378 9.83
Certificates of deposit
which mature:
Within 1 year......... 175,817 35.26 (32,513) 208,330 44.63 54,391 153,939 35.71
After 1 year, but
within 2 years....... 46,407 9.31 33,668 12,739 2.73 (7,296) 20,037 4.65
After 2 years, but
within 5 years....... 6,759 1.36 1,028 5,731 1.23 (1,279) 7,010 1.63
Certificates maturing
thereafter........... 396 0.08 275 121 0.03 73 48 0.01
-------- ------ -------- -------- ------ ------- -------- ------
Total................... $498,572 100.00% $ 31,837 $466,735 100.00% $35,674 $431,061 100.00%
======== ====== ======== ======== ====== ======= ======== ======
24
Certificates of Deposit by Rates. The following table sets forth the
certificates of deposit in the Bank classified by rates as of the dates
indicated.
At September 30,
------------------------------
2008 2007 2006
-------- -------- --------
(In thousands)
0.00 - 1.99%........... $ 866 $ 676 $ 2,176
2.00 - 3.99%........... 203,859 46,810 69,736
4.00 - 5.99%........... 24,274 179,008 108,636
6.00% - and over....... 380 427 486
-------- -------- --------
Total.................. $229,379 $226,921 $181,034
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth
the amount and maturities of certificates of deposit at September 30, 2008.
Amount Due
-------------------------------------------------
After
One to Two to
Less Than Two Five After
One Year Years Years Five Years Total
--------- ------- ------- ---------- -------
(In thousands)
0.00 - 1.99%............ $ 803 $ 63 $ -- $ -- $ 866
2.00 - 3.99%............ 160,090 37,830 5,543 396 203,859
4.00 - 5.99%............ 14,914 8,199 1,161 -- 24,274
6.00% and over.......... 10 315 55 -- 380
-------- ------- ------ ---- --------
Total................... $175,817 $46,407 $6,759 $396 $229,379
======== ======= ====== ==== ========
Deposit Activities. The following table sets forth the savings
activities of the Bank for the periods indicated.
Year Ended September 30,
------------------------------
2008 2007 2006
-------- -------- --------
(In thousands)
Beginning balance....................... $466,735 $431,061 $411,665
Net deposits before interest credited .. 20,075 24,382 11,491
Interest credited....................... 11,762 11,292 7,905
Net increase in deposits................ 31,837 35,674 19,396
-------- -------- --------
Ending balance.......................... $498,572 $466,735 $431,061
======== ======== ========
Borrowings. Deposits are generally the primary source of funds for the
Bank's lending and investment activities and for general business purposes.
The Bank has the ability to use advances from the FHLB-Seattle to supplement
its supply of lendable funds and to meet deposit withdrawal requirements. The
FHLB-Seattle functions as a central reserve bank providing credit for member
financial institutions. As a member of the FHLB-Seattle, the Bank is required
to own capital stock in the FHLB-Seattle and is authorized to apply for
advances on the security of such stock and certain mortgage loans and other
assets (principally securities which are obligations of, or guaranteed by, the
United States government) provided certain creditworthiness standards have
been met. Advances are made pursuant to several different credit programs.
Each credit program has its own interest rate and range of maturities.
Depending on the program, limitations on the amount of advances are based on
the financial condition of the member institution and the adequacy of
collateral pledged to secure the credit. At September 30, 2008, the Bank
maintained an uncommitted credit facility with the FHLB-Seattle that provided
for immediately available advances up to an aggregate amount of 30% of the
Bank's total assets, limited by available collateral, under which $104.6
million was outstanding. The Bank also
25
utilizes overnight repurchase agreements with customers. These overnight
repurchase agreements are classified as other borrowings and totaled $758,000
at September 30, 2008, $595,000 at September 30, 2007 and $947,000 at
September 30, 2006. At September 30, 2008, the Bank also maintained a $10.0
million overnight borrowing line with PCBB under which there was no
outstanding balance.
The following table sets forth certain information regarding borrowings
by the Bank at the end of and during the periods indicated:
At or For the
Year Ended September 30,
----------------------------
2008 2007 2006
------ ------ ------
(Dollars in thousands)
Average total borrowings................... $108,858 $ 85,599 $55,773
Weighted average rate paid on total
borrowings............................... 4.27% 5.24% 5.22%
Total borrowings outstanding at end of
period................................... $105,386 $100,292 $63,708
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated.
Borrowings are considered short-term when the original maturity is less than
one year.
At or For the
Year Ended September 30,
----------------------------
2008 2007 2006
------ ------ ------
(Dollars in thousands)
Maximum amount outstanding at any month end:
FHLB advances.............................. $42,600 $72,750 $29,000
Repurchase agreements...................... 1,884 4,460 1,895
PCBB advances.............................. -- -- --
Average outstanding during period:
FHLB advances.............................. $13,366 $34,156 $ 3,516
Repurchase agreements...................... 943 1,019 1,148
PCBB advances.............................. 12 32 --
------- ------- -------
Total average outstanding during period..... $14,321 $35,207 $ 4,664
======= ======= =======
Weighted average rate paid during period:
FHLB advances.............................. 4.44% 5.58% 4.81%
Repurchase agreements...................... 2.12 4.61 4.27
PCBB advances.............................. 5.27 6.45 --
Total weighted average rate paid during
period..................................... 4.29% 5.55% 4.67%
Outstanding at end of period:
FHLB advances.............................. $ -- $30,000 $29,000
Repurchase agreements...................... 758 595 947
PCBB advances.............................. -- -- --
------- ------- -------
Total outstanding at end of period.......... $ 758 $30,595 $29,947
======= ======= =======
Weighted average rate at end of period:
FHLB advances.............................. --% 5.19% 5.49%
Repurchase agreements...................... 1.05 4.42 5.01
PCBB advances.............................. -- -- --
Total weighted average rate at end of
period..................................... 1.05% 5.17% 5.47%
26
Bank Owned Life Insurance
The Bank has purchased life insurance policies covering certain officers.
These policies are recorded at their cash surrender value, net of any policy
premium charged. Increases in cash surrender value, net of policy premiums,
and proceeds from death benefits are recorded in non-interest income. At
September 30, 2008, the Bank had $12.9 million in bank owned life insurance.
Regulation of the Bank
General. The Bank, as a state-chartered savings bank, is subject to
regulation and oversight by the Division and the applicable provisions of
Washington law and regulations of the Division adopted thereunder. The Bank
also is subject to regulation and examination by the FDIC, which insures the
deposits of the Bank to the maximum extent permitted by law, and requirements
established by the Federal Reserve. State law and regulations govern the
Bank's ability to take deposits and pay interest thereon, to make loans on or
invest in residential and other real estate, to make consumer loans, to invest
in securities, to offer various banking services to its customers, and to
establish branch offices. Under state law, savings banks in Washington also
generally have all of the powers that federal savings banks have under federal
laws and regulations. The Bank is subject to periodic examination and
reporting requirements by and of the Division and the FDIC.
Insurance of Accounts and Regulation by the FDIC. The Bank's deposits
are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.
As insurer, the FDIC imposes deposit insurance premiums and is authorized to
conduct examinations of and to require reporting by FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in any
activity the FDIC determines by regulation or order to pose a serious risk to
the insurance fund.
Under regulations effective January 1, 2007, the FDIC adopted a new
risk-based premium system that provides for quarterly assessments based on an
insured institution's ranking in one of four risk categories based upon
supervisory and capital evaluations. Institutions are assessed at annual
rates ranging from 5 to 43 basis points, respectively, depending on each
institution's risk of default as measured by regulatory capital ratios and
other supervisory measures. Under a proposal announced by the FDIC on October
7, 2008, the assessment rate schedule would be raised uniformly by 7 basis
points (annualized) beginning on January 1, 2009. Beginning with the second
quarter of 2009, changes would be made to the deposit insurance assessment
system by requiring riskier institutions to pay a larger share. The proposal
would impose higher assessment rates on institutions with a significant
reliance on secured liabilities and on institutions which rely significantly
on brokered deposits (but, for well-managed and well-capitalized institutions,
only when accompanied by rapid asset growth). The proposal would reduce
assessment rates for institutions that hold long-term unsecured debt and, for
smaller institutions, high levels of Tier 1 (defined below) capital.
FDIC-insured institutions are required to pay a Financing Corporation
assessment, in order to fund the interest on bonds issued to resolve thrift
failures in the 1980s. For the quarterly period ended September 30, 2008, the
Financing Corporation assessment equaled 1.10 basis points for each $100 in
domestic deposits. These assessments, which may be revised based upon the
level of deposits, will continue until the bonds mature in the years 2017
through 2019.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC. It also may suspend
deposit insurance temporarily during the hearing process for the permanent
termination of insurance, if the institution has no tangible capital. If
insurance of accounts is terminated, the accounts at the institution at the
time of the termination, less subsequent withdrawals, shall continue to be
insured for a period of six months to two years, as determined by the FDIC.
Management of the Bank is not aware of any practice, condition or violation
that might lead to termination of the Bank's deposit insurance.
Prompt Corrective Action. The FDIC is required to take certain
supervisory actions against undercapitalized savings institutions, the
severity of which depends upon the institution's degree of
undercapitalization. Generally, an
27
institution that has a ratio of total capital to risk-weighted assets of less
than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than
4%, or a ratio of core capital to total assets of less than 4% (3% or less for
institutions with the highest examination rating) is considered to be
undercapitalized. An institution that has a total risk-based capital ratio
less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that
is less than 3% is considered to be significantly undercapitalized and an
institution that has a tangible capital to assets ratio equal to or less than
2% is deemed to be critically undercapitalized. Subject to a narrow
exception, the FDIC is required to appoint a receiver or conservator for a
savings institution that is critically undercapitalized. FDIC regulations also
require that a capital restoration plan be filed with the FDIC within 45 days
of the date a savings institution receives notice that it is undercapitalized,
significantly undercapitalized or critically undercapitalized. Compliance
with the plan must be guaranteed by any parent holding company in an amount of
up to the lesser of 5% of the institution's assets or the amount which would
bring the institution into compliance with all capital standards. In
addition, numerous mandatory supervisory actions become immediately applicable
to an undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The FDIC also could take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
At September 30, 2008, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC.
Standards for Safety and Soundness. The federal banking regulatory
agencies have prescribed, by regulation, guidelines for all insured depository
institutions relating to: internal controls, information systems and internal
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, asset quality, earnings, and compensation, fees and
benefits. The guidelines set forth the safety and soundness standards that
the federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired. Each insured
depository institution must implement a comprehensive written information
security program that includes administrative, technical, and physical
safeguards appropriate to the institution's size and complexity and the nature
and scope of its activities. The information security program also must be
designed to ensure the security and confidentiality of customer information,
protect against any unanticipated threats or hazards to the security or
integrity of such information, protect against unauthorized access to or use
of such information that could result in substantial harm or inconvenience to
any customer, and ensure the proper disposal of customer and consumer
information. Each insured depository institution must also develop and
implement a risk-based response program to address incidents of unauthorized
access to customer information in customer information systems. If the FDIC
determines that the Bank fails to meet any standard prescribed by the
guidelines, the agency may require the Bank to submit to the agency an
acceptable plan to achieve compliance with the standard. FDIC regulations
establish deadlines for the submission and review of such safety and soundness
compliance plans. Management of the Bank is not aware of any conditions
relating to these safety and soundness standards which would require
submission of a plan of compliance.
Capital Requirements. FDIC regulations recognize two types or tiers of
capital: core ("Tier 1") capital and supplementary ("Tier 2") capital. Tier 1
capital generally includes common shareholders' equity and noncumulative
perpetual preferred stock, less most intangible assets. Tier 2 capital, which
is limited to 100% of Tier 1 capital, includes such items as qualifying
general loan loss reserves, cumulative perpetual preferred stock, mandatory
convertible debt, term subordinated debt and limited life preferred stock;
however, the amount of term subordinated debt and intermediate term preferred
stock (original maturity of at least five years but less than 20 years) that
may be included in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets. At September 30, 2008, the Bank had a Tier
1 leverage capital ratio of 9.2%. The FDIC retains the right to require an
institution to maintain a higher capital level based on the institution's
particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in
one of four categories and given a percentage weight based on the relative
risk of
28
that category. In addition, certain off-balance-sheet items are converted to
balance-sheet credit equivalent amounts, and each amount is then assigned to
one of the four categories. Under the guidelines, the ratio of total capital
(Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least
8%, and the ratio of Tier 1 capital to risk-weighted assets must be at least
4%. In evaluating the adequacy of a bank's capital, the FDIC may also
consider other factors that may affect a bank's financial condition. Such
factors may include interest rate risk exposure, liquidity, funding and market
risks, the quality and level of earnings, concentration of credit risk, risks
arising from nontraditional activities, loan and investment quality, the
effectiveness of loan and investment policies, and management's ability to
monitor and control financial operating risks. At September 30, 2008, the
Bank's ratio of total capital to risk-weighted assets was 12.3% and the ratio
of Tier 1 capital to risk-weighted assets was 11.1%.
The Division requires that net worth equal at least 5% of total assets.
Intangible assets must be deducted from net worth and assets when computing
compliance with this requirement. At September 30, 2008, the Bank had a net
worth of 9.0% of total assets.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2008. The definitions of the terms
used in the table are those provided in the capital regulations issued by the
FDIC, and the Bank has not been notified by the FDIC of any higher capital
requirements specifically applicable to it.
At September 30, 2008
-----------------------------
Percent of Adjusted
Amount Total Assets (1)
------ -------------------
(Dollars in thousands)
Tier 1 (leverage) capital (2)............... $61,326 9.2%
Tier 1 (leverage) capital requirement....... 26,649 4.0
------- ----
Excess...................................... $34,677 5.2%
======= ====
Tier 1 risk adjusted capital................ $61,326 11.1%
Tier 1 risk adjusted capital requirement.... 22,192 4.0
------- ----
Excess...................................... $39,134 7.1%
======= ====
Total risk-based capital.................... $68,275 12.3%
Total risk-based capital requirement........ 44,384 8.0
------- ----
Excess...................................... $23,891 4.3%
======= ====
------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $666.2 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $554.8 million.
(2) As a Washington-chartered savings bank, the Bank is subject to the
capital requirements of the FDIC and the Division. The FDIC requires
state-chartered savings banks, including the Bank, to have a minimum
leverage ratio of Tier 1 capital to total assets of at least 3%,
provided, however, that all institutions, other than those (i) receiving
the highest rating during the examination process and (ii) not
anticipating any significant growth, are required to maintain a ratio of
1% to 2% above the stated minimum, with an absolute total capital to
risk-weighted assets of at least 8%. The Bank has not been notified by
the FDIC of any leverage capital requirement specifically applicable to
it.
The Bank's management believes that, under the current regulations, the
Bank will continue to meet its minimum capital requirements in the foreseeable
future. However, events beyond the control of the Bank, such as a downturn in
the economy in areas where the Bank has most of its loans, could adversely
affect future earnings and, consequently, the ability of the Bank to meet its
capital requirements.
29
Emergency Economic Stabilization Act of 2008. In October 2008, the EESA
was enacted. The EESA authorizes the Treasury Department to purchase from
financial institutions and their holding companies up to $700 billion in
mortgage loans, mortgage-related securities and certain other financial
instruments, including debt and equity securities issued by financial
institutions and their holding companies in a troubled asset relief program
("TARP"). The purpose of TARP is to restore confidence and stability to the
U.S. banking system and to encourage financial institutions to increase their
lending to customers and to each other. The Treasury Department has allocated
$250 billion towards the TARP Capital Purchase Program ("CPP"). Under the
CPP, the Treasury will purchase debt or equity securities from participating
institutions. The TARP also will include direct purchases or guarantees of
troubled assets of financial institutions. Participants in the CPP are
subject to executive compensation limits and are encouraged to expand their
lending and mortgage loan modifications. The Company has submitted an initial
application for the sale of preferred shares equal to 3.0% of its
risk-weighted assets.
EESA also increased FDIC deposit insurance on most accounts from $100,000
to $250,000. This increase expires at the end of 2009 and it not covered by
deposit insurance premiums paid by the banking industry.
Real Estate Lending Standards. FDIC regulations require the Bank to
adopt and maintain written policies that establish appropriate limits and
standards for real estate loans. These standards, which must be consistent
with safe and sound banking practices, must establish loan portfolio
diversification standards, prudent underwriting standards (including
loan-to-value ratio limits) that are clear and measurable, loan administration
procedures, and documentation, approval and reporting requirements. The Bank
is obligated to monitor conditions in its real estate markets to ensure that
its standards continue to be appropriate for current market conditions. The
Bank's Board of Directors is required to review and approve the Bank's
standards at least annually. The FDIC has published guidelines for compliance
with these regulations, including supervisory limitations on loan-to-value
ratios for different categories of real estate loans. Under the guidelines,
the aggregate amount of all loans in excess of the supervisory loan-to-value
ratios should not exceed 100% of total capital, and the total of all loans for
commercial, agricultural, multifamily or other non-one-to-four-family
residential properties should not exceed 30% of total capital. Loans in
excess of the supervisory loan-to-value ratio limitations must be identified
in the Bank's records and reported at least quarterly to the Bank's Board of
Directors. The Bank is in compliance with the record and reporting
requirements. As of September 30, 2008, the Bank's aggregate loans in excess
of the supervisory loan-to-value ratios were 19% of total capital and the
Bank's loans on commercial, agricultural, multifamily or other
non-one-to-four-family residential properties in excess of the supervisory
loan-to-value ratios were 16% of total capital.
Initiatives Prompted by the Subprime Mortgage Crisis. In response to the
recent subprime mortgage crisis," federal and state regulatory agencies have
focused attention on subprime and nontraditional mortgage products both with
an aim toward enhancing the regulation of such loans and providing relief to
adversely affected borrowers.
Guidance on Subprime Mortgage Lending. On June 29, 2007, the federal
banking agencies issued guidance on subprime mortgage lending to address
issues related to certain mortgage products marketed to subprime borrowers,
particularly adjustable rate mortgage products that can involve "payment
shock" and other risky characteristics. Although the guidance focuses on
subprime borrowers, the banking agencies note that institutions should look to
the principles contained in the guidance when offering such adjustable rate
mortgages to non-subprime borrowers. The guidance prohibits predatory lending
programs; provides that institutions should underwrite a mortgage loan on the
borrower's ability to repay the debt by its final maturity at the
fully-indexed rate, assuming a fully amortizing repayment schedule; encourages
reasonable workout arrangements with borrowers who are in default; mandates
clear and balanced advertisements and other communications; encourages
arrangements for the escrowing of real estate taxes and insurance; and states
that institutions should develop strong control and monitoring systems. The
guidance recommends that institutions refer to the Real Estate Lending
Standards (discussed above) which provide underwriting standards for all real
estate loans.
The federal banking agencies announced their intention to carefully
review the risk management and consumer compliance processes, policies and
procedures of their supervised financial institutions and their intention to
take action against institutions that engage in predatory lending practices,
violate consumer protection laws or fair lending laws, engage in unfair or
deceptive acts or practices, or otherwise engage in unsafe or unsound lending
practices.
30
Guidance on Loss Mitigation Strategies for Servicers of Residential
Mortgages. On September 5, 2007, the federal banking agencies issued a
statement encouraging regulated institutions and state-supervised entities
that service residential mortgages to pursue strategies to mitigate losses
while preserving homeownership to the extent possible and appropriate. The
guidance recognizes that many mortgage loans, including subprime loans, have
been transferred into securitization trusts and servicing for such loans is
governed by contract documents. The guidance advises servicers to review
governing documentation to determine the full extent of their authority to
restructure loans that are delinquent or are in default or are in imminent
risk of default.
The guidance encourages that servicers take proactive steps to preserve
homeownership in situations where there are heightened risks to homeowners
losing their homes to foreclosures. Such steps may include loan modification;
deferral of payments; extensions of loan maturities; conversion of adjustable
rate mortgages into fixed rate or fully indexed, fully amortizing adjustable
rate mortgages; capitalization of delinquent amounts; or any combination of
these actions. Servicers are instructed to consider the borrower's ability to
repay the modified obligation to final maturity according to its terms, taking
into account the borrower's total monthly housing-related payments as a
percentage of the borrower's gross monthly income, the borrower's other
obligations, and any additional tax liabilities that may result from loan
modifications. Where appropriate, servicers are encouraged to refer borrowers
to qualified non-profit and other homeownership counseling services and/or to
government programs that are able to work with all parties and avoid
unnecessary foreclosures. The guidance states that servicers are expected to
treat consumers fairly and to adhere to all applicable legal requirements.
Consumer Relief Initiative for Borrowers. In October 2007, the Treasury
Secretary announced the Homeowner Assistance Initiative to encourage mortgage
servicers, mortgage counselors, government officials and non-profit groups to
coordinate their efforts to help struggling borrowers restructure their
mortgage payments and stay in their homes. The initiative, called HOPE NOW,
is aimed at coordinating and improving outreach to borrowers, developing best
practices for mortgage counselors across the country and ensuring that groups
able to help homeowners work out new loan arrangements with lenders have
adequate resources to carry out this mission.
Economic Stimulus Act of 2008 and Housing and Economic Recovery Act of
2008. President Bush signed the Economic Stimulus Act of 2008 into law on
February 13, 2008. While the main thrust of the act is to stimulate the
economy, the act also temporarily increased the maximum size of mortgage loans
(the conforming loan limit) that Fannie Mae and Freddie Mac may purchase from
the current $417,000 cap to a maximum of $729,750 for certain loans made
during the July 1, 2007 - December 31, 2008 period. The cap on the Federal
Housing Administration's conforming loan limit for mortgage loans was raised
from $362,000 to $729,750 for certain loans made on or before December 31,
2008. These changes are intended, among other purposes, to provide more
liquidity and stability for the jumbo loan market. The Housing and Economic
Recovery Act of 2008, signed by President Bush on July 30, 2008, was designed
to address a variety of issues relating to the subprime mortgage crises. This
act established a new conforming loan limit for Fannie Mae and Freddie Mac in
high cost areas to 150% of the conforming loan limit, to take effect after the
limits established by the Economic Stimulus Act of 2008 expire. The FHA's
conforming loan limit has been increased from 95% to 110% of the area median
home price up to 150% of the Fannie Mae/Freddie Mac conforming loan limit, to
take effect at the same time. Among other things, the Housing and Economic
Recovery Act of 2008 enhanced the regulation of Fannie Mae, Freddie Mac and
Federal Housing Administration loans; established a new Federal Housing
Finance Agency to replace the prior Federal Housing Finance Board and Office
of Federal Housing Enterprise Oversight; will require enhanced mortgage
disclosures; and will require a comprehensive licensing, supervisory, and
tracking system for mortgage originators. Using its new powers, on September
7, 2008 the Federal Housing Finance Agency announced that it had put Fannie
Mae and Freddie Mac under conservatorship. The Housing and Economic Recovery
Act of 2008 also establishes the HOPE for Homeowners program, which is a new,
temporary, voluntary program to back Federal Housing Administration-insured
mortgages to distressed borrowers. The new mortgages offered by Federal
Housing Administration-approved lenders will refinance distressed loans at a
significant discount for owner-occupants at risk of losing their homes to
foreclosure.
New Regulations Establishing Protections for Consumers in the Residential
Mortgage Market. The Federal Reserve Board has issued new regulations under
the federal Truth-in-Lending Act and the Home Ownership and Equity Protection
Act. For mortgage loans governed by the Home Ownership and Equity Protection
Act, the new regulations
31
further restrict prepayment penalties, and enhance the standards relating to
the consumer's ability to repay. For a new category of closed-end
"higher-priced" mortgage loans, the new regulations restrict prepayment
penalties, and require escrows for property taxes and property-related
insurance for most first lien mortgage loans. For all closed-end loans
secured by a principal dwelling, the new regulations prohibit the coercion of
appraisers; require the prompt crediting of payments; prohibit the pyramiding
of late fees; require prompt responses to requests for pay-off figures; and
require the delivery of transaction-specific Truth-in-Lending Act disclosures
within three business days following the receipt of an application for a
closed-end home loan. The new regulations also impose new restrictions on
mortgage loan advertising for both open-end and closed-end products. In
general, the new regulations are effective October 10, 2009, but the rules
governing escrows for higher-priced mortgages are effective on April 1, 2010,
and for higher-priced mortgage loans secured by manufactured housing, on
October 1, 2010.
Pending Legislation and Regulatory Proposals. As a result of the
subprime mortgage crisis, federal and state legislative agencies are
considering a broad variety of legislative and regulatory proposals covering
mortgage loan products, loan terms and underwriting standards, risk management
practices and consumer protection. It is unclear which, if any, of these
initiatives will be adopted, what effect they will have on the Company or the
Bank and whether any of these initiatives will change the competitive
landscape in the mortgage industry.
Guidance on Nontraditional Mortgage Product Risks. On September 29,
2006, the federal banking agencies issued guidance to address the risks posed
by nontraditional residential mortgage products, that is, mortgage products
that allow borrowers to defer repayment of principal or interest. The
guidance instructs institutions to ensure that loan terms and underwriting
standards are consistent with prudent lending practices, including
consideration of a borrower's ability to repay the debt by final maturity at
the fully indexed rate and assuming a fully amortizing repayment schedule;
requires institutions to recognize, for higher risk loans, the necessity of
verifying the borrower's income, assets and liabilities; requires institutions
to address the risks associated with simultaneous second-lien loans,
introductory interest rates, lending to subprime borrowers, non-owner-occupied
investor loans, and reduced documentation loans; requires institutions to
recognize that nontraditional mortgages, particularly those with risk-layering
features, are untested in a stressed environment; requires institutions to
recognize that nontraditional mortgage products warrant strong controls and
risk management standards, capital levels commensurate with that risk, and
allowances for loan and lease losses that reflect the collectibility of the
portfolio; and ensure that consumers have sufficient information to clearly
understand loan terms and associated risks prior to making product and payment
choices. The guidance recommends practices for addressing the risks raised by
nontraditional mortgages, including enhanced communications with consumers,
beginning when the consumer is first shopping for a mortgage; promotional
materials and other product descriptions that provide information about the
costs, terms, features and risks of nontraditional mortgages, including with
respect to payment shock, negative amortization, prepayment penalties, and the
cost of reduced documentation loans; more informative monthly statements for
payment option adjustable rate mortgages; and specified practices to avoid.
Subsequently, the federal banking agencies produced model disclosures that are
designed to provide information about the costs, terms, features and risks of
nontraditional mortgages.
Guidance on Real Estate Concentrations. On December 6, 2006, the federal
banking agencies issued a guidance on sound risk management practices for
concentrations in commercial real estate lending. The particular focus is on
exposure to commercial real estate loans that are dependent on the cash flow
from the real estate held as collateral and that are likely to be sensitive to
conditions in the commercial real estate market (as opposed to real estate
collateral held as a secondary source of repayment or as an abundance of
caution). The purpose of the guidance is not to limit a bank's commercial
real estate lending but to guide banks in developing risk management practices
and capital levels commensurate with the level and nature of real estate
concentrations. The FDIC and other bank regulatory agencies will be focusing
their supervisory resources on institutions that may have significant
commercial real estate loan concentration risk. A bank that has experienced
rapid growth in commercial real estate lending, has notable exposure to a
specific type of commercial real estate loan, or is approaching or exceeding
the following supervisory criteria may be identified for further supervisory
analysis with respect to real estate concentration risk:
* Total reported loans for construction, land development and other
land represent 100% or more of the bank's capital; or
32
* Total commercial real estate loans (as defined in the guidance)
represent 300% or more of the bank's total capital and the
outstanding balance of the bank's commercial real estate loan
portfolio has increased 50% or more during the prior 36 months.
