Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017

OR

[  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____ to _____.

Commission file number 000-23333

TIMBERLAND BANCORP, INC.
(Exact name of registrant as specified in its charter) 
Washington 
91-1863696 
(State or other jurisdiction of incorporation or organization) 
(IRS Employer Identification No.) 
 
624 Simpson Avenue, Hoquiam, Washington 
98550
(Address of principal executive offices) 
(Zip Code)
 
(360) 533-4747
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes X     No ___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes _X_   No __
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐ Accelerated filer ☒    Non-accelerated filer ☐ Smaller reporting company ☐   Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ___    No   _X_

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
CLASS
 
SHARES OUTSTANDING AT AUGUST 3, 2017
 
Common stock, $.01 par value
7,358,877
 



INDEX

 
 
Page
 
 
 
 
  Item 1.    
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Item 2.     
 
 
 
 
 
  Item 3.    
 
 
 
 
 
  Item 4.     
 
 
 
 
 
 
 
 
 
 
 
  Item 1.     
 
  
 
 
 
  Item 1A.     
 
 
 
 
 
  Item 2.     
 
 
 
 
 
  Item 3.     
 
 
 
 
 
  Item 4.
 
 
 
 
 
  Item 5.     
 
50 
 
 
 
 
  Item 6.     
 
 
 
 
 
 
Certifications 
 
 
 
Exhibit 31.1
 
 
 
Exhibit 31.2
 
 
 
Exhibit 32
 
 
 
Exhibit 101
 


2


PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements (unaudited)
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
June 30, 2017 and September 30, 2016
(Dollars in thousands, except per share amounts)
 
 
June 30,
2017

 
September 30,
2016

 
(Unaudited)
 
*

Assets
 
 
 
Cash and cash equivalents:
 
 
 
Cash and due from financial institutions
$
17,476

 
$
16,686

Interest-bearing deposits in banks
114,964

 
92,255

Total cash and cash equivalents
132,440

 
108,941

 
 
 
 
Certificates of deposit (“CDs”) held for investment (at cost, which
     approximates fair value)
41,187

 
53,000

Investment securities held to maturity, at amortized cost
     (estimated fair value $7,912 and $8,395)
7,244

 
7,511

Investment securities available for sale, at fair value
1,260

 
1,342

Federal Home Loan Bank of Des Moines (“FHLB”) stock
1,107

 
2,204

Other investments, at cost
3,000

 

Loans held for sale
3,523

 
3,604

Loans receivable, net of allowance for loan losses of $9,610 and $9,826
687,158

 
663,146

Premises and equipment, net
18,465

 
16,159

Other real estate owned (“OREO”) and other repossessed assets, net
3,417

 
4,117

Accrued interest receivable
2,437

 
2,348

Bank owned life insurance (“BOLI”)
19,127

 
18,721

Goodwill
5,650

 
5,650

Mortgage servicing rights (“MSRs”), net
1,781

 
1,573

Other assets
3,213

 
3,072

Total assets
$
931,009

 
$
891,388

 
 
 
 
Liabilities and shareholders’ equity
 

 
 

Liabilities
 

 
 

Deposits:
 
 
 
     Non-interest-bearing demand
$
197,527

 
$
172,283

     Interest-bearing
621,291

 
589,251

Total deposits
818,818

 
761,534

 
 
 
 
FHLB borrowings

 
30,000

Other liabilities and accrued expenses
3,575

 
3,020

Total liabilities
822,393

 
794,554

* Derived from audited consolidated financial statements.

See notes to unaudited consolidated financial statements

3


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (continued)
June 30, 2017 and September 30, 2016
(Dollars in thousands, except per share amounts)
 
 
June 30,
2017

 
September 30,
2016

 
(Unaudited)
 
*

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

 
$

Common stock, $.01 par value; 50,000,000 shares authorized;
7,354,577 shares issued and outstanding - June 30, 2017 6,943,868 shares issued and outstanding - September 30, 2016
13,223

 
9,961

Unearned shares issued to Employee Stock Ownership Plan (“ESOP”)
(463
)
 
(661
)
Retained earnings
96,018

 
87,709

Accumulated other comprehensive loss
(162
)
 
(175
)
Total shareholders’ equity
108,616

 
96,834

Total liabilities and shareholders’ equity
$
931,009

 
$
891,388

* Derived from audited consolidated financial statements.


See notes to unaudited consolidated financial statements


4


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the three and nine months ended June 30, 2017 and 2016
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Three Months Ended 
 June 30,
 
Nine months ended June 30,
 
2017

 
2016

 
2017

 
2016

Interest and dividend income
 
 
 
 
 
 
 
Loans receivable and loans held for sale
$
9,652

 
$
8,257

 
$
27,280

 
$
24,992

Investment securities
69

 
70

 
207

 
213

Dividends from mutual funds, other investments and FHLB stock
23

 
22

 
60

 
83

Interest-bearing deposits in banks and CDs
421

 
247

 
1,081

 
649

Total interest and dividend income
10,165

 
8,596

 
28,628

 
25,937

 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
 
Deposits
549

 
508

 
1,637

 
1,520

FHLB borrowings
369

 
472

 
979

 
1,420

Total interest expense
918

 
980

 
2,616

 
2,940

 
 
 
 
 
 
 
 
Net interest income
9,247

 
7,616

 
26,012

 
22,997

 
 
 
 
 
 
 
 
Recapture of loan losses
(1,000
)
 

 
(1,250
)
 

 
 
 
 
 
 
 
 
Net interest income after recapture of loan losses
10,247

 
7,616

 
27,262

 
22,997

 
 
 
 
 
 
 
 
Non-interest income
 
 
 
 
 
 
 
Other than temporary impairment ("OTTI") on investment securities

 
(4
)
 

 
(27
)
Adjustment for portion of OTTI transferred from other comprehensive income before income taxes

 

 

 
(1
)
Net OTTI on investment securities

 
(4
)
 

 
(28
)
Service charges on deposits
1,153

 
989

 
3,348

 
2,898

ATM and debit card interchange transaction fees
855

 
778

 
2,448

 
2,187

BOLI net earnings
133

 
137

 
406

 
410

Gain on sales of loans, net
561

 
443

 
1,656

 
1,230

Escrow fees
51

 
64

 
191

 
153

Servicing income on loans sold
106

 
60

 
302

 
180

Other, net
297

 
282

 
873

 
750

Total non-interest income, net
3,156

 
2,749

 
9,224

 
7,780



 See notes to unaudited consolidated financial statements

5


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (continued)
For the three and nine months ended June 30, 2017 and 2016
(Dollars in thousands, except per share amounts)
(Unaudited)
 
Three Months Ended 
 June 30,
 
Nine months ended June 30,
 
2017

 
2016

 
2017

 
2016

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
3,741

 
$
3,397

 
$
11,176

 
$
10,333

Premises and equipment
767

 
774

 
2,298

 
2,305

Advertising
170

 
192

 
499

 
590

OREO and other repossessed assets, net
4

 
123

 
22

 
561

ATM and debit card interchange transaction fees
375

 
337

 
1,036

 
990

Postage and courier
109

 
98

 
324

 
309

State and local taxes
176

 
141

 
484

 
410

Professional fees
230

 
202

 
629

 
449

Federal Deposit Insurance Corporation ("FDIC") insurance
99

 
100

 
319

 
334

Loan administration and foreclosure
20

 
92

 
113

 
216

Data processing and telecommunications
480

 
470

 
1,394

 
1,394

Deposit operations
301

 
232

 
850

 
638

Other
466

 
410

 
1,462

 
1,146

Total non-interest expense
6,938

 
6,568

 
20,606

 
19,675

 
 
 
 
 
 
 
 
Income before federal income taxes
6,465

 
3,797

 
15,880

 
11,102

 
 
 
 
 
 
 
 
Provision for federal income taxes
2,188

 
1,250

 
5,328

 
3,647

 
 
 
 
 
 
 
 
     Net income
$
4,277

 
$
2,547

 
$
10,552

 
$
7,455

 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
Basic
$
0.59

 
$
0.37

 
$
1.49

 
$
1.09

Diluted
$
0.58

 
$
0.36

 
$
1.44

 
$
1.05

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
7,269,564

 
6,822,608

 
7,088,134

 
6,846,373

Diluted
7,432,171

 
7,111,199

 
7,348,486

 
7,091,661

 
 
 
 
 
 
 
 
Dividends paid per common share
$
0.11

 
$
0.08

 
$
0.31

 
$
0.28


See notes to unaudited consolidated financial statements

6


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three and nine months ended June 30, 2017 and 2016
(Dollars in thousands)
(Unaudited) 
 
Three Months Ended 
 June 30,
 
Nine Months Ended 
 June 30,
 
2017

 
2016

 
2017

 
2016

Comprehensive income
 
 
 
 
 
 
 
Net income
$
4,277

 
$
2,547

 
$
10,552

 
$
7,455

Unrealized holding gains (losses) on investment securities available for sale, net of income taxes of $3, $3, ($11) and $2, respectively
5

 
6

 
(22
)
 
5

Change in OTTI on investment securities held to maturity, net of income taxes:
 
 
 
 
 
 
 
Adjustments related to other factors for which OTTI was previously recognized, net of income taxes of $0, $0, $0 and $6, respectively

 

 

 
10

Amount reclassified to credit loss (recorded as market loss), net of income taxes of $0, $0, $0 and $1, respectively

 

 

 
1

Accretion of OTTI on investment securities held to maturity, net of income taxes of $5, $4, $18 and $13, respectively
11

 
7

 
35

 
24

Total other comprehensive income, net of income taxes
16

 
13

 
13

 
40

 
 
 
 
 
 
 
 
Total comprehensive income
$
4,293

 
$
2,560

 
$
10,565


$
7,495




See notes to unaudited consolidated financial statements

7


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the nine months ended June 30, 2017 and 2016
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Number of Shares
 
Amount
 
Unearned
 Shares Issued to ESOP

 
 
 
Accumulated
Other
Compre-
hensive
Loss

 
 
 
 
Common
Stock
 
Common
Stock
 
 
Retained
Earnings
 
 
Total
Balance, September 30, 2015
 
6,988,848

 
$
10,293

 
$
(926
)
 
$
80,133

 
$
(313
)
 
$
89,187

Net income
 

 

 

 
7,455

 

 
7,455

Other comprehensive income
 

 

 

 

 
40

 
40

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

 

 

 
(820
)
Exercise of stock options
 
16,220

 
128

 

 

 

 
128

Common stock dividends ($0.28 per common share)
 

 

 

 
(1,953
)
 

 
(1,953
)
Earned ESOP shares, net of income taxes
 

 
94

 
198

 

 

 
292

Stock option compensation expense
 

 
123

 

 

 

 
123

Balance, June 30, 2016
 
6,939,068

 
9,818

 
(728
)
 
85,635

 
(273
)
 
94,452

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2016
 
6,943,868

 
9,961

 
(661
)
 
87,709

 
(175
)
 
96,834

Net income
 

 

 

 
10,552

 

 
10,552

Other comprehensive income
 

 

 

 

 
13

 
13

Exercise of stock warrant
 
370,899

 
2,496

 

 

 

 
2,496

Exercise of stock options
 
39,810

 
265

 

 

 

 
265

Common stock dividends ($0.31 per common share)
 

 

 

 
(2,243
)
 

 
(2,243
)
Earned ESOP shares, net of income taxes
 

 
230

 
198

 

 

 
428

Stock option compensation expense
 

 
271

 

 

 

 
271

Balance, June 30, 2017
 
7,354,577

 
$
13,223

 
$
(463
)
 
$
96,018

 
$
(162
)
 
$
108,616

See notes to unaudited consolidated financial statements

8


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended June 30, 2017 and 2016
(In thousands)
(Unaudited)

 
Nine Months Ended
June 30,
 
2017

 
2016

Cash flows from operating activities
 
 
 
Net income
$
10,552

 
$
7,455

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

 
 

Recapture of loan losses
(1,250
)
 

Depreciation
946

 
998

Earned ESOP shares
198

 
198

Stock option compensation expense
118

 
114

Stock option tax effect less excess tax benefit
22

 
5

Gain on sales of OREO and other repossessed assets, net
(53
)
 
(47
)
Provision for OREO losses
42

 
394

(Gain) loss on sales/dispositions of premises and equipment, net
(3
)
 
4

BOLI net earnings
(406
)
 
(410
)
Gain on sales of loans, net
(1,656
)
 
(1,230
)
Loans originated for sale
(54,805
)
 
(41,353
)
Proceeds from sales of loans
56,542

 
40,749

Increase in deferred loan origination fees
80

 
40

Net OTTI on investment securities

 
28

Amortization of MSRs
369

 
428

Net change in accrued interest receivable and other assets, and other liabilities and accrued expenses
(326
)
 