The strength of an institution's lending and risk management practices
with respect to such concentrations will be taken into account in supervisory
evaluation of capital adequacy.
On March 17, 2008, the FDIC issued a release to re-emphasize the
importance of strong capital and loan loss allowance levels and robust credit
risk management practices for institutions with concentrated commercial real
estate exposures. The FDIC suggested that institutions with significant
construction and development and commercial real estate loan concentrations
increase or maintain strong capital levels; ensure that loan loss allowances
are appropriately strong; manage construction and development and commercial
real estate loan portfolios closely; maintain updated financial and analytical
information on their borrowers and collateral; and bolster the loan workout
infrastructure.
Temporary Liquidity Guaranty Program. Following a systemic risk
determination, the FDIC established a Temporary Liquidity Guarantee Program
("TLGP") on October 14, 2008. The TLGP includes the Transaction Account
Guarantee Program, which provides unlimited deposit insurance coverage through
December 31, 2009 for noninterest-bearing transaction accounts (typically
business checking accounts) and certain funds swept into noninterest-bearing
savings accounts ("TAGP"). Institutions participating in the TAGP pay a 10
basis points fee (annualized) on the balance of each covered account in excess
of $250,000, while the extra deposit insurance is in place. The TLGP also
includes the Debt Guarantee Program, under which the FDIC guarantees certain
senior unsecured debt of FDIC-insured institutions and their holding companies
("DGP"). The unsecured debt must be issued on or after October 14, 2008 and
not later than June 30, 2009, and the guarantee is effective through the
earlier of the maturity date or June 30, 2012. The DGP coverage limit is
generally 125% of the eligible entity's eligible debt outstanding on September
30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain
insured institutions, 2% of their liabilities as of September 30, 2008.
Depending on the term of the debt maturity, the nonrefundable DGP fee ranges
from 50 to 100 basis points (annualized) for covered debt outstanding until
the earlier of maturity or June 30, 2012. The TAGP and DGP are in effect for
all eligible entities, unless the entity opted out on or before December 5,
2008. The Company did not opt out of the program.
Activities and Investments of Insured State-Financial Institutions.
Federal law generally limits the activities and equity investments of
FDIC-insured, state-chartered banks to those that are permissible for national
banks. An insured state bank is not prohibited from, among other things, (i)
acquiring or retaining a majority interest in a subsidiary, (ii) investing as
a limited partner in a partnership the sole purpose of which is direct or
indirect investment in the acquisition, rehabilitation or new construction of
a qualified housing project, provided that such limited partnership
investments may not exceed 2% of the bank's total assets, (iii) acquiring up
to 10% of the voting stock of a company that solely provides or reinsures
directors', trustees' and officers' liability insurance coverage or bankers'
blanket bond group insurance coverage for insured depository institutions, and
(iv) acquiring or retaining the voting shares of a depository institution if
certain requirements are met.
Washington law provides financial institution parity between commercial
banks and savings banks. Primarily, the law affords Washington-chartered
commercial banks the same powers as Washington-chartered savings banks. In
order for a bank to exercise these powers, it must provide 30 days notice to
the Director of Washington Division of Financial Institutions and the Director
must authorize the requested activity. In addition, the law provides that
Washington-chartered commercial banks may exercise any of the powers that the
Federal Reserve has determined to be closely related to the business of
banking and the powers of national banks, subject to the approval of the
Director in certain situations. The law also provides that
Washington-chartered savings banks may exercise any of the powers of
Washington-chartered commercial banks, national banks and federally-chartered
savings banks, subject to the approval of the Director in certain situations.
Finally, the law provides additional flexibility for Washington-chartered
commercial and savings banks with respect to interest rates on loans and other
extensions of credit. Specifically, they may charge the maximum interest rate
allowable for loans and other extensions of credit by federally-chartered
financial institutions to Washington residents.
33
Environmental Issues Associated With Real Estate Lending. The
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), a federal statute, generally imposes strict liability on all prior
and present "owners and operators" of hazardous waste sites. However, the
U.S. Congress created a safe harbor provision to protect secured creditors by
providing that the term "owner and operator" excludes a person whose ownership
is limited to protecting its security interest in the site. Since the
enactment of the CERCLA, this "secured creditor exemption" has been the
subject of judicial interpretations which have left open the possibility that
lenders could be liable for cleanup costs on contaminated property that they
hold as collateral for a loan.
To the extent that legal uncertainty exists in this area, all creditors,
including the Bank, that have made loans secured by properties with potential
hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
Federal Reserve System. The Federal Reserve Board requires under
Regulation D that all depository institutions, including savings banks,
maintain reserves on transaction accounts or non-personal time deposits
(however,as of September 30, 2008, the reserve requirement for non-personal
time deposits is 0%). These reserves may be in the form of cash or
non-interest-bearing deposits with the regional Federal Reserve Bank.
Negotiable order of withdrawal accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any non-personal time deposits at a savings bank. As of September 30,
2008, the Bank's deposit with the Federal Reserve and vault cash exceeded its
Regulation D reserve requirements.
Affiliate Transactions. The Company and the Bank are separate and
distinct legal entities. Federal laws strictly limit the ability of banks to
engage in certain transactions with their affiliates, including their bank
holding companies. Transactions deemed to be a "covered transaction" under
Section 23A of the Federal Reserve Act and between a subsidiary bank and its
parent company or the nonbank subsidiaries of the bank holding company are
limited to 10% of the bank subsidiary's capital and surplus and, with respect
to the parent company and all such nonbank subsidiaries, to an aggregate of
20% of the bank subsidiary's capital and surplus. Further, covered
transactions that are loans and extensions of credit generally are required to
be secured by eligible collateral in specified amounts. Federal law also
requires that covered transactions and certain other transactions listed in
Section 23B of the Federal Reserve Act between a bank and its affiliates be on
terms as favorable to the bank as transactions with non-affiliates.
Community Reinvestment Act. Under the Community Reinvestment Act
("CRA"), every FDIC-insured institution has a continuing and affirmative
obligation consistent with safe and sound banking practices to help meet the
credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the FDIC, in connection with its examination of the Bank, to assess
the institution's record of meeting the credit needs of its community and to
take such record into account in its evaluation of certain applications, such
as a merger or the establishment of a branch, by the Bank. An unsatisfactory
rating may be used as the basis for the denial of an application by the FDIC.
As a result of the heightened attention being given to the CRA in the past few
years, the Bank may be required to devote additional funds for investment and
lending in its local community. The Bank was examined for CRA compliance and
received a rating of "satisfactory" in its latest examination.
Dividends. Dividends from the Bank constitute the major source of funds
for dividends which may be paid by the Company. The amount of dividends
payable by the Bank to the Company depends upon the Bank's earnings and
capital position, and is limited by federal and state laws, regulations and
policies. According to Washington law, the Bank may not declare or pay a cash
dividend on its capital stock if it would cause its net worth to be reduced
below (i) the amount required for liquidation accounts or (ii) the net worth
requirements, if any, imposed by the Director of the Division. In addition,
dividends on the Bank's capital stock may not be paid in an aggregate amount
greater than the aggregate retained earnings of the Bank, without the approval
of the Director of the Division.
The amount of dividends actually paid during any one period will be
strongly affected by the Bank's management policy of maintaining a strong
capital position. Federal law further provides that no insured depository
34
institution may make any capital distribution (which would include a cash
dividend) if, after making the distribution, the institution would be
"undercapitalized," as defined in the prompt corrective action regulations.
Moreover, the federal bank regulatory agencies also have the general authority
to limit the dividends paid by insured banks if such payments should be deemed
to constitute an unsafe and unsound practice.
Privacy Standards. The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA"), which was enacted in 1999, modernized the
financial services industry by establishing a comprehensive framework to
permit affiliations among commercial banks, insurance companies, securities
firms and other financial service providers. The Bank is subject to FDIC
regulations implementing the privacy protection provisions of the GLBA. These
regulations require the Bank to disclose its privacy policy, including
identifying with whom it shares "non-public personal information," to
customers at the time of establishing the customer relationship and annually
thereafter. The privacy policy must be provided to consumers before nonpublic
personal information is shared with a nonaffiliated third party. Customers
and certain consumers must be provided the right to opt out of the sharing of
certain information by the Bank with both affiliates and non-affiliated third
parties. FDIC regulations that became mandatory on October 1, 2008 limit the
right of an affiliate of the Bank to use consumer information obtained from
the Bank for marketing purposes, unless the consumer is provided with a clear
and conspicuous notice of his/her right to opt out from that use and the
consumer has not opted out. The Bank is also subject to state privacy laws,
which may impose more stringent information sharing requirements. The Bank is
in compliance with these requirements.
Bank Secrecy Act and USA Patriot Act. The Bank Secrecy Act, or the BSA,
is a law that is part of the federal government's framework to prevent and
detect money laundering and to deter other criminal enterprises. Under the
BSA, financial institutions such as the Bank are required to maintain certain
records and file certain reports regarding domestic currency transactions and
cross-border transporting of currency. Among other requirements, the BSA
requires financial institutions to report imports and exports of currency in
the amount of $10,000 or more and, in general, all cash transactions of
$10,000 or more. The BSA also requires that financial institutions report to
relevant law enforcement agencies any suspicious transactions potentially
involving violations of law.
The terrorist attacks in September 2001 impacted the financial services
industry and led to the enactment of the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act
of 2001, or the USA Patriot Act. Part of the USA Patriot Act is the
International Money Laundering Abatement and Financial Anti-Terrorism Act of
2001, or IMLAFATA. Pursuant to IMLAFATA, an additional purpose was added to
the BSA: "To assist in the conduct of intelligence or counter-intelligence
activities, including analysis, to protect against international terrorism."
IMLAFATA also significantly expanded the role of financial institutions
in combating money laundering. In particular, it required financial
institutions to establish anti-money laundering programs, which, at a minimum,
include internal policies, procedures, and controls designed to prevent the
institution from being used for money laundering; the designation of a BSA
compliance officer; ongoing employee training; and an independent audit
program to test the effectiveness of the institution's anti-money laundering
programs. The FDIC and the other federal banking agencies promptly adopted
regulations requiring each financial institution to establish comprehensive
anti-money laundering compliance programs designed to assure compliance with
the BSA and otherwise meeting the statutory requirements for such programs set
forth in IMLAFATA. In addition, these regulations required each financial
institution to establish a customer identification program to be implemented
as part of the institution's anti-money laundering compliance program.
Failure to establish and maintain such BSA/anti-money laundering programs are
grounds for the taking of enforcement actions by the federal banking
regulators.
IMLAFATA authorizes the Treasury Secretary, in consultation with the
heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, and/or other financial institutions. These
measures may include enhanced recordkeeping and reporting requirements for
certain financial transactions that are of primary money laundering concern,
due diligence requirements concerning the beneficial ownership of certain
types of accounts, and restrictions or prohibitions on certain types of
accounts with foreign financial institutions.
35
Among its other provisions, IMLAFATA requires each financial institution
to (i) establish due diligence policies, procedures, and controls with respect
to its private banking accounts and correspondent banking accounts involving
foreign individuals and certain foreign banks, and (ii) avoid establishing,
maintaining, administering, or managing correspondent accounts in the U.S.
for, or on behalf of, a foreign bank that does not have a physical presence in
any country. In addition, IMLAFATA contains a provision encouraging
cooperation among financial institutions, regulatory authorities and law
enforcement authorities with respect to individuals, entities, and
organizations engaged in, or reasonably suspected of engaging in, terrorist
acts or money laundering activities. IMLAFATA expands the circumstances under
which funds in a bank account may be forfeited and requires covered financial
institutions to respond under certain circumstances to requests for
information from federal banking agencies within 120 hours. IMLAFATA also
requires the federal banking agencies to consider the effectiveness of a
financial institution's anti-money laundering activities in connection with a
potential bank merger under the Bank Merger Act.
Other Consumer Protection Laws and Regulations. The Bank is subject to a
broad array of federal and state consumer protection laws and regulations that
govern almost every aspect of its business relationships with consumers.
While the list set forth below is not exhaustive, these include the
Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer
Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act,
the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt
Collection Practices Act, the Right to Financial Privacy Act, the Home
Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit
Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st
Century Act, laws governing flood insurance, laws governing consumer
protections in connection with the sale of insurance, federal and state laws
prohibiting unfair and deceptive business practices, and various regulations
that implement some or all of the foregoing. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits, making
loans, collecting loans, and providing other services. Failure to comply with
these laws and regulations can subject the Bank to various penalties,
including but not limited to, enforcement actions, injunctions, fines, civil
liability, criminal penalties, punitive damages, and the loss of certain
contractual rights.
The Americans with Disabilities Act requires employers with 15 or more
employees and all businesses operating "commercial facilities" or "public
accommodations" to accommodate disabled employees and customers. The
Americans with Disabilities Act has two major objectives: (i) to prevent
discrimination against disabled job applicants, job candidates and employees,
and (ii) to provide disabled persons with ready access to commercial
facilities and public accommodations. Commercial facilities, such as the
Bank, must ensure that all new facilities are accessible to disabled persons,
and in some instances may be required to adapt existing facilities to make
them accessible.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank is a bank
holding company and is registered as such with the Federal Reserve. Bank
holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"), and
the regulations of the Federal Reserve. As a bank holding company, the
Company is required to file with the Federal Reserve annual reports and such
additional information as the Federal Reserve may require and will be subject
to regular examinations by the Federal Reserve. The Federal Reserve also has
extensive enforcement authority over bank holding companies, including, among
other things, the ability to assess civil money penalties, to issue cease and
desist or removal orders and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices.
The Bank Holding Company Act. Under the Bank Holding Company Act, the
Company is supervised by the Federal Reserve. The Federal Reserve has a
policy that a bank holding company is required to serve as a source of
financial and managerial strength to its subsidiary banks and may not conduct
its operations in an unsafe or unsound manner. In addition, the Federal
Reserve provides that bank holding companies should serve as a source of
strength to its subsidiary banks by being prepared to use available resources
to provide adequate capital funds to its subsidiary banks during periods of
financial stress or adversity, and should maintain the financial flexibility
and capital raising capacity to obtain additional resources for assisting its
subsidiary banks. A bank holding company's failure to meet its obligation
36
to serve as a source of strength to its subsidiary banks will generally be
considered by the Federal Reserve to be an unsafe and unsound banking practice
or a violation of the Federal Reserve's regulations or both.
The Company is required to file quarterly and periodic reports with the
Federal Reserve and provide additional information as the Federal Reserve may
require. The Federal Reserve may examine the Company, and any of its
subsidiaries, and charge the Company for the cost of the examination.
The Company and any subsidiaries that it may control are considered
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between our bank subsidiary and affiliates are subject to numerous
restrictions. With some exceptions, the Company and its subsidiaries, are
prohibited from tying the provision of various services, such as extensions of
credit, to other services offered by the Company, or its affiliates.
Acquisitions. The BHCA prohibits a bank holding company, with certain
exceptions, from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any company that is not a bank or bank holding
company and from engaging directly or indirectly in activities other than
those of banking, managing or controlling banks, or providing services for its
subsidiaries. Under the BHCA, the Federal Reserve is authorized to approve
the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve has determined to be so closely
related to the business of banking or managing or controlling banks as to be a
proper incident thereto. The list of activities determined by regulation to
be closely related to banking within the meaning of the BHCA includes, among
other things: operating a savings institution, mortgage company, finance
company, credit card company or factoring company; performing certain data
processing operations; providing certain investment and financial advice;
underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and U.S. Savings Bonds; real
estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing
securities brokerage services for customers.
Interstate Banking. The Federal Reserve must approve an application of
an adequately capitalized and adequately managed bank holding company to
acquire control of, or acquire all or substantially all of the assets of, a
bank located in a state other than such holding company's home state, without
regard to whether the transaction is prohibited by the laws of any state. The
Federal Reserve may not approve the acquisition of a bank that has not been in
existence for the minimum time period, not exceeding five years, specified by
the statutory law of the host state. Nor may the Federal Reserve approve an
application if the applicant, and its depository institution affiliates,
controls or would control more than 10% of the insured deposits in the United
States or 30% or more of the deposits in the target bank's home state or in
any state in which the target bank maintains a branch. Federal law does not
affect the authority of states to limit the percentage of total insured
deposits in the state which may be held or controlled by a bank holding
company to the extent such limitation does not discriminate against
out-of-state banks or bank holding companies. Individual states may also
waive the 30% state-wide concentration limit contained in the federal law.
The Federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends. The Federal Reserve has issued a policy statement on the
payment of cash dividends by bank holding companies, which expresses the
Federal Reserve's view that a bank holding company should pay cash dividends
only to the extent that the company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earning retention
that is consistent with the company's capital needs, asset quality and overall
financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow
funds to pay dividends.
37
Stock Repurchases. Bank holding companies, except for certain
"well-capitalized" and highly rated bank holding companies, are required to
give the Federal Reserve prior written notice of any purchase or redemption of
its outstanding equity securities if the gross consideration for the purchase
or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding 12 months, is equal to 10% or
more of their consolidated net worth. The Federal Reserve may disapprove such
a purchase or redemption if it determines that the proposal would constitute
an unsafe or unsound practice or would violate any law, regulation, Federal
Reserve order, or any condition imposed by, or written agreement with, the
Federal Reserve.
Capital Requirements. The Federal Reserve has established capital
adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for the Bank. The Federal Reserve
regulations provide that capital standards will be applied on a consolidated
basis in the case of a bank holding company with $150 million or more in total
consolidated assets.
The Company's total risk based capital must equal 8% of risk-weighted
assets and one half of the 8%, or 4%, must consist of Tier 1 (core) capital
and its Tier 1 (core) capital must equal 4% of total assets. As of September
30, 2008, the Company's total risk based capital was 13.6% of risk-weighted
assets and its risk based capital of Tier 1 (core) capital was 12.4% of
risk-weighted assets.
Sarbanes-Oxley Act of 2002. As a public company, the Company is subject
to the Sarbanes-Oxley Act of 2002, which implements a broad range of corporate
governance and accounting measures for public companies designed to promote
honesty and transparency in corporate America and better protect investors
from corporate wrongdoing. The Sarbanes-Oxley Act of 2002 was signed into law
by President Bush on July 30, 2002 in response to public concerns regarding
corporate accountability in connection with several accounting scandals. The
stated goals of the Sarbanes-Oxley Act are to increase corporate
responsibility, to provide for enhanced penalties for accounting and auditing
improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to
the securities laws.
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the Securities and
Exchange Commission and securities exchanges to adopt extensive additional
disclosure, corporate governance and other related rules and mandates further
studies of certain issues by the SEC and the Comptroller General.
Taxation
Federal Taxation
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." These
rules required that all institutions recapture all or a portion of their bad
debt reserves added since the base year (last taxable year beginning before
January 1, 1988). The Bank had previously recorded deferred taxes equal to
the bad debt recapture and as such the new rules had no effect on the net
income or federal income tax expense. For taxable years beginning after
December 31, 1995, the Bank's bad debt deduction is determined under the
experience method using a formula based on actual bad debt experience over a
period of years or, if the Bank is a "large" association (assets in excess of
$500 million) on the basis of net charge-offs during the taxable
38
year. The unrecaptured base year reserves will not be subject to recapture as
long as the institution continues to carry on the business of banking. In
addition, the balance of the pre-1988 bad debt reserves continue to be subject
to provisions of present law referred to below that require recapture in the
case of certain excess distributions to shareholders. The Bank has recaptured
all federal tax bad debt reserves that had been accumulated since October 1,
1988.
Distributions. To the extent that the Bank makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserve as of December 31,
1987 (or a lesser amount if the Bank's loan portfolio decreased since December
31, 1987) and then from the supplemental reserve for losses on loans ("Excess
Distributions"), and an amount based on the Excess Distributions will be
included in the Bank's taxable income. Nondividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not be considered to result in a distribution from the Bank's
bad debt reserve. The amount of additional taxable income created from an
Excess Distribution is an amount that, when reduced by the tax attributable to
the income, is equal to the amount of the distribution. Thus, if the Bank
makes a "nondividend distribution," then approximately one and one-half times
the Excess Distribution would be includable in gross income for federal income
tax purposes, assuming a 35% corporate income tax rate (exclusive of state and
local taxes). See "- Regulation of the Bank - Dividends" for limits on the
payment of dividends by the Bank. The Bank does not intend to pay dividends
that would result in a recapture of any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. In addition, only 90% of
AMTI can be offset by net operating loss carryovers. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses).
Dividends-Received Deduction. The Company may exclude from its income
100% of dividends received from the Bank as a member of the same affiliated
group of corporations. The corporate dividends-received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
Audits. The Bank's federal income tax returns have been audited through
September 30, 1997.
Washington Taxation. The Bank is subject to a business and occupation
tax imposed under Washington law at the rate of 1.50% of gross receipts.
Interest received on loans secured by mortgages or deeds of trust on
residential properties is exempt from such tax.
Competition
The Bank operates in an intensely competitive market for the attraction
of deposits (generally its primary source of lendable funds) and in the
origination of loans. Historically, its most direct competition for deposits
has come from large commercial banks, thrift institutions and credit unions in
its primary market area. In times of high interest rates, the Bank
experiences additional significant competition for investors' funds from
short-term money market securities and other corporate and government
securities. The Bank's competition for loans comes principally from mortgage
bankers, commercial banks and other thrift institutions. Such competition for
deposits and the origination of loans may limit the Bank's future growth and
earnings prospects.
Subsidiary Activities
The Bank has one wholly-owned subsidiary, Timberland Service Corporation
("Timberland Service"), whose primary function is to act as the Bank's escrow
department and offer non-deposit investment services.
39
Personnel
As of September 30, 2008, the Bank had 254 full-time employees and 33
part-time and on-call employees. The employees are not represented by a
collective bargaining unit and the Bank believes its relationship with its
employees is good.
Executive Officers of the Registrant
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank.
Executive Officers of the Company and Bank
Age at Position
September -------------------------------------------------
Name 30, 2008 Company Bank
----------------- --------- ------------------------- ----------------------
Michael R. Sand 54 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 41 Executive Vice President, Executive Vice
Chief Financial Officer President, Chief
and Secretary Financial Officer and
Secretary
Robert A. Drugge 57 Executive Vice President Executive Vice
President and
Business Banking
Division Manager
John P. Norawong 43 Executive Vice President Executive Vice
President and
Community Banking
Division Manager
Marci A. Basich 39 Senior Vice President and Senior Vice President
Treasurer and Treasurer
Kathie M. Bailey 57 Senior Vice President Senior Vice President
and Chief Operations
Officer
Michael J. Scott 62 Senior Vice President
and Chief Credit
Administrator
Biographical Information.
Michael R. Sand has been affiliated with the Bank since 1977 and has
served as President of the Bank and the Company since January 23, 2003. On
September 30, 2003, he was appointed as Chief Executive Officer of the Bank
and Company. Prior to appointment as President and Chief Executive Officer,
Mr. Sand had served as Executive Vice President and Secretary of the Bank
since 1993 and as Executive Vice President and Secretary of the Company since
its formation in 1997.
Dean J. Brydon has been affiliated with the Bank since 1994 and has
served as the Chief Financial Officer of the Company and the Bank since
January 2000 and Secretary of the Company and Bank since January 2004. Mr.
Brydon is a Certified Public Accountant.
40
Robert A. Drugge has been affiliated with the Bank since April 2006 and
has served as Executive Vice President and Business Banking Manager since
September 2006. Prior to joining Timberland, Mr. Drugge was employed at Bank
of America as an executive officer and most recently served as Senior Vice
President. Mr. Drugge began his banking career at Seafirst in 1974, which was
acquired by Bank America Corp. and became known as Bank of America.
John P. Norawong has been affiliated with the Bank since July 2006 and
has served as Executive Vice President and Community Banking Division Manager
since September 2006. Prior to joining Timberland, Mr. Norawong served as
Senior Vice President and Commercial Bank Manager at United Commercial Bank
from February 2006 to July 2006, and as Vice President and Senior Vice
President at Key Bank from 1999 through 2006.
Marci A. Basich has been affiliated with the Bank since 1999 and has
served as Treasurer of the Company and the Bank since January 2002. Ms.
Basich is a Certified Public Accountant.
Kathie M. Bailey has been affiliated with the Bank since 1984 and has
served as Senior Vice President and Chief Operations Officer since 2003.
Michael J. Scott has been affiliated with the Bank since January 2008 and
has served as Senior Vice President and Chief Credit Administrator. Prior to
joining Timberland, Mr. Scott was employed by Bank of America where he was a
Senior Vice President and Senior Credit Products Officer for the past several
years in both Seattle and Tacoma. He began his banking career at Seafirst in
1973, which was acquired by Bank America Corp. and became known as Bank of
America.
Item 1A. Risk Factors
----------------------
We assume and manage a certain degree of risk in order to conduct our
business strategy. In addition to the risk factors described below, other
risks and uncertainties not specifically mentioned, or that are currently
known to, or deemed to be immaterial by management, also may materially and
adversely affect our financial position, results of operation and/or cash
flows. Before making an investment decision, you should carefully consider
the risks described below together with all of the other information included
in this Form 10-K. If any of the circumstances described in the following
risk factors actually occur to a significant degree, the value of our common
stock could decline, and you could lose all or part of your investment.
Business Risks
Our business may be adversely affected by downturns in the local economies on
which we depend that could adversely impact our results of operations and
financial condition.
Our business is directly affected by market conditions, trends in
industry and finance, legislative and regulatory changes, and changes in
governmental monetary and fiscal policies and inflation, all of which are
beyond our control. In 2007, the housing and real estate sectors experienced
an economic slowdown that has continued into 2008. A sustained weakness or
weakening in business and economic conditions generally or specifically in the
principal markets in which we do business could have one or more of the
following adverse impacts on business:
* A decrease in the demand for loans and other products and services
offered by us;
* A decrease in the value of our loans held for sale;
* An increase or decrease in the usage of unfunded commitments; or
* An increase in the number of our customers and counterparties who
become delinquent, file for protection under bankruptcy laws or
default on their loans or other obligations to us. An increase in
the number of delinquencies, bankruptcies or defaults could result
in a higher level of non-performing assets, net charge-offs,
provision for loan losses, and valuation adjustments on loans held
for sale.
41
Downturns in the real estate markets in our primary market areas could hurt
our business.
Our business activities and credit exposure are primarily concentrated in
our local market areas of Grays Harbor, Thurston, Pierce, King, Kitsap and
Lewis Counties. Our residential loan portfolio, and our commercial real
estate and multi-family loan portfolio and a certain number of our other loans
have been affected by the downturn in the residential real estate market. We
anticipate that further declines in the real estate markets in our primary
market areas will negatively impact our business. As of September 30, 2008,
substantially all of our loan portfolio consisted of loans secured by real
estate located in Washington. If real estate values continue to decline the
collateral for our loans will provide less security. As a result, our ability
to recover on defaulted loans by selling the underlying real estate will be
diminished, and we would be more likely to suffer losses on defaulted loans.
The events and conditions described in this risk factor could therefore have a
material adverse effect on our business, results of operations and financial
condition.
We may suffer losses in our loan portfolio despite our underwriting practices.
We seek to mitigate the risks inherent in our loan portfolio by adhering
to specific underwriting practices. Although we believe that our underwriting
criteria are appropriate for the various kinds of loans we make, we may incur
losses on loans that meet our underwriting criteria, and these losses may
exceed the amounts set aside as reserves in our allowance for loan losses.
Our loan portfolio includes increased risk due to changes in category
composition of the portfolio. The percentage of loans secured by first
mortgages on one-to four-family residential properties has decreased as the
portfolio has been positioned into higher-yielding loan categories that
typically involve a higher degree of risk.
From September 30, 2004 through September 30, 2008, our total loans have
grown by 54.8%. During this period the percentage of one- to four-family loans
in the loan portfolio has decreased to 18.4% from 25.3%. Our commercial real
estate loans, construction and land development loans, multi-family loans,
land loans, commercial business loans, and consumer loans accounted for
approximately 81.6% of our total loan portfolio as of September 30, 2008. We
consider these types of loans to involve a higher degree of risk compared to
first mortgage loans on one- to four-family, owner-occupied residential
properties, and therefore, may cause higher future loan losses. Accordingly,
as a result of the inherent risks associated with these types of loans, and
the unseasoned nature of a portion of these loans, it may become necessary to
increase the level of our provision for loan losses. An increase in our
provision for loan losses would reduce our profits.
For further information concerning the risks associated with
multi-family, and commercial real estate loans, construction loans, and
consumer loans, see "Item 1. Business - Lending Activities."
We have increased our construction and land development lending which presents
greater risk than one- to four-family and consumer lending.
From September 30, 2004 through September 30, 2008, our total
construction and land development loans have grown by 35.0%. During this
period the percentage of construction and land development loans in the loan
portfolio increased to 30.5% from 26.9%. Construction lending is generally
considered to involve a higher level of risk as compared to single-family
residential or consumer lending, as a result of the concentration of principal
in a limited number of loans and borrowers, and the effects of general
economic conditions on developers and builders. Moreover, a construction loan
can involve additional risks because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost
(including interest) of the project. The nature of these loans is such that
they are generally more difficult to evaluate and monitor. In addition,
speculative construction loans to a builder are often associated with homes
that are not pre-sold, and thus pose a greater potential risk to us than
construction loans to individuals on their personal residences. Construction
loans on land under development or held for future construction also poses
additional risk because of the lack of income being produced by the property
and the potential illiquid nature of the security.
42
Fluctuations in interest rates could reduce our profitability and affect the
value of our assets.
Like other financial institutions, we are subject to interest rate risk.
Our primary source of income is net interest income, which is the difference
between interest earned on loans and investment securities and the interest
paid on deposits and borrowings. We expect that we will periodically
experience imbalances in the interest rate sensitivity of our assets and
liabilities and the relationships of various interest rates to each other.
Over any period of time, our interest-earning assets may be more sensitive to
changes in market interest rates than our interest-bearing liabilities, or
vice versa. In addition, the individual market interest rates underlying our
loan and deposit products may not change to the same degree over a given time
period. In any event, if market interest rates should move contrary to our
position, our earnings may be negatively affected. In addition, loan volume
and quality and deposit volume and mix can be affected by market interest
rates. Changes in levels of market interest rates could materially adversely
affect our net interest spread, asset quality, origination volume and overall
profitability.
Interest rates have recently decreased after increasing for several
years. The U.S. Federal Reserve increased its target for the federal funds
rate 17 times, from 1.00% to 5.25% during the period from June 30, 2004 to
June 29, 2006. The target rate for federal funds remained at 5.25% until
September 18, 2007 when the U.S. Federal Reserve began a series of nine rate
reductions that lowered the target rate by 425 points to 1.00% on October 29,
2008. A sustained falling interest rate environment would negatively impact
margins as the Bank has more interest earning assets that would adjust
downward than interest-bearing liabilities that would adjust downward.
We manage our assets and liabilities in order to achieve long-term
profitability while limiting our exposure to the fluctuation of interest
rates. We anticipate periodic imbalances in the interest rate sensitivity of
our assets and liabilities and the relationship of various interest rates to
each other. At any reporting period, we may have earning assets which are
more sensitive to changes in interest rates than interest-bearing liabilities,
or vice versa. The fluctuation of market interest rates can materially affect
our net interest spread, interest margin, loan originations, deposit volumes
and overall profitability. In addition, we may have valuation risk in
measuring our interest rate risk position. The valuation risk is attributable
to calculation methods (modeling risks) and assumptions used in the model,
including loan prepayments and forward interest rates.
For further information on our interest rate risks, see the discussion
included in "Item 7A. Quantitative and Qualitative Disclosure About Market
Risk" of this Form 10-K.
We are required to maintain a higher capital ratio because of our level of
commercial real estate loans.
The FDIC, along with the Federal Reserve and the Office of the
Comptroller of the Currency, has issued final guidance for financial
institutions with concentrations in commercial real estate lending. The
guidance provides that a bank has a concentration in commercial real estate
lending if (i) total reported loans for construction, land development, and
other land represent 100% or more of total capital or (ii) total reported
loans secured by multi-family and non-farm residential properties and loans
for construction, land development, and other land represent 300% or more of
total capital and its construction loan portfolio has increase 50% or more
during the prior 36 months. If a concentration is present, management must
employ heightened risk management practices including board and management
oversight and strategic planning, development of underwriting standards, risk
assessment and monitoring through market analysis and stress testing, and
increasing capital requirements. Based on the Bank's projected commercial
real estate lending levels, it is considered to have a concentration in
commercial real estate lending and must implement the practices outlined in
the final guidance.
Our commercial business lending activities involves greater risk than other
types of lending.
Our commercial business lending has increased since 2003 and we intend to
continue to offer commercial business loans to small and medium sized
businesses. Our ability to originate commercial business loans is determined
by the demand for these loans and our ability to attract and retain qualified
commercial lending personnel. Because payments on commercial business loans
generally depend on the successful operation of the business involved,
repayment of commercial business loans may be subject to a greater extent to
adverse conditions in the economy than
43
other types of lending. Although commercial business loans often have
equipment, inventory, accounts receivable or other business assets as
collateral, the sale of the collateral in the event the borrower does not
repay the loan is often not sufficient to repay the loan because the
collateral may be uncollectible and inventories and equipment may be obsolete
or of limited use, among other things.
Our funding sources may prove insufficient to replace deposits and support our
future growth.
We rely on customer deposits and advances from the FHLB of Seattle and
other borrowings to fund our operations. Although we have historically been
able to replace maturing deposits and advances if desired, we may not be able
to replace such funds in the future if our financial condition or the
financial condition of the FHLB of Seattle or market conditions were to
change. Our financial flexibility will be severely constrained if we are
unable to maintain our access to funding or if adequate financing is not
available to accommodate future growth at acceptable interest rates. Finally,
if we are required to rely more heavily on more expensive funding sources to
support future growth, our revenues may not increase proportionately to cover
our costs. In this case, our profitability would be adversely affected.
Although we consider such sources of funds adequate for our liquidity
needs, we may seek additional debt in the future to achieve our long-term
business objectives. Additional borrowings, if sought, may not be available
to us or, if available, may not be available on reasonable terms. If
additional financing sources are unavailable or are not available on
reasonable terms, our growth and future prospects could be adversely affected.
If our allowance for loan losses is not sufficient to cover future loan
losses, our earnings could decrease.
We make various assumptions and judgments about the collectibility of our
loan portfolio, including the creditworthiness of our borrowers and the value
of the real estate and other assets serving as collateral for the repayment of
many of our loans. In determining the amount of the allowance for loan
losses, we review several factors including our loan loss and delinquency
experience, underwriting practices, and economic conditions. If our
assumptions are incorrect, our allowance for loan losses may not be sufficient
to cover future losses in the loan portfolio, resulting in the need for
greater additions to our allowance. Material additions to the allowance could
materially decrease our net income. Our allowance for loan losses was 1.42% of
total loans receivable (net) and 67.1% of non-performing loans at September
30, 2008.
In addition, bank regulators periodically review our allowance for loan
losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs. Any increase in our allowance for loan
losses or loan charge-offs as required by these regulatory authorities may
have a material adverse effect on our financial condition and results of
operations.
Our deposit insurance premiums are expected to increase substantially, which
will adversely affect our profits.
Our deposit insurance premiums during fiscal 2008 totaled $296,000.
These premiums were, however, offset by $166,000 in credits, leaving the net
expense recorded for deposit insurance premiums during the year ended
September 30, 2008 at $130,000. These credits were fully depleted during the
quarter ended June 30, 2008. Those premiums are expected to increase in 2009
due to recent strains on the FDIC deposit insurance fund due to the cost of
large bank failures and increase in the number of troubled banks. The current
rates for FDIC assessments have ranged from 5 to 43 basis points, depending on
the health of the insured institution. The FDIC has proposed increasing that
assessment range to 12 to 50 basis points for the first quarter of 2009. For
the remainder of 2009, it has proposed a range of 10 to 45 basis points for
institutions that do not trigger risk factors for brokered deposits and
unsecured debt and higher rates for those that do trigger those risk factors.
The FDIC also proposed that it could increase assessment rates in the future
without formal rulemaking.
Competition with other financial institutions could adversely affect our
profitability.
The banking and financial services industry is very competitive. Legal
and regulatory developments have made it easier for new and sometimes
unregulated competitors to compete with us. Consolidation among financial
service
44
providers has resulted in fewer very large national and regional banking and
financial institutions holding a large accumulation of assets. These
institutions generally have significantly greater resources, a wider
geographic presence or greater accessibility. Our competitors sometimes are
also able to offer more services, more favorable pricing or greater customer
convenience than we do. In addition, our competition has grown from new banks
and other financial services providers that target our existing or potential
customers. As consolidation continues among large banks, we expect additional
institutions to try to exploit our market.
Technological developments have allowed competitors including some
non-depository institutions, to compete more effectively in local markets and
have expanded the range of financial products, services and capital available
to our target customers. If we are unable to implement, maintain and use such
technologies effectively, we may not be able to offer products or achieve the
cost-efficiencies necessary to compete in our industry. In addition, some of
these competitors have fewer regulatory constraints and lower cost structures.
The loss of key members of our senior management team could adversely affect
our business.
We believe that our success depends largely on the efforts and abilities
of our senior management. Their experience and industry contacts
significantly benefit us. The competition for qualified personnel in the
financial services industry is intense, and the loss of any of our key
personnel or an inability to continue to attract, retain and motivate key
personnel could adversely affect our business.
We are subject to extensive government regulation and supervision.
We are subject to extensive federal and state regulation and supervision,
primarily through the Bank and certain non-bank subsidiaries. Banking
regulations are primarily intended to protect depositors' funds, federal
deposit insurance funds and the banking system as a whole, not shareholders.
These regulations affect our lending practices, capital structure, investment
practices, dividend policy and growth, among other things. Congress and
federal regulatory agencies continually review banking laws, regulations and
policies for possible changes. Changes to statutes, regulations or regulatory
policies, including changes in interpretation or implementation of statutes,
regulations or policies, could affect us in substantial and unpredictable
ways. Such changes could subject us to additional costs, limit the types of
financial services and products we may offer and/or increase the ability of
non-banks to offer competing financial services and products, among other
things. Failure to comply with laws, regulations or policies could result in
sanctions by regulatory agencies, civil money penalties and/or reputation
damage, which could have a material adverse effect on our business, financial
condition and results of operations. While we have policies and procedures
designed to prevent any such violations, there can be no assurance that such
violations will not occur. For further information, see "Item 1. Business -
Regulation of the Company."
We rely heavily on the proper functioning of our technology.
We rely heavily on communications and information systems to conduct our
business. Any failure, interruption or breach in security of these systems
could result in failures or disruptions in our customer relationship
management, general ledger, deposit, loan and other systems. While we have
policies and procedures designed to prevent or limit the effect of the
failure, interruption or security breach of our information systems, such
failures, interruptions or security breaches may still occur and, if they do
occur, they may not be adequately addressed. The occurrence of any failures,
interruptions or security breaches of our information systems could damage our
reputation, result in a loss of customer business, subject us to additional
regulatory scrutiny, or expose us to civil litigation and possible financial
liability, any of which could have a material adverse effect on our financial
condition and results of operations.
We rely on third-party service providers for much of our communications,
information, operating and financial control systems technology. If any of our
third-party service providers experience financial, operational or
technological difficulties, or if there is any other disruption in our
relationships with them, we may be required to locate alternative sources of
such services, and we may not be able to negotiate terms that are as favorable
to us, or obtain services with similar functionality, as found in our existing
systems, without the need to expend substantial resources, if at all. Any of
these circumstances could have an adverse effect on our business.
45
We rely on dividends from subsidiaries for most of our revenue.
The Company is a separate and distinct legal entity from its subsidiary.
We receive substantially all of our revenue from dividends from our
subsidiary. These dividends are the principal source of funds to pay
dividends on our common stock and interest and principal on our debt. Various
federal and/or state laws and regulations limit the amount of dividends that
the Bank may pay to the Company. Also, our right to participate in a
distribution of assets upon a subsidiary's liquidation or reorganization is
subject to the prior claims of the subsidiary's creditors. In the event the
Bank is unable to pay dividends to the Company, we may not be able to service
our debt, pay obligations or pay dividends on our common stock. The inability
to receive dividends from the Bank could have a material adverse effect on our
business, financial condition and results of operations
If we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results or
prevent fraud, and, as a result, investors and depositors could lose
confidence in our financial reporting, which could adversely affect our
business, the trading price of our stock and our ability to attract additional
deposits.
In connection with the enactment of the Sarbanes-Oxley Act of 2002 and
the implementation of the rules and regulations promulgated by the SEC, we
document and evaluate our internal control over financial reporting in order
to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act. This
requires us to prepare an annual management report on our internal control
over financial reporting, including among other matters, management's
assessment of the effectiveness of internal control over financial reporting
and an attestation report by our independent auditors addressing these
assessments. If we fail to identify and correct any significant deficiencies
in the design or operating effectiveness of our internal control over
financial reporting or fail to prevent fraud, current and potential
shareholders and depositors could lose confidence in our internal controls and
financial reporting, which could adversely affect our business, financial
condition and results of operations, the trading price of our stock and our
ability to attract additional deposits.
Changes in accounting standards may affect our performance.
Our accounting policies and methods are fundamental to how we record and
report our financial condition and results of operations. From time to time
there are changes in the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be
difficult to predict and can materially impact how we report and record our
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in
restating prior period financial statements.
Risks Related to the U.S. Financial Industry
Recently enacted legislation and other measures undertaken by the Treasury,
the Federal Reserve and other governmental agencies to help stabilize the U.S.
financial system or improve the housing market may not be successful.
On October 3, 2008, President Bush signed into law the Emergency Economic
Stabilization Act of 2008 (the "EESA"), which, among other measures,
authorized the Treasury Secretary to establish the Troubled Asset Relief
Program ("TARP"). EESA gives broad authority to Treasury to purchase, manage,
modify, sell and insure the troubled mortgage related assts that triggered the
current economic crisis as well as other "troubled assets." EESA includes
additional provisions directed at bolstering the economy, including:
* Authority for the Federal Reserve to pay interest on depository
institution balances;
* Mortgage loss mitigation and homeowner protection;
* Temporary increase in FDIC insurance coverage from $100,000 to
$250,000 through December 31, 2009; and
46
* Authority to the SEC to suspend mark-to-market accounting
requirements for any issuer or class of category of transactions.
Pursuant to the TARP, the Treasury has the authority to, among other
things, purchase up to $700 billion (of which $250 billion is currently
available) of mortgages, mortgage-backed securities and certain other
financial instruments from financial institutions for the purpose of
stabilizing and providing liquidity to the U.S. financial markets. In
addition, the Treasury has created a capital purchase program, under the TARP
pursuant to which it is providing access to capital to financial institutions
through a standardized program to acquire preferred stock (accompanied by
warrants) from eligible financial institutions that will serve as Tier I
capital. The Company submitted an initial application for the sale of
preferred shares equal to 3.0% of its risk-weighted assets.
EESA also contains a number of significant employee benefit and executive
compensation provisions, some of which apply to employee benefit plans
generally, and others which impose on financial institutions that participate
in the TARP program restrictions on executive compensation.
EESA followed, and has been followed by, numerous actions by the Federal
Reserve, Congress, Treasury, the SEC and others to address the currently
liquidity and credit crisis that has followed the sub-prime meltdown that
commenced in 2007. These measures include homeowner relief that encourage
loan restructuring and modification; the establishment of significant
liquidity and credit facilities for financial institutions and investment
banks; the lowering of the federal funds rate, including a 50 basis point
decrease on October 8, 2008; emergency action against short selling practices;
a temporary guaranty program for money market funds; the establishment of a
commercial paper funding facility to provide back-stop liquidity to commercial
paper issuers; and coordinated international efforts to address illiquidity
and other weaknesses in the banking sector.
In addition, the Internal Revenue Service has issued an unprecedented
wave of guidance in response to the credit crisis, including a relaxation of
limits on the ability of financial institutions that undergo an "ownership
change" to utilize their pre-change net operating losses and net unrealized
built-in losses. The relaxation of these limits may make significantly more
attractive the acquisition of financial institutions whose tax basis in their
loan portfolios significantly exceeds the fair market value of those
portfolios.
On October 14, 2008, the FDIC announced the establishment of a temporary
liquidity guarantee program to provide full deposit insurance for all
non-interest bearing transaction accounts and guarantees of certain newly
issued senior unsecured debt issued by FDIC-insured institutions and their
holding companies. Insured institutions are automatically covered by this
program for the period commencing October 14, 2008 and will continue to be
covered as long as they do not opt out of the program by December 5, 2008. We
did not opt out of the program. Under the program, the FDIC will guarantee
timely payment of newly issued senior unsecured debt issued on or before June
30, 2009. The debt includes all newly issued unsecured senior debt (e.g.,
promissory notes, commercial paper and inter-bank funding). The aggregate
coverage for an institution may not exceed 125% of its debt outstanding on
September 30, 2008 that was scheduled to mature before June 30. 2009, or for
certain insured institutions, 2% of liabilities as of September 30, 2008. The
guarantee will extend to June 30, 2012 even if the maturity of the debt is
after that date. Many details of the program still remain to be worked out.
The actual impact that EESA and such related measures undertaken to
alleviate the liquidity and credit crisis will have generally on the financial
markets, including the extreme levels of volatility and limited credit
availability currently being experienced is unknown The failure of such
measures to help stabilize the financial markets and a continuation or
worsening of current financial market conditions could materially and
adversely affect our business, financial condition, results of operations,
access to credit or the trading price of our common stock. The specific
impact that such measures may have on us, and whether we will be eligible to
obtain capital from the Treasury under the TARP program, is also unknown.
47
Difficult market conditions have adversely affected our industry.
We are particularly exposed to downturns in the U.S. housing market.
Dramatic declines in the housing market over the past year, with falling home
prices and increasing foreclosures, unemployment and under-employment, have
negatively impacted the credit performance of mortgage loans and resulted in
significant write-downs of asset values by financial institutions, including
government-sponsored entities, major commercial and investment banks, and
regional financial institutions such as our Company. Reflecting concern about
the stability of the financial markets generally and the strength of
counterparties, many lenders and institutional investors have reduced or
ceased providing funding to borrowers, including to other financial
institutions. This market turmoil and tightening of credit have led to an
increased level of commercial and consumer delinquencies, lack of consumer
confidence, increased market volatility and widespread reduction of business
activity generally. The resulting economic pressure on consumers and lack of
confidence in the financial markets have adversely affected our business,
financial condition and results of operations. We do not expect that the
difficult conditions in the financial markets are likely to improve in the
near future. A worsening of these conditions would likely exacerbate the
adverse effects of these difficult market conditions on us and others in the
financial institutions industry. In particular, we may face the following
risks in connection with these events:
* We expect to face increased regulation of our industry. Compliance
with such regulation may increase our costs and limit our ability
to pursue business opportunities.
* Our ability to assess the creditworthiness of our customers may be
impaired if the models and approaches we use to select, manage and
underwrite our customers become less predictive of future
behaviors.
* The analysis we use to estimate losses inherent in our credit
exposure requires difficult, subjective and complex judgments.
Forecasts of economic conditions and how these economic predictions
might impair the ability of our borrowers to repay their loans, may
no longer be capable of accurate estimation. This may impact the
reliability of our analysis.
* Our ability to borrow from other financial institutions on
favorable terms, or at all, could be adversely affected by further
disruptions in the capital markets or other events, including
actions by rating agencies and deteriorating investor expectations.
* Competition in our industry could intensify as a result of the
increasing consolidation of financial services companies in
connection with current market conditions.
* We may be required to pay significantly higher deposit insurance
premiums because market developments have significantly depleted
the insurance fund of the FDIC and reduced the ratio of reserves to
insured deposits.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and
disruption for more than a year. In recent months, the volatility and
disruption has reached unprecedented levels. In some cases, the markets have
produced downward pressure on stock prices and credit availability for certain
issuers without regard to those issuers' underlying financial strength. If
current levels of market disruption and volatility continue or worsen our
ability to access capital may be adversely affected which, in turn, could
adversely affect our business, financial condition and results of operations.
Item 1B. Unresolved Staff Comments
-----------------------------------
Not applicable.
48
Item 2. Properties
-------------------
At September 30, 2008 the Bank operated 21 full service facilities and
one loan production office. The following table sets forth certain
information regarding the Bank's offices, all of which are owned, except for
the Tacoma office, the Gig Harbor office, the Lacey office at 1751 Circle Lane
SE, the Centralia loan production office, and the Check Processing Department
office at 504 8th Street, which are leased.
Approximate Deposits at
Location Year Opened Square Footage September 30, 2008
--------------------------- ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $111,367
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 32,314
Aberdeen, Washington 98520
201Main Street South 2004 3,200 48,171
Montesano, Washington 98563
361 Damon Road 1977 2,100 23,080
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 34,495
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 19,652
Auburn, Washington 98002
12814 Meridian East (South Hill) 1996 4,200 36,764
Puyallup, Washington 98373
1201 Marvin Road, N.E. 1997 4,400 13,169
Lacey, Washington 98516
101 Yelm Avenue W. 1999 1,800 13,086
Yelm, Washington 98597
20464 Viking Way NW 1999 3,400 6,947
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,900 17,785
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 19,792
Tumwater, Washington 98512
7805 South Hosmer Street 2001 5,000 10,177
Tacoma, Washington 98408
(table continued on following page)
49
Approximate Deposits at
Location Year Opened Square Footage September 30, 2008
--------------------------- ----------- -------------- ------------------
(In thousands)
2401 Bucklin Hill Road 2003 4,000 12,108
Silverdale, Washington 98383
423 Washington Street SE 2003 3,000 11,799
Olympia, Washington 98501
3105 Judson St 2004 2,700 7,276
Gig Harbor, Washington 98335
117 N. Broadway 2004 3,700 13,599
Aberdeen, Washington 98520
313 West Waldrip 2004 5,900 23,420
Elma, Washington 98541
1751 Circle Lane SE 2004 900 11,192
Lacey, Washington 98503
101 2nd Street 2004 1,800 17,640
Toledo, Washington 98591
209 NE 1st Street 2004 3,400 14,739
Winlock, Washington 98586
Loan Production Office:
1641 Kresky Avenue, Suite 2 2006 800
Centralia, Washington 98531
Check Processing Facility:
504 8th Street 2003 5,400
Hoquiam, Washington 98550
Loan Center/Data Center:
120 Lincoln Street 2003 6,000
Hoquiam, Washington 98550
Other Properties:
305 8th Street(1)
Hoquiam, Washington 98550 2004 4,100
-----------
(1) Office at 305 8th Street, Hoquiam, Washington was consolidated into the
office at 624 Simpson Avenue, Hoquiam, Washington on November 15, 2004.
The building is currently being used for storage and other administrative
purposes.
Management believes that all facilities are appropriately insured and are
adequately equipped for carrying on the business of the Bank.
At September 30, 2008 the Bank operated 21 proprietary ATMs that are part
of a nationwide cash exchange network.
50
Item 3. Legal Proceedings
--------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties
in which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Bank is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 2008.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
---------------------------------------------------------------------------
and Issuer Purchases of Equity Securities
-----------------------------------------
The Company's common stock is traded on the Nasdaq Global Market under
the symbol "TSBK." As of November 30, 2008, there were 6,980,329 shares of
common stock issued and approximately 650 shareholders of record. The
following table sets forth the market price range of the Company's common
stock for the years ended September 30, 2008 and 2007. This information was
provided by the Nasdaq Stock Market. All amounts have been adjusted to
reflect the two-for-one stock split, paid in the form of a 100% stock
dividend, on June 5, 2007.
High Low Dividends
-------- ------- ---------
Fiscal 2008
First Quarter.................. $16.28 $11.85 $0.10
Second Quarter................. 13.00 10.55 0.11
Third Quarter.................. 12.34 7.80 0.11
Fourth Quarter................. 9.40 5.90 0.11
High Low Dividends
-------- ------- ---------
Fiscal 2007
First Quarter.................. $18.94 $17.48 $0.09
Second Quarter................. 18.82 17.63 0.09
Third Quarter.................. 18.61 15.70 0.09
Fourth Quarter................. 16.40 15.10 0.10
Dividends
Dividend payments by the Company are dependent primarily on dividends
received by the Company from the Bank. Under federal regulations, the dollar
amount of dividends the Bank may pay is dependent upon its capital position
and recent net income. Generally, if the Bank satisfies its regulatory
capital requirements, it may make dividend payments up to the limits
prescribed in the FDIC regulations. However, institutions that have converted
to a stock form of ownership may not declare or pay a dividend on, or
repurchase any of, its common stock if the effect thereof would cause the
regulatory capital of the institution to be reduced below the amount required
for the liquidation account which was established in connection with the
mutual to stock conversion.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d)
in Part III, Item 12. of this Form 10-K is incorporated herein by reference.
51
Stock Repurchases
The Company has had various buy-back programs since January 1998. On
February 25, 2008, the Company announced a plan to repurchase 343,468 shares
of the Company's common stock. This was the Company's 16th stock repurchase
plan. As of September 30, 2008, the Company had not repurchased any shares
under this plan. Cumulatively, the Company has repurchased 7,783,934 shares
at an average price of $8.98 per share. This represents 58.9% of the
13,225,000 shares that were issued when the Company went public in January
1998.
The following table sets forth the Company's repurchases of its
outstanding Common Stock during the fourth quarter of the year ended September
30, 2008.
Maximum
Total Number Number (or
of Shares Approximate
Purchased as Dollar Value)
Total Part of of Shares that
Number of Average Publicly May Yet Be
Shares Price Paid Announced Purchased
Period Purchased per Share Plans Under the Plans
----------------------- --------- ---------- ----------- ---------------
July 1, 2008 -
July 31, 2008......... -- -- -- 343,468
August 1, 2008 -
August 31, 2008....... -- -- -- 343,468
September 1, 2008 -
September 30, 2008.... -- -- -- 343,468
Total.................. -- -- -- 343,468
52
The following graph compares the cumulative total shareholder return on
our common stock with the cumulative total return on the Nasdaq U.S. Companies
Index and with the SNL $250 to $500 Million Asset Thrift Index and the SNL
$500 to $1 Billion Asset Thrift Index, peer group indices. Total return
assumes the reinvestment of all dividends and that the value of the Company's
Common Stock and each index was $100 on September 30, 2003.