(151
)
Net cash provided by operating activities
10,370

 
7,222

 
 
 
 
Cash flows from investing activities
 

 
 

Net decrease (increase) in CDs held for investment
11,813

 
(3,824
)
Proceeds from maturities and prepayments of investment securities held to maturity
387

 
388

Proceeds from maturities and prepayments of investment securities available for sale
49

 
37

Purchase of FHLB stock
(103
)
 
(105
)
Redemption of FHLB stock
1,200

 

Purchase of other investments
(3,000
)
 

Increase in loans receivable, net
(23,566
)
 
(43,452
)
Additions to premises and equipment
(3,249
)
 
(372
)
Capitalized improvements to OREO

 
(142
)
Proceeds from sales of OREO and other repossessed assets
1,435

 
3,210

Net cash used in investing activities
(15,034
)
 
(44,260
)
 
 
 
 
See notes to unaudited consolidated financial statements

9


TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the nine months ended June 30, 2017 and 2016
(In thousands)
(Unaudited)

 
Nine Months Ended
June 30,
 
2017

 
2016

Cash flows from financing activities
 

 
 

Net increase in deposits
$
57,284

 
$
36,469

Repayment of FHLB borrowings
(30,000
)
 

ESOP tax effect
230

 
94

Proceeds from exercise of stock options
265

 
128

Stock option excess tax benefit
131

 
4

Proceeds from exercise of stock warrant
2,492

 

Issuance of common stock
4

 

Repurchase of common stock

 
(820
)
Payment of dividends
(2,243
)
 
(1,953
)
Net cash provided by financing activities
28,163

 
33,922

 
 

 
 

Net increase in cash and cash equivalents
23,499

 
(3,116
)
Cash and cash equivalents
 

 
 

Beginning of period
108,941

 
92,289

End of period
$
132,440

 
$
89,173

 
 
 
 
Supplemental disclosure of cash flow information
 

 
 

Income taxes paid
$
5,376

 
$
3,450

Interest paid
2,701

 
2,924

 
 
 
 
Supplemental disclosure of non-cash investing activities
 

 
 

Loans transferred to OREO and other repossessed assets
$
724

 
$
323

Other comprehensive income related to investment securities
13

 
40

See notes to unaudited consolidated financial statements

10


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

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)  Basis of Presentation:  The accompanying unaudited consolidated financial statements for Timberland Bancorp, Inc. (“Company”) were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with GAAP. However, all adjustments which are, in the opinion of management, necessary for a fair presentation of the interim consolidated financial statements have been included.  All such adjustments are of a normal recurring nature. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2016 (“2016 Form 10-K”).  The unaudited consolidated results of operations for the nine months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the entire fiscal year ending September 30, 2017.

(b)  Principles of Consolidation:  The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Timberland Bank (“Bank”), and the Bank’s wholly-owned subsidiary, Timberland Service Corporation.   All significant intercompany transactions and balances have been eliminated in consolidation.

(c)  Operating Segment:  The Company has one reportable operating segment which is defined as community banking in western Washington under the operating name, “Timberland Bank.”

(d)  The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.

(e)  Certain prior period amounts have been reclassified to conform to the June 30, 2017 presentation with no change to net income or total shareholders’ equity as previously reported.































11


(2) INVESTMENT SECURITIES

Held to maturity and available for sale investment securities have been classified according to management’s intent and were as follows as of June 30, 2017 and September 30, 2016 (dollars in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
June 30, 2017
 
 
 
 
 
 
 
Held to maturity
 
 
 
 
 
 
 
Mortgage-backed securities ("MBS"):
 
 
 
 
 
 
 
U.S. government agencies
$
565

 
$
12

 
$
(1
)
 
$
576

Private label residential
671

 
651

 
(4
)
 
1,318

U.S. Treasury and U.S government agency securities
6,008

 
16

 
(6
)
 
6,018

Total
$
7,244

 
$
679

 
$
(11
)
 
$
7,912

 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

MBS: U.S. government agencies
$
288

 
$
21

 
$

 
$
309

Mutual funds
1,000

 

 
(49
)
 
951

Total
$
1,288

 
$
21

 
$
(49
)
 
$
1,260

 
 
 
 
 
 
 
 
September 30, 2016
 
 
 
 
 
 
 
Held to maturity
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

U.S. government agencies
$
670

 
$
18

 
$
(1
)
 
$
687

Private label residential
835

 
762

 
(2
)
 
1,595

U.S. Treasury and U.S. government agency securities
6,006

 
107

 

 
6,113

Total
$
7,511

 
$
887

 
$
(3
)
 
$
8,395

 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

MBS: U.S. government agencies
$
336

 
$
30

 
$

 
$
366

Mutual funds
1,000

 

 
(24
)
 
976

Total
$
1,336

 
$
30

 
$
(24
)
 
$
1,342



12


Held to maturity and available for sale investment securities with unrealized losses were as follows for June 30, 2017 (dollars in thousands):
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Estimated
 Fair
 Value
 
Gross
Unrealized
Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized
Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized
Losses
Held to maturity
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government agencies
$
46

 
$
(1
)
 
2

 
$
81

 
$

 
5

 
$
127

 
$
(1
)
Private label residential
21

 
(1
)
 
2

 
92

 
(3
)
 
11

 
113

 
(4
)
U.S. Treasury and U.S. government agency securities
2,987

 
(6
)
 
1

 

 

 

 
2,987

 
(6
)
     Total
$
3,054

 
$
(8
)
 
5

 
$
173

 
$
(3
)
 
16

 
$
3,227

 
$
(11
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Mutual funds
$

 
$

 

 
$
951

 
$
(49
)
 
1

 
$
951

 
$
(49
)
     Total
$

 
$

 

 
$
951

 
$
(49
)
 
1

 
$
951

 
$
(49
)

Held to maturity and available for sale investment securities with unrealized losses were as follows for September 30, 2016 (dollars in thousands):
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Estimated
 Fair
 Value
 
Gross
Unrealized Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized Losses
 
Quantity
 
Estimated
 Fair
 Value
 
Gross
Unrealized Losses
Held to maturity
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government agencies
$
9

 
$

 
1

 
$
96

 
$
(1
)
 
5

 
$
105

 
$
(1
)
Private label residential
1

 

 
1

 
112

 
(2
)
 
10

 
113

 
(2
)
     Total
$
10

 
$

 
2

 
$
208

 
$
(3
)
 
15

 
$
218

 
$
(3
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Mutual funds
$

 
$

 

 
$
976

 
$
(24
)
 
1

 
$
976

 
$
(24
)
     Total
$

 
$

 

 
$
976

 
$
(24
)
 
1

 
$
976

 
$
(24
)

The Company has evaluated the investment securities in the above tables and has determined that the decline in their value is temporary.  The unrealized losses are primarily due to changes in market interest rates and spreads in the market for mortgage-related products. The fair value of these securities is expected to recover as the securities approach their maturity dates and/or as the pricing spreads narrow on mortgage-related securities.  The Company has the ability and the intent to hold the investments until the market value recovers.  Furthermore, as of June 30, 2017, management does not have the intent to sell any of the securities classified as available for sale where the estimated fair value is below the recorded value and believes that it is more likely than not that the Company will not have to sell such securities before a recovery of cost or recorded value if previously written down.

In accordance with GAAP, the Company bifurcates OTTI into (1) amounts related to credit losses which are recognized through earnings and (2) amounts related to all other factors which are recognized as a component of other comprehensive income (loss). To determine the component of the gross OTTI related to credit losses, the Company compared the amortized cost basis of the OTTI security to the present value of its revised expected cash flows, discounted using its pre-impairment yield.  The revised expected cash flow estimates for individual securities are based primarily on an analysis of default rates, prepayment speeds and

13


third-party analytic reports.  Significant judgment by management is required in this analysis that includes, but is not limited to, assumptions regarding the collectability of principal and interest, net of related expenses, on the underlying loans.  

The following table presents a summary of the significant inputs utilized to measure management’s estimates of the credit loss component on OTTI securities as of June 30, 2017 and 2016:
 
Range
 
Weighted
 
Minimum 
 
Maximum 
 
Average 
June 30, 2017
 
 
 
 
 
Constant prepayment rate
6.00
%
 
15.00
%
 
11.54
%
Collateral default rate
0.09
%
 
9.88
%
 
4.66
%
Loss severity rate
6.00
%
 
62.00
%
 
41.93
%
 
 
 
 
 
 
June 30, 2016
 
 
 
 
 
Constant prepayment rate
6.00
%
 
15.00
%
 
11.17
%
Collateral default rate
0.06
%
 
15.44
%
 
5.50
%
Loss severity rate
1.00
%
 
75.00
%
 
41.23
%

The following table presents the OTTI for the three and nine months ended June 30, 2017 and 2016 (dollars in thousands):
 
 
Three Months Ended June 30, 2017
 
Three Months Ended
June 30, 2016
 
Held To
Maturity
 
Available
For Sale
 
Held To
Maturity
 
Available
For Sale
Total OTTI
$

 
$

 
$
(4
)
 
$

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

 

 

 

Net OTTI recognized in earnings (2)
$

 
$

 
$
(4
)
 
$

 
Nine Months Ended June 30, 2017
 
Nine Months Ended
June 30, 2016
 
Held To
Maturity
 
Available
For Sale
 
Held To
Maturity
 
Available
For Sale
Total OTTI
$

 
$

 
$
(27
)
 
$

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

 

 
(1
)
 

Net OTTI recognized in earnings (2)
$

 
$

 
$
(28
)
 
$

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

14


The following table presents a roll forward of the credit loss component of held to maturity and available for sale debt securities that have been written down for OTTI with the credit loss component recognized in earnings for the nine months ended June 30, 2017 and 2016 (dollars in thousands):
 
Nine Months Ended June 30,
 
2017

 
2016

Beginning balance of credit loss
$
1,505

 
$
1,576

Additions:
 

 
 

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

 
22

Subtractions:
 
 
 

Realized losses previously recorded
as credit losses
(48
)
 
(74
)
Ending balance of credit loss
$
1,457

 
$
1,524


During the three months ended June 30, 2017, the Company recorded a $12,000 net realized loss (as a result of the securities being deemed worthless) on 15 held to maturity residential MBS, of which the entire amount had been recognized previously as a credit loss. During the nine months ended June 30, 2017, the Company recorded a $48,000 net realized loss (as a result of securities being deemed worthless) on 18 held to maturity residential MBS, of which the entire amount had been previously recognized as a credit loss. During the three months ended June 30, 2016, the Company recorded a $17,000 net realized loss (as a result of the securities being deemed worthless) on 13 held to maturity residential MBS, of which $15,000 had been recognized previously as a credit loss. During the nine months ended June 30, 2016, the Company recorded a $81,000 net realized loss (as a result of securities being deemed worthless) on 16 held to maturity residential MBS, of which $74,000 had been previously recognized as a credit loss.

The recorded amount of residential MBS, treasury and agency securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits, FHLB collateral and other non-profit organization deposits totaled $6.88 million and $7.04 million at June 30, 2017 and September 30, 2016, respectively.

The contractual maturities of debt securities at June 30, 2017 were as follows (dollars in thousands).  Expected maturities may differ from scheduled maturities due to the prepayment of principal or call provisions.
 
Held to Maturity
 
Available for Sale
 
Amortized
Cost
 
Estimated
Fair
Value
 
Amortized
Cost
 
Estimated
Fair
Value
Due within one year
$
14

 
$
14

 
$

 
$

Due after one year to five years
5,995

 
6,005

 

 

Due after five to ten years
14

 
14

 

 

Due after ten years
1,221

 
1,879

 
288

 
309

Total
$
7,244

 
$
7,912

 
$
288

 
$
309



(3) GOODWILL

Goodwill is initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired.  Goodwill is presumed to have an indefinite useful life and is analyzed annually for impairment.  The Company performs an annual review during the third quarter of each fiscal year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill is impaired.

The annual goodwill impairment test begins with a qualitative assessment of whether it is "more likely than not" that the reporting unit's fair value is less than its carrying amount. If an entity concludes that it is not "more likely than not" that the fair value of a reporting unit is less than its carrying amount, it need not perform a two-step impairment test. In the case of the

15


Company, the services offered through the Bank and its subsidiary are managed as one strategic unit and represent the Company's only reporting unit.

Management's qualitative assessment takes into consideration macroeconomic conditions, industry and market considerations, cost or margin factors, financial performance and share price. Based on this assessment, the Company determined that it is not "more likely than not" that the Company's fair value is less than its carrying amount and therefore goodwill was determined not to be impaired at May 31, 2017.