[GRAPH APPEARS HERE]
Period Ending
----------------------------------------------------------
Index 09-30-03 09-30-04 09-30-05 09-30-06 09-30-07 09-30-08
------------------- -------- -------- -------- -------- -------- --------
Timberland Bancorp,
Inc.............. $100.00 100.64 102.06 158.11 143.99 72.34
NASDAQ Composite... 100.00 106.25 120.41 126.39 151.18 117.06
SNL $250m-$500 M
Thrift Index...... 100.00 112.57 110.69 120.45 111.30 94.64
SNL $500m-$1 B
Thrift Index...... 100.00 112.71 114.99 133.59 128.75 96.40
* Source: SNL Financial LC, Charlottesville, VA
53
Item 6. Selected Financial Data
--------------------------------
The following table sets forth certain information concerning the
consolidated financial position and results of operations of the Company and
subsidiaries at and for the dates indicated. The consolidated data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements of the Company and its subsidiary presented herein.
At September 30,
---------------------------------------------
2008 2007 2006 2005 2004
------ ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION
DATA:
Total assets................ $681,883 $644,848 $577,087 $552,765 $460,419
Loans receivable and loans
held for sale, net......... 557,687 515,341 424,645 388,109 344,594
Investment securities
available-for-sale......... -- 50,851 63,805 65,860 41,560
Investment securities
held-to-maturity........... 28 -- -- -- --
Mortgage-backed securities
held-to-maturity........... 14,205 71 75 104 174
Mortgage-backed securities
available-for-sale......... 17,098 13,047 17,603 23,735 18,329
FHLB Stock.................. 5,705 5,705 5,705 5,705 5,682
Cash and due from financial
institutions, interest-
bearing deposits in banks
and fed funds sold......... 42,874 16,670 22,889 28,718 19,833
Deposits.................... 498,572 466,735 431,061 411,665 319,570
FHLB advances............... 104,628 99,697 62,761 62,353 65,421
Shareholders' equity........ 74,841 74,547 79,365 74,642 72,817
Year Ended September 30,
---------------------------------------------
2008 2007 2006 2005 2004
------ ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income..................... $43,338 $41,944 $35,452 $30,936 $26,571
Interest expense............ 16,413 15,778 10,814 8,609 7,325
------- ------- ------- ------- -------
Net interest income......... 26,295 26,166 24,638 22,327 19,246
Provision for loan losses... 3,900 686 -- 141 167
------- ------- ------- ------- -------
Net interest income after
provision for loan losses.. 23,025 25,480 24,638 22,186 19,079
Non-interest income......... 4,178 5,962 6,244 6,073 4,576
Non-interest expense........ 20,374 19,451 18,896 18,536 15,575
Income before income taxes.. 6,829 11,991 11,986 9,723 8,080
Federal income taxes........ 2,824 3,828 3,829 3,105 2,492
------- ------- ------- ------- -------
Net income.................. $ 4,005 $ 8,163 $ 8,157 $ 6,618 $ 5,588
======= ======= ======= ======= =======
Earnings per share (1):
Basic..................... $ 0.62 $ 1.20 $ 1.16 $ 0.95 $ 0.77
Diluted................... $ 0.61 $ 1.17 $ 1.12 $ 0.91 $ 0.73
Dividends per share (1)..... $ 0.43 $ 0.37 $ 0.33 $ 0.31 $ 0.29
Dividend payout ratio....... 74.33% 32.86% 30.55% 35.01% 41.52%
------------------
(1) Have been restated to reflect the two-for-one split of common stock, in
the form of a 100% stock dividend paid on June 5, 2007.
54
At September 30,
---------------------------------------------
2008 2007 2006 2005 2004
------ ------ ------ ------ ------
OTHER DATA:
Number of real estate loans
outstanding................. 3,261 3,295 3,005 3,022 2,857
Deposit accounts............. 53,501 53,166 51,392 51,496 40,348
Full-service offices......... 21 21 21 21 16
At or For the Year Ended September 30,
---------------------------------------------
2008 2007 2006 2005 2004
------ ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average
assets (1)................. 0.61% 1.34% 1.47% 1.23% 1.24%
Return on average
equity (2)................. 5.35 10.67 10.59 9.08 7.52
Interest rate spread (3).... 3.98 4.18 4.49 4.30 4.30
Net interest margin (4)..... 4.41 4.69 4.91 4.60 4.67
Average interest-earning
assets to average
interest-bearing
liabilities................ 115.70 118.01 119.20 116.56 120.68
Noninterest expense as a
percent of average total
assets..................... 3.10 3.20 3.41 3.44 3.46
Efficiency ratio (5)........ 65.50 60.54 61.19 65.27 65.38
Book value per share (6).... $10.74 $10.72 $10.56 $ 9.93 $ 9.38
Book value per share (7).... 11.34 11.39 11.22 10.65 10.14
Tangible book value per
share (6)(8)................ 9.79 9.73 9.61 8.93 9.38
Tangible book value per
share (7)(8)................ 10.34 10.34 10.21 9.58 10.14
Asset Quality Ratios:
Non-accrual and 90 days
or more past due loans
as a percent of total
loans receivable, net...... 2.12% 0.29% 0.02% 0.75% 0.41%
Non-performing assets as
a percent of total
assets (9)................. 1.83 0.23 0.02 0.62 0.40
Allowance for loan losses as
a percent of total loans
receivable, net (10)....... 1.44 0.92 0.96 1.05 1.14
Allowance for losses as a
percent of non-performing
loans (11)................. 67.14 321.95 5,152.50 140.09 276.77
Net charge-offs (recoveries)
to average outstanding
loans...................... 0.12 -- (0.01) 0.01 0.02
Capital Ratios:
Total equity-to-assets
ratio...................... 10.98% 11.56% 13.75% 13.50% 15.82%
Tangible equity-to-assets
ratio...................... 10.00 10.49 12.51 12.15 15.82
Average equity to average
assets (12)................ 11.47 12.58 13.90 13.53 16.52
--------------
(1) Net income divided by average total assets.
(2) Net income divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(4) Net interest income (before provision for loan losses) as a percentage
of average interest-earning assets.
(5) Other expenses (excluding federal income tax expense) divided by the sum
of net interest income and noninterest income.
(6) Calculation includes Employee Stock Ownership Plan ("ESOP") shares not
committed to be released.
(7) Calculation excludes ESOP shares not committed to be released.
(8) Calculation subtracts goodwill and core deposit intangible from the
equity component.
(9) Non-performing assets include non-accrual loans, other real estate owned
and other repossessed assets.
(10) Loans receivable includes loans held for sale and is before the
allowance for loan losses.
(11) Non-performing loans include non-accrual loans. Troubled debt
restructured loans that are on accrual status are not included.
(12) Average total equity divided by average total assets.
55
Item 7. Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
Results of Operations
---------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results
of Operations is intended to assist in understanding the consolidated
financial condition and results of operations of the Company. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying notes thereto included in Item 8 of this
Annual Report on Form 10-K.
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis and Results of Operations and other
portions of this Form 10-K contain certain "forward-looking statements"
concerning future operations of the Company. Management desires to take
advantage of the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995 and is including this statement for the express purpose of
availing the Company of the protections of such safe harbor with respect to
all "forward-looking statements" contained in this Annual Report. The Company
has used "forward-looking statements" to describe future plans and strategies,
including its expectations of the Company's future financial results.
Management's ability to predict results or the effect of future plans or
strategies is inherently uncertain. Factors which could affect actual results
include interest rate trends, the general economic climate in the Company's
market area and the country as a whole, the ability of the Company to control
expenses, deposit flows, demand for mortgages and other loans, real estate
values, vacancy rates, results of examinations by banking regulatory agencies,
competition, loan delinquency rates, and changes in federal and state
regulation. These factors should be considered in evaluating the
"forward-looking statements," and undue reliance should not be placed on such
statements. The Company does not undertake to update any "forward-looking
statement" that may be made on behalf of the Company.
Critical Accounting Policies and Estimates
The Company has established various accounting policies that govern the
application of accounting principles generally accepted in the United States
of America ("GAAP") in the preparation of the Company's Consolidated Financial
Statements. The Company has identified two policies, that as a result of
judgments, estimates and assumptions inherent in those policies, are critical
to an understanding of the Company's Consolidated Financial Statements. These
policies relate to the methodology for the determination of the allowance for
loan losses and the valuation of mortgage servicing rights ("MSRs"). These
policies and the judgments, estimates and assumptions are described in greater
detail in subsequent sections of Management's Discussion and Analysis
contained herein and in the notes to the Consolidated Financial Statements
contained in Item 8 of this Form 10-K. In particular, Note 1 of the Notes to
Consolidated Financial Statements, "Summary of Significant Accounting
Policies," generally describes the Company's accounting policies. Management
believes that the judgments, estimates and assumptions used in the preparation
of the Company's Consolidated Financial Statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of the
Company's Consolidated Financial Statements to these critical policies, the
use of other judgments, estimates and assumptions could result in material
differences in the Company's results of operations or financial condition.
Allowance for Loan Losses. The allowance for loan losses is maintained at
a level sufficient to provide for probable loan losses based on evaluating
known and inherent risks in the portfolio. The allowance is based upon
management's comprehensive analysis of the pertinent factors underlying the
quality of the loan portfolio. These factors include changes in the amount
and composition of the loan portfolio, actual loan loss experience, current
economic conditions, and detailed analysis of individual loans for which full
collectibility may not be assured. The detailed analysis includes methods to
estimate the fair value of loan collateral and the existence of potential
alternative sources of repayment. The appropriate allowance for loan loss
level is estimated based upon factors and trends identified by management at
the time the consolidated financial statements are prepared.
56
Mortgage Servicing Rights. Mortgage servicing rights are capitalized when
acquired through the origination of loans that are subsequently sold with
servicing rights retained and are amortized to servicing income on loans sold
in proportion to and over the period of estimated net servicing income. The
value of MSRs at the date of the sale of loans is determined based on the
discounted present value of expected future cash flows using key assumptions
for servicing income and costs and prepayment rates on the underlying loans.
The estimated fair value is evaluated at least annually for impairment by
comparing actual cash flows and estimated cash flows from the servicing assets
to those estimated at the time servicing assets were originated. The effect
of changes in market interest rates on estimated rates of loan prepayments
represents the predominant risk characteristic underlying the MSRs' portfolio.
The Company's methodology for estimating the fair value of MSRs is highly
sensitive to changes in assumptions. For example, the determination of fair
value uses anticipated prepayment speeds. Actual prepayment experience may
differ and any difference may have a material effect on the fair value. Thus,
any measurement of MSRs' fair value is limited by the conditions existing and
assumptions as of the date made. Those assumptions may not be appropriate if
they are applied at different times.
New Accounting Pronouncements
For a discussion of new accounting pronouncements and their impact on the
Company, see Note 1 of the Notes to the Consolidated Financial Statements
contained in "Item 8. Financial Statements and Supplementary Data."
Operating Strategy
The Company is a bank holding company which operates primarily through
its subsidiary, the Bank. The Bank is a community-oriented bank which has
traditionally offered a wide variety of savings products to its retail
customers while concentrating its lending activities on real estate loans.
The primary elements of the Bank's operating strategy include:
Diversify Primary Market Area by Expanding Branch Office Network. In an
effort to lessen its dependence on the Grays Harbor County market whose
economy has historically been tied to the timber and fishing industries, the
Bank has opened branch offices in Pierce, King, Thurston and Kitsap Counties.
Pierce, King, Thurston and Kitsap Counties contain the Olympia, Bremerton, and
Seattle-Tacoma metropolitan areas and their economies are more diversified
with the presence of government, aerospace and computer technology industries.
In October 2004, the Bank continued its geographic diversification by
acquiring two branches in Lewis County as part of a seven-branch acquisition.
In August 2008, the Bank announced plans to open an additional full-service
branch in Lewis County. The Bank's existing loan production office in Lewis
County will be consolidated into the new facility, which is expected to open
in 2009.
Limit Exposure to Interest Rate Risk. In recent years, a majority of the
loans that the Bank has retained in its portfolio generally have periodic
interest rate adjustment features or have been relatively short-term in
nature. Loans originated for portfolio retention primarily have included ARM
loans and short-term construction loans. Longer term fixed-rate mortgage
loans have generally been originated for sale in the secondary market.
Management believes that the interest rate sensitivity of these
adjustable-rate and short-term loans more closely match the interest rate
sensitivity of the Bank's funding sources than other longer duration assets
with fixed-interest rates.
Emphasize Residential Mortgage Lending. The Bank has historically
attempted to establish itself as a niche lender in its primary market areas by
focusing a part of its lending activities on the origination of loans secured
by one-to four-family residential dwellings, including loans for the
construction of residential dwellings. In an effort to meet the credit needs
of borrowers in its primary market areas, the Bank originates one- to
four-family mortgage loans that do not qualify for sale in the secondary
market under FHLMC guidelines. The Bank has also been an active participant in
the secondary market, originating residential loans for sale to the FHLMC on a
servicing retained basis. The Bank occasionally retains fixed-rate one- to
four-family mortgage loans in its portfolio for yield and asset-liability
management purposes.
57
Emphasize the Origination of Commercial Real Estate and Commercial
Business Loans. The Bank has hired additional commercial loan officers since
2006 for the purpose of increasing the Bank's origination of commercial real
estate and commercial business loans.
Increase the Consumer Loan Portfolio. In 2001 the Bank hired a consumer
loan specialist to increase the origination of consumer loans. The consumer
loans generated since that time have been secured primarily by real estate.
The Bank expects to continue expanding its portfolio of consumer loans.
Pursue Low Cost Core Deposits and Deposit Related Fee Income. The Bank
has placed an emphasis on attracting commercial and personal checking
accounts. These transactional accounts typically provide a lower cost of
funding than certificates of deposit accounts and generate non-interest fee
income. In October 2004, the Bank increased its transaction account base by
acquiring seven branches and the related deposits.
Market Risk and Asset and Liability Management
General. Market risk is the risk of loss from adverse changes in market
prices and rates. The Company's market risk arises primarily from interest
rate risk inherent in its lending, investment, deposit and borrowing
activities. The Bank, like other financial institutions, is subject to
interest rate risk to the extent that its interest-earning assets reprice
differently than its interest-bearing liabilities. Management actively
monitors and manages its interest rate risk exposure. Although the Bank
manages other risks, such as credit quality and liquidity risk, in the normal
course of business management considers interest rate risk to be its most
significant market risk that could potentially have the largest material
effect on the Bank's financial condition and results of operations. The Bank
does not maintain a trading account for any class of financial instruments nor
does it engage in hedging activities. Furthermore, the Bank is not subject to
foreign currency exchange rate risk or commodity price risk.
Qualitative Aspects of Market Risk. The Bank's principal financial
objective is to achieve long-term profitability while reducing its exposure to
fluctuating market interest rates. The Bank has sought to reduce the exposure
of its earnings to changes in market interest rates by attempting to manage
the difference between asset and liability maturities and interest rates. The
principal element in achieving this objective is to increase the interest-rate
sensitivity of the Bank's interest-earning assets by retaining in its
portfolio, short-term loans and loans with interest rates subject to periodic
adjustments. The Bank relies on retail deposits as its primary source of
funds. As part of its interest rate risk management strategy, the Bank
promotes transaction accounts and certificates of deposit with terms of up to
six years.
The Bank has adopted a strategy that is designed to substantially match
the interest rate sensitivity of assets relative to its liabilities. The
primary elements of this strategy involve originating ARM loans for its
portfolio, maintaining residential construction loans as a portion of total
net loans receivable because of their generally shorter terms and higher
yields than other one- to four-family residential mortgage loans, matching
asset and liability maturities, investing in short-term securities,
originating fixed-rate loans for retention or sale in the secondary market,
and retaining the related mortgage servicing rights.
Sharp increases or decreases in interest rates may adversely affect the
Bank's earnings. Management of the Bank monitors the Bank's interest rate
sensitivity through the use of a model provided for the Bank by FIMAC
Solutions, LLC ("FIMAC"), a company that specializes in providing the
financial services industry interest risk rate risk and balance sheet
management services. Based on a rate shock analysis prepared by FIMAC, an
immediate increase in interest rates of 200 basis points would increase the
Bank's projected net interest income by approximately 5.7%, primarily because
a larger portion of the Bank's interest rate sensitive assets than interest
rate sensitive liabilities would reprice within a one year period. Similarly,
an immediate 200 basis point decrease in interest rates would negatively
affect net interest income by approximately 7.0%, as repricing would have the
opposite effect. See "- Quantitative Aspects of Market Risk" below for
additional information. Management has sought to sustain the match between
asset and liability maturities and rates, while maintaining an acceptable
interest rate spread. Pursuant to this strategy, the Bank actively originates
adjustable-rate loans for retention in its loan portfolio. Fixed-rate
mortgage loans with maturities greater than seven years generally are
originated for the immediate or future resale in the secondary mortgage
market. At September 30, 2008, adjustable-rate mortgage loans constituted
$216.1 million or 58.6%, of the Bank's total mortgage loan portfolio due after
58
one year. Although the Bank has sought to originate ARM loans, the ability to
originate such loans depends to a great extent on market interest rates and
borrowers' preferences. Particularly in lower interest rate environments,
borrowers often prefer fixed-rate loans.
Consumer loans and construction and land development loans typically have
shorter terms and higher yields than permanent residential mortgage loans, and
accordingly reduce the Bank's exposure to fluctuations in interest rates. At
September 30, 2008, the construction and land development, and consumer loan
portfolios amounted to $186.3 million and $59.3 million, or 30.5% and 9.7% of
total loans receivable (including loans held for sale), respectively.
Quantitative Aspects of Market Risk. The model provided for the Bank by
FIMAC estimates the changes in net portfolio value ("NPV") and net interest
income in response to a range of assumed changes in market interest rates.
The model first estimates the level of the Bank's NPV (market value of assets,
less market value of liabilities, plus or minus the market value of any
off-balance sheet items) under the current rate environment. In general,
market values are estimated by discounting the estimated cash flows of each
instrument by appropriate discount rates. The model then recalculates the
Bank's NPV under different interest rate scenarios. The change in NPV under
the different interest rate scenarios provides a measure of the Bank's
exposure to interest rate risk. The following table is provided by FIMAC
based on data at September 30, 2008.
Net Interest Income(1)(2) Current Market Value
Projected ------------------------------ -------------------------------
Interest Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario Value from Base from Base Value from Base from Base
------------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
+300 $26,633 $ 2,059 8.38% $80,443 $(7,750) (8.79)%
+200 25,981 1,407 5.72 82,749 (5,444) (6.17)
+100 25,330 756 3.07 85,849 (2,344) (2.66)
BASE 24,574 -- -- 88,193 -- --
-100 23,906 (668) (2.72) 87,030 (1,163) (1.32)
-200 22,844 (1,730) (7.04) 84,869 (3,324) (3.77)
-300 21,942 (2,632) (10.71) 82,193 (6,000) (6.80)
-------------
(1) Does not include loan fees.
(2) Includes BOLI income, which is included in non-interest income on the
Consolidated Financial Statements.
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan repayments and deposit decay, and should not be relied
upon as indicative of actual results. Furthermore, the computations do not
reflect any actions management may undertake in response to changes in
interest rates.
In the event of a 200 basis point decrease in interest rates, the Bank
would be expected to experience a 3.8% decrease in NPV and a 7.0% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 6.2% decrease in NPV and a 5.7% increase in net interest income would
be expected. Based upon the modeling described above, the Bank's asset and
liability structure generally results in decreases in net interest income in a
declining interest rate scenario and increases in net interest income in a
rising rate scenario. This structure also generally results in decreases in
NPV in rising and declining rate scenarios.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities
or periods to repricing, they may react in different degrees to changes in
market interest rates. Also, the interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types may lag behind changes in market rates.
Additionally, certain assets have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates,
59
expected rates of prepayments on loans and early withdrawals from certificates
could possibly deviate significantly from those assumed in calculating the
table.
Comparison of Financial Condition at September 30, 2008 and September 30, 2007
The Company's total assets increased by $37.1 million, or 5.7%, to $681.9
million at September 30, 2008 from $644.8 million at September 30, 2007,
primarily attributable to a $42.4 million increase in net loans receivable and
a $26.2 million increase in cash equivalents. These increases were partially
offset by a $32.7 million decrease in investment and mortgage-backed
securities. This asset growth was primarily funded by a $31.9 million
increase in deposits and a $4.9 million increase in FHLB advances.
The Company's capital increased by $294,000, or 0.4%, to $74.8 million at
September 30, 2008 from $74.5 million at September 30, 2007, primarily as a
result of retained net income and proceeds from the exercise of stock options,
reduced by the payment of cash dividends and share repurchases. The Company
remains well capitalized with a total capital to risk-weighted assets ratio of
13.6% at September 30, 2008.
A more detailed explanation of the changes in significant balance sheet
categories follows:
Cash Equivalents: Cash equivalents increased by $26.2 million or 157.2%
to $42.9 million at September 30, 2008 from $16.7 million at September 30,
2007. The increase was primarily reflected in a $21.7 million increase in
federal funds sold as the Company increased its liquidity position.
Investment Securities and Mortgage-backed Securities and FHLB Stock:
Investment and mortgage-backed securities (including FHLB stock) decreased by
$32.7 million or 46.8% to $37.0 million at September 30, 2008 from $69.7
million at September 30, 2007, primarily as the result of the maturity or call
of U.S. agency securities, the redemption of mutual funds, and regular
amortization and prepayments on mortgage-backed securities. In June 2008, the
Company redeemed its $29.1 million investment in the AMF family of mutual
funds for the underlying securities and cash, and recorded a loss of $2.8
million. The Company used the proceeds from the security maturities and
prepayments to fund loan growth rather than reinvesting into investment
securities. For additional details on investments and mortgage-backed
securities, see "Item 1. Business - Investment Activities" and Note 3 of the
Notes to the Consolidated Financial Statements contained in "Item 8. Financial
Statements and Supplemental Data."
Loans Receivable and Loans Held for Sale, Net of Allowance for Loan
Losses: Net loans receivable, including loans held for sale, increased by
$42.4 million or 8.2% to $557.7 million at September 30, 2008 from $515.3
million at September 30, 2007. The increase in the portfolio was primarily a
result of a $22.4 million increase in construction loans (net of the
undisbursed portion of construction loans in process), an $18.4 million
increase in commercial real estate loans, a $9.9 million increase in one- to
four-family mortgage loans, and a $2.9 million increase in commercial business
loans. These increases were partially offset by a $9.2 million decrease in
multi-family loans.
Loan originations (including participation interests purchased) decreased
by 12.7% to $261.4 million for the year ended September 30, 2008 from $299.4
million for the year ended September 30, 2007. The decrease in loan
originations was primarily a result of lower demand for financing in the
Bank's market areas due to a slowing economy and a tightening in the Bank's
underwriting standards. The Bank sold $45.3 million in fixed rate one- to
four-family mortgage loans during the year ended September 30, 2008 compared
to $29.9 million for the fiscal year ended September 30, 2007. For
additional information on loans, see "Item 1. Business - Lending Activities"
and Note 4 of the Notes to Consolidated Financial Statements contained in
"Item 8. Financial Statements and Supplementary Data."
Premises and Equipment: Premises and equipment increased by $309,000 to
$16.9 million at September 30, 2008 from $16.6 million at September 30, 2007.
The increase was primarily as a result of the purchase of land for the Bank's
new branch facility that will be constructed in Lewis County, and remodeling
costs associated with several branch offices. These increases were partially
offset by depreciation and the sale of a building in Grays Harbor County that
previously served as a branch facility. For additional information on
premises and equipment, see "Item 2. Properties"
60
and Note 6 of the Notes to Consolidated Financial Statements contained in
"Item 8. Financial Statements and Supplementary Data."
Other Real Estate Owned ("OREO"): OREO and other repossessed items
totaled $511,000 at September 30, 2008 and consisted of one single family
residence in Pierce County and two vehicles. The Company did not have any
OREO or other repossessed items at September 30, 2007. For additional
information on OREOs, see "Item 1. Business - Lending Activities -
Non-performing Assets" and Note 7 of the Notes to Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
Goodwill and Core Deposit Intangible ("CDI"): Goodwill and CDI decreased
by $249,000 to $6.6 million at September 30, 2008 from $6.9 million at
September 30, 2007 due to scheduled amortization of CDI. The Company recorded
goodwill and CDI in connection with the October 2004 acquisition of seven
branches and related deposits. The Company performed its annual review of
goodwill as of June 30, 2008 and determined that there was no impairment to
goodwill. For additional information of Goodwill and CDI, see Note 1 and Note
8 of the Notes to Consolidated Financial Statements contained in "Item 8.
Financial Statements and Supplemental Data."
Deposits: Deposits increased by $31.9 million, or 6.8%, to $498.6 million
at September 30, 2008 from $466.7 million at September 30, 2007, primarily due
to a $22.3 million increase is money market accounts, a $10.1 million increase
in N.O.W. checking accounts, and a $2.5 million increase in certificates of
deposit accounts. These increases were partially offset by a $3.0 million
decrease in non-interest bearing accounts. The increase in money market
accounts was partially a result of a $10.5 million short-term deposit by a
commercial customer that was transferred out of the deposit base and into the
Bank's Certificate of Deposit Registry Service ("CDARS") program in early
October 2008. For additional information on deposits, see "Item 1. Business -
Deposit Activities and Other Sources of Funds" and Note 9 of the Consolidated
Financial Statements contained in "Item 8. Financial Statements and
Supplementary Data."
FHLB Advances and Other Borrowings: FHLB advances and other borrowings
increased by $5.1 million, or 5.1%, to $105.4 million at September 30, 2008
from $100.3 million at September 30, 2007 as the Bank used additional advances
to fund loan portfolio growth. For additional information on borrowings, see
"Item 1. Business - Deposit Activities and Other Sources of Funds -
Borrowings" and Notes 10 and 11 of the Notes to Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
Shareholders' Equity: Total shareholders' equity increased by $294,000,
or 0.4%, to $74.8 million at September 30, 2008 from $74.5 million at
September 30, 2007, primarily as a result net income of $4.0 million and
proceeds from the exercise of stock options of $857,000 and a $323,000 net
increase in the fair value of investment securities available for sale.
These increases to shareholders' equity were partially offset by the payment
of $3.0 million in cash dividends to shareholders and share repurchases of
$1.9 million.
During the year ended September 30, 2008 the Company repurchased 144,950
shares of its common stock for $1.9 million (an average price of $13.26 per
share.) The Company had 343,468 shares remaining to be purchased on its
existing stock repurchase plan at September 30, 2008. Cumulatively, the
Company has repurchased 7,783,934 shares (58.9%) of the 13,225,000 shares that
were issued in its 1998 initial public offering, at an average price of $8.98
per share. For additional information on shareholders' equity, see the
Consolidated Statements of Shareholders' Equity contained in "Item 8.