If the Company's qualitative assessment concluded that it is "more likely than not" that the fair value of its reporting unit is less than its carrying amount, it must perform the two-step impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized, if any. The first step of the goodwill impairment test compares the estimated fair value of the reporting unit with its carrying amount, or the book value, including goodwill. If the estimated fair value of the reporting unit equals or exceeds its book value, goodwill is considered not impaired, and the second step of the impairment test is unnecessary.

The second step, if necessary, measures the amount of goodwill impairment loss to be recognized. The reporting unit must determine fair value for all assets and liabilities, excluding goodwill. The net of the assigned fair value of assets and liabilities is then compared to the book value of the reporting unit, and any excess book value becomes the implied fair value of goodwill. If the carrying amount of the goodwill exceeds the newly calculated implied fair value of goodwill, an impairment loss is recognized in the amount required to write-down the goodwill to the implied fair value.

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

As of June 30, 2017, management believed that there had been no events or changes in the circumstances since May 31, 2017 that would indicate a potential impairment of goodwill. No assurances can be given, however, that the Company will not record an impairment loss on goodwill in the future.

16


(4) LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans receivable by portfolio segment consisted of the following at June 30, 2017 and September 30, 2016 (dollars in thousands):
 
June 30,
2017
 
September 30,
2016
 
Amount
 
Percent
 
Amount
 
Percent
Mortgage loans:
 
 
 
 
 
 
 
One- to four-family (a)
$
121,705

 
15.8
%
 
$
118,560

 
16.4
%
Multi-family
61,051

 
7.9

 
62,303

 
8.6

Commercial
331,901

 
43.0

 
312,525

 
43.2

Construction - custom and owner/builder
109,578

 
14.3

 
93,049

 
12.9

Construction - speculative one- to four-family
8,002

 
1.0

 
8,106

 
1.1

Construction - commercial
20,067

 
2.6

 
9,365

 
1.3

Construction - multi-family
11,057

 
1.4

 
12,590

 
1.7

Land
24,333

 
3.2

 
21,627

 
3.0

Total mortgage loans
687,694

 
89.2

 
638,125

 
88.2

 
 
 
 
 
 
 
 
Consumer loans:
 

 
 

 
 

 
 

Home equity and second mortgage
36,320

 
4.7

 
39,727

 
5.5

Other
3,789

 
0.5

 
4,139

 
0.5

Total consumer loans
40,109

 
5.2

 
43,866

 
6.0

 
 
 
 
 
 
 
 
Commercial business loans
43,407

 
5.6

 
41,837

 
5.8

 
 
 
 
 
 
 
 
Total loans receivable
771,210

 
100.0
%
 
723,828

 
100.0
%
Less:
 

 
 

 
 

 
 

Undisbursed portion of construction 
loans in process
72,133

 
 

 
48,627

 
 

Deferred loan origination fees, net
2,309

 
 

 
2,229

 
 

Allowance for loan losses
9,610

 
 

 
9,826

 
 

 
84,052

 
 
 
60,682

 
 
Loans receivable, net
$
687,158

 
 

 
$
663,146

 
 

_____________________________
 
 
 
 
 
 
 
 (a) Does not include one- to four-family loans held for sale totaling $3,523 and $3,604 at June 30, 2017 and September 30, 2016, respectively.



















17



Allowance for Loan Losses
The following tables set forth information for the three and nine months ended June 30, 2017 and 2016 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):

 
Three Months Ended June 30, 2017
 
Beginning
Allowance
 
Provision for
(Recapture of) Loan Losses
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
One- to four-family
$
1,126

 
$
(11
)
 
$

 
$

 
$
1,115

Multi-family
480

 
(16
)
 

 

 
464

Commercial
4,316

 
(1,040
)
 

 
1,061

 
4,337

Construction – custom and owner/builder
695

 
17

 

 

 
712

Construction – speculative one- to four-family
85

 
(15
)
 

 
5

 
75

Construction – commercial
268

 
15

 

 

 
283

Construction – multi-family
96

 
36

 

 

 
132

Land
947

 
1

 
(49
)
 
5

 
904

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
957

 
(2
)
 

 

 
955

Other
130

 
6

 
(2
)
 

 
134

Commercial business loans
490

 
9

 

 

 
499

Total
$
9,590

 
$
(1,000
)
 
$
(51
)
 
$
1,071

 
$
9,610


 
Nine Months Ended June 30, 2017
 
Beginning
Allowance
 
Provision for
(Recapture of) Loan Losses
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
One-to four-family
$
1,239

 
$
(145
)
 
$

 
$
21

 
$
1,115

Multi-family
473

 
(9
)
 

 

 
464

Commercial
4,384

 
(1,095
)
 
(13
)
 
1,061

 
4,337

Construction – custom and owner/builder
619

 
93

 

 

 
712

Construction – speculative one- to four-family
130

 
(60
)
 

 
5

 
75

Construction – commercial
268

 
15

 

 

 
283

Construction – multi-family
316

 
(184
)
 

 

 
132

Land
820

 
120

 
(51
)
 
15

 
904

Consumer loans:
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
939

 
16

 

 

 
955

Other
156

 
(18
)
 
(6
)
 
2

 
134

Commercial business loans
482

 
17

 

 

 
499

Total
$
9,826

 
$
(1,250
)
 
$
(70
)
 
$
1,104

 
$
9,610

 
 
 
 
 
 
 
 
 
 


18


 
Three Months Ended June 30, 2016
 
Beginning
Allowance
 
Provision for
(Recapture of) Loan Losses
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
  One- to four-family
$
1,323

 
$
(83
)
 
$
(27
)
 
$
1

 
$
1,214

  Multi-family
315

 
33

 

 

 
348
  Commercial
4,083

 
19

 
(128
)
 

 
3,974
  Construction – custom and owner/builder
542

 
93

 

 

 
635
  Construction – speculative one- to four-family
96

 
25

 

 

 
121
  Construction – commercial
617

 
7

 

 

 
624
Construction – multi-family
409

 
(22
)
 

 

 
387

  Land
954

 
9

 
(50
)
 
6

 
919
Consumer loans:
 
 
 
 
 
 
 
 
 
  Home equity and second mortgage
1,021

 
(55
)
 
(5
)
 

 
961
  Other
162

 
(4
)
 
(2
)
 
1

 
157
Commercial business loans
521

 
(22
)
 

 
3

 
502
Total
$
10,043

 
$

 
$
(212
)
 
$
11

 
$
9,842



 
Nine Months Ended June 30, 2016
 
Beginning
Allowance
 
Provision for
(Recapture of) Loan Losses
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
  One-to four-family
$
1,480

 
$
(267
)
 
$
(55
)
 
$
56

 
$
1,214

  Multi-family
392

 
(44)

 

 

 
348
  Commercial
4,065

 
118

 
(209
)
 

 
3,974
  Construction – custom and owner/builder
451

 
184

 

 

 
635
  Construction – speculative one- to four-family
123

 
(4)

 

 
2

 
121
  Construction – commercial
426

 
198

 

 

 
624
Construction – multi-family
283

 
(77
)
 

 
181

 
387

  Land
1,021

 
(63)

 
(58
)
 
19

 
919
Consumer loans:
 
 
 
 
 
 
 
 
 
  Home equity and second mortgage
1,073

 
(94)

 
(18
)
 

 
961
  Other
187

 
(25)

 
(7
)
 
2

 
157
Commercial business loans
423

 
74

 

 
5

 
502
Total
$
9,924

 
$

 
$
(347
)
 
$
265

 
$
9,842

 
 
 
 
 
 
 
 
 
 


19


The following tables present information on the loans evaluated individually and collectively for impairment in the allowance for loan losses by portfolio segment at June 30, 2017 and September 30, 2016 (dollars in thousands):

 
Allowance for Loan Losses
 
Recorded Investment in Loans
 
Individually
Evaluated for
Impairment
 
Collectively
Evaluated for
Impairment
 
Total
 
Individually
Evaluated for
Impairment
 
Collectively
Evaluated for
Impairment
 
Total
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$

 
$
1,115

 
$
1,115

 
$
1,469

 
$
120,236

 
$
121,705

Multi-family

 
464

 
464

 

 
61,051

 
61,051

Commercial
20

 
4,317

 
4,337

 
4,084

 
327,817

 
331,901

Construction – custom and owner/builder

 
712

 
712

 

 
59,352

 
59,352

Construction – speculative one- to four-family

 
75

 
75

 

 
2,506

 
2,506

Construction – commercial

 
283

 
283

 

 
9,417

 
9,417

Construction –  multi-family

 
132

 
132

 

 
5,296

 
5,296

Land
89

 
815

 
904

 
1,054

 
23,279

 
24,333

Consumer loans:
 

 
 
 
 

 
 

 
 

 
 

Home equity and second mortgage
320

 
635

 
955

 
560

 
35,760

 
36,320

Other

 
134

 
134

 

 
3,789

 
3,789

Commercial business loans

 
499

 
499

 

 
43,407

 
43,407

Total
$
429

 
$
9,181

 
$
9,610

 
$
7,167

 
$
691,910

 
$
699,077

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
$
70

 
$
1,169

 
$
1,239

 
$
2,264

 
$
116,296

 
$
118,560

Multi-family

 
473

 
473

 

 
62,303

 
62,303

Commercial
413

 
3,971

 
4,384

 
11,309

 
301,216

 
312,525

Construction – custom and owner/builder

 
619

 
619

 
367

 
51,662

 
52,029

Construction – speculative one- to four-family

 
130

 
130

 

 
4,074

 
4,074

Construction – commercial

 
268

 
268

 

 
6,841

 
6,841

Construction – multi-family

 
316

 
316

 

 
11,539

 
11,539

Land
53

 
767

 
820

 
1,268

 
20,359

 
21,627

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
227

 
712

 
939

 
999

 
38,728

 
39,727

Other
13

 
143

 
156

 
30

 
4,109

 
4,139

Commercial business loans

 
482

 
482

 

 
41,837

 
41,837

Total
$
776

 
$
9,050

 
$
9,826

 
$
16,237

 
$
658,964

 
$
675,201



20


The following tables present an analysis of loans by aging category and portfolio segment at June 30, 2017 and September 30, 2016 (dollars in thousands):
 
30–59
Days
Past Due
 
60-89
Days
Past Due
 
Non-
Accrual (1)
 
Past Due
90 Days
or More
and Still
Accruing
 
Total
Past Due
 
Current
 
Total
Loans
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$

 
$
4

 
$
896

 
$

 
$
900

 
$
120,805

 
$
121,705

Multi-family

 

 

 

 

 
61,051

 
61,051

Commercial
108

 

 
403

 

 
511

 
331,390

 
331,901

Construction – custom and owner/builder

 

 

 

 

 
59,352

 
59,352

Construction – speculative one- to four- family

 

 

 

 

 
2,506

 
2,506

Construction – commercial

 

 

 

 

 
9,417

 
9,417

Construction – multi-family

 

 

 

 

 
5,296

 
5,296

Land

 
102

 
496

 

 
598

 
23,735

 
24,333

Consumer loans:
 

 
 

 
 

 
 

 


 
 
 
 
Home equity and second mortgage

 
87

 
260

 

 
347

 
35,973

 
36,320

Other
68

 

 

 

 
68

 
3,721

 
3,789

Commercial business loans

 
17

 

 

 
17

 
43,390

 
43,407

Total
$
176

 
$
210

 
$
2,055

 
$

 
$
2,441

 
$
696,636

 
$
699,077

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 

 
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
$

 
$
207

 
$
914

 
$

 
$
1,121

 
$
117,439

 
$
118,560

Multi-family

 

 

 

 

 
62,303

 
62,303

Commercial
113

 

 
612

 

 
725

 
311,800

 
312,525

   Construction – custom and owner/
       builder

 

 
367

 

 
367

 
51,662

 
52,029

Construction – speculative one- to four- family

 

 

 

 

 
4,074

 
4,074

Construction – commercial

 

 

 

 

 
6,841

 
6,841

Construction – multi-family

 

 

 

 

 
11,539

 
11,539

Land

 

 
548

 

 
548

 
21,079

 
21,627

Consumer loans:
 

 
 

 
 

 
 

 
 
 
 

 
 
Home equity and second mortgage
37

 

 
402

 
135

 
574

 
39,153

 
39,727

Other
31

 

 
30

 

 
61

 
4,078

 
4,139

Commercial business loans
37

 
38

 

 

 
75

 
41,762

 
41,837

Total
$
218

 
$
245

 
$
2,873

 
$
135

 
$
3,471

 
$
671,730

 
$
675,201

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

Credit Quality Indicators
The Company uses credit risk grades which reflect the Company’s assessment of a loan’s risk or loss potential.  The Company categorizes loans into risk grade categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors such as the estimated fair value of the collateral.  The Company uses the following definitions for credit risk ratings as part of the on-going monitoring of the credit quality of its loan portfolio:

Pass:  Pass loans are defined as those loans that meet acceptable quality underwriting standards.