Financial Statements and Supplementary Data."
Comparison of Operating Results for the Years Ended September 30, 2008 and
2007
The Company's net income decreased by $4.16 million, or 50.9%, to $4.01
million for the year ended September 30, 2008 from $8.16 million for the year
ended September 30, 2007. The decrease was primarily as a result of increased
provision for loan losses, decreased non-interest income due to a loss on the
redemption of mutual funds, and increased non-interest expenses, which were
partially offset by increased net interest income. Diluted earnings per share
decreased by 47.9% to $0.61 for the year ended September 30, 2008 from $1.17
for the year ended September 30, 2007.
61
The increased provision for loan losses was primarily a result of an
increase in the level of non-performing loans, an increase in the level of
performing loans classified as substandard under the Bank's loan grading
system, loan portfolio growth, and uncertainties in the housing market in
certain markets of the Pacific Northwest. Net charge-offs were $647,000
during the year ended September 30, 2008, which was equivalent to 0.12% of the
average outstanding loans.
The decreased non-interest income was primarily a result of a $2.82
million loss on the sale of securities, as the Company redeemed its investment
in the AMF family of mutual funds in June 2008. This loss was partially
offset by increased income from service charges on deposit accounts and
increased income from loan sales.
The increased non-interest expense was primarily a result of increased
employee costs and increased deposit related expenses. The increased salary
and employee benefit expenses were primarily a result of annual salary
adjustments and increased insurance expenses. The increased deposit related
expenses were primarily a result of the expenses associated with several new
deposit related programs implemented during the year.
The increased net interest income was primarily a result of a larger
interest earning asset base due to an increased loan portfolio. The increase
in net interest income attributable to a larger interest earning asset base
was, however, partially offset by a decrease in the Company's net interest
margin.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2008 decreased
by $4.16 million, or 50.9%, to $4.01 million, or $0.61 per diluted share
($0.62 per basic share) from $8.16 million, or $1.17 per diluted share ($1.20
per basic share) for the year ended September 30, 2007. The $0.56 decrease in
diluted earnings per share for the year ended September 30, 2008 was primarily
the result of a $2.82 million ($2.59 million net of income tax - $0.39 per
diluted share) charge from the redemption of the Company's investment in the
AMF family of mutual funds, a $3.21 million ($2.12 million net of income tax -
$0.30 per diluted share) increase in the provision for loan losses, and a
$923,000 ($609,000 net of income tax - $0.08 per diluted share) increase in
non-interest expense. These items were partially offset by a $759,000
($501,000 net of income tax - $0.07 per diluted share) increase in net
interest income, a $1.04 million ($688,000 net of income tax - $0.10 per
diluted share) increase in non-interest income, excluding the mutual fund
redemption charge, and a lower number of weighted average shares outstanding
which increased diluted earnings per share by approximately $0.04.
Net Interest Income: Net interest income increased by $759,000, or 2.9%,
to $26.93 million for the year ended September 30, 2008 from $26.17 million
for the year ended September 30, 2007, primarily due to a larger interest
earning asset base due to an increased loan portfolio. Total interest and
dividend income increased by $1.39 million to $43.34 million for the year
ended September 30, 2008 from $41.94 million for the year ended September 30,
2007 as average total interest earning assets increased by $52.84 million.
The yield on interest earning assets decreased to 7.09% for the year ended
September 30, 2008 from 7.51% for the year ended September 30, 2007. Total
interest expense increased by $635,000 to $16.41 million for the year ended
September 30, 2008 from $15.78 million for the year ended September 30, 2007
as average interest bearing liabilities increased by $55.09 million. The
average rate paid on interest bearing liabilities decreased to 3.11% for the
year ended September 30, 2008 from 3.33% for the year ended September 30,
2007.
The increase in net interest income attributable to a larger interest
earning asset base was, however, partially offset by a compression of the
Company's net interest margin. The net interest margin decreased 28 basis
points to 4.41% for the year ended September 30, 2008 from 4.69% for the year
ended September 30, 2007 as the yield on interest earnings assets decreased at
a greater rate than funding costs were decreased. This was primarily a result
of the decreasing interest rate environment which reduced yields on loans at a
faster pace than the Bank was able to reduce deposit and borrowing costs.
Provision for Loan Losses: The provision for loan losses increased by
$3.21 million, or 468.5%, to $3.90 million for the year ended September 30,
2008 from $686,000 for the year ended September 30, 2007. The increased
62
provision for loan losses was primarily a result of an increase in
non-performing loans, an increase in the level of performing loans classified
as substandard under the Bank's loan grading system, loan portfolio growth,
and uncertainties in the housing market in certain markets of the Pacific
Northwest. The Bank had a net charge-off of $647,000 for the year ended
September 30, 2008 compared to a net charge-off of $11,000 for the year ended
September 30, 2007. The net charge-offs to average outstanding loans ratio
was 0.12% for the year ended September 30, 2008 and 0.002% for the year ended
September 30, 2007.
The Bank has established a comprehensive methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration pertinent factors underlying the quality of the loan
portfolio. These factors include changes in the size and composition of the
loan portfolio, historical loss experience for various loan segments, changes
in economic conditions, delinquency rates, a detailed analysis of individual
loans on non-accrual status, and other factors to determine the level of
allowance for loan losses needed. Management's analysis, however, for the
year ended September 30, 2008, placed a greater emphasis on the Bank's
construction and land development portfolio and the effect of various factors
such as geographic and loan type concentrations. The Bank also reviewed the
national trend of declining home sales with potential housing market value
depreciation. The allowance for loan losses increased $3.25 million to $8.05
million at September 30, 2008 from $4.80 million at September 30, 2007. The
increased level of the allowance for loan losses was primarily attributable to
an increase in non-performing loans, an increase in the level of performing
loans classified as substandard under the Bank's grading system, loan
portfolio growth, and uncertainties in the housing market and economy.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $8.05 million at September 30, 2008 (1.42% of loans
receivable and 67.1% of non-performing loans) adequate to provide for probable
losses based on an evaluation of known and inherent risks in the loan
portfolio at that date. While the Bank believes it has established its
existing allowance for loan losses in accordance with GAAP, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be necessary should the quality of any loans deteriorate. Any material
increase in the allowance for loan losses would adversely affect the Bank's
financial condition and results of operations. For additional information,
see "Item 1. Business - Lending Activities - Allowance for Loan Losses."
Non-interest Income: Total non-interest income decreased by $1.78
million, or 29.9%, to $4.18 million for the year ended September 30, 2008 from
$5.96 million for the year ended September 30, 2007, primarily due to a $2.82
million loss on the redemption of investments in the AMF family of mutual
funds.
Non-interest income, excluding the mutual fund redemption loss increased
by $1.04 million, or 17.4%, to $7.0 million for the year ended September 30,
2008 from $5.96 million from the year ended September 30, 2007. This increase
was primarily a result of a $717,000 increase in service charges on deposit
accounts and a $240,000 increase in income from loan sales (gain on sale of
loans and servicing income on loans sold). The increase in service charges on
deposit accounts was primarily a result of implementing a new automated
overdraft decision system during the year and increasing the fee charged for
overdrafts. The increase in income from loan sales was primarily a result of
an increase in the dollar value of fixed rate one- to four-family mortgage
loans sold during the year. The sale of fixed rate one-to four-family
mortgage loans totaled $45.3 million for the year ended September 30, 2008
compared to $29.9 million for the year ended September 30, 2007.
Non-interest Expense: Total non-interest expense increased by $923,000,
or 4.7%, to $20.37 million for the year ended September 30, 2008 from $19.45
million for the year ended September 30, 2007. The increase was primarily
attributable to a $641,000 increase in salary and benefit expenses and a
$269,000 increase in deposit related expenses. Salary and benefit expenses
increased primarily as a result of annual salary adjustments and increased
health insurance expenses. Deposit related expenses increased primarily as a
result of the expenses associated with several new deposit related programs
implemented during the year and an increase in FDIC insurance expense recorded
as the Bank's credit with the FDIC was fully depleted during the quarter ended
June 30, 2008.
63
The Company's efficiency ratio increased to 65.50% for the year ended
September 30, 2008 from 60.54% for the year ended September 30, 2007. The
efficiency ratio, excluding the mutual fund redemption loss, was 60.06% for
the year ended September 30, 2008.
Provision for Income Taxes: The provision for income taxes decreased by
$1.01 million to $2.82 million for the year ended September 30, 2008 from
$3.83 million for the year ended September 30, 2007 primarily as a result of
lower income before taxes. The provision for income taxes for the year ended
September 30, 2008 was also impacted by the $2.82 million loss on the
redemption of mutual funds. The redemption of the mutual funds resulted in a
capital loss which can only be deducted for tax purposes to the extent that
capital gains are realized within a three year carry back period and a five
year carry forward period. The Company has estimated that it will have
$679,000 in capital gains during the allowable tax period to offset the
capital loss. Therefore $2.14 million of the $2.82 million loss has been
treated as non-deductible for tax purposes. The Company's effective tax rate
was 41.35% (or 31.65% exclusive of the mutual fund redemption loss and
associated tax impact) for the year ended September 30, 2008 and 31.92% for
the year ended September 30, 2007.
Comparison of Operating Results for the Years Ended September 30, 2007 and
2006
The Company's net income was nearly identical at $8.16 million for the
years ended September 30, 2007 and 2006 as increased net interest income was
offset by increased non-interest expense, increased provision for loan losses,
and decreased non-interest income. Diluted earnings per share, however,
increased by 4.5% to $1.17 for the year ended September 30, 2007 from $1.12
for the year ended September 30, 2006. The increased earnings per diluted
share were primarily a result of a decrease in the weighted average number of
shares outstanding as a result of share repurchases.
The increased net interest income was primarily a result of a larger
interest earning asset base due to an increased loan portfolio. The increase
in net interest income attributable to a larger interest earning asset base
was, however, partially offset by a decrease in the Company's net interest
margin.
The increased provision for loan losses was primarily the result of a
larger loan portfolio and an increase in the level of loans classified as
substandard. Net charge-offs remained low at only $11,000 during the year
ended September 30, 2007, which is equivalent to 0.002% of average outstanding
loans.
The increased non-interest expense was primarily a result of increased
employee costs and increased advertising expenses. The increased salary and
employee benefit expenses were primarily because of a larger employee base and
annual salary adjustments, and the increased advertising expenses were
primarily the result of additional advertising campaigns.
The decreased non-interest income was primarily a result of decreased
income from service charges on deposit accounts and decreased fee income from
the sale of non-deposit investment products.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2007 increased
by $6,000 to $8.16 million, or $1.17 per diluted share ($1.20 per basic share)
from $8.16 million, or $1.12 per diluted share ($1.16 per basic share) for the
year ended September 30, 2006. The $0.05 increase in diluted earnings per
share for the year ended September 30, 2007 was primarily the result of a
$1.53 million ($1.01 million net of income tax - $0.14 per diluted share)
increase in net interest income and a lower number of weighted average shares
outstanding which increased diluted earnings per share by approximately $0.05.
These items were partially offset by a $686,000 ($439,000 net of income tax -
$0.06 per diluted share) increase in the provision for loan losses, a $555,000
($366,000 net of income tax - $0.05 per diluted share) increase in
non-interest expense and a $282,000 ($186,000 net of income tax - $0.03 per
diluted share) decrease in non-interest income.
Net Interest Income: Net interest income increased by $1.53 million to
$26.17 million for the year ended September 30, 2007 from $24.64 million for
the year ended September 30, 2006, primarily due to a larger interest
64
earning asset base due to an increased loan portfolio. Total interest and
dividend income increased by $6.49 million to $41.94 million for the year
ended September 30, 2007 from $35.45 million for the year ended September 30,
2006 as average total interest earning assets increased by $56.10 million.
The yield on interest earning assets increased to 7.51% for the year ended
September 30, 2007 from 7.06% for the year ended September 30, 2006. Total
interest expense increased by $4.96 million to $15.78 million for the year
ended September 30, 2007 from $10.81 million for the year ended September 30,
2006 as average interest bearing liabilities increased by $51.79 million. The
average rate paid on interest bearing liabilities increased to 3.33% for the
year ended September 30, 2007 from 2.57% for the year ended September 30,
2006.
The increase in net interest income attributable to a larger interest
earning asset base was, however, partially offset by a compression of the
Company's net interest margin. The net interest margin decreased 22 basis
points to 4.69% for the year ended September 30, 2007 from 4.91% for the year
ended September 30, 2006 as funding costs increased at a greater rate than
yields increased on interest earning assets. This was primarily due to an
increased reliance on wholesale funding (FHLB advances and brokered deposits)
and increased competition for deposits in the Company's primary market areas,
which increased overall funding costs. Also factoring into the decrease in
this year's net interest margin was the collection of prepayment penalties and
non-accrual interest last year which increased the net interest margin for the
year ended September 30, 2006 by approximately 10 basis points.
Provision for Loan Losses: The provision for loan losses increased to
$686,000 for the year ended September 30, 2007 compared to no provision made
during the year ended September 30, 2006. The provision for loan losses
increased primarily due to an increase in the loan portfolio and an increase
in the level of loans classified as substandard. The Bank had a net
charge-off of $11,000 for the year ended September 30, 2007 compared to a net
recovery of $23,000 for the year ended September 30, 2006. The net
charge-offs (recoveries) to average outstanding loans ratio was 0.002% for the
year ended September 30, 2007 and (0.006%) for the year ended September 30,
2006.
The Bank has established a comprehensive methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration pertinent factors underlying the quality of the loan
portfolio. These factors include changes in the size and composition of the
loan portfolio, historical loss experience for various loan segments, changes
in economic conditions, delinquency rates, a detailed analysis of individual
loans on non-accrual status, and other factors to determine the level of
allowance for loan losses needed. The allowance for loan losses increased
$675,000 to $4.80 million at September 30, 2007 from $4.12 million at
September 30, 2006. The increased level of the allowance for loan losses was
primarily attributable to a larger loan portfolio (loans receivable and loans
held for sale), which increased by $90.7 million to $515.3 million at
September 30, 2007 from $424.6 million at September 30, 2006. Also
contributing to the increased allowance was an increase in the level of loans
classified as substandard.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $4.80 million at September 30, 2007 (0.92% of loans
receivable and 321.9% of non-performing loans) adequate to provide for
probable losses based on an evaluation of known and inherent risks in the loan
portfolio at that date. While the Bank believes it has established its
existing allowance for loan losses in accordance with GAAP, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be necessary should the quality of any loans deteriorate. Any material
increase in the allowance for loan losses would adversely affect the Bank's
financial condition and results of operations. For additional information,
see "Item 1. Business - Lending Activities - Allowance for Loan Losses."
Non-interest Income: Total non-interest income decreased by $282,000 to
$5.96 million for the year ended September 30, 2007 from $6.24 million for the
year ended September 30, 2006, primarily due to a $205,000 decrease in service
charges on deposits and a $166,000 decrease in fees from the sale of
non-deposit investment products, and a $30,000 decrease in gain on sale of
loans. The decrease in income from service charges on deposits was primarily
a result of a decrease in the number of customer overdrafts. The decrease in
gross fees received from that sale of non-deposit investment products was
primarily due to decreased sales and a change in the fee structure with the
Bank's
65
third-party vendor. These decreases were partially offset by a $112,000
increase in ATM transaction fees and an $80,000 increase in servicing income
on loans sold.
Non-interest Expense: Total non-interest expense increased by $555,000
to $19.45 million for the year ended September 30, 2007 from $18.90 million
for the year ended September 30, 2006. Non-interest expense increased in the
current year primarily due to a $184,000 increase in salary and benefit
expenses, a $155,000 increase in advertising expenses, a $69,000 increase in
ATM expenses, a $49,000 increase in premises and equipment expense and smaller
increases in several other expense categories. The increased salary and
benefit expenses were primarily due to a larger employee base and annual
salary adjustments and the increased advertising expenses were a result of
additional advertising campaigns. Also contributing to the increase in
non-interest expense was a $143,000 change in the other real estate operations
expense category. This change was primarily due to larger gains on the sale
of OREO properties that were included in this category during the 2006 fiscal
year.
These increases to non-interest expense were partially offset by a
$143,000 decrease in professional fees. The decrease in professional fees was
primarily a result of decreased consulting, legal, and audit related expenses.
The Company's efficiency ratio improved to 60.54% for the year ended
September 30, 2007 from 61.19% for the year ended September 30, 2006.
Provision for Income Taxes: The provision for income taxes remained at
$3.83 million for the years ended September 30, 2007 and 2006. The Company's
effective tax rate was 31.92% for the year ended September 30, 2007 and 31.95%
for the year ended September 30, 2006.
Average Balances, Interest and Average Yields/Cost
The earnings of the Company depend largely on the spread between the
yield on interest-earning assets and the cost of interest-bearing liabilities,
as well as the relative amount of the Company's interest-earning assets and
interest- bearing liability portfolios.
The following table sets forth, for the periods indicated, information
regarding average balances of assets and liabilities as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and average yields
and costs. Such yields and costs for the periods indicated are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the periods presented.
66
Year Ended September 30,
--------------------------------------------------------------------------------
2008 2007 2006
-------------------------- ------------------------ -------------------------
Interest Interest Interest
Average and Yield/ Average and Yield/ Average and Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- --------- ------ ------- --------- ------ ------- --------- ------
(Dollars in thousands)
Interest-earning assets:
Loans receivable (1)(2).. $552,318 $40,924 7.41% $477,029 $38,386 8.04% $399,811 $31,397 7.85%
Mortgage-backed and
investment securities... 19,799 1,064 5.37 37,411 1,529 4.09 55,373 2,152 3.89
FHLB stock and equity
securities.............. 29,201 1,123 3.85 37,347 1,692 4.53 36,882 1,436 3.89
Federal funds sold....... 8,318 191 2.30 5,030 260 5.17 8,414 389 4.62
Interest-bearing
deposits................ 1,499 36 2.40 1,481 77 5.17 1,714 78 4.55
-------- ------- -------- ------- -------- -------
Total interest-earning
assets................ 611,135 43,338 7.09 558,298 41,944 7.51 502,194 35,452 7.06
Non-interest-earning
assets................... 47,086 49,483 52,037
-------- -------- --------
Total assets........... $658,221 $607,781 $554,231
======== ======== ========
Interest-bearing
liabilities:
Savings accounts......... $ 56,461 398 0.70 $ 60,124 425 0.71% $ 62,255 442 0.71%
Money market accounts.... 51,943 1,249 2.40 46,013 1,186 2.58 43,204 711 1.65
NOW accounts............. 86,441 774 0.90 82,323 638 0.77 91,507 684 0.75
Certificates of deposit.. 224,493 9,342 4.16 199,046 9,043 4.55 168,578 6,068 3.60
Short-term
borrowings (3).......... 14,321 615 4.29 35,206 1,954 5.55 4,664 218 4.67
Long-term
borrowings (4).......... 94,537 4,035 4.27 50,393 2,532 5.02 51,109 2,691 5.27
-------- ------- -------- ------- -------- -------
Total interest
bearing
liabilities........... 528,196 16,413 3.11 473,105 15,778 3.33 421,317 10,814 2.57
Non-interest bearing
liabilities.............. 55,150 58,179 55,870
-------- -------- --------
Total liabilities...... 583,346 531,284 477,187
Shareholders' equity...... 74,875 76,497 77,044
-------- -------- --------
Total liabilities
and shareholders'
equity................ $658,221 $607,781 $554,231
======== ======== ========
Net interest income....... $26,925 $26,166 $24,638
======= ======= =======
Interest rate spread...... 3.98% 4.18% 4.49%
====== ====== ======
Net interest margin (5)... 4.41% 4.69% 4.91%
====== ====== ======
Ratio of average
interest-earning assets
to average interest-
bearing liabilities...... 115.70% 118.01% 119.20%
====== ====== ======
---------------
(1) Does not include interest on loans 90 days or more past due. Includes loans originated for sale.
Amortized net deferred loan fees, late fees, extension fees and prepayment penalties (2008, $1,804;
2007, $1,794; and 2006, $2,137) included with interest and dividends.
(2) Average balance includes nonaccrual loans.
(3) Includes FHLB advances and PCBB advances with original maturities of less than one year and other
short-term borrowings-repurchase agreements.
(4) Includes FHLB advances with original maturities of one year or greater.
(5) Net interest income divided by total average interest earning assets.
67
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes
on net interest income on the Company. Information is provided with respect
to the (i) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate), and (ii) effects on interest
income attributable to changes in rate (changes in rate multiplied by prior
volume), and (iii) the net change (sum of the prior columns). Changes in
rate/volume have been allocated to rate and volume variances based on the
absolute values of each.
Year Ended September 30, Year Ended September 30,
2008 Compared to Year 2007 Compared to Year
Ended September 30, 2007 Ended September 30, 2006
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------ ------------------------
Net Net
Rate Volume Change Rate Volume Change
---- ------ -------- ---- ------ ------
(In thousands)
Interest-earning assets:
Loans receivable (1)... $(3,201) $5,739 $ 2,538 $ 793 $6,196 $6,989
Investments and
mortgage-backed
securities............ 391 (856) (465) (11) (118) (129)
FHLB stock and equity
securities............ (233) (336) (569) 2 (3) (1)
Federal funds sold..... (188) 119 (69) (38) (585) (623)
Interest-bearing
deposits.............. (42) 1 (41) 237 19 256
Total net change in
income on interest-
earning assets......... (3,273) 4,667 1,394 983 5,509 6,492
Interest-bearing
liabilities:
Savings accounts....... (1) (26) (27) -- (17) (17)
NOW accounts........... 103 33 136 (3) (43) (46)
Money market accounts.. (83) 146 63 424 51 475
Certificate accounts... (798) 1,097 299 2,356 619 2,975
Short-term borrowings.. (370) (969) (1,339) 47 1,689 1,736
Long-term borrowings... (430) 1,933 1,503 (123) (36) (159)
-------- ------ ------- ------- ------ ------
Total net change in
expense on interest-
bearing liabilities.... (1,579) 2,214 635 2,701 2,263 4,964
-------- ------ ------- ------- ------ ------
Net change in net
interest income........$(1,694) $2,453 $ 759 $(1,718) $3,246 $1,528
======= ====== ======= ======= ====== ======
----------------
(1) Excludes interest on loans 90 days or more past due. Includes loans
originated for sale.
68
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds
from principal and interest payments on loans, the sale of loans, maturing
securities and FHLB advances. While the maturity and scheduled amortization
of loans are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and competition.
The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to fund loan originations and deposit
withdrawals, to satisfy other financial commitments and to take advantage of
investment opportunities. The Bank generally maintains sufficient cash and
short-term investments to meet short-term liquidity needs. At September 30,
2008, 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 9.77%. At September 30, 2008, the Bank maintained an uncommitted credit
facility with the FHLB-Seattle that provided for immediately available
advances up to an aggregate amount equal to 30% of total assets, limited by
available collateral, under which $104.6 million was outstanding. The Bank
also maintained a $10.0 million overnight borrowing line with PCBB. At
September 30, 2008, the Bank did not have an outstanding balance on this
borrowing line.
Liquidity management is both a short and long-term responsibility of the
Bank's management. The Bank adjusts its investments in liquid assets based
upon management's assessment of (i) expected loan demand, (ii) projected loan
sales, (iii) expected deposit flows, and (iv) yields available on interest-
bearing deposits. Excess liquidity is invested generally in interest-bearing
overnight deposits and other short-term government and agency obligations. If
the Bank requires funds beyond its ability to generate them internally, it has
additional borrowing capacity with the FHLB, PCBB and collateral for
repurchase agreements.
The Bank's primary investing activity is the origination of mortgage
loans, which includes construction and land development loans. During the
years ended September 30, 2008, 2007 and 2006, the Bank originated $223.9
million, $235.7 million and $215.8 million of mortgage loans, respectively.
At September 30, 2008, the Bank had loan commitments totaling $40.6 million
and undisbursed loans in process totaling $43.4 million. The Bank anticipates
that it will have sufficient funds available to meet current loan commitments.
Certificates of deposit that are scheduled to mature in less than one year
from September 30, 2008 totaled $175.8 million. Historically, the Bank has
been able to retain a significant amount of its deposits as they mature.
The Bank's liquidity is also affected by the volume of loans sold and
loan principal payments. During the years ended September 30, 2008, 2007 and
2006, the Bank sold $45.3 million $29.9 million and $26.4 million in fixed
rate, one- to four-family mortgage loans, respectively. The Bank also sold
$17.0 million in participation loans during the year ended September 30, 2008.
During the years ended September 30, 2008, 2007, and 2006, the Bank received
$176.1 million, $164.9 million and $177.0 million in principal repayments,
respectively.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2008, 2007 and 2006, deposits increased
by $31.8 million, $35.7 million and $19.4 million, respectively.
Investment and mortgage-backed securities, federal funds sold, and
interest bearing deposits in other banks decreased to $60.2 million at
September 30, 2008 from $69.8 million at September 30, 2007.
Federally-insured state-chartered banks are required to maintain minimum
levels of regulatory capital. Under current FDIC regulations, insured
state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage
capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most
highly rated banks), (ii) a ratio of Tier 1 capital to risk weighted assets of
at least 4.0% and (iii) a ratio of total capital to risk weighted assets of at
least 8.0%. At September 30, 2008, the Bank was in compliance with all
applicable capital requirements. For additional details see Note 19 of the
Notes to Consolidated Financial Statements contained in "Item 8. Financial
Statements and Supplementary Data" and "Item 1. Business - Regulation of the
Bank - Capital Requirements."
69
Contractual obligations. The following table presents, as of September
30, 2008, the Company's significant fixed and determinable contractual
obligations, within the categories described below, by payment date or
contractual maturity. These contractual obligations, except for the operating
lease obligations are included in the Consolidated Balance Sheet. The payment
amounts represent those amounts contractually due at September 30, 2008.
Payments due by period
----------------------------------------------
After After
1 year 3 years
Within through through After
Contractual obligations 1 year 3 years 5 years 5 years Total
------ ------- ------- ------- -------
(In thousands)
Short-term debt obligations... $ 758 $ -- $ -- $ -- $ 758
Long-term debt obligations.... 4,628 40,000 10,000 50,000 104,628
Operating lease obligations... 228 286 134 -- 648
Capital lease obligations..... 6 -- -- -- 6
------ ------- ------- ------- --------
Total contractual
obligations................ $5,620 $40,286 $10,134 $50,000 $106,040
====== ======= ======= ======= ========
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data
presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America which require the
measurement of financial position and operating results in terms of historical
dollars, without considering the change in the relative purchasing power of
money over time due to inflation. The primary impact of inflation on the
operation of the Company is reflected in increased operating costs. Unlike
most industrial companies, virtually all the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates
generally have a more significant impact on a financial institution's
performance than do general levels of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the prices of
goods and services.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------
The information contained under "Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Risk and
Asset and Liability Management" of this Form 10-K is incorporated herein by
reference.
70
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
Management's Report on Internal Control Over Financial Reporting
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally
accepted accounting principles. The Company's internal control over financial
reporting includes those policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and disposition of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management
and directors of the Company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or
disposition of the Company's assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
The Company's management conducted an evaluation of the effectiveness of
internal control over financial reporting based on the framework in Internal
Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this evaluation,
management concluded that the Company's internal control over financial
reporting was effective as of September 30, 2008. Management's assessment of
the effectiveness of the Company's internal control over financial reporting
has been audited by McGladrey & Pullen, LLP, an independent registered public
accounting firm, as stated in their report which is included herein.