Watch:  Watch loans are defined as those loans that still exhibit acceptable quality, but have some concerns that justify greater attention.  If these concerns are not corrected, a potential for further adverse categorization exists.  These concerns could relate to a specific condition peculiar to the borrower, its industry segment or the general economic environment.


21


Special Mention: Special mention loans are defined as those loans deemed by management to have some potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in the deterioration of the payment prospects of the loan. 

Substandard:  Substandard loans are defined as those loans that are inadequately protected by the current net worth and paying capacity of the obligor, or of the collateral pledged.  Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt.  If the weakness or weaknesses are not corrected, there is the distinct possibility that some loss will be sustained.

Loss:  Loans in this classification are considered uncollectible and of such little value that continuance as bankable assets is not warranted.  This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this loan even though partial recovery may be realized in the future. At June 30, 2017 and September 30, 2016, there were no loans classified as loss.

The following tables present an analysis of loans by credit quality indicator and portfolio segment at June 30, 2017 and September 30, 2016 (dollars in thousands):
 
Loan Grades
 
 
June 30, 2017
Pass
 
Watch
 
Special
Mention
 
Substandard
 
Total
Mortgage loans:
 
 
 
 
 
 
 
 
 
One- to four-family
$
118,923

 
$
507

 
$
648

 
$
1,627

 
$
121,705

Multi-family
59,289

 

 
1,762

 

 
61,051

Commercial
321,664

 
6,274

 
3,560

 
403

 
331,901

Construction – custom and owner/builder
59,352

 

 

 

 
59,352

Construction – speculative one- to four-family
2,506

 

 

 

 
2,506

Construction – commercial
9,417

 

 

 

 
9,417

Construction – multi-family
5,296

 

 

 

 
5,296

Land
20,955

 
1,030

 
1,807

 
541

 
24,333

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
35,661

 
155

 
55

 
449

 
36,320

Other
3,723

 

 

 
66

 
3,789

Commercial business loans
43,374

 
33

 

 

 
43,407

Total
$
680,160

 
$
7,999

 
$
7,832

 
$
3,086

 
$
699,077

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2016
 

 
 

 
 

 
 

 
 

Mortgage loans:
 
 
 

 
 

 
 

 
 

One- to four-family
$
115,131

 
$
364

 
$
661

 
$
2,404

 
$
118,560

Multi-family
60,504

 

 
1,799

 

 
62,303

Commercial
292,756

 
8,411

 
10,746

 
612

 
312,525

Construction – custom and owner/builder
51,432

 
229

 

 
368

 
52,029

Construction – speculative one- to four-family
4,074

 

 

 

 
4,074

Construction – commercial
6,841

 

 

 

 
6,841

Construction – multi-family
11,539

 

 

 

 
11,539

Land
18,010

 
1,043

 
1,859

 
715

 
21,627

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
38,261

 
590

 

 
876

 
39,727

Other
4,078

 

 

 
61

 
4,139

Commercial business loans
41,797

 
40

 

 

 
41,837

Total
$
644,423

 
$
10,677

 
$
15,065

 
$
5,036

 
$
675,201


22



Impaired Loans
In accordance with GAAP, a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts (principal and interest) when due according to the contractual terms of the loan agreement. Smaller balance homogeneous loans, such as residential mortgage loans and consumer loans, may be collectively evaluated for impairment. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when, as an alternative, the current estimated fair value of the collateral, reduced by estimated costs to sell (if applicable), or observable market price is used. The valuation of real estate collateral is subjective in nature and may be adjusted in future periods because of changes in economic conditions.  Management considers third-party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling real estate, in determining the estimated fair value of particular properties.  In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred subsequent to the most recent appraisals.  Accordingly, the amounts of any such potential changes and any related adjustments are generally recorded at the time such information is received. When the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest and net deferred loan origination fees or costs), impairment is recognized by creating or adjusting an allocation of the allowance for loan losses and uncollected accrued interest is reversed against interest income. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance.

The categories of non-accrual loans and impaired loans overlap, although they are not identical.  

23


The following table is a summary of information related to impaired loans by portfolio segment as of June 30, 2017 and for the three and nine months then ended (dollars in thousands):
 
Recorded
Investment
 
Unpaid Principal Balance (Loan Balance Plus Charge Off)
 
Related
Allowance
 
Quarter to Date ("QTD") Average Recorded Investment (1)
 
Year to Date ("YTD") Average Recorded Investment (2)
 
QTD Interest Income Recognized (1)
 
YTD Interest Income Recognized (2)
 
QTD Cash Basis Interest Income Recognized (1)
 
YTD Cash Basis Interest Income Recognized (2)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
1,423

 
$
1,570

 
$

 
$
1,145

 
$
1,024

 
$
23

 
$
46

 
$
20

 
$
43

Commercial
839

 
839

 

 
1,540

 
4,384

 
2

 
166

 
2

 
127

Construction – custom and owner/
    builder

 

 

 

 
184

 

 
7

 

 
7

Land
252

 
369

 

 
345

 
566

 

 
8

 

 
6

Consumer loans:
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
125

 
125

 

 
254

 
324

 

 

 

 

Commercial business loans

 

 

 
27

 
14

 

 

 

 

Subtotal
2,639

 
2,903

 

 
3,311

 
6,496

 
25

 
227

 
22

 
183

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
46

 
46

 

 
479

 
901

 
1

 
50

 
1

 
38

Commercial
3,245

 
3,245

 
20

 
3,629

 
3,681

 
45

 
159

 
35

 
128

Land
802

 
802

 
89

 
683

 
627

 
9

 
28

 
7

 
23

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
435

 
435

 
320

 
513

 
554

 
5

 
25

 
5

 
23

Other 

 

 

 
14

 
22

 

 

 

 

Subtotal
4,528

 
4,528

 
429

 
5,318

 
5,785

 
60

 
262

 
48

 
212

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
1,469

 
1,616

 

 
1,624

 
1,925

 
24

 
96

 
21

 
81

Commercial
4,084

 
4,084

 
20

 
5,169

 
8,065

 
47

 
325

 
37

 
255

Construction – custom and owner/
    builder

 

 

 

 
184

 

 
7

 

 
7

Land
1,054

 
1,171

 
89

 
1,028

 
1,193

 
9

 
36

 
7

 
29

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
560

 
560

 
320

 
767

 
878

 
5

 
25

 
5

 
23

Other

 

 

 
14

 
22

 

 

 

 

Commercial business loans

 

 

 
27

 
14

 

 

 

 

Total
$
7,167

 
$
7,431

 
$
429

 
$
8,629

 
$
12,281

 
$
85

 
$
489

 
$
70

 
$
395

______________________________________________
(1)
For the three months ended June 30, 2017.
(2)
For the nine months ended June 30, 2017.

24


The following table is a summary of information related to impaired loans by portfolio segment as of and for the year ended September 30, 2016 (dollars in thousands):
 
Recorded
Investment
 
Unpaid Principal Balance (Loan Balance Plus Charge Off)
 
Related
Allowance
 

Average
Recorded
Investment (1)
 
Interest
Income
Recognized
(1)
 
Cash Basis Interest Income Recognized (1)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
914

 
$
1,060

 
$

 
$
1,349

 
$
38

 
$
38

Multi-family

 

 

 
152

 

 

Commercial
7,566

 
8,685

 

 
7,784

 
421

 
330

Construction – custom and owner/builder
367

 
367

 

 
73

 

 

Land
693

 
1,101

 

 
839

 
16

 
12

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
402

 
593

 

 
264

 

 

Commercial business loans

 

 

 
15

 

 

Subtotal
9,942

 
11,806

 

 
10,476

 
475

 
380

 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
1,350

 
1,350

 
70

 
1,921

 
118

 
89

Multi-family

 

 

 
655

 

 

Commercial
3,743

 
3,743

 
413

 
4,181

 
275

 
215

Land
575

 
575

 
53

 
604

 
39

 
32

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
597

 
597

 
227

 
709

 
44

 
40

Other
30

 
30

 
13

 
33

 
2

 
2

Subtotal
6,295

 
6,295

 
776

 
8,103

 
478

 
378

Total:
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
2,264

 
2,410

 
70

 
3,270

 
156

 
127

Multi-family

 

 

 
807

 

 

Commercial
11,309

 
12,428

 
413

 
11,965

 
696

 
545

Construction – custom and owner/builder
367

 
367

 

 
73

 

 

Land
1,268

 
1,676

 
53

 
1,443

 
55

 
44

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
999

 
1,190

 
227

 
973

 
44

 
40

Other
30

 
30

 
13

 
33

 
2

 
2

Commercial business loans

 

 

 
15

 

 

Total
$
16,237

 
$
18,101

 
$
776

 
$
18,579

 
$
953

 
$
758

______________________________________________
(1) For the year ended September 30, 2016.


A troubled debt restructured ("TDR") loan is a loan for which the Company, for reasons related to a borrower’s financial difficulties, grants a significant concession to the borrower that the Company would not otherwise consider.  Examples of such concessions include but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market rates; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-amortizations, extensions, deferrals and renewals.  TDR loans are considered impaired and are individually evaluated for impairment.  TDR loans are classified as either accrual or non-accrual. TDR loans are classified as non-performing loans unless they have been performing in accordance with their modified terms for a period of at least six months. The Company had $3.61 million and $8.16 million in TDR loans included in impaired loans at June 30, 2017 and September 30, 2016, respectively, and had no commitments at these dates to lend additional funds on these loans.  The allowance for loan losses allocated to TDR loans at June 30, 2017 and September 30, 2016 was $9,000 and $465,000, respectively. There were no TDR loans which incurred a payment default within 12 months of the restructure date during the nine months ended June 30, 2017.


25


The following tables set forth information with respect to the Company’s TDR loans by interest accrual status as of June 30, 2017 and September 30, 2016 (dollars in thousands):

 
June 30, 2017
 
Accruing
 
Non-
Accrual
 
Total
Mortgage loans:
 
 
 
 
 
One- to four-family
$
573

 
$

 
$
573

Commercial
2,229

 

 
2,229

Land
559

 
252

 
811

Total
$
3,361

 
$
252

 
$
3,613


 
September 30, 2016
 
Accruing
 
Non-
Accrual
 
Total
Mortgage loans:
 
 
 
 
 
One- to four-family
$
1,350

 
$
126

 
$
1,476

Commercial
5,268

 

 
5,268

Land
720

 
253

 
973

Consumer loans:
 

 
 

 
 

Home equity and second mortgage
291

 
152

 
443

Total
$
7,629

 
$
531

 
$
8,160


The were no new TDR loans during the nine months ended June 30, 2017 or the year ended September 30, 2016.



26


(5) NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income to common shareholders by the weighted average number of common shares outstanding during the period, without considering any dilutive items.  Diluted net income per common share is computed by dividing net income to common shareholders by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method at the average share price for the Company’s common stock during the period.  Common stock equivalents arise from the assumed conversion of outstanding stock options and the outstanding warrant to purchase common stock.  Shares owned by the Bank’s ESOP that have not been allocated are not considered to be outstanding for the purpose of computing basic and diluted net income per common share. At June 30, 2017 and 2016, there were 79,032 and 111,500 shares, respectively, that had not been allocated under the Bank’s ESOP.

Information regarding the calculation of basic and diluted net income per common share for the three and nine months ended June 30, 2017 and 2016 is as follows (dollars in thousands, except per share amounts):
 
Three Months Ended
June 30,
 
Nine Months Ended June 30,
 
2017

 
2016

 
2017

 
2016

Basic net income per common share computation
 
 
 
 
 
 
 
Numerator – net income
$
4,277

 
$
2,547

 
$
10,552

 
$
7,455

 
 
 
 
 
 
 
 
Denominator – weighted average common shares outstanding
7,269,564

 
6,822,608

 
7,088,134

 
6,846,373

 
 
 
 
 
 
 
 
Basic net income per common share
$
0.59

 
$
0.37

 
$
1.49

 
$
1.09

 
 
 
 
 
 
 
 
Diluted net income per common share computation
 
 
 
 
 

 
 

Numerator – net income
$
4,277

 
$
2,547

 
$
10,552

 
$
7,455

 
 
 
 
 
 
 
 
Denominator – weighted average common shares outstanding
7,269,564

 
6,822,608

 
7,088,134

 
6,846,373

Effect of dilutive stock options (1)
162,607

 
93,041

 
153,941

 
69,291

Effect of dilutive stock warrant (2)

 
195,550

 
106,411

 
175,997

Weighted average common shares outstanding - assuming dilution
7,432,171

 
7,111,199

 
7,348,486

 
7,091,661

 
 
 
 
 
 
 
 
Diluted net income per common share
$
0.58

 
$
0.36

 
$
1.44

 
$
1.05

____________________________________________
(1) For the three and nine months ended June 30, 2017 all outstanding options were included in the computation of diluted net income per share. For the nine months ended June 30, 2016, average options to purchase 56,358 shares of common stock were outstanding but not included in the computation of diluted net income per common share because their effect would have been anti-dilutive. For the three months ended June 30, 2016 all outstanding options were included in the computation of diluted earnings per share.

(2) Represented a warrant to purchase 370,899 shares of the Company's common stock at an exercise price of $6.73 per share (subject to anti-dilution adjustments) at any time through December 23, 2018 (the "Warrant"). The Warrant was granted on December 23, 2008 to the U.S. Treasury Department ("Treasury") as part of the Company's participation in the Treasury's Troubled Asset Relief Program ("TARP"). On June 12, 2013, the Treasury sold the Warrant to private investors. On January 31, 2017, the Warrant was exercised and 370,899 shares of the Company's common stock were issued in exchange for $2.50 million.


27


(6) ACCUMULATED OTHER COMPREHENSIVE LOSS

The changes in accumulated other comprehensive loss ("AOCI") by component during the three and nine months ended June 30, 2017 and 2016 are as follows (dollars in thousands):
 
Three Months Ended June 30, 2017
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
(23
)
 
$
(155
)
 
$
(178
)
Net change
5

 
11

 
16

Balance of AOCI at the end of period
$
(18
)
 
$
(144
)
 
$
(162
)
 
Nine Months Ended June 30, 2017
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
4

 
$
(179
)
 
$
(175
)
Net change
(22
)
 
35

 
13

Balance of AOCI at the end of period
$
(18
)
 
$
(144
)
 
$
(162
)
 
 
 
 
 
 
 
Three Months Ended June 30, 2016
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
2

 
$
(288
)
 
$
(286
)
Net change
6

 
7

 
13

Balance of AOCI at the end of period
$
8

 
$
(281
)
 
$
(273
)
 
Nine Months Ended June 30, 2016
 
Changes in fair value of available for sale securities (1)
 
Changes in OTTI on held to maturity securities (1)
 
Total (1)
Balance of AOCI at the beginning of period
$
3

 
$
(316
)
 
$
(313
)
Net change
5

 
35

 
40

Balance of AOCI at the end of period
$
8

 
$
(281
)
 
$
(273
)
 
 
 
 
 
 
__________________________
(1) All amounts are net of income taxes.


(7) STOCK COMPENSATION PLANS

Under the Company’s 2003 Stock Option Plan, the Company was able to grant options for up to 300,000 shares of common stock to employees, officers, directors and directors emeriti.  Under the Company's 2014 Equity Incentive Plan, the Company is able to grant options and awards of restricted stock (with or without performance measures) for up to 352,366 shares of common stock to employees, officers, directors and directors emeriti.  Shares issued may be purchased in the open market or may be issued from authorized and unissued shares.  The exercise price of each option equals the fair market value of the Company’s common stock on the date of grant. Generally, options and restricted stock vest in 20% annual installments on each of the five anniversaries from the date of the grant, and options generally have a maximum contractual term of ten years from the date of grant. At June 30, 2017, there were 171,866 shares of common stock available which may be awarded as options or

28


restricted stock pursuant to future grant under the 2014 Equity Incentive Plan. At June 30, 2017, there were no options available for future grant under the 2003 Stock Option Plan.

At both June 30, 2017 and 2016, there were no unvested restricted stock grant shares. There were no restricted stock grants awarded during the nine months ended June 30, 2017 and 2016.

Stock option activity for the nine months ended June 30, 2017 and 2016 is summarized as follows:
 
Nine Months Ended
June 30, 2017
 
Nine Months Ended
June 30, 2016
 
 Number of Shares

 
Weighted
Average
Exercise
Price

 
 Number of Shares

 
Weighted
Average
Exercise
Price

Options outstanding, beginning of period
373,130

 
$
9.82

 
341,300

 
$
8.73

Exercised
(39,810
)
 
6.65

 
(16,220
)
 
7.88

Forfeited
(4,950
)
 
6.28

 
(2,900
)
 
9.96

Options outstanding, end of period
328,370

 
$
10.26

 
322,180

 
$
8.76


The aggregate intrinsic value of options exercised during the nine months ended June 30, 2017 and 2016 was $545,000 and $82,000, respectively.

At June 30, 2017, there were 201,100 unvested options with an aggregate grant date fair value of $393,000, all of which the Company assumes will vest. The aggregate intrinsic value of unvested options at June 30, 2017 was $2.79 million.  There were 48,600 options with an aggregate grant date fair value of $111,000 that vested during the nine months ended June 30, 2017.

At June 30, 2016, there were 211,200 unvested options with an aggregate grant date fair value of $457,000. There were 48,600 options with an aggregate grant date fair value of $111,000 that vested during the nine months ended June 30, 2016.
 
 
Additional information regarding options outstanding at June 30, 2017 is as follows:
 
 
Options Outstanding
 
Options Exercisable
Range of
Exercise
Prices ($)
 
Number

 
Weighted
Average
Exercise
Price

 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Number

 
Weighted
Average
Exercise
Price

 
Weighted
Average
Remaining
Contractual
Life (Years)
$ 4.01 - 4.55
 
10,200

 
$
4.27

 
3.4
 
10,200

 
$
4.27

 
3.4
   5.86 - 6.00
 
40,800

 
5.93

 
5.3
 
29,000

 
5.94

 
5.3
   9.00
 
83,000

 
9.00

 
6.3
 
44,600

 
9.00

 
6.3
 10.26 - 10.71
 
139,370

 
10.58

 
7.8
 
43,470

 
10.54

 
7.6
 15.67
 
55,000

 
15.67

 
9.3
 

 
N/A

 
N/A
 
 
328,370

 
$
10.26

 
7.5
 
127,270

 
$
8.45

 
6.6

The aggregate intrinsic value of options outstanding at June 30, 2017 and 2016 was $4.93 million and $2.01 million, respectively.

Compensation expense during the nine months ended June 30, 2017 and 2016 for all stock-based plans was as follows (dollars in thousands):
 
Nine Months Ended June 30,
 
2017
 
2016
Stock options
$
271

 
$
123

Less: related tax benefit recognized
(153
)
 
(9
)
Total
$
118

 
$
114



29


As of June 30, 2017, unrecognized compensation cost related to non-vested stock options was $305,000, which is expected to be recognized over a weighted average life of 1.85 years.


(8) FAIR VALUE MEASUREMENTS

GAAP defines fair value and establishes a framework for measuring fair value.  Fair value is the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date.  The three levels for categorizing assets and liabilities under GAAP's fair value measurement requirements are as follows:

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2: Significant observable inputs other than quoted prices included within Level 1, such as quoted prices for similar (as opposed to identical) assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions market participants would use in pricing an asset or liability based on the best information available in the circumstances.

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

The Company had no liabilities measured at fair value on a recurring basis at June 30, 2017 and September 30, 2016. The Company's assets measured at estimated fair value on a recurring basis at June 30, 2017 and September 30, 2016 are as follows (dollars in thousands):
June 30, 2017
Estimated Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale investment securities
 
 
 
 
 
 
 
MBS: U.S. government agencies
$

 
$
309

 
$

 
$
309

Mutual funds
951

 

 

 
951

Total
$
951

 
$
309

 
$

 
$
1,260

September 30, 2016
Estimated Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale investment securities
 
 
 
 
 
 
 
MBS: U.S. government agencies
$

 
$
366

 
$

 
$
366

Mutual funds
976

 

 

 
976

Total
$
976

 
$
366

 
$

 
$
1,342


There were no transfers among Level 1, Level 2 and Level 3 during the nine months ended June 30, 2017 and the year ended September 30, 2016.

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

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

Impaired Loans: The estimated fair value of impaired loans is calculated using the collateral value method or on a discounted cash flow basis.  The specific reserve for collateral dependent impaired loans is based on the estimated fair value of the collateral less estimated costs to sell, if applicable.  In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal and known changes in the market

30


and in the collateral. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

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

OREO and Other Repossessed Assets, net:  OREO and other repossessed assets are recorded at estimated fair value less estimated costs to sell.  Estimated fair value is generally determined by management based on a number of factors, including third-party appraisals of estimated fair value in an orderly sale.  Estimated costs to sell are based on standard market factors.  The valuation of OREO and other repossessed assets is subject to significant external and internal judgment (Level 3).

The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at June 30, 2017 (dollars in thousands):
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
One- to four-family
$

 
$

 
$
46

Commercial

 

 
3,225

Land

 

 
713

Consumer loans:
 
 
 
 
 
Home equity and second mortgage

 

 
115

Total impaired loans

 

 
4,099

 
 
 
 
 
 
OREO and other repossessed assets

 

 
3,417

Total
$

 
$

 
$
7,516


The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis as of June 30, 2017 (dollars in thousands):
 
 Estimated
Fair Value
 
 Valuation
Technique(s)
 
 Unobservable Input(s)
 
 Range
Impaired loans
$
4,099

 
Market approach
 
Appraised value less selling costs
 
NA
 
 
 
 
 
 
 
 
OREO and other repossessed assets
$
3,417

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


31


The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at September 30, 2016 (dollars in thousands):
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
One- to four-family
$

 
$

 
$
1,280

Commercial

 

 
3,330

Land

 

 
522

Consumer loans:
 

 
 

 
 

Home equity and second mortgage

 

 
370

Other

 

 
17

Total impaired loans

 

 
5,519

Investment securities – held to maturity:
 

 
 

 
 

MBS - private label residential

 
20

 

OREO and other repossessed assets

 

 
4,117

Total
$

 
$
20

 
$
9,636


The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis as of September 30, 2016 (dollars in thousands):
 
 Estimated
Fair Value
 
 Valuation
Technique(s)
 
 Unobservable Input(s)
 
 Range
Impaired loans
$
5,519

 
Market approach
 
Appraised value less selling costs
 
NA
 
 
 
 
 
 
 
 
OREO and other repossessed assets
$
4,117

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


GAAP requires disclosure of estimated fair values for financial instruments.  Such estimates are subjective in nature, and significant judgment is required regarding the risk characteristics of various financial instruments at a discrete point in time.  Therefore, such estimates could vary significantly if assumptions regarding uncertain factors were to change.  In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed.  The disclosures also do not include estimated fair value amounts for certain items which are not defined as financial instruments but which may have significant value.  The Company does not believe that it would be practicable to estimate a representational fair value for these types of items as of June 30, 2017 and September 30, 2016.  Because GAAP excludes certain items from fair value disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company.

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

Cash and Cash Equivalents:  The estimated fair value of financial instruments that are short-term or re-price frequently and that have little or no risk are considered to have an estimated fair value equal to the recorded value.

CDs Held for Investment:  The estimated fair value of financial instruments that are short-term or re-price frequently and that have little or no risk are considered to have an estimated fair value equal to the recorded value.

Investment Securities: See descriptions above.

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

Other Investments: The Bank invests in the Solomon Hess SBA Loan fund. Shares in the funds are not publicly traded and therefore have no readily determinable fair market value, therefore they are recorded on the balance sheet at cost. An investor can have its investment in the funds redeemed for the balances of its capital account at any quarter end with 60 days notice to the fund.


32


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

Loans Held for Sale:  The estimated fair value is based on quoted market prices (for one-to four-family loans) and the guaranteed value of U.S. Small Business Administration ("SBA") loans (made to small businesses under the SBA's 7(a) loan programs). Quoted market prices are obtained from the Federal Home Loan Mortgage Corporation ("Freddie Mac") and the FHLB.

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

Deposits:  The estimated fair value of deposits with no stated maturity date is deemed to be the amount payable on demand.  The estimated fair value of fixed maturity certificates of deposit is computed by discounting future cash flows using the rates currently offered by the Bank for deposits of similar remaining maturities.

FHLB Borrowings:  The estimated fair value of FHLB borrowings is computed by discounting the future cash flows of the borrowings at a rate which approximates the current offering rate of the borrowings with a comparable remaining life.

Off-Balance-Sheet Instruments:  Since the majority of the Company’s off-balance-sheet instruments consist of variable-rate commitments, the Company has determined that they do not have a distinguishable estimated fair value.