71
McGladrey & Pullen
Certified Public Accountants
Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited Timberland Bancorp, Inc.'s internal control over financial
reporting as of September 30, 2008, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Timberland Bancorp, Inc.'s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audit also included
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, Timberland Bancorp, Inc. maintained, in all material respects,
effective internal control over financial reporting as of September 30, 2008,
based on criteria established in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the annual consolidated financial
statements of Timberland Bancorp, Inc. and Subsidiary and our report dated
December 8, 2008, expressed an unqualified opinion.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 8, 2008
72
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm................ 74
Consolidated Balance Sheets as of September 30, 2008 and 2007.......... 75
Consolidated Statements of Income For the Years Ended
September 30, 2008, 2007, and 2006.................................. 76
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2008, 2007 and 2006....................... 77
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2008, 2007 and 2006................................... 78
Consolidated Statements of Comprehensive Income For the
Years Ended September 30, 2008, 2007 and 2006....................... 80
Notes to Consolidated Financial Statements............................. 81
73
McGladrey & Pullen
Certified Public Accountants
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited the consolidated balance sheets of Timberland Bancorp, Inc.
and Subsidiary as of September 30, 2008 and 2007, and the related consolidated
statements of income, shareholders' equity, cash flows and comprehensive
income for each of the three years in the period ended September 30, 2008.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Timberland
Bancorp, Inc. and Subsidiary as of September 30, 2008 and 2007, and the
results of their operations and their cash flows for each of the three years
in the period ended September 30, 2008, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Timberland Bancorp, Inc. and
Subsidiary's internal control over financial reporting as of September 30,
2008, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) and our report dated December 8, 2008, expressed an unqualified opinion
on the effectiveness of Timberland Bancorp, Inc. and Subsidiary's internal
control over financial reporting.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 8, 2008
74
Consolidated Balance Sheets
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
2008 2007
Assets
Cash equivalents:
Cash and due from financial institutions $ 14,013 $ 10,813
Interest-bearing deposits in other banks 3,431 2,082
Federal funds sold 25,430 3,775
42,874 16,670
Investments and mortgage-backed securities - held to
maturity (market value $11,974 and $70) 14,233 71
Investments and mortgage-backed securities - available
for sale 17,098 63,898
Federal Home Loan Bank ("FHLB") stock (at cost) 5,705 5,705
Loans receivable, net of allowance for loan losses of
$8,050 and $4,797 555,914 514,584
Loans held for sale 1,773 757
557,687 515,341
Premises and equipment, net 16,884 16,575
Other real estate owned ("OREO") and other repossessed
items 511 - -
Accrued interest receivable 2,870 3,424
Bank owned life insurance ("BOLI") 12,902 12,415
Goodwill 5,650 5,650
Core deposit intangible ("CDI") 972 1,221
Mortgage servicing rights 1,306 1,051
Other assets 3,191 2,827
Total assets $681,883 $644,848
Liabilities and shareholders' equity
Liabilities
Deposits:
Demand, non-interest-bearing $ 51,955 $ 54,962
Interest-bearing 446,617 411,773
Total deposits 498,572 466,735
FHLB advances 104,628 99,697
Other borrowings: repurchase agreements 758 595
Other liabilities and accrued expenses 3,084 3,274
Total liabilities 607,042 570,301
Commitments and contingencies (See Note 17) - - - -
Shareholders' equity
Preferred stock, $0.01 par value; 50,000,000 shares
authorized; none issued - - - -
Common stock, $0.01 par value; 50,000,000 shares authorized;
2008 - 6,967,579 shares issued and outstanding
2007 - 6,953,360 shares issued and outstanding 70 70
Additional paid-in capital 8,602 9,923
Unearned shares issued to Employee Stock Ownership
Plan ("ESOP") (2,776) (3,040)
Retained earnings 69,406 68,378
Accumulated other comprehensive loss (461) (784)
Total shareholders' equity 74,841 74,547
Total liabilities and shareholders' equity $681,883 $644,848
See notes to consolidated financial statements.
75
Consolidated Statements of Income
------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2008, 2007 and 2006
2008 2007 2006
Interest and dividend income
Loans receivable $40,924 $38,386 $31,397
Investments and mortgage-backed securities 1,064 1,529 2,152
Dividends from mutual funds and FHLB stock 1,123 1,692 1,436
Interest-bearing deposits in banks 227 337 467
Total interest and dividend income 43,338 41,944 35,452
Interest expense
Deposits 11,763 11,292 7,905
FHLB advances - short term 593 1,905 169
FHLB advances - long term 4,035 2,532 2,691
Other borrowings 22 49 49
Total interest expense 16,413 15,778 10,814
Net interest income 26,925 26,166 24,638
Provision for loan losses 3,900 686 - -
Net interest income after provision for loan
losses 23,025 25,480 24,638
Non-interest income
Service charges on deposits 3,493 2,776 2,981
ATM transaction fees 1,251 1,138 1,026
BOLI net earnings 486 464 449
Gain on sale of loans, net 432 356 386
Loss on sale/redemption of mutual funds, net (2,822) - - - -
Servicing income on loans sold 669 505 425
Escrow fees 9 92 120
Fee income from non-deposit investment sales 124 120 286
Other 536 511 571
Total non-interest income 4,178 5,962 6,244
Non-interest expense
Salaries and employee benefits 11,569 10,928 10,744
Premises and equipment 2,307 2,452 2,403
Advertising 897 843 688
OREO and other repossessed items expense
(income) (3) (13) (156)
ATM expenses 576 497 428
Postage and courier 514 478 486
Amortization of CDI 249 285 328
State and local taxes 622 571 564
Professional fees 678 650 793
Other 2,965 2,760 2,618
Total non-interest expense 20,374 19,451 18,896
Income before federal income taxes 6,829 11,991 11,986
Federal income taxes 2,824 3,828 3,829
Net income $ 4,005 $ 8,163 $ 8,157
Earnings per share
Basic $ 0.62 $ 1.20 $ 1.16
Diluted 0.61 1.17 1.12
See notes to consolidated financial statements.
76
Consolidated Statements of Shareholders' Equity
------------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2008, 2007 and 2006
Accumulated
Other
Unearned Compre-
Additional Shares hensive
Common Stock Paid-in Issued to Retained Income
Shares Amount Capital ESOP Earnings (Loss) Total
Balance,
September 30, 2005 7,519,874 $ 38 $22,040 ($3,833) $57,268 ($871) $74,642
Net income - - - - - - - - 8,157 - - 8,157
Issuance of Management
Recognition & Development
Plan ("MRDP") shares 12,000 - - - - - - - - - - - -
Repurchase of common stock (217,200) (1) (3,700) - - - - - - (3,701)
Exercise of stock options 200,678 1 1,827 - - - - - - 1,828
Cash dividends ($.33 per share) - - - - - - - - (2,492) - - (2,492)
Earned ESOP shares and tax effect - - 480 528 - - - - 1,008
MRDP compensation expense - - - - 3 - - - - - - 3
Stock option compensation exp. - - - - 50 - - - - - - 50
Unrealized holding loss on
securities available for sale,
net of tax - - - - - - - - - - (130) (130)
Balance,
September 30, 2006 7,515,352 $ 38 $20,700 ($3,305) $62,933 ($1,001) $79,365
Net income - - - - - - - - 8,163 - - 8,163
Stock split - - 36 - - - - (36) - - - -
Issuance of MRDP shares 15,080 - - - - - - - - - - - -
Repurchase of common stock (687,542) (4) (12,427) - - - - - - (12,431)
Exercise of stock options 110,470 - - 1,207 - - - - - - 1,207
Cash dividends ($.37 per share) - - - - - - - - (2,682) - - (2,682)
Earned ESOP shares and tax effect - - 354 265 - - - - 619
MRDP compensation expense - - 64 - - - - - - 64
Stock option compensation exp. - - - - 25 - - - - - - 25
Unrealized holding gain on
securities available for sale,
net of tax - - - - - - - - - - 217 217
Balance,
September 30, 2007 6,953,360 $ 70 $ 9,923 ($3,040) $68,378 ($ 784) $74,547
Net income - - - - - - - - 4,005 - - 4,005
Issuance of MRDP shares 20,315 - - - - - - - - - - - -
Repurchase of common stock (144,950) (1) (1,920) - - - - - - (1,921)
Exercise of stock options 138,854 1 856 - - - - - - 857
Cash dividends ($.43 per share) - - - - - - - - (2,977) - - (2,977)
Earned ESOP shares and tax effect - - (409) 264 - - - - (145)
MRDP compensation expense - - 147 - - - - - - 147
Stock option compensation exp. - - - - 5 - - - - - - 5
Unrealized holding gain on
securities available for sale,
net of tax - - - - - - - - - - 323 323
Balance,
September 30, 2008 6,967,579 $ 70 $ 8,602 ($2,776) $69,406 ($ 461) $74,841
See notes to consolidated financial statements.
77
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2008, 2007 and 2006
2008 2007 2006
Cash flows from operating activities
Net income $ 4,005 $ 8,163 $ 8,157
Non-cash revenues, expenses, gains and losses
included in net income:
Depreciation 1,100 1,038 998
Deferred federal income taxes (1,217) (101) 226
Amortization of CDI 249 285 328
Earned ESOP shares 264 265 528
MRDP compensation expense 131 59 7
Stock option compensation expense 5 25 50
Stock option tax effect 15 464 607
Less stock option excess tax benefit (11) (354) (494)
Loss on redemption of mutual funds 2,600 - - - -
Loss on sale of mutual funds 222 - - - -
Write-down on securities held-to-maturity 4 - - - -
Gain on sale of OREO and other repossessed
items, net (47) (19) (158)
Gain on sale of loans (432) (356) (386)
Gain on sale of premises and equipment (288) (71) (37)
Provision for loan losses 3,900 686 - -
Loans originated for sale (45,853) (27,845) (26,153)
Proceeds from sale of loans held for sale 45,269 29,893 26,445
BOLI net earnings (486) (464) (449)
Net change in accrued interest receivable and
other assets, and other liabilities and
accrued expenses 520 (275) (1,906)
Net cash provided by operating activities 9,950 11,393 7,763
Cash flows from investing activities
Net decrease in CDs held for investment - - 100 100
Activity in securities held to maturity:
Maturities and prepayments 579 3 27
Activity in securities/mutual funds available
for sale:
Maturities and prepayments 22,862 17,806 7,960
Proceeds from sales 6,929 - - - -
Increase in loans receivable, net (46,413) (93,316) (36,398)
Additions to premises and equipment (1,495) (1,135) (1,924)
Proceeds from sale of OREO and other
repossessed items 926 105 680
Proceeds from the disposition of premises
and equipment 374 323 95
Net cash used by investing activities (16,238) (76,114) (29,460)
(continued)
See notes to consolidated financial statements.
78
Consolidated Statements of Cash Flows
------------------------------------------------------------------------------
(concluded) (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2008, 2007 and 2006
2008 2007 2006
Cash flows from financing activities
Increase in deposits $ 31,837 $ 35,674 $ 19,396
Proceeds from FHLB advances - long term 50,000 60,000 10,000
Repayment of FHLB advances - long term (15,069) (24,064) (30,592)
Net increase (decrease) in FHLB advances -
short term (30,000) 1,000 21,000
Net increase (decrease) in repurchase
agreements 163 (352) 166
Proceeds from exercise of stock options 841 744 1,221
Earned ESOP shares and tax effect (409) 354 480
MRDP compensation tax effect 16 5 (4)
Stock option excess tax benefit 11 354 494
Repurchase of common stock (1,921) (12,431) (3,701)
Payment of dividends (2,977) (2,682) (2,492)
Net cash provided by financing activities 32,492 58,602 15,968
Net increase (decrease) in cash equivalents 26,204 (6,119) (5,729)
Cash equivalents
Beginning of year 16,670 22,789 28,518
End of year $ 42,874 $ 16,670 $ 22,789
Supplemental disclosures of cash flow
information
Income taxes paid $ 4,120 $ 3,646 $ 3,755
Interest paid 16,656 15,426 10,496
Supplemental disclosures of non-cash investing
and financing activities
Market value adjustment of securities held
for sale, net of tax $ 323 $ 217 ($ 130)
Loans transferred to OREO and other
repossessed items 1,404 71 28
Shares issued to MRDP 259 263 195
Loans to facilitate sale of OREO 257 - - - -
Mutual funds redeemed for mortgage-backed
securities 22,188 - - - -
See notes to consolidated financial statements.
79
Consolidated Statements of Comprehensive Income
------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2008, 2007 and 2006
2008 2007 2006
Comprehensive income
Net income $4,005 $8,163 $8,157
Unrealized holding gain (loss) on
securities available for sale, net of tax 323 217 (130)
Total comprehensive income $4,328 $8,380 $8,027
See notes to consolidated financial statements.
80
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. ("Company"); its wholly owned subsidiary, Timberland Bank
("Bank"); and the Bank's wholly owned subsidiary, Timberland Service Corp.
All significant intercompany transactions and balances have been eliminated.
Nature of Operations
The Company is a bank holding company which operates primarily through its
subsidiary, the Bank. The Bank was established in 1915 and, through its 21
branches located in Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis
counties in Washington State, attracts deposits from the general public, and
uses those funds, along with other borrowings, to provide residential real
estate, construction and land development, commercial real estate, commercial
business and consumer loans to borrowers primarily in western Washington and
to a lesser extent, to invest in investment securities and mortgage-backed
securities.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
practices within the banking industry. The preparation of consolidated
financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and the disclosure
of contingent assets and liabilities, as of the date of the balance sheet, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and the valuation of mortgage
servicing rights.
Certain prior year amounts have been reclassified to conform to the 2008
presentation with no change to net income or shareholders' equity previously
reported.
Stock Split
On June 5, 2007, the Company's common stock was split two-for-one in the form
of a 100% stock dividend. Each shareholder of record as of May 22, 2007
received one additional share for every share owned. All per share amounts
(including stock options) in the consolidated financial statements and
accompanying notes were restated to reflect the split, except as otherwise
noted.
Segment Reporting
The Company provides a broad range of financial services to individuals and
companies located primarily in western Washington. These services include
demand, time and savings deposits; real estate, business and consumer lending;
escrow services; and investment advisory services. While the Company's chief
operating decision maker monitors the revenue streams from the various
products and services, operations are managed and financial performance is
evaluated on a Company-wide basis. Accordingly, all of the Company's
operations are considered by management to be one reportable operating
segment.
(continued)
81
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (continued)
Investments and Mortgage-Backed Securities - Available for Sale
Debt and equity securities that may be sold in response to changes in market
interest rates, prepayment rates, need for liquidity, and changes in the
availability of and the yield of alternative investments, are considered
securities available for sale, and are reported at fair value. Unrealized
gains and losses are excluded from earnings, and are reported as a separate
component of shareholders' equity, net of the related deferred tax effect,
entitled "Accumulated other comprehensive income (loss)." Realized gains and
losses on securities available for sale, determined using the specific
identification method, are included in earnings. Amortization of premiums and
accretion of discounts are recognized in interest income over the period to
maturity.
Declines in the fair value of individual securities available for sale below
their cost that are other than temporary would result in write-downs of the
individual securities that are recognized in the statement of income as
realized losses. Management evaluates individual securities for other than
temporary impairment on a quarterly basis based on the securities' current
credit quality, interest rates, term to maturity and management's intent and
ability to hold the securities until the net book value is recovered.
Management considers an investment security to be other than temporarily
impaired if the decline in fair value is due to credit quality deterioration
which management believes will affect repayment of the investment principal,
or if for any other reason the Company does not have the ability and intent to
hold the investment until the decline in fair value recovers.
Investments and Mortgage-Backed Securities - Held to Maturity
Debt securities for which the Company has the positive intent and ability to
hold to maturity are reported at cost, adjusted for amortization of premiums
and accretion of discounts, which are recognized in interest income using the
interest method.
Declines in the fair value of individual securities held to maturity below
their cost that are other than temporary would result in write-downs of the
individual securities to their fair value. Management evaluates individual
securities for other than temporary impairment on a quarterly basis based on
the securities' current credit quality, interest rates, term to maturity and
management's intent and ability to hold the securities until the net book
value is recovered. Management considers an investment security to be other
than temporarily impaired if the decline in fair value is due to credit
quality deterioration which management believes will affect repayment of the
investment principal, or if for any other reason the Company does not have the
ability and intent to hold the investment until the decline in fair value
recovers. Any other than temporary declines in fair value are recognized in
the statement of income as realized losses.
In addition, the Company accounts for mortgage-backed securities in its
portfolio that did not have a "AA" rating or higher at the time of acquisition
in accordance with the Emerging Issues Task Force ("EITF") 99-20, Recognition
of Interest Income and Impairment on Purchased and Retained Beneficial
Interests in Securitized Financial Assets.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank of Seattle ("FHLB"), is
required to maintain an investment in capital stock of the FHLB in an amount
equal to the greater of 1% of its outstanding home loans or 5% of advances
from the FHLB. The recorded amount of FHLB stock equals its fair value
because the shares can only be redeemed by the FHLB at the $100 per share par
value.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
stated in the aggregate at the lower of cost or estimated market value. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income. Gains or losses on sales of loans are recognized at the
time of sale. The gain or loss is the difference between the net sales
proceeds and the recorded value of the loans, including any remaining
unamortized deferred loan origination fees.
(continued)
82
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (continued)
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed
portion of construction loans in process, deferred loan origination fees and
an allowance for loan losses.
Troubled Debt Restructured Loans
A troubled debt restructured loan is a loan which the Bank, for reasons
related to a borrower's financial difficulties, grants a concession to the
borrower that the Bank would not otherwise consider.
The loan terms which have been modified or restructured due to a borrower's
financial difficulty, include but are not limited to a reduction in the stated
interest rate; an extension of the maturity at an interest rate below current
market; a reduction in the face amount of the debt; a reduction in the accrued
interest; or re-aging, extensions, deferrals, renewals and rewrites. A
troubled debt restructured loan would generally be considered impaired.
Impaired Loans
A loan is considered impaired when it is probable the Bank will be unable to
collect all contractual principal and interest payments due in accordance with
the terms of the loan agreement.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to provide
for estimated loan losses based on evaluating known and inherent risks in the
loan portfolio. The allowance is provided based upon management's
comprehensive analysis of the pertinent factors underlying the quality of the
loan portfolio. These factors include changes in the amount and composition
of the loan portfolio, delinquency levels, actual loan loss experience,
current economic conditions, and detailed analysis of individual loans for
which full collectability may not be assured. The detailed analysis includes
methods to estimate the fair value of loan collateral and the existence of
potential alternative sources of repayment. The allowance consists of
specific, general and unallocated components. The specific component relates
to loans that are deemed impaired. For such loans that are classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower
than the recorded value of that loan. The general component covers
non-classified loans and classified loans that are not evaluated individually
for impairment and is based on historical loss experience adjusted for
qualitative factors. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses. The
unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for
estimating specific and general losses in the portfolio. The appropriateness
of the allowance for losses on loans is estimated based upon these factors and
trends identified by management at the time financial statements are prepared.
In accordance with Statement of Financial Accounting Standards ("SFAS" or
"Statement") No. 114, Accounting by Creditors for Impairment of a Loan, and
SFAS No. 118, an amendment of SFAS No. 114, a loan is considered impaired when
it is probable that a creditor will be unable to collect all amounts
(principal and interest) due according to the contractual terms of the loan
agreement. Smaller balance homogenous loans, such as residential mortgage
loans and consumer loans, may be collectively evaluated for potential loss.
When a loan has been identified as being impaired, the amount of the
impairment is measured by using discounted cash flows, except when, as an
alternative, the current fair value of the collateral, reduced by costs to
sell, is used. When the measurement of the impaired loan is less than the
recorded investment in the loan (including accrued interest and net deferred
loan origination fees or costs), an impairment is recognized by creating or
adjusting an allocation of the allowance for loan losses. Uncollected accrued
interest is reversed against interest income. If ultimate collection of
principal is in doubt, all cash receipts on impaired loans are applied to
reduce the principal balance.
(continued)
83
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (continued)
A provision for loan losses is charged against income and is added to the
allowance for loan losses based on quarterly comprehensive analyses of the
loan portfolio. The allowance for loan losses is allocated to certain loan
categories based on the relative risk characteristics, asset classifications
and actual loss experience of the loan portfolio. While management has
allocated the allowance for loan losses to various loan portfolio segments,
the allowance is general in nature and is available for the loan portfolio in
its entirety.
The ultimate recovery of all loans is susceptible to future market factors
beyond the Bank's control. These factors may result in losses or recoveries
differing significantly from those provided in the consolidated financial
statements. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses,
and may require the Bank to make additions to the allowance based on their
judgment about information available to them at the time of their
examinations.
Interest on Loans and Loan Fees
Interest on loans is accrued daily based on the principal amount outstanding.
For impaired loans, accrual of interest is discontinued on a loan when
management believes, after considering collection efforts and other factors
that the borrower's financial condition is such that collection of interest is
doubtful, and in no event when the loan is more than 90 days past due (based
on contractual terms.) All interest accrued but not collected for loans that
are placed on nonaccrual status or charged off is reversed against interest
income. Subsequent collections on a cash basis are applied proportionately to
past due principal and interest, unless collectability of principal is in
doubt, in which case all payments are applied to principal. Loans are
returned to accrual status when the loan is deemed current, and the
collectability of principal and interest is no longer doubtful, or on one- to
four-family loans, when the loan is less than 90 days delinquent.
The Bank charges fees for originating loans. These fees, net of certain loan
origination costs, are deferred and amortized to income, on the level-yield
basis, over the loan term. If the loan is repaid prior to maturity, the
remaining unamortized deferred loan origination fee is recognized in income at
the time of repayment.
Mortgage Servicing Rights
Mortgage servicing rights are capitalized when acquired through the
origination of loans that are subsequently sold with the servicing rights
retained and are amortized to servicing income on loans sold in proportion to
and over the period of estimated net servicing income. The value of mortgage
servicing rights at the date of the sale of loans is determined based on the
discounted present value of expected future cash flows using key assumptions
for servicing income and costs and prepayment rates on the underlying loans.
The estimated fair value is periodically evaluated for impairment by comparing
actual cash flows and estimated future cash flows from the servicing assets to
those estimated at the time servicing assets were originated. Fair values are
estimated using discounted cash flows based on current market rates of
interest. For purposes of measuring impairment, the rights must be stratified
by one or more predominant risk characteristics of the underlying loans. The
Company stratifies its capitalized mortgage servicing rights based on product
type, interest rate and term of the underlying loans. The amount of
impairment recognized is the amount, if any, by which the amortized cost of
the rights for each stratum exceed their fair value.
Bank Owned Life Insurance ("BOLI")
Bank-owned life insurance policies are recorded at their cash surrender value
less applicable cash surrender charges. Income from BOLI is recognized when
earned.
(continued)
84
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (continued)
Goodwill
Goodwill is initially recorded when the purchase price paid for an acquisition
exceeds the estimated fair value of the net identified tangible and intangible
assets acquired. Goodwill is presumed to have an indefinite useful life and
is analyzed annually for impairment. An annual review is performed at the end
of the third quarter of each fiscal year, or more frequently if indicators of
potential impairment exist, to determine if the recorded goodwill is impaired.
If the fair value of the reporting unit exceeds the recorded value of the
reporting unit, goodwill is not considered impaired and no additional analysis
is necessary. As of June 30, 2008 the fair value of the reporting unit
exceeded the recorded value. As of September 30, 2008, there have been no
events or changes in the circumstances that would indicate a potential
impairment.
Core Deposit Intangible
The core deposit intangible is amortized to non-interest expense using an
accelerated method over a ten-year period.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed on the
straight-line method over the following estimated useful lives: buildings and
improvements - up to 40 years; furniture and equipment - three to seven years;
and automobiles - five years. The cost of maintenance and repairs is charged
to expense as incurred. Gains and losses on dispositions are reflected in
earnings.
Other Real Estate Owned and Other Repossessed Items
Other real estate owned and other repossessed items consist of properties or
assets acquired through or in lieu of foreclosure, and are recorded initially
at the fair value of the properties less estimated costs of disposal. Costs
relating to development and improvement of the properties or assets are
capitalized while costs relating to holding the properties or assets are
expensed.
Valuations are periodically performed by management, and a charge to earnings
is recorded if the recorded value of a property exceeds its estimated net
realizable value.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Company does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
(continued)
85
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (continued)
Income Taxes
The Company files a consolidated federal income tax return with its
Subsidiary. The Bank provides for income taxes separately and remits to the
Company amounts currently due.
Deferred federal income taxes result from temporary differences between the
tax basis of assets and liabilities, and their reported amounts in the
consolidated financial statements. These will result in differences between
income for tax purposes and income for financial reporting purposes in future
years. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. Valuation
allowances are established to reduce the net recorded amount of deferred tax
assets if it is determined to be more likely than not, that all or some
portion of the potential deferred tax asset will not be realized.
In June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, Accounting for Uncertainty in Income Taxes an
Interpretation of FASB Statement No. 109 ("FIN 48"). The interpretation
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to
be taken in a tax return. The Company adopted the provisions of FIN 48 on
October 1, 2007. As of September 30, 2008 the Company recorded a liability of
$25,000 for unrecognized taxes related to various state income tax matters.
It is the Company's policy to record any penalties or interest arising from
federal or state taxes as a component of non-interest expense.
The Company is no longer subject to United States federal income tax
examination by tax authorities for years ended on or before September 30,
2004.
Employee Stock Ownership Plan
The Bank sponsors a leveraged Employee Stock Ownership Plan ("ESOP"). The
ESOP is accounted for in accordance with the American Institute of Certified
Public Accountants Statement of Position 93-6, Employers' Accounting for
Employee Stock Ownership Plan. Accordingly, the debt of the ESOP is recorded
as other borrowed funds of the Bank, and the shares pledged as collateral are
reported as unearned shares issued to the employee stock ownership trust on
the consolidated balance sheets. The debt of the ESOP is with the Company and
is thereby eliminated in the consolidated financial statements. As shares are
released from collateral, compensation expense is recorded equal to the
average market price of the shares for the period, and the shares become
available for earnings per share calculations. Dividends paid on unallocated
shares reduce the Company's cash contributions to the ESOP.
Cash Equivalents and Cash Flows
The Company considers amounts included in the balance sheets' captions "Cash
and due from financial institutions", "Interest-bearing deposits in other
banks" and "Federal funds sold" to be cash equivalents. Cash flows from
loans, deposits, FHLB advances short term, and other borrowings are reported
net.
Advertising
Costs for advertising and marketing are expensed as incurred.
(continued)
86
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
The Company accounts for stock based compensation in accordance with SFAS No.
123(Revised), Share Based Payment, which requires measurement of the
compensation cost for all stock-based awards based on the grant-date fair
value and recognition of compensation cost over the service period of
stock-based awards.
The fair value of stock options is determined using the Black-Scholes
valuation model, which is consistent with the Company's valuation methodology
previously utilized for options in footnote disclosure required under SFAS No.
123, Accounting for Stock-Based Compensation. The fair value of stock grants
under the Management Recognition and Development Plan ("MRDP") is equal to the
fair value of the shares at the grant date.