The recorded amounts and estimated fair values of financial instruments were as follows as of June 30, 2017 and September 30, 2016 (dollars in thousands):
 
June 30, 2017
 
 
 
Fair Value Measurements Using:
 
Recorded
Amount
 
 Estimated Fair Value
 
 
Level 1
 
 
Level 2
 
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
132,440

 
$
132,440

 
$
132,440

 
$

 
$

CDs held for investment
41,187

 
41,187

 
41,187

 

 

Investment securities
8,504

 
9,172

 
3,952

 
5,220

 

FHLB stock
1,107

 
1,107

 
1,107

 

 

Other investments
3,000

 
3,000

 
3,000

 

 

Loans receivable, net
687,158

 
686,285

 

 

 
686,285

Loans held for sale
3,523

 
3,616

 
3,616

 

 

Accrued interest receivable
2,437

 
2,437

 
2,437

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 
 
 

Non-interest-bearing demand
197,527

 
197,527

 
197,527

 

 

Interest-bearing
621,291

 
621,863

 
481,001

 

 
140,862

Total deposits
818,818

 
819,390

 
678,528

 

 
140,862

Accrued interest payable
162

 
162

 
162

 

 


33


 
September 30, 2016
 
 
 
Fair Value Measurements Using:
 
Recorded
Amount
 
 Estimated Fair Value
 
 
Level 1
 
 
Level 2
 
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
108,941

 
$
108,941

 
$
108,941

 
$

 
$

CDs held for investment
53,000

 
53,000

 
53,000

 

 

Investment securities
8,853

 
9,737

 
4,029

 
5,708

 

FHLB stock
2,204

 
2,204

 
2,204

 

 

Loans receivable, net
663,146

 
671,017

 

 

 
671,017

Loans held for sale
3,604

 
3,714

 
3,714

 

 

Accrued interest receivable
2,348

 
2,348

 
2,348

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 
 
 

Non-interest-bearing demand
172,283

 
172,283

 
172,283

 

 

Interest-bearing
589,251

 
589,762

 
441,277

 

 
148,485

Total deposits
761,534

 
762,045

 
613,560

 

 
148,485

FHLB borrowings
30,000

 
30,684

 

 
30,684

 

Accrued interest payable
247

 
247

 
247

 

 


The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations.  As a result, the estimated fair value of the Company’s financial instruments will change when interest rate levels change, and that change may either be favorable or unfavorable to the Company.  Management attempts to match maturities of assets and liabilities to the extent believed necessary to appropriately manage interest rate risk.  However, borrowers with fixed interest rate obligations are less likely to prepay in a rising interest rate environment and more likely to prepay in a falling interest rate environment.  Conversely, depositors who are receiving fixed interest rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment.  Management monitors interest rates and maturities of assets and liabilities, and attempts to manage interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.


(9) RECENT ACCOUNTING PRONOUNCEMENTS

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

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

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet and

34


disclosure of key information about leasing arrangements. The principal change required by this ASU relates to lessee accounting, and is that for operating leases, a lessee is required to (1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position, (2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis, and (3) classify all cash payments within operating activities in the statement of cash flows. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. This ASU also changes disclosure requirements related to leasing activities and requires certain qualitative disclosures along with specific quantitative disclosures. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early application of the amendments in this ASU is permitted. The effect of adoption will depend on leases at the time of adoption. Once adopted, the Company expects to report higher assets and liabilities as a result of including right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements, however, based on current leases the adoption of ASU No. 2016-02 is not expected to have a material impact on the Company's future consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company is currently evaluating the impact that the adoption of ASU No. 2016-09 will have on the Company's future consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses. This ASU replaces the existing incurred losses methodology for estimating allowances with a current expected credit losses methodology with respect to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held to maturity investment securities and off-balance sheet commitments. In addition, this ASU requires credit losses relating to available for sale debt securities to be recorded through an allowance for credit losses rather than a reduction of the carrying amount. ASU No. 2016-13 also changes the accounting for purchased credit-impaired debt securities and loans. The standard retains many of the current disclosure requirements in current GAAP and expands certain disclosure requirements. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the impact that the adoption of ASU No. 2016-13 will have on the Company’s future consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. This ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under ASU No. 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU No. 2017-04 will be effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early application of this ASU is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of ASU No. 2017-04 is not expected to have a material impact on the Company's future consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The adoption of ASU No. 2017-08 is not expected to have a material impact on the Company's future consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation--Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU was issued to provide clarity as to when to apply modification accounting when there is a change in the terms or conditions of a share-based payment award. According to this ASU, an entity should account for the effects of a modification unless the fair value, vesting conditions, and balance sheet classification of the award are the same after the modification as compared to the original award prior to modification. ASU No. 2017-09 is effective for fiscal years, and

35


interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The adoption of ASU No. 2017-09 is not expected to have a material impact on the Company's future consolidated financial statements.


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


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

The following analysis discusses the material changes in the consolidated financial condition and results of operations of the Company at and for the three and nine months ended June 30, 2017.  This analysis as well as other sections of this report contains certain “forward-looking statements.”

Certain matters discussed in this Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements relate to our financial condition, results of operations, plans, objectives, future performance or business.  Forward-looking statements are not statements of historical fact, are based on certain assumptions and often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.”  Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance.  These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets which may lead to increased losses and non-performing loans in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our loan loss reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; secondary market conditions for loans and our ability to sell loans in the secondary market; results of examinations of us by the Board of Governors of the Federal Reserve System ("Federal Reserve") and of our bank subsidiary by the FDIC, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, institute a formal or informal enforcement action against us or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including as a result of Basel III; the impact of the Dodd Frank Wall Street Reform and Consumer Protection Act and implementing regulations; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risks associated with the loans on our consolidated balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; the failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our business strategies; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services; and other risks described elsewhere in this Form

36


10-Q and in the Company's other reports filed with or furnished to the Securities and Exchange Commission, including our 2016 Form 10-K.

Any of the forward-looking statements that we make in this Form 10-Q and in the other public statements we make are based upon management’s beliefs and assumptions at the time they are made.  We do not undertake and specifically disclaim any obligation to publicly update or revise any forward-looking statements included in this report to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur and we caution readers not to place undue reliance on any forward-looking statements.  These risks could cause our actual results for fiscal 2017 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of us, and could negatively affect the Company’s consolidated financial condition and results of operations as well as its stock price performance.


Overview

Timberland Bancorp, Inc., a Washington corporation, is the holding company for Timberland Bank.  The Bank opened for business in 1915 and serves consumers and businesses across Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis counties, Washington with a full range of lending and deposit services through its 22 branches (including its main office in Hoquiam).  At June 30, 2017, the Company had total assets of $931.01 million and total shareholders’ equity of $108.62 million.  The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank.  Accordingly, the information set forth in this report relates primarily to the Bank’s operations.

The profitability of the Company’s operations depends primarily on its net interest income after provision for (recapture of) loan losses.  Net interest income is the difference between interest income, which is the income that the Company earns on interest-earning assets, which are primarily loans and investments, and interest expense, the amount the Company pays on its interest-bearing liabilities, which are primarily deposits and borrowings.  Net interest income is affected by changes in the volume and mix of interest-earning assets, interest earned on those assets, the volume and mix of interest-bearing liabilities and interest paid on those interest-bearing liabilities. Management strives to match the re-pricing characteristics of the interest-earning assets and interest-bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve.

The provision for (recapture of) loan losses is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions.  The allowance for loan losses reflects the amount that the Company believes is adequate to cover probable credit losses inherent in its loan portfolio.

Net income is also affected by non-interest income and non-interest expenses.  For the three and nine month period ended June 30, 2017, non-interest income consisted primarily of service charges on deposit accounts, gain on sales of loans, ATM and debit card interchange transaction fees, an increase in the cash surrender value of BOLI, servicing income on loans sold and other operating income.  Non-interest income is reduced by net OTTI losses on investment securities, if any.  Non-interest expenses consisted primarily of salaries and employee benefits, premises and equipment, advertising, ATM and debit card interchange transaction fees, OREO and other repossessed asset expenses, postage and courier expenses, state and local taxes, professional fees, FDIC insurance premiums, loan administration and foreclosure expenses, data processing and telecommunication expenses, deposit operation expenses and other non-interest expenses.  Non-interest income and non-interest expenses are affected by the growth of the Company's operations and growth in the number of loan and deposit accounts.

Results of operations may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail customers while concentrating its lending activities on real estate mortgage loans.  Lending activities have been focused primarily on the origination of loans secured by real estate, including residential construction loans, one- to four-family residential loans, multi-family loans and commercial real estate loans.  The Bank originates adjustable-rate residential mortgage loans that do not qualify for sale in the secondary market.  The Bank also originates commercial business loans and other consumer loans.


Critical Accounting Policies and Estimates

37



The Company has identified several accounting policies that as a result of judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company’s Consolidated Financial Statements. Critical accounting policies and estimates are discussed in the Company’s 2016 Form 10-K under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies and Estimates.” That discussion highlights estimates the Company makes that involve uncertainty or potential for substantial change. There have been no material changes in the Company’s critical accounting policies and estimates as previously disclosed in the Company’s 2016 Form 10-K.

Comparison of Financial Condition at June 30, 2017 and September 30, 2016

The Company’s total assets increased by $39.62 million, or 4.4%, to $931.01 million at June 30, 2017 from $891.39 million at September 30, 2016.  The increase in total assets was primarily due to an increase in total cash and cash equivalents and net loans receivable. The increase in total assets was funded primarily by an increase in total deposits.

Net loans receivable increased by $24.01 million, or 3.6%, to $687.16 million at June 30, 2017 from $663.15 million at September 30, 2016.  The increase was primarily due to increases in commercial real estate loans, one- to four-family custom and owner/builder construction loans, commercial construction loans, one- to four- family mortgage loans, land loans and commercial business loans. These increases to net loans receivable were partially offset by a decrease in consumer loans, multi-family construction loans, multi-family loans and an increase in the undisbursed portion of construction loans in process.

Total deposits increased by $57.28 million, or 7.5%, to $818.82 million at June 30, 2017 from $761.53 million at September 30, 2016. The increase was primarily a result of increases in non-interest-bearing demand, savings, money market, and N.O.W. checking account balances which were partially offset by a decrease in certificates of deposit.
 
Shareholders’ equity increased by $11.78 million, or 12.2%, to $108.62 million at June 30, 2017 from $96.83 million at September 30, 2016.  The increase in shareholders' equity was primarily due to net income for the nine months ended June 30, 2017 and funds received from the exercise of the Warrant. These increases to shareholders' equity were partially offset by the payment of dividends to common shareholders.

A more detailed explanation of the changes in significant balance sheet categories follows:

Cash and Cash Equivalents and CDs Held for Investment: Cash and cash equivalents and CDs held for investment increased by $11.69 million, or 7.2%, to $173.63 million at June 30, 2017 from $161.94 million at September 30, 2016.  The increase was primarily due to a $23.50 million increase in cash and cash equivalents, which was partially offset by an $11.81 million decrease in CDs held for investment.

Investment Securities:  Investment securities decreased by $349,000, or 3.9%, to $8.50 million at June 30, 2017 from $8.85 million at September 30, 2016. This decrease is primarily due to scheduled amortization and prepayments. For additional information on investment securities, see Note 2 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”

FHLB Stock: FHLB stock decreased by $1.10 million or 49.8%, to $1.11 million at June 30, 2017 from $2.20 million at September 30, 2016 as excess stock was redeemed. The required investment in FHLB stock decreased primarily due to a decrease in FHLB borrowings.

Other Investments: Other investments increased by $3.00 million at June 30, 2017 from nothing at September 30, 2016 due to the Bank investing in the Solomon Hess SBA Loan Fund. This investment is utilized to help satisfy compliance with the Bank's Community Reinvestment Act ("CRA") investment test requirements.

Loans: Net loans receivable increased by $24.01 million, or 3.6%, to $687.16 million at June 30, 2017 from $663.15 million at September 30, 2016.  The increase in the portfolio was primarily a result of a $19.38 million increase in commercial real estate loans, a $16.53 million increase in custom and owner/builder construction loans, a $10.70 million increase in commercial construction loans, a $3.15 million increase in one- to four-family mortgage loans, a $2.71 million increase in land loans, and a $1.57 million increase in commercial business loans. These increases in net loans receivable were partially offset by a $23.51 million increase in the amount of undisbursed construction loans in process, a $3.76 million decrease in consumer loans, a $1.53 million decrease in multi-family construction loans, and a $1.25 million decrease in multi-family loans.

Loan originations increased by $60.43 million, or 29.9%, to $262.58 million for the nine months ended June 30, 2017 from $202.15 million for the nine months ended June 30, 2016, primarily due to increased market demand.  The Company continued

38


to sell longer-term fixed rate one- to four-family mortgage loans for asset liability management purposes and to generate non-interest income. The Company also (on a much smaller volume) sells the guaranteed portion of U.S. Small Business Administration ("SBA") loans.  Sales of fixed rate one- to four-family mortgage loans and SBA loans increased by $15.79 million, or 38.7%, to $56.54 million for the nine months ended June 30, 2017 compared to $40.75 million for the nine months ended June 30, 2016 as more one- to four-family construction loans were completed, converted to permanent financing and then were sold in the secondary market.

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

Premises and Equipment:  Premises and equipment increased by $2.31 million, or 14.3%, to $18.47 million at June 30, 2017 from $16.16 million at September 30, 2016.  The increase was primarily a result of the Bank purchasing the building that it had been leasing for its Gig Harbor branch office for $1.84 million in December 2016 and a remodel of the Bank's Edgewood branch office.

OREO (Other Real Estate Owned): OREO and other repossessed assets decreased by $700,000, or 17.0%, to $3.42 million at June 30, 2017 from $4.12 million at September 30, 2016. The decrease was primarily due to the disposition of nine OREO properties and one other repossessed asset.  At June 30, 2017, total OREO and other repossessed assets consisted of 17 individual properties.  The properties consisted of 12 land parcels totaling $1.90 million, three single-family homes totaling $927,000, and two commercial real estate properties totaling $587,000.  

Goodwill:  The recorded amount of goodwill of $5.65 million at June 30, 2017 was unchanged from September 30, 2016.  

Deposits: Deposits increased by $57.28 million, or 7.5%, to $818.82 million at June 30, 2017 from $761.53 million at September 30, 2016.  The increase was primarily a result of a $25.24 million increase in non-interest bearing demand account balances, a $13.54 million increase in money market account balances, a $13.28 million increase in savings account balances, and a $12.91 million increase in negotiable order of withdrawal ("N.O.W.") checking account balances. These increases were partially offset by a $7.68 million decrease in certificates of deposit accounts.

Deposits consisted of the following at June 30, 2017 and September 30, 2016 (dollars in thousands):
 
June 30, 2017
 
September 30, 2016
 
Amount
 
Percent
 
Amount
 
Percent
Non-interest-bearing demand
$
197,527

 
24
%
 
$
172,283

 
23
%
N.O.W. checking
216,719

 
26
%
 
203,812

 
27
%
Savings
136,750

 
17
%
 
123,474

 
16
%
Money market
119,025

 
15
%
 
107,083

 
14
%
Money market - brokered
8,506

 
1
%
 
6,908

 
1
%
Certificates of deposit under $250
121,505

 
15
%
 
128,330

 
17
%
Certificates of deposit $250 and over
15,590

 
2
%
 
16,439

 
2
%
Certificates of deposit - brokered
3,196

 
%
 
3,205

 
%
Total
$
818,818

 
100
%
 
$
761,534

 
100
%

FHLB Borrowings: The Company has short- and long-term borrowing lines with the FHLB with total credit available on the lines equal to 35% of the Bank’s total assets, limited by available collateral. Borrowings are considered short-term when the original maturity is less than one year. There were no FHLB borrowings at June 30, 2017 and $30.00 million at September 30, 2016 as the Company prepaid on April 26, 2017 FHLB borrowings with a weighted average cost of 3.98% and incurred prepayment penalties of $282,000. Prepaying the FHLB borrowings eliminated interest expense by approximately $100,000 per month.

Shareholders’ Equity:  Total shareholders’ equity increased by $11.78 million, or 12.2%, to $108.62 million at June 30, 2017 from $96.83 million at September 30, 2016.  The increase was primarily due to net income of $10.55 million for the nine months ended June 30, 2017 and the exercise of the Warrant for $2.50 million, which was partially offset by the payment of $2.24 million in dividends on the Company's common stock. The Company did not repurchase any shares of its common stock during the nine months ended June 30, 2017, and at June 30, 2017, had 221,893 shares authorized to be repurchased under the Company's existing stock repurchase plan. For additional information, see Item 2 of Part II of this Form 10-Q.


39


Asset Quality: The non-performing assets to total assets ratio improved to 0.65% at June 30, 2017 from 0.88% at September 30, 2016 as total non-performing assets decreased by $1.80 million, or 22.9%, to $6.06 million at June 30, 2017 from $7.86 million at September 30, 2016. The decrease was primarily due to an $818,000 decrease in non-accrual loans and a $700,000 decrease in OREO and other repossessed assets.

TDR loans on accrual status (which are not included in the non-performing asset totals) decreased by $4.27 million, or 55.9%, to $3.36 million at June 30, 2017 from $7.63 million at September 30, 2016, primarily due loan payoffs. As part of the TDR repayments, the Company recovered, to the allowance for loan losses, $1.06 million in previously charged off amounts. In addition, the Company collected $718,000 in non-accrual interest in connection with these TDR repayments during the quarter ended June 30, 2017.


40


The following table sets forth information with respect to the Company’s non-performing assets at June 30, 2017 and September 30, 2016 (dollars in thousands):
 
June 30,
2017

 
September 30,
2016

Loans accounted for on a non-accrual basis:
 
 
 
Mortgage loans:
 
 
 
    One- to four-family (1)
$
896

 
$
914

    Commercial
403

 
612

    Construction – custom and owner/builder

 
367

    Land
496

 
548

Consumer loans:
 

 
 

    Home equity and second mortgage
260

 
402

Other

 
30

       Total loans accounted for on a non-accrual basis
2,055

 
2,873

 
 
 
 
Accruing loans which are contractually
past due 90 days or more

 
135

 
 
 
 
Total of non-accrual and 90 days past due loans
2,055

 
3,008

 
 
 
 
Non-accrual investment securities
590

 
734

 
 
 
 
OREO and other repossessed assets, net (2)
3,417

 
4,117

       Total non-performing assets (3)
$
6,062

 
$
7,859

 
 
 
 
TDR loans on accrual status (4)
$
3,361

 
$
7,629

 
 
 
 
Non-accrual and 90 days or more past due loans as a percentage of loans receivable
0.29
%
 
0.45
%
 
 
 
 
Non-accrual and 90 days or more past due loans as a percentage of total assets
0.22
%
 
0.34
%
 
 
 
 
Non-performing assets as a percentage of total assets
0.65
%
 
0.88
%
 
 
 
 
Loans receivable (5)
$
696,768

 
$
672,972

 
 
 
 
Total assets
$
931,009

 
$
891,388

___________________________________
(1) As of June 30, 2017 and September 30, 2016, the balance of non-accrual one- to-four family properties included $100,000 and $138,000, respectively, in the process of foreclosure.
(2) As of June 30, 2017 and September 30, 2016, the balance of OREO included $927,000 and $1.07 million, respectively, of foreclosed residential real estate property recorded as a result of obtaining physical possession of the property.
(3) Does not include TDR loans on accrual status.
(4) Does not include TDR loans totaling $252,000 and $531,000 reported as non-accrual loans at June 30, 2017 and September 30, 2016, respectively.
(5)  Does not include loans held for sale and loan balances are before the allowance for loan losses.
 

Comparison of Operating Results for the Three and Nine Months Ended June 30, 2017 and 2016

Net income increased by $1.73 million, or 67.9%, to $4.28 million for the quarter ended June 30, 2017 from $2.55 million for the quarter ended June 30, 2016. Net income per diluted common share increased $0.22, or 61.1%, to $0.58 for the quarter ended June 30, 2017 from $0.36 for the quarter ended June 30, 2016.


41


Net income increased by $3.10 million, or 41.5%, to $10.55 million for the nine months ended June 30, 2017 from $7.46 million for the nine months ended June 30, 2016. Net income per common share increased $0.39, or 37.1%. to $1.44 for the nine months ended June 30, 2017 from $1.05 for the nine months ended June 30, 2016.

The increase in net income for the three and nine months ended June 30, 2017 was primarily due to increases in net interest income, non-interest income, and recapture of loan losses, which were partially offset by an increase in non-interest expense. A more detailed explanation of the income statement categories is presented below.

Net Interest Income: Net interest income increased by $1.63 million, or 21.4%, to $9.25 million for the quarter ended June 30, 2017 from $7.62 million for the quarter ended June 30, 2016.  Total interest and dividend income increased by $1.57 million, or 18.25%, to $10.17 million for the quarter ended June 30, 2017 from $8.60 million for the quarter ended June 30, 2016, primarily due to an increase in the average balance of total interest-earning assets and a $785,000 increase in non-accrual interest and prepayment penalties collected. The average balance of total interest-earning assets increased by $66.56 million, or 8.4%, to $862.92 million for the quarter ended June 30, 2017 from $796.37 million for the quarter ended June 30, 2016. The average balance of loans receivable increased $46.15 million, or 7.1%, between the periods. During the quarter ended June 30, 2017, a total of $819,000 in non-accrual interest and prepayment penalties was collected compared to $34,000 for the quarter ended June 30, 2016. The average yield on interest-earning assets increased to 4.71% for the quarter ended June 30, 2017 from 4.32% for the quarter ended June 30, 2016, primarily due to the increase in non-accrual interest and prepayment penalties collected. Total interest expense decreased by $62,000, or 6.3%, to $918,000 for the quarter ended June 30, 2017 from $980,000 for the quarter ended June 30, 2016. The decrease in interest expense was primarily due to a $103,000 decrease in interest expense on FHLB borrowings, as the average balance of FHLB borrowings decreased by $36.43 million, or 81.0%, to $8.57 million for the quarter ended June 30, 2017 from $45.00 million for the quarter ended June 30, 2016. Partially offsetting the decrease in FHLB borrowing interest expense due to the lower average balances were prepayment penalties of $282,000 (included as interest expense) incurred for paying off the borrowings before their scheduled maturities. The decrease in interest expense on FHLB borrowings was partially offset by a $41,000 increase in interest expense on deposits as the average balance of interest-bearing deposits increased by $50.96 million, or 9.1%, to $611.21 million for the quarter ended June 30, 2017 from $560.25 million for the quarter ended June 30, 2016. As a result of these changes, the net interest margin increased to 4.29% for the quarter ended June 30, 2017 from 3.83% for the quarter ended June 30, 2016. The net interest margin for the current quarter was increased by approximately 25 basis points due to the net effect of collecting $819,000 in non-accrual interest and prepayment penalties and paying the $282,000 in FHLB borrowing prepayment penalties.

Net interest income increased by $3.02 million, or 13.1%, to $26.01 million for the nine months ended June 30, 2017 from $23.00 million for the nine months ended June 30, 2016. Total interest and dividend income increased by $2.69 million, or 10.4%, to $28.63 million for the nine months ended June 30, 2017 from $25.94 million for the nine months ended June 30, 2016, primarily due to an increase in the average balance of total interest-earning assets and a $318,000 increase in non-accrual interest and prepayment penalties collected. The average balance of total interest-earning assets increased by $77.29 million, or 9.9%, to $860.84 million for the nine months ended June 30, 2017 from $783.55 million for the nine months ended June 30, 2016. During the nine months ended June 30, 2017 a total of $1.07 million in non-accrual interest and prepayment penalties was collected compared to a total of $754,000 during the nine months ended June 30, 2016. Total interest expense decreased by $324,000, or 11.0%, to $2.62 million for the nine months ended June 30, 2017 from $2.94 million for the nine months ended June 30, 2016. The decrease in interest expense was primarily due to a $441,000 decrease in interest expense on FHLB borrowings, as the average balance of FHLB borrowings decreased by $22.14 million, or 49.2%, to $22.86 million for the nine months ended June 30, 2017 from $45.00 million for the nine months ended June 30, 2016. The decrease in interest expense on FHLB borrowings was partially offset by a $117,000 increase in interest expense on deposits as the average balance of interest-bearing deposits increased by $53.73 million, or 9.7%, to $607.86 million for the nine months ended June 30, 2017 from $554.13 million for the nine months ended June 30, 2016. As a result of these changes, the net interest margin for the nine months ended June 30, 2017 increased to 4.03% from 3.91% for the nine months ended June 30, 2016.