The Company's stock compensation plans are described more fully in Note 15.
Earnings Per Share
Basic earnings per share exclude dilution and are computed by dividing net
income by the weighted average number of common shares outstanding. Diluted
earnings per share reflect the potential dilution that could occur if common
shares were issued under the Company's stock option plans and MRDP unless such
options are anti-dilutive.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, The Fair Value Options for
Financial Assets and Financial Liabilities Including an Amendment of FASB
Statement No. 115 ("SFAS 159"). This Statement permits entities to choose to
measure many financial instruments and certain other items at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex
hedge accounting provisions. This Statement is expected to expand the use of
fair value measurement, which is consistent with the FASB's long-term
measurement objectives for accounting for financial instruments. This
Statement is effective as of the beginning of an entity's first fiscal year
that begins after November 15, 2007. The Company adopted SFAS 159 on October
1, 2008 and does not expect it to have a material impact on the Company's
Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
("SFAS 157"), which defines fair value, establishes a framework for measuring
fair value under Generally Accepted Accounting Principles ("GAAP"), and
expands disclosures about fair value measurements. This Statement expands
other accounting pronouncements that require or permit fair value
measurements. This Statement is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. The Company adopted SFAS 157 on October 1, 2008 and does
not expect it to have a material impact on the Company's Consolidated
Financial Statements.
In October 2008, the FASB issued Staff Position ("FSP") FAS No. 157-3,
Determining Fair Value of a Financial Asset When the Market for That Asset Is
Not Active. The FSP clarifies the application of SFAS 157, Fair Value
Measurements, when the market for a financial asset is not active. The FSP
was effective upon issuance, including reporting for prior periods for which
financial statements have not been issued. The Company adopted this FSP in
October 2008 and does not expect it to have a material impact on the Company's
Consolidated Financial Statements.
(continued)
87
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 1 - Summary of Significant Accounting Policies (concluded)
Recent Accounting Pronouncements (concluded)
In June 2008 the FASB issued FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities.
This FSP states that unvested share-based payment awards that contain
non-forfeitable rights to dividends or dividend equivalents (whether paid or
unpaid) are participating securities and shall be included in the computation
of earnings per share pursuant to the two-class method. The FSP is effective
for financial statements issued for fiscal years beginning after December 15,
2008 and interim periods within those years. The adoption of this FSP is not
expected to have a material impact on the Company's Consolidated Financial
Statements.
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain
minimum reserve balances on hand or on deposit with the Federal Reserve Bank,
based on a percentage of transaction account deposits. The amount of the
reserve requirement balance for the years ended September 30, 2008 and 2007
was approximately $676,000 and $679,000, respectively.
88
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 3 - Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities have been classified according to
management's intent (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
September 30, 2008
Held to Maturity
Mortgage-backed securities $14,205 $ 8 ($2,267) $11,946
U.S. agency securities 28 - - - - 28
Total $14,233 $ 8 ($2,267) $11,974
Available for Sale
Mortgage-backed securities $16,806 $ 52 ($696) $16,162
Mutual funds 1,000 - - (64) 936
Total $17,806 $ 52 ($760) $17,098
September 30, 2007
Held to Maturity
Mortgage-backed securities $ 71 $- - ($1) $ 70
Available for Sale
Mortgage-backed securities $13,148 $ 31 ($131) $13,048
Mutual funds 32,938 - - (1,063) 31,875
U.S. agency securities 19,000 - - (25) 18,975
Total $65,086 $ 31 ($1,219) $63,898
The fair value of temporarily impaired securities, the amount of unrealized
losses and the length of time these unrealized losses existed as of September
30, 2008, are as follows (in thousands):
Less Than 12 Months 12 Months or Longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Losses Value Losses Value Losses
Mutual funds $ - - $ - - $ 936 ($64) $ 936 ($64)
Mortgage-backed securities 25,011 (2,961) 117 (2) 25,128 (2,963)
U.S. agency securities - - - - - - - - - - - -
Total $25,011 ($2,961) $1,053 ($66) $26,064 ($3,027)
(continued)
89
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 3 - Investments and Mortgage-Backed Securities (concluded)
The Company has evaluated these securities and has determined that the decline
in their value is temporary and is not related to any specific company event.
The unrealized losses are primarily due to unusually large spreads in the
market for private label mortgage-related products. The fair value of the
mortgage-backed securities is expected to recover as the securities approach
their maturity date and / or as the pricing spreads narrow on mortgage-related
securities. The Company has the ability and intent to hold the investments
until the market value recovers.
Mortgage-backed and agency securities pledged as collateral for public fund
deposits, federal treasury tax and loan deposits, FHLB collateral, retail
repurchase agreements and other non-profit organization deposits totaled
$23,001,000 and $31,869,000 at September 30, 2008 and 2007, respectively.
The contractual maturities of debt securities at September 30, 2008, are as
follows (in thousands). Expected maturities may differ from scheduled
maturities due to the prepayment of principal or call provisions. Maturities
for mortgage-backed securities are based on the last payment due date.
Held to Maturity Available for Sale
---------------- ------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Due within one year $ - - $ - - $ - - $ - -
Due after one year to five years 15 15 635 576
Due after five to ten years 72 71 278 283
Due after ten years 14,146 11,888 15,893 15,303
Mutual funds - - - - 1,000 936
Total $14,233 $11,974 $17,806 $17,098
There were no gross realized gains on sales of securities for the years ended
September 30, 2008, 2007 and 2006. Gross realized losses on sale and
redemption of mutual funds classified as available for sale were $2,822,000
and gross realized losses on impaired securities held-to-maturity were $4,000
for the year ended September 30, 2008. There were no gross realized losses on
sales of securities for the years ended September 30, 2007 and 2006. During
the quarter ended June 30, 2008, the Company redeemed its investment in the
AMF family of mutual funds and recognized a $2,822,000 loss on the redemption.
The Company redeemed $29,120,000 in mutual funds and received $22,190,000 in
underlying mortgage-backed securities and $6,930,000 in cash.
90
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable and loans held for sale consisted of the following at
September 30 (in thousands):
2008 2007
Mortgage loans:
One- to four-family $110,526 $101,677
Multi-family 25,927 35,157
Commercial 146,223 127,866
Construction and land development 186,344 186,261
Land 60,701 60,706
Total mortgage loans 529,721 511,667
Consumer loans:
Home equity and second mortgage 48,690 47,269
Other 10,635 10,922
Total consumer loans 59,325 58,191
Commercial business loans 21,018 18,164
Total loans receivable 610,064 588,022
Less:
Undisbursed portion of construction loans in process 43,353 65,673
Deferred loan origination fees 2,747 2,968
Allowance for loan losses 8,050 4,797
54,150 73,438
Loans receivable, net 555,914 514,584
Loans held for sale (one- to four-family) 1,773 757
Total loans receivable and loans held for sale $557,687 $515,341
Certain related parties of the Bank, principally Bank directors and officers,
were loan customers of the Bank in the ordinary course of business during the
years ended September 30, 2008 and 2007. These loans were performing
according to their terms at September 30, 2008 and 2007. Activity in related
party loans during the years ended September 30 is as follows (in thousands):
2008 2007
Balance, beginning of year $2,786 $2,622
New loans 486 490
Repayments (221) (326)
Balance, end of year $3,051 $2,786
(continued)
91
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
At September 30, 2008, 2007 and 2006, the Bank had impaired loans totaling
approximately $13,647,000, $1,490,000 and $80,000 respectively. At September
30, 2008, 2007 and 2006, no loans were 90 days or more past due and still
accruing interest. Interest income recognized on impaired loans for the years
ended September 30, 2008, 2007 and 2006 was $41,000, $58,000 and $384,000
respectively. Interest income recognized on a cash basis on impaired loans
for the years ended September 30, 2008, 2007 and 2006 was $21,000, $58,000 and
$384,000, respectively. The average investment in impaired loans for the
years ended September 30, 2008, 2007 and 2006 was $6,955,000, $623,000 and
$1,938,000 respectively. The Bank had $272,000 in trouble debt restructured
loans that were included in impaired loans as of September 30, 2008. There
were no trouble debt restructured loans as of September 30, 2007 and 2006.
There were no commitments to lend additional funds on trouble debt
restructured loans for the years ended September 30, 2008, 2007 and 2006.
An analysis of the allowance for loan losses for the years ended September 30
follows (in thousands):
2008 2007 2006
Balance, beginning of year $4,797 $4,122 $4,099
Provision for loan losses 3,900 686 - -
Loans charged off (648) (12) (2)
Recoveries 1 1 25
Net recovery (charge-off) (647) (11) 23
Balance, end of year $8,050 $4,797 $4,122
Following is a summary of information related to impaired loans at September
30 (in thousands):
2008 2007 2006
Impaired loans without a valuation allowance $ 8,872 $ 490 $ 80
Impaired loans with a valuation allowance 4,775 1,000 - -
$13,647 $1,490 $ 80
Valuation allowance related to impaired loans $ 790 $ 75 $- -
Note 5 - Loan Servicing
Loans serviced for the Federal Home Loan Mortgage Corporation and others are
not included on the consolidated balance sheets. The principal amounts of
those loans at September 30, 2008, 2007 and 2006 were $175,619,000,
$161,565,000 and $156,187,000, respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (in thousands):
2008 2007 2006
Balance, at beginning of year $1,051 $ 932 $ 928
Additions 578 391 241
Amortization (323) (272) (237)
Balance, end of year $1,306 $1,051 $ 932
(continued)
92
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 5 - Loan Servicing (concluded)
At September 30, 2008, 2007 and 2006, the fair value of mortgage servicing
rights totaled $1,818,000, $1,958,000 and $1,891,000, respectively. The fair
values for 2008, 2007, and 2006 were estimated using premium rates of 10.60%,
9.58% and 9.59%, and prepayment speed factors of 214, 194 and 204,
respectively. There was no valuation allowance at September 30, 2008, 2007 or
2006.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (in
thousands):
2008 2007
Land $ 4,333 $ 3,760
Buildings and improvements 14,229 14,260
Furniture and equipment 5,899 6,302
Property held for future expansion 111 40
Construction and purchases in progress 299 160
24,871 24,522
Less accumulated depreciation 7,987 7,947
Total premises and equipment $16,884 $16,575
The Bank leases premises under operating leases. Rental expense of leased
premises was $241,000, $242,000, and $207,000 for September 30, 2008, 2007 and
2006, respectively, which is included in premises and equipment expense.
Minimum net rental commitments under noncancellable leases having an original
or remaining term of more than one year for future years ending September 30
are as follows (in thousands):
2009 $228
2010 219
2011 67
2012 67
2013 67
Thereafter - -
Total minimum payments required $648
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
93
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 7 - Other Real Estate Owned and Other Repossessed Items
Other real estate owned and other repossessed items consisted of the following
at September 30 (in thousands):
2008 2007
Real estate acquired through foreclosure $ 508 - -
Items acquired through repossession 3 - -
Total other real estate owned and other repossessed items $ 511 - -
Note 8 - Core Deposit Intangibles ("CDI")
During the year ended September 30, 2005, the Company recorded a core deposit
intangible of $2,201,000 in connection with the October 2004 acquisition of
seven branches and related deposits. Net unamortized core deposit intangible
totaled $972,000 and $1,221,000 at September 30, 2008 and 2007, respectively.
Amortization expense related to the core deposit intangible for the years
ended September 30, 2008, 2007 and 2006 was $249,000, $285,000 and $328,000,
respectively.
Amortization expense for the core deposit intangible for future years ending
September 30 is estimated to be as follows (in thousands):
2009 $217
2010 190
2011 167
2012 148
2013 131
Thereafter 119
Total $972
94
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 9 - Deposits
Deposits consisted of the following at September 30 (in thousands):
2008 2007
Non-interest-bearing $ 51,955 $ 54,962
NOW checking 90,468 80,372
Savings 56,391 56,412
Money market accounts 70,379 48,068
Certificates of deposit 203,420 202,844
Certificates of deposit - brokered 25,959 24,077
Total deposits $498,572 $466,735
Certificates of deposit of $100,000 or greater totaled $73,107,000 and
$67,316,000 at September 30, 2008 and 2007, respectively.
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (in thousands):
2009 $175,817
2010 46,407
2011 1,629
2012 1,576
2013 3,554
Thereafter 396
Total $229,379
Interest expense by account type is as follows for the years ended September
30 (in thousands):
2008 2007 2006
NOW checking $ 774 $ 638 $ 684
Savings 398 425 442
Money market accounts 1,250 1,186 711
Certificates of deposit 8,480 8,818 6,068
Certificates of deposit - brokered 861 225 - -
Total $11,763 $11,292 $7,905
95
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 10 - Other Borrowings - Repurchase Agreements
Other borrowings at September 30, 2008 and 2007 consisted of overnight
repurchase agreements with customers totaling $758,000 and $595,000,
respectively.
Information concerning repurchase agreements is summarized as follows at
September 30 (dollars in thousands):
2008 2007
Average daily balance during the period $ 943 $1,019
Average daily interest rate during the period 2.12% 4.61%
Maximum month-end balance during the period $1,884 $4,460
Weighted average rate at end of period 1.05% 4.42%
Securities underlying the agreements at the end of
period:
Recorded value $1,614 $1,701
Fair value 1,614 1,701
The securities underlying the agreements at September 30, 2008 were under the
Company's control in safekeeping at third-party financial institutions.
Note 11 - Federal Home Loan Bank ("FHLB") Advances and Other Borrowing Lines
The Bank has long- and short-term borrowing lines with the FHLB of Seattle
with total credit on the lines equal to 30% of the Bank's total assets,
limited by available collateral. Borrowings are considered short-term when
the original maturity is less than one year. FHLB advances consisted of the
following at September 30 (in thousands):
2008 2007
Short-term $ - - $30,000
Long-term 104,628 69,697
Total $104,628 $99,697
The long-term borrowings mature at various dates through September 2017 and
bear interest at rates ranging from 3.49% to 5.54%. Advances totaling
$4,628,000 have monthly payments aggregating $6,000 plus interest. Under the
Advances, Security and Deposit Agreement, virtually all of the Bank's assets,
not otherwise encumbered, are pledged as collateral for advances. Principal
reductions due for future years ending September 30 are as follows (in
thousands):
2009 $ 4,628
2010 20,000
2011 20,000
2012 10,000
2013 - -
Thereafter 50,000
$104,628
(continued)
96
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 11 - Federal Home Loan Bank ("FHLB") Advances and Other Borrowing Lines
(concluded)
A portion of the long-term advances have a putable feature and may be called
earlier by the FHLB than the above schedule indicates.
The Bank also maintains a short-term $10,000,000 overnight borrowing line with
Pacific Coast Banker's Bank. The borrowing line may be reduced or withdrawn
at any time. As of September 30, 2008 and 2007, the Bank did not have any
outstanding advances on this borrowing line.
Information concerning total short-term advances is summarized as follows at
September 30 (dollars in thousands):
2008 2007
Average daily balance during the period $13,378 $34,187
Average daily interest rate during the period 4.44% 5.58%
Maximum month-end balance during the period $42,600 $72,750
Weighted average rate at end of the period - - 5.19%
Note 12 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses were comprised of the following at
September 30 (in thousands):
2008 2007
Accrued deferred compensation and profit sharing
plans payable $ 454 $ 605
Accrued interest payable on deposits, FHLB advances
and other borrowings 1,135 1,378
Accounts payable and accrued expenses - other 1,495 1,291
Total other liabilities and accrued expenses $3,084 $3,274
Note 13 - Federal Income Taxes
The components of the provision for federal income taxes for the years ended
September 30 are as follows (in thousands):
2008 2007 2006
Current $4,041 $3,929 $3,603
Deferred (1,217) (101) 226
Total federal income taxes $2,824 $3,828 $3,829
(continued)
97
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 13 - Federal Income Taxes (continued)
The components of the Company's prepaid federal income taxes and net deferred
tax assets included in other assets as of September 30 are as follows (in
thousands):
2008 2007
Prepaid federal income taxes $ 525 $1,154
Net deferred tax assets 1,945 884
Total $2,470 $2,038
The components of the Company's deferred tax assets and liabilities at
September 30 are as follows (in thousands):
2008 2007
Deferred Tax Assets
Accrued interest on loans $ 5 $ 1
Accrued vacation 115 106
Deferred compensation 54 69
Unearned ESOP shares 450 438
Allowance for loan losses 2,822 1,679
CDI 226 189
Unearned MRDP shares 61 26
Net unrealized securities losses 248 404
Capital loss carry-forward 928 - -
Stock option compensation expense 21 20
Total deferred tax assets 4,930 2,932
Deferred Tax Liabilities
FHLB stock dividends 906 906
Depreciation 262 243
Goodwill 527 396
Certificate of deposit valuation 21 23
Mortgage servicing rights 457 368
Prepaid expenses 122 112
Total deferred tax liabilities 2,295 2,048
Valuation allowance for capital loss on sale
of securities (690) - -
Net deferred tax assets $1,945 $ 884
The Company has a capital loss carry forward in the amount of $2,643,000 that
will expire in 2013.
98
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 13 - Federal Income Taxes (concluded)
The provision for federal income taxes for the years ended September 30
differs from that computed at the statutory corporate tax rate as follows
(dollars in thousands):
2008 2007 2006
Amount Percent Amount Percent Amount Percent
Taxes at statutory rate $2,390 35.0% $4,197 35.0% $4,195 35.0%
BOLI income (170) (2.5) (162) (1.4) (157) (1.3)
Non-deductible capital
loss 750 11.0 - - - - - - - -
Dividends on ESOP (136) (2.0) (123) (1.0) (114) (1.0)
Other - net (10) (0.1) (84) (0.7) (95) (0.8)
Federal income taxes $2,824 41.4% $3,828 31.9% $3,829 31.9%
Note 14 - Employee Stock Ownership and 401(k) Plan ("KSOP")
Effective October 3, 2007, the Bank established the Timberland Bank Employee
Stock Ownership and 401(k) Plan ("KSOP") by combining the existing Timberland
Bank Employee Stock Ownership Plan (established in 1997) and the Timberland
Bank 401(k) Profit Sharing Plan (established in 1970). The KSOP is comprised
of two components, the Employee Stock Ownership Plan ("ESOP") and the 401(k)
Plan. The KSOP benefits employees with at least one year of service who are
21 years of age or older. It may be funded by Bank contributions in cash or
stock for the ESOP and in cash only for the 401(k) profit sharing. Employee
vesting occurs over six years.
ESOP
----
The amount of the annual contribution is discretionary, except that it must be
sufficient to enable the ESOP to service its debt. All dividends received by
the ESOP are used to pay debt service. Dividends of $389,000, $351,000, and
$326,000 were used to service the debt during the years ended September 30,
2008, 2007 and 2006, respectively. As of September 30, 2008, 164,229 ESOP
shares had been distributed to participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase
1,058,000 shares of common stock of the Company. The term of the loan was
extended by 75 months in December 2006. The extension of the loan reduces the
annual number of shares allocated to participants. The loan is being repaid
primarily from the Bank's contributions to the ESOP and is scheduled to be
fully repaid by March 31, 2019. The interest rate on the loan is 8.5%.
Interest expense on the ESOP debt was $359,000, $375,000, and $411,000 for the
years ended September 30, 2008, 2007 and 2006, respectively. The balance of
the loan at September 30, 2008 was $4,063,000.
Shares held by the ESOP as of September 30 were classified as follows:
2008 2007 2006
Unallocated s 370,294 405,562 440,830
Shares released for allocation 523,477 518,066 542,216
Total ESOP shares 893,771 923,628 983,046
The approximate fair market value of the Bank's unallocated shares at
September 30, 2008, 2007 and 2006, was $2,796,000, $6,347,000 and $7,737,000,
respectively. Compensation expense recognized under the ESOP was $7,000,
$274,000 and $683,000 for the years ended September 30, 2008, 2007 and 2006,
respectively.
(continued) 99
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 14 - Employee Stock Ownership and 401(k) Plan ("KSOP") (concluded)
401(k)
------
Eligible employees may contribute up to the maximum established by the
Internal Revenue Service. Contributions by the Bank are at the discretion of
the board of directors except for a 3% safe harbor contribution which is
mandatory per the plan. Bank contributions totaled $422,000, $371,000 and
$558,000 for the years ended September 30, 2008, 2007 and 2006, respectively.
Note 15 - Stock Compensation Plans
Stock Options Plans
-------------------
Under the Company's stock option plans (1999 Stock Option Plan and 2003 Stock
Option Plan), the Company may grant options for up to 1,622,500 shares of
common stock to employees, officers and directors. Shares issued may be
purchased in the open market or may be issued from authorized and unissued
shares. The exercise price of each option equals the fair market value of the
Company's stock on the date of grant. The options vest over a ten-year
period, which may be accelerated if the Company meets certain performance
criteria. Generally, options vest in annual installments of 10% on each of
the ten anniversaries from the date of grant and if the Company meets three of
four established performance criteria the vesting is accelerated to 20% for
that year. These four performance criteria are: (i) generating a return on
assets which exceeds that of the median of all thrifts in the 12th FHLB
District having assets within $250 million of the Company; (ii) generating an
efficiency ratio which is less than that of the median of all thrifts in the
12th FHLB District having assets within $250 million of the Company; (iii)
generating a net interest margin which exceeds the median of all thrifts in
the 12th FHLB District having assets within $250 million of the Company; and
(iv) increasing the Company's earnings per share over the prior fiscal year.
The Company performs the accelerated vesting analysis in February of each year
based on the results of the most recently completed fiscal year. At September
30, 2008, options for 279,416 shares are available for future grant under
these plans.
The Company uses the Black-Scholes option pricing model to estimate the fair
value of stock-based awards with the weighted average assumptions noted in the
following table. The risk-free interest rate is based on the U.S. Treasury
rate of a similar term as the stock option at the particular grant date. The
expected life is based on historical data, vesting terms, and estimated
exercise dates. The expected dividend yield is based on the most recent
quarterly dividend on an annualized basis. The expected volatility is based
on historical volatility of the Company's stock price. There were no options
granted during the fiscal years ended September 30, 2008, 2007 or 2006.
Stock option activity is summarized in the following table:
Weighted
Average
Number of Exercise
Shares Price
Outstanding September 30, 2005 724,822 $ 6.93
Options exercised (200,678) 6.09
Outstanding September 30, 2006 524,144 7.26
Options exercised (110,470) 6.73
Options forfeited (1,000) 7.60
Outstanding September 30, 2007 412,674 7.39
Options exercised (138,854) 6.06
Outstanding September 30, 2008 273,820 8.07
(continued) 100
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 15 - Stock Compensation Plans (continued)
The total fair value of shares that vested during the years ended September
30, 2008, 2007 and 2006 was $30,000, $52,000 and $65,000, respectively.
Proceeds related tax benefits realized from options exercised and intrinsic
value of options exercised for the years ended September 30 were as follows
(in thousands):
2008 2007 2006
Proceeds from options exercised $ 842 $ 744 $1,221
Related tax benefit recognized 15 463 607
Intrinsic value of options exercised 531 1,231 1,785
Additional information regarding options outstanding at September 30, 2008, is
as follows:
Options Outstanding Options Exercisable
----------------------------- ------------------------------
Weighted Weighted
Average Average
Weighted Remaining Weighted Remaining
Range of Average Contractual Average Contractual
Exercise Exercise Life Exercise Life
Prices Number Price (Years) Number Price (Years)
$ 6.00 104,956 $ 6.00 0.3 104,956 $ 6.00 0.3
7.45 56,638 7.45 2.7 56,638 7.45 2.7
7.85 - 7.98 6,000 7.91 3.6 6,000 7.91 3.6
9.52 56,680 9.52 4.4 51,012 9.52 4.4
11.46 - 11.63 49,546 11.51 5.3 49,546 11.51 5.3
273,820 $ 8.07 2.6 268,152 $ 8.04 2.6
The aggregate intrinsic value of all options outstanding at September 30, 2008
was $168,000. At September 30, 2008, there were 5,668 unvested options, all
of which are assumed to vest, with an aggregate intrinsic value of $0. The
aggregate intrinsic value of all options that were exercisable at September
30, 2008 was $168,000.
Management Recognition and Development Plan ("MRDP")
---------------------------------------------------
In November 1998, the Board of Directors adopted the MRDP. In January 1999,
shareholders approved the adoption of the MRDP for the benefit of employees,
officers and directors of the Company. The objective of the MRDP is to retain
personnel of experience and ability in key positions by providing them with a
proprietary interest in the Company.
The MRDP allows for the issuance to participants of up to 529,000 shares of
the Company's common stock. Shares issued may be purchased in the open market
or may be issued from authorized and unissued shares. Awards under the MRDP
are made in the form of restricted shares of common stock that are subject to
restrictions on the transfer of ownership and are subject to a five-year
vesting period. Compensation expense in the amount of the fair value of the
common stock at the date of the grant to the plan participants is recognized
over a five-year vesting period, with 20% vesting on each of the five
anniversaries from the date of the grant.
(continued)
101
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 15 - Stock Compensation Plans (continued)
A summary of MRDP shares granted and vested for the years ended September 30,
were as follows:
2008 2007 2006
Shares granted 20,315 15,080 12,000
Weighted average grant date fair value $12.76 $17.44 $16.22
Shares vested 5,416 2,400 - -
Aggregate vesting date fair value $46,000 $39,000 $ - -
A summary of unvested MRDP shares as of September 30, 2008 and changes during
the year ended September 30, 2008, were as follows:
Weighted Average
Grant Date
Shares Fair Value
Unvested shares, beginning of period 24,680 $16.97
Shares granted 20,315 12.76
Shares vested (5,416) 16.90
Unvested shared, end of period 39,579 14.82
At September 30, 2008, there were 39,579 unvested MRDP shares with an
aggregate grant date fair value of $586,000 and there were 71,751 shares
available for future grant under the MRDP.
Expense for Stock Compensation Plans
------------------------------------
Compensation expense recorded in the financial statements for all stock-based
plans were as follows for the years ended September 30, (in thousands):
2008 2007 2006
Stock options $ 5 $ 25 $ 50
MRDP stock grants 147 66 8
Less: related tax benefit recognized (53) (31) (20)
$ 99 $ 60 $ 38
(continued)
102
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 15 - Stock Compensation Plans (concluded)
The compensation expense yet to be recognized for stock based awards that been
awarded but not vested for the years ending September 30, is as follows (in
thousands):
Stock
Stock Grants Total
Options (MRDP) Awards
2009 $ 3 $143 $146
2010 -- 143 143
2011 -- 137 137
2012 -- 84 84
2013 -- 11 11
$ 3 $518 $521
Note 16 - Deferred Compensation Plans
The Bank has a deferred compensation/non-competition arrangement with its
former chief executive officer, which provides monthly payments of $2,000 per
month upon retirement. Payments under this agreement began in March 2004 and
will continue until his death, at which time payments will continue to his
surviving spouse until the earlier of her death or for 60 months. The present
value of the payments as of September 30, 2008 and 2007, $129,000 and
$153,000, respectively, has been accrued for under the agreement and is
included in other liabilities on the consolidated balance sheets.
The Company adopted the Timberland Bancorp, Inc. Directors Deferred
Compensation Plan in 2004. This plan allows directors to defer a portion of
their monthly directors' fees until retirement with no income tax payable by
the director until retirement benefits are received. The Company accrues
interest on the liability at a rate of 1.00% over the Bank's one-year CD rate.
The liability accrued for under the plan as of September 30, 2008 and 2007 was
$10,000 and is included in other liabilities on the consolidated balance
sheets.
Note 17 - Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. These instruments
involve, to varying degrees, elements of credit risk not recognized on the
consolidated balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments as it does for on-balance-sheet
instruments. A summary of the Bank's commitments at September 30, is as
follows (in thousands):
2008 2007
Undisbursed portion of construction loans in process
(see Note 4) $43,353 $65,673
Undisbursed lines of credit 25,343 20,522
Commitments to extend credit 15,281 35,784
(continued)
103
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 17 - Commitments and Contingencies (continued)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since
commitments may expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of credit,
is based on management's credit evaluation of the party. Collateral held
varies, but may include accounts receivable, inventory, property and
equipment, residential real estate, land, and income-producing commercial
properties.
In March 2007, the Bank adopted the Timberland Bank Employee Severance
Compensation Plan, which replaced the existing employee severance compensation
agreement adopted in 1998. The new plan, which expires in 2017, was adopted
to provide severance pay benefits to eligible employees in the event of a
change in control of the Company or the Bank (as defined in the plan). In
general, all employees (except those who have signed separate employment
related agreements) with two or more years of service will be eligible to
participate in the plan. Under the plan, in the event of a change in control
of the Company or the Bank, eligible employees who are terminated or who
terminate employment (but only upon the occurrence of events specified in the
plan) within 12 months of the effective date of a change in control would be
entitled to a payment based on years of service or officer rank with the Bank.
The maximum payment for any eligible employee would be equal to 24 months of
their current compensation.
In April 2007, the Bank and the Company entered into employment agreements
with the Chief Executive Officer and the Chief Financial Officer. The
employment agreements provide for a severance payment and other benefits if
the officers are involuntarily terminated following a change in control of the
Company or the Bank. The maximum value of the severance benefits under the
employment agreements is 2.99 times the officer's average annual compensation
during the five-year period prior to the effective date of the change in
control.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these
claims, if any, will not have a material effect on the financial position of
the Company.
Note 18 - Significant Concentrations of Credit Risk
Most of the Bank's lending activity is with customers located in the state of
Washington and involves real estate. At September 30, 2008, the Bank had
$580,184,000 (including $43,353,000 of undisbursed construction loan proceeds)
in loans secured by real estate, which represents 94.8% of the total loan
portfolio. The real estate loan portfolio is primarily secured by one- to
four-family properties, multi-family properties, undeveloped land, and a
variety of commercial real estate property types. At September 30, 2008,
there were no concentrations of real estate loans to a specific industry or
secured by a specific collateral type that equaled or exceeded 20% of the
Bank's total loan portfolio, other than loans secured by one-to four-family
properties. The ultimate collectability of a substantial portion of the loan
portfolio is susceptible to changes in economic and market conditions in the
region and the impact of those changes on the real estate market. The Bank
typically maintains loan-to-value ratios of no greater than 90% on real estate
loans.
The Bank believes its lending policies and procedures adequately minimize the
potential exposure to such risks and that adequate provisions for loan losses
are provided for all known and inherent risks. Collateral and / or guarantees
are required for all loans.
104
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 19 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's consolidated financial statements.
Under capital adequacy guidelines of the regulatory framework for prompt
corrective action, the Bank must meet specific capital adequacy guidelines
that involve quantitative measures of the Bank's assets, liabilities and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The capital classifications of the Company and the Bank are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios as
defined in the regulations (set forth in the table below) of Tier 1 capital to
average assets, and minimum ratios of Tier 1 and total capital to
risk-weighted assets.
At September 30, 2008, the most recent notification from the Bank's regulator
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank
must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since
that notification that management believes have changed the Bank's category.
(continued)
105
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 19 - Regulatory Matters (concluded)
Restrictions on Retained Earnings
The Company's and the Bank's actual capital amounts (dollars in thousands) and
ratios are also presented in the table.
To be Well
Capitalized
Under Prompt
Capital Adequacy Corrective Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
September 30, 2008
Tier 1 capital
(to average assets):
Consolidated $68,615 10.3% $26,709 4.0% N/A N/A
Timberland Bank 61,326 9.2 26,649 4.0 $33,311 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 68,615 12.4 22,189 4.0 N/A N/A
Timberland Bank 61,326 11.1 22,192 4.0 33,288 6.0
Total capital (to
risk-weighted assets):
Consolidated 75,563 13.6 44,378 8.0 N/A N/A
Timberland Bank 68,275 12.3 44,384 8.0 55,480 10.0
September 30, 2007
Tier 1 capital
(to average assets):
Consolidated $67,397 10.7% $25,116 4.0% N/A N/A
Timberland Bank 59,308 9.5 25,058 4.0 $31,323 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 67,397 12.7 21,172 4.0 N/A N/A
Timberland Bank 59,308 11.2 21,154 4.0 31,731 6.0
Total capital
(to risk-weighted
assets):
Consolidated 72,194 13.6 42,344 8.0 N/A N/A
Timberland Bank 64,105 12.1 42,308 8.0 52,885 10.0
The Bank is subject to certain restrictions on the amount of dividends that it
may declare without prior regulatory approval.
At the time of conversion of the Bank from a Washington-chartered mutual
savings bank to a Washington-chartered stock savings bank, the Bank
established a liquidation account in an amount equal to its retained earnings
of $23,866,000 as of June 30, 1997, the date of the latest statement of
financial condition used in the final conversion prospectus. The liquidation
account is maintained for the benefit of eligible account holders who have
maintained their deposit accounts in the Bank after conversion. The
liquidation account reduces annually to the extent that eligible account
holders have reduced their qualifying deposits as of each anniversary date.
Subsequent increases do not restore an eligible account holder's interest in
the liquidation account. In the event of a complete liquidation of the Bank
(and only in such an event), eligible depositors who have continued to
maintain accounts will be entitled to receive a distribution from the
liquidation account before any liquidation may be made with respect to common
stock. The Bank may not declare or pay cash dividends if the effect thereof
would reduce its regulatory capital below the amount required for the
liquidation account.
106
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 20 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(In Thousands)
2008 2007
Assets
Cash and due from financial institutions $ 280 $ 73
Interest-bearing deposits in banks 2,903 1,253
Investments and mortgage-backed securities (available
for sale) - - 2,064
Loan receivable from Bank 4,063 4,293
Investment in Bank 67,552 66,434
Other assets 1,345 1,906
Total assets $76,143 $76,023
Liabilities and shareholders' equity
Loan payable to Bank $ - - $ 1,400
Accrued expenses 1,302 76
Shareholders' equity 74,841 74,547
Total liabilities and shareholders' equity $76,143 $76,023
Condensed Statements of Income - Years Ended September 30
(In Thousands)
2008 2007 2006
Operating income
Interest-bearing deposits in banks $ 22 $ 26 $ 27
Interest on loan receivable from Bank 359 375 411
Dividends on investments 65 108 91
Loss on sale of investment securities
available for sale ("AFS") (171) - - - -
Dividends from Bank 3,850 12,823 4,500
Total operating income 4,125 13,332 5,029
Non-operating income - - - - 3
Operating expenses 589 633 465
Income before income taxes and equity
in undistributed income of Bank 3,536 12,699 4,567
Income taxes (benefit) (193) (166) (91)
Income before equity in undistributed
income of Bank 3,729 12,865 4,658
Equity in undistributed income of bank
(dividends in excess of income of Bank) 276 (4,702) 3,499
Net income $4,005 $8,163 $8,157
(continued)
107
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 20 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30 (In Thousands)
2008 2007 2006
Cash flows from operating activities
Net income $ 4,005 $ 8,163 $ 8,157
Adjustments to reconcile net income to net
cash provided:
(Equity in undistributed income of Bank)
dividends in excess of income of Bank (276) 4,702 (3,499)
ESOP shares earned 264 265 528
MRDP compensation expense 131 59 7
Stock option compensation expense 5 25 50
Stock option tax effect 15 464 607
Less stock option excess tax benefit (11) (354) (494)
Loss on sale of securities AFS 171 - - - -
Other, net 1,764 (256) (462)
Net cash provided by operating activities 6,068 13,068 4,894
Cash flows from investing activities
Investment in Bank (562) (698) (1,062)
Proceeds from sale of securities AFS 1,959 - - - -
Principal repayments on loan receivable from
Bank 230 214 525
Net cash provided by (used in) investing
activities 1,627 (484) (537)
Cash flows from financing activities
Increase (decrease) in borrowings from Bank (1,400) 1,400 - -
Proceeds from exercise of stock options 841 744 1,221
Repurchase of common stock (1,920) (12,431) (3,701)
Payment of dividends (2,977) (2,682) (2,492)
ESOP tax effect (409) 354 480
MRDP compensation tax effect 16 5 (4)
Stock option tax effect 11 354 494
Net cash used in financing activities (5,838) (12,256) (4,002)
Net increase in cash 1,857 328 355
Cash equivalents
Beginning of year 1,326 998 643
End of year $ 3,183 $ 1,326 $ 998
108
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 21 - Earnings Per Share Disclosures
Basic earnings per share are computed by dividing net income applicable to
common stock by the weighted average number of common shares outstanding
during the period, without considering any dilutive items. Diluted earnings
per share are computed by dividing net income applicable to common stock by
the weighted average number of common shares and common stock equivalents for
items that are dilutive, net of shares assumed to be repurchased using the
treasury stock method at the average share price for the Company's common
stock during the period. Common stock equivalents arise from assumed
conversion of outstanding stock options and from assumed vesting of shares
awarded but not released under the Company's MRDP. In accordance with
Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership
Plans, issued by the American Institute of Certified Public Accountants,
shares owned by the Bank's ESOP that have not been allocated are not
considered to be outstanding for the purpose of computing earnings per share.
Information regarding the calculation of basic and diluted earnings per share
for the years ended September 30 is as follows (dollars in thousands, except
per share amounts):
2008 2007 2006
Basic EPS Computation
Numerator - net income $4,005 $8,163 $8,157
Denominator - weighted average common
shares outstanding 6,475,385 6,775,822 7,032,662
Basic EPS $0.62 $1.20 $1.16
Diluted EPS Computation
Numerator - net income $4,005 $8,163 $8,157
Denominator - weighted average common
shares outstanding 6,475,385 6,775,822 7,032,662
Effect of dilutive stock options 95,107 204,636 249,090
Effect of dilutive MRDP shares - - 1,649 144
Weighted average common shares
outstanding-assuming dilution 6,570,492 6,982,107 7,281,896
Diluted EPS $0.61 $1.17 $1.12
For the year ended September 30, 2008, options to purchase 40,443 shares of
common stock were outstanding but not included in the computation of diluted
earnings per share because the options' exercise prices were greater than the
average market price of the common shares and, therefore, their effect would
have been anti-dilutive. There were no options to purchase shares of common
stock excluded from the computation of diluted earnings per share for the
years ended September 30, 2007 and 2006.
109
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 22 - Accumulated Other Comprehensive Income (Loss)
Net unrealized gains and losses included in accumulated other comprehensive
income (loss) were computed as follows for the years ended September 30 (in
thousands):
Tax
Before-Tax (Benefit) Net-of-Tax
Amount Expense Amount
2008
Unrealized holding losses arising
during the year ($2,329) ($58) ($2,271)
Reclassification adjustment for
losses included in net income 2,826 232 2,594
Net unrealized gains $ 497 $174 $ 323
2007
Unrealized holding gains arising
during the year $ 329 $112 $ 217
Net unrealized gains $ 329 $112 $ 217
2006
Unrealized holding losses arising
during the year ($196) ($66) ($130)
Net unrealized losses ($196) ($66) ($130)
110
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 23 - Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires
disclosure of estimated fair values for financial instruments. Such estimates
are subjective in nature, and significant judgment is required regarding the
risk characteristics of various financial instruments at a discrete point in
time. Therefore, such estimates could vary significantly if assumptions
regarding uncertain factors were to change. Major assumptions, methods and
fair value estimates for the Company's significant financial instruments are
set forth below:
Cash and Due from Financial Institutions, Interest-Bearing Deposits in
Banks, and Federal Funds Sold The recorded amount is a reasonable
estimate of fair value.
Investments and Mortgage-Backed Securities
The fair value of investments and mortgage-backed securities has been
based on quoted market prices, dealer quotes, or discounted cash flows.
Federal Home Loan Bank Stock
The recorded value of stock holdings approximates fair value.
Loans Receivable and Loans Held for Sale
Fair value of loans is estimated for portfolios of loans with similar
financial characteristics. Fair value 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. Loans held for sale has
been based on quoted market prices.
Deposits
The fair value of deposits with no stated maturity date is included at
the amount payable on demand. The fair value of fixed maturity
certificates of deposit is estimated by discounting future cash flows
using the rates currently offered by the Bank for deposits of similar
remaining maturities.
Federal Home Loan Bank Advances
The fair value of borrowed funds is estimated by discounting the future
cash flows of the borrowings at a rate which approximates the current
offering rate of the borrowings with a comparable remaining life.
Other Borrowings: Repurchase Agreements
The recorded value of repurchase agreements approximates fair value.
Accrued Interest
The recorded amounts of accrued interest approximate fair value.
Mortgage Servicing Rights ("MSRs")
The fair value of the mortgage servicing rights was determined using a
model, which incorporates the expected life of the loans, estimated cost
to service the loans, servicing fees received and other factors. The
Company calculates MSRs fair value by stratifying MSRs based on the
predominant risk characteristics that include the underlying loan's
interest rate, cash flows of the loan, origination date and term.
(continued)
111
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 23 - Fair Value of Financial Instruments (concluded)
Off-Balance-Sheet Instruments
The fair value of commitments to extend credit was estimated using the
fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the present
creditworthiness of the customers. Since the majority of the Bank's off-
balance-sheet instruments consist of variable-rate commitments, the Bank
has determined they do not have a distinguishable fair value.
The estimated fair value of financial instruments at September 30, were as
follows (in thousands):
2008 Estimated 2007 Estimated
Recorded Fair Recorded Fair
Amount Value Amount Value
Financial Assets
Cash and due from financial
institutions and interest-
bearing deposits in banks $ 17,444 $ 17,444 $ 12,895 $ 12,895
Federal funds sold 25,430 25,430 3,775 3,775
Investments and mortgage-backed
securities 31,331 29,072 63,969 63,968
FHLB stock 5,705 5,705 5,705 5,705
Loans receivable and loans
held for sale 557,687 558,379 515,341 510,924
Accrued interest receivable 2,870 2,870 3,424 3,424
Mortgage servicing rights 1,306 1,818 1,051 1,958
Financial Liabilities
Deposits $498,572 $498,806 $466,735 $466,648
FHLB advances - short term - - - - 30,000 30,000
FHLB advances - long term 104,628 105,958 69,697 69,556
Other borrowings: repurchase
agreements 758 758 595 595
Accrued interest payable 1,135 1,135 1,378 1,378
The Bank assumes interest rate risk (the risk that general interest rate
levels will change) as a result of its normal operations. As a result, the
fair value of the Bank's financial instruments will change when interest rate
levels change and that change may either be favorable or unfavorable to the
Bank. Management attempts to match maturities of assets and liabilities to
the extent believed necessary to minimize interest rate risk. However,
borrowers with fixed interest rate obligations are less likely to prepay in a
rising interest rate environment and more likely to prepay in a falling
interest rate environment. Conversely, depositors who are receiving fixed
interest rates are more likely to withdraw funds before maturity in a rising
interest rate environment and less likely to do so in a falling interest rate
environment. Management monitors interest rates and maturities of assets and
liabilities, and attempts to minimize interest rate risk by adjusting terms of
new loans, and deposits and by investing in securities with terms that
mitigate the Bank's overall interest rate risk.
112
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 24 - Stock Repurchase Plan
The Company repurchased 144,950 shares of stock during the year ended
September 30, 2008. The Company had 343,468 shares remaining to be purchased
on its existing stock repurchase plan at September 30, 2008.
Note 25 - Subsequent Events
On October 29, 2008, the Company's board of directors approved a dividend in
the amount of $0.11 per share to be paid on November 26, 2008 to shareholders
of record as of November 13, 2008.
Note 26 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data are presented for the quarters ended (in
thousands, except per share amounts):
September 30, June 30, March 31, December 31,
2008 2008 2008 2007
Interest and dividend
income $10,567 $10,368 $10,926 $11,477
Interest expense (3,732) (3,868) (4,255) (4,558)
Net interest income 6,835 6,500 6,671 6,919
Provision for loan losses (1,500) (500) (700) (1,200)
Non-interest income 2,019 (893) 1,555 1,497
Non-interest expense (5,397) (4,919) (5,207) (4,851)
Income before income
taxes 1,957 188 2,319 2,365
Federal income taxes 607 733 734 750
Net income $ 1,350 $ (545) $ 1,585 $ 1,615
Basic earnings per share $ 0.208 $(0.085) $ 0.246 $ 0.248
Diluted earnings per share 0.207 (0.084) 0.242 0.242
(continued)
113
Notes to Consolidated Financial Statements
------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiary
September 30, 2008 and 2007
Note 26 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30, June 30, March 31, December 31,
2007 2007 2007 2006
Interest and dividend
income $11,197 $10,814 $10,168 $9,765
Interest expense (4,453) (4,156) (3,680) (3,489)
Net interest income 6,744 6,658 6,488 6,276
Provision for loan losses (270) (260) (156) - -
Non-interest income 1,557 1,501 1,424 1,480
Non-interest expense (4,854) (4,761) (4,939) (4,897)
Income before income
taxes 3,177 3,138 2,817 2,859
Federal income taxes 1,022 1,000 901 905
Net income $ 2,155 $ 2,138 $ 1,916 $ 1,954
Basic earnings per share $ 0.330 $ 0.318 $ 0.279 $ 0.279
Diluted earnings per share 0.322 0.309 0.270 0.270
114
Item 9. Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
Item 9A. Controls and Procedures
---------------------------------
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
the Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
of the Securities Exchange Act of 1934 (the "Exchange Act")) was carried out
under the supervision and with the participation of the Company's Chief
Executive Officer, Chief Financial Officer and several other members of the
Company's senior management as of the end of the period covered by this annual
report. The Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures in effect as
of September 30, 2008, are effective in ensuring that the information required
to be disclosed by the Company in the reports it files or submits under the
Act is (i) accumulated and communicated to the Company's management (including
the Chief Executive Officer and Chief Financial Officer) in a timely manner,
and (ii) recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms.
(b) Changes in Internal Controls: There have been no changes in our
internal control over financial reporting (as defined in 13a-15(f) of the
Exchange Act) that occurred during the quarter ended September 30, 2008, that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. The Company continued, however, to
implement suggestions from its internal auditor and independent auditors on
ways to strengthen existing controls. The Company does not expect that its
disclosure controls and procedures and internal controls over financial
reporting will prevent all error and fraud. A control procedure, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control procedure are met. Because of
the inherent limitations in all control procedures, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the Company have been detected. These inherent limitations
include the realities that judgements in decision-making can be faulty, and
that breakdowns in controls or procedures can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control. The design of any control procedure is based in part upon
certain assumptions about the likelihood of future events and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, controls become inadequate because of
changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control procedure, misstatements due to error or fraud may
occur and not de detected.
Management's Report on Internal Control Over Financial Reporting is
included in this Form 10-K under Part II, Item 8, "Financial Statements and
Supplementary Data."
Item 9B. Other Information
---------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The information contained under the section captioned "Proposal I -
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 2009 Annual Meeting of Stockholders ("Proxy Statement") and is
incorporated herein by reference.
For information regarding the executive officers of the Company and the
Bank, see "Item 1. Business - Executive Officers."
115
Compliance with Section 16(a) of the Exchange Act
The information contained under the section captioned "Section 16(a)
Beneficial Ownership Reporting Compliance" is included in the Company's Proxy
Statement and is incorporated herein by reference.
Audit Committee Financial Expert
The Company has a separately designated standing Audit Committee,
composed of Directors Mason, Robbel and Smith. Each member of the Audit
Committee is "independent" as defined in the Nasdaq Stock Market listing
standards. The Company's Board of Directors has designated Director Robbel as
the Audit Committee financial expert, as defined in the SEC's Regulation S-K.
Directors Mason, Robbel and Smith are independent as that term is used in Item
7(c) of Schedule 14A promulgated under the Exchange Act.
Code of Ethics
The Board of Directors ratified its Code of Ethics for the Company's
officers (including its senior financial officers), directors and employees
during the year ended September 30, 2008. The Code of Ethics requires the
Company's officers, directors and employees to maintain the highest standards
of professional conduct. The Company's Code of Ethics was filed as an exhibit
to its Annual Report on Form 10-K for the year ended September 30, 2003 and is
available on our website at www.timberlandbank.com.
Item 11. Executive Compensation
--------------------------------
The information contained under the sections captioned "Executive
Compensation" and "Directors' Compensation" is included in the Company's Proxy
Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
----------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
(a) Security Ownership of Certain Beneficial Owners.
The information contained under the section captioned "Security Ownership
of Certain Beneficial Owners and Management" is included in the Company's
Proxy Statement and is incorporated herein by reference.
(b) Security Ownership of Management.
The information contained under the sections captioned "Security
Ownership of Certain Beneficial Owners and Management" and "Proposal I -
Election of Directors" is included in the Company's Proxy Statement and are
incorporated herein by reference.
(c) Changes In Control.
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
116
(d) Equity Compensation Plan Information. The following table
summarizes share and exercise price information about the Company's equity
compensation plans as of September 30, 2008.
Number of
securities
remaining
available for
future issuance
under equity
Number of securities Weighted-average compensation
to be issued upon exercise price of plans (excluding
exercise of outstanding securities
outstanding options, options, warrants reflected
Plan category warrants and rights and rights in column (a))
----------------- ------------------- ----------------- ----------------
(a) (b) (c)
Equity compensation
plans approved by
security holders:
Management
Recognition
and Development
Plan........... -- $ -- 71,751
1999 Stock Option
Plan............ 261,688 7.90 3,678
2003 Stock Option
Plan............ 12,132 11.63 275,738
Equity compensation
plans not approved
by security
holders.......... -- -- --
Total.......... 273,820 $ 8.07 351,167
Item 13. Certain Relationships and Related Transactions, and Director
-----------------------------------------------------------------------
Independence
------------
The information contained under the section captioned "Meetings and
Committees of the Board of Directors And Corporate Governance Matters -
Corporate Governance - Related Party Transactions" and "Meetings and
Committees of the Board of Directors and Corporate Governance Matters -
Corporate Governance - Director Independence" are included in the Company's
Proxy Statement and are incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
------------------------------------------------
The information contained under the section captioned "Independent
Auditor" is included in the Company's Proxy Statement and is incorporated
herein by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules
-------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (1)
3.2 Amended and Restated Bylaws of the Registrant (2)
3.3 Amendment to Bylaws(3)
10.1 Employee Severance Compensation Plan (4)
10.2 Employee Stock Ownership Plan (5)
10.3 1999 Stock Option Plan (6)
10.4 2003 Stock Option Plan (7)
10.5 Form of Incentive Stock Option Agreement (8)
10.6 Form of Non-qualified Stock Option Agreement (8)
10.7 Management Recognition and Development Plan (6)
10.8 Form of Management Recognition and Development Award
Agreement (7)
10.10 Employment Agreement with Michael R. Sand (9)
10.11 Employment Agreement with Dean J. Brydon (9)
14 Code of Ethics (10)
117
21 Subsidiaries of the Registrant
23 Consent of Accountants
31.1 Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act
-------------
(1) Filed as an exhibit 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
dated December 18, 2007.
(3) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2002.
(4) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997; and to the Registrant's
Current Report on Form 8-K dated April 13, 2007.
(5) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997.
(6) Incorporated by reference to Exhibit 99 included in the Registrant's
Registration Statement on Form S-8 (333-32386)
(7) Incorporated by reference to Exhibit 99.2 included in the Registrant's
Registration Statement on Form S-8 (333-1161163)
(8) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2005.
(9) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated April 13, 2007.
(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2003.
118
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
TIMBERLAND BANCORP, INC.
Date: December 9, 2008 By:/s/ Michael R. Sand
---------------------------------
Michael R. Sand
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
/s/ Michael R. Sand President, Chief Executive Officer December 9, 2008
---------------------- and Director (Principal Executive
Michael R. Sand Officer)
/s/ Clarence E. Hamre Chairman of the Board December 9, 2008
----------------------
Clarence E. Hamre
/s/ Dean J. Brydon Chief Financial Officer December 9, 2008
---------------------- (Principal Financial and
Dean J. Brydon Accounting Officer)
/s/ Andrea M. Clinton Director December 9, 2008
----------------------
Andrea M. Clinton
/s/ David A. Smith Director December 9, 2008
----------------------
David A. Smith
/s/ Jon C. Parker Director December 9, 2008
----------------------
Jon C. Parker
/s/ James C. Mason Director December 9, 2008
----------------------
James C. Mason
/s/ Ronald A. Robbel Director December 9, 2008
----------------------
Ronald A. Robbel
119
EXHIBIT INDEX
Exhibit No. Description of Exhibit
----------- ---------------------------------------------------
21 Subsidiaries of the Registrant
23 Consent of Accountants
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act
Exhibit 21
Subsidiaries of the Registrant
Parent
----------------------------------
Timberland Bancorp, Inc.
Percentage Jurisdiction or
Subsidiaries of Ownership State of Incorporation
----------------------------------- ------------ ----------------------
Timberland Bank 100% Washington
Timberland Service Corporation (1) 100% Washington
---------------
(1) This corporation is a wholly-owned subsidiary of Timberland Bank.
Exhibit 23
Consent of Accountants
McGladrey & Pullen
Certified Public Accountants
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statements No.
333-32386 and No. 333-116163 on Form S-8 of Timberland Bancorp, Inc. of our
reports dated December 8, 2008, relating to the consolidated financial
statements and the effectiveness of internal control over financial reporting
of Timberland Bancorp, Inc. which appear in this Form 10-K for the year ended
September 30, 2008.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 8, 2008
Exhibit 31.1
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Michael R. Sand, certify that:
1 I have reviewed this Annual Report on Form 10-K of Timberland Bancorp,
Inc.;
2 Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3 Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4 The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5 The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: December 9, 2008
/s/ Michael R. Sand
--------------------------------
Michael R. Sand
Chief Executive Officer
Exhibit 31.2
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Dean J. Brydon, certify that:
1 I have reviewed this Annual Report on Form 10-K of Timberland Bancorp,
Inc.;
2 Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3 Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4 The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5 The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: December 9, 2008
/s/ Dean J. Brydon
--------------------------------
Dean J. Brydon
Chief Financial Officer
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF TIMBERLAND BANCORP, INC.
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form
10-K, that:
1 the report fully complies with the requirements of Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, and
2 the information contained in the report fairly presents, in all
material respects, the Company's financial condition and results of
operations, as of the dates and for the periods presented in the
financial statements included in such report.
/s/ Michael R. Sand /s/ Dean J. Brydon
--------------------------------- --------------------------------
Michael R. Sand Dean J. Brydon
Chief Executive Officer Chief Financial Officer
Dated: December 9, 2008