42


Average Balances, Interest and Average Yields/Cost
The following tables set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the periods presented. (Dollars in thousands)

 
Three Months Ended June 30,
 
2017
 
2016
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable (1)(2)
$
693,931

 
$
9,652

 
5.58
%
 
$
647,781

 
$
8,257

 
5.10
%
Investment securities (2)
7,610

 
69

 
3.63

 
8,084

 
70

 
3.46

Dividends from mutual funds, other investments and FHLB stock
4,872

 
23

 
1.89

 
3,776

 
22

 
2.34

Interest-earning deposits
156,507

 
421

 
1.08

 
136,724

 
247

 
0.73

Total interest-earning assets
862,920

 
10,165

 
4.71

 
796,365

 
8,596

 
4.32

Non-interest-earning assets
57,841

 
 

 
 

 
55,926

 
 

 
 

     Total assets
$
920,761

 
 

 
 

 
$
852,291

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Savings
$
137,108

 
20

 
0.06

 
$
116,818

 
15

 
0.05

Money market
125,787

 
110

 
0.35

 
105,884

 
83

 
0.32

N.O.W. checking
207,060

 
113

 
0.22

 
187,836

 
114

 
0.24

Certificates of deposit
141,254

 
306

 
0.87

 
149,713

 
296

 
0.79

Short-term borrowings

 

 

 

 

 

Long-term borrowings (3)
8,571

 
369

 
17.27

 
45,000

 
472

 
4.22

Total interest-bearing liabilities
619,780

 
918

 
0.59

 
605,251

 
980

 
0.65

Non-interest-bearing deposits
190,631

 
 
 
 
 
150,331

 
 
 
 
Other liabilities
4,379

 
 

 
 

 
3,750

 
 

 
 

Total liabilities
814,790

 
 

 
 

 
759,332

 
 

 
 

Shareholders' equity
105,971

 
 

 
 

 
92,959

 
 

 
 

Total liabilities and
 
 
 

 
 

 
 
 
 

 
 

shareholders' equity
$
920,761

 
 
 
 
 
$
852,291

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
9,247

 
 
 
 

 
$
7,616

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread
 
 
 
 
4.12
%
 
 

 
 

 
3.67
%
Net interest margin (4)
 
 
 
 
4.29
%
 
 

 
 

 
3.83
%
Ratio of average interest-earning
   assets to average interest-bearing
   liabilities
 
 
 
 
139.23
%
 
 

 
 

 
131.58
%

43


 
Nine Months Ended June 30,
 
2017
 
2016
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable (1)(2)
$
688,936

 
$
27,280

 
5.29
%
 
$
634,981

 
$
24,992

 
5.25
%
Investment securities (2)
7,717

 
207

 
3.58

 
8,182

 
213

 
3.45

Dividends from mutual funds, other investments and FHLB stock
3,730

 
60

 
2.15

 
3,705

 
83

 
2.99

Interest-earning deposits
160,458

 
1,081

 
0.90

 
136,681

 
649

 
0.63

Total interest-earning assets
860,841

 
28,628

 
4.43

 
783,549

 
25,937

 
4.41

Non-interest-earning assets
58,324

 
 

 
 

 
57,079

 
 

 
 

     Total assets
$
919,165

 
 

 
 

 
$
840,628

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Savings
$
132,922

 
57

 
0.06

 
$
113,069

 
46

 
0.05

Money market
124,650

 
314

 
0.34

 
105,307

 
242

 
0.31

N.O.W. checking
206,037

 
346

 
0.22

 
183,938

 
340

 
0.25

Certificates of deposit
144,249

 
920

 
0.85

 
151,813

 
892

 
0.78

Long-term borrowings (3)
22,857

 
979

 
5.73

 
45,000

 
1,420

 
4.22

Total interest-bearing liabilities
630,715

 
2,616

 
0.55

 
599,127

 
2,940

 
0.66

Non-interest-bearing deposits
182,117

 
 
 
 
 
146,466

 
 
 
 
Other liabilities
4,368

 
 

 
 

 
3,661

 
 

 
 

Total liabilities
817,200

 
 

 
 

 
749,254

 
 

 
 

Shareholders' equity
101,965

 
 

 
 

 
91,374

 
 

 
 

Total liabilities and
 
 
 

 
 

 
 
 
 

 
 

shareholders' equity
$
919,165

 
 

 
 

 
$
840,628

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
26,012

 
 

 
 

 
$
22,997

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread
 

 
 

 
3.88
%
 
 

 
 

 
3.76
%
Net interest margin (4)
 

 
 

 
4.03
%
 
 

 
 

 
3.91
%
Ratio of average interest-earning
   assets to average interest-bearing
   liabilities
 

 
 

 
136.49
%
 
 

 
 

 
130.78
%
_______________
(1)
Does not include interest on loans on non-accrual status. Includes loans held for sale. Amortized net deferred loan fees, late fees, extension fees and prepayment penalties are included with interest and dividends.
(2)
Average balances include loans and investment securities on non-accrual status.
(3)
Includes FHLB borrowings with original maturities of one year or greater. Includes prepayment penalties of $282,000 for both the three and nine months ended June 30, 2017.
(4)
Net interest income divided by total average interest-earning assets, annualized.

44


Rate Volume Analysis
The following table sets forth the effects of changing rates and volumes on the net interest income of the Company.   Information is provided with respect to the (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate), (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) the net change (sum of the prior columns).  Changes in rate/volume have been allocated to rate and volume variances based on the absolute values of each (in thousands):
 
Three months ended June 30, 2017
compared to three months
ended June 30, 2016
increase (decrease) due to
 
Nine months ended June 30, 2017
compared to nine months
ended June 30, 2016
increase (decrease) due to
 
Rate
 
Volume
 
Net
Change
 
Rate
 
Volume
 
Net
Change
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable and loans held for sale
$
784

 
$
611

 
$
1,395

 
$
152

 
$
2,136

 
$
2,288

Investment securities
3

 
(4
)
 
(1
)
 

 
(6
)
 
(6
)
Dividends from mutual funds, other investments and FHLB stock
(4
)
 
5

 
1

 
(23
)
 

 
(23
)
  Interest-earning deposits
133

 
41

 
174

 
304

 
128

 
432

Total net increase in income on interest-earning assets
916

 
653

 
1,569

 
433

 
2,258

 
2,691

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 
 
 
 
 
Savings
2

 
3

 
5

 
2

 
9

 
11

Money market
10

 
17

 
27

 
(6
)
 
12

 
6

N.O.W. checking
(12
)
 
11

 
(1
)
 
19

 
53

 
72

Certificates of deposit
27

 
(17
)
 
10

 
31

 
(3
)
 
28

   Long term FHLB borrowings
527

 
(630
)
 
(103
)
 
8

 
(449
)
 
(441
)
Total net increase (decrease) in expense on interest-bearing liabilities
554

 
(616
)
 
(62
)
 
54

 
(378
)
 
(324
)
 
 
 
 
 
 
 
 
 
 
 
 
Net increase in net interest income
$
362

 
$
1,269

 
$
1,631

 
$
379

 
$
2,636

 
$
3,015


Provision for (Recapture of) Loan Losses:  For the quarter ended June 30, 2017 there was a $1.00 million recapture of loan losses compared to no provision for or (recapture of) loan losses for the quarter ended June 30, 2016. The recapture of loan losses during the quarter was primarily due to net recoveries and overall improvements in credit quality metrics. For the quarter ended June 30, 2017 there were net recoveries of $1.02 million, compared to a net charge-off of $201,000 for the quarter ended June 30, 2016.

For the nine months ended June 30, 2017 there was a $1.25 million recapture of loan losses compared to no provision for or (recapture of) loan losses for the nine months ended June 30, 2016. The recapture of loan losses for the nine months ended June 30, 2017 was primarily due to net recoveries and overall improvements in credit quality metrics. Net recoveries for the nine months ended June 30, 2017 were $1.03 million compared to net charge-offs of $82,000 for the nine months ended June 30, 2016.

Non-accrual loans decreased by 28.2% to $2.06 million at June 30, 2017, from $2.87 million at September 30, 2016 and decreased by 30.4% from $2.96 million at June 30, 2016. Total delinquent loans (past due 30 days or more) and non-accrual loans decreased by 29.7% to $2.44 million at June 30, 2017, from $3.47 million at September 30, 2016 and decreased by 39.2% from $4.01 million one year ago. 

The Company has established a comprehensive methodology for determining the allowance for loan losses.  On a quarterly basis the Company performs an analysis that considers pertinent factors underlying the quality of the loan portfolio.  The factors include changes in the amount and composition of the loan portfolio, historical loss experience for various loan segments, changes in economic conditions, delinquency rates, a detailed analysis of impaired loans, and other factors to determine an appropriate level of allowance for loan losses.  Based on its comprehensive analysis, management believes the

45


allowance for loan losses of $9.61 million at June 30, 2017 (1.38% of loans receivable and 467.6% of non-performing loans) was adequate to provide for probable losses inherent in the loan portfolio based on an evaluation of known and inherent risks in the loan portfolio at that date.  Impaired loans are subjected to an impairment analysis to determine an appropriate reserve amount to be allocated to each loan.  The aggregate principal impairment reserve amount determined at June 30, 2017 was $429,000 compared to $776,000 at September 30, 2016 and $809,000 at June 30, 2016.  The allowance for loan losses was $9.83 million (1.46% of loans receivable and 326.7% of non-performing loans) at September 30, 2016 and $9.84 mil1ion(1.50% of loans receivable and 318.5% of non-performing loans) at June 30, 2016.

While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proved incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact the Company’s consolidated financial condition and results of operations.  In addition, the determination of the amount of the Company’s allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional reserves based upon their analysis of information available to them at the time of their examination. Any material increase in the allowance for loan losses would adversely affect the Company’s consolidated financial condition and results of operations.  For additional information, see Note 4 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”

Non-interest Income: Total non-interest income increased by $407,000, or 14.8%, to $3.16 million for the quarter ended June 30, 2017 from $2.75 million for the quarter ended June 30, 2016. The increase in non-interest income was primarily due to a $164,000 increase in service charges on deposits, a $118,000 increase in gain on sale of loans, net, a $77,000 increase in ATM and debit card interchange transaction fees and smaller increases in several other categories. The increase in service charges on deposits was primarily due to an increase in the amount of service charges collected on checking accounts owned by businesses associated with the marijuana (or Initiative-502) industry in Washington State. It is permissible in Washington State to handle accounts associated with this industry in compliance with federal regulatory guidelines. The increase in gain on sale of loans was primarily due to an increase in the dollar volume of fixed-rate one- to four-family loans sold during the current quarter. The increase in ATM and debit card interchange transaction fees was primarily due to an increase in debit card transactions.

Total non-interest income increased by $1.44 million, or 18.6%, to $9.22 million for the nine months ended June 30, 2017 from $7.78 million for the nine months ended June 30, 2016. The increase in non-interest income was primarily due to a $450,000 increase in service charges on deposits, a $426,000 increase in gain on sale of loans, a $261,000 increase in ATM and debit card interchange transaction fees and smaller increases in several other categories. The increase in service charges on deposits was primarily due to an increase in the amount of service charges collected on checking accounts owned by businesses associated with the marijuana industry. The increase in gain on sale of loans was primarily due to an increase in the dollar volume of fixed-rate one- to four-family loans sold during the current nine month period. The increase in ATM and debit card interchange transaction fees was primarily due to an increase in debit card transactions.

Non-interest Expense:  Total non-interest expense increased by $370,000, or 5.6%, to $6.94 million for the quarter ended June 30, 2017 from $6.57 million for the quarter ended June 30, 2016.  The increased expense was primarily due to a $344,000 increase in salaries and employee benefits expense and smaller increases in several other categories. These increases were partially offset by a $119,000 decrease in OREO and other repossessed assets expense and smaller decreases in several other categories. The increase in salary and employee benefits expense was primarily due to annual salary adjustments and the hiring of additional lending personnel.

Total non-interest expense increased by $931,000, or 4.7%, to $20.61 million for the nine months ended June 30, 2017 from $19.68 million for the nine months ended June 30, 2016. The increased expense was primarily due to a $843,000 increase in salaries and employee benefits expense, a $212,000 increase in deposit operations expense, a $180,000 increase in professional fees expense and smaller increases in several other categories. These increases were partially offset by a $539,000 decrease in OREO and other repossessed assets expense and smaller decreases in several other categories. The increase in salaries and employee benefits expense was primarily due annual salary adjustments and the hiring of additional lending personnel. The increase in deposit operations expense was primarily due to an increase in the level of checking account acquisition promotional costs and check fraud expenses. The increase in professional fees for the nine months ended June 30, 2017, was primarily a result of legal fee recoveries associated with several non-accrual loans that were paid off during the comparable period one year ago, which reduced professional fees for the nine months ended June 30, 2016. The decrease in OREO and other repossessed assets expense was primarily due to a decrease in the level of market value write-downs on OREO properties and gains on the sale of several OREO properties.


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The efficiency ratio for the current quarter improved to 55.94% from 63.37% for the comparable quarter one year ago as the increases in net interest income and non-interest income outpaced the increase in non-interest expense. The efficiency ratio for the nine months ended June 30, 2017 improved to 58.48% from 63.93% for the nine months ended June 30, 2016.

Provision for Federal Income Taxes: The provision for federal income taxes increased by $938,000, or 75.0%, to $2.19 million for the quarter ended June 30, 2017 from $1.25 million for the quarter ended June 30, 2016, primarily as a result of increased income before federal income taxes. The Company's effective tax rate was 33.84% for the quarter ended June 30, 2017 and 32.92% for the quarter ended June 30, 2016.

The provision for federal income taxes increased by $1.68 million, or 46.1%, to $5.33 million for the nine months ended June 30, 2017 from $3.65 million for the nine months ended June 30, 2016, primarily as a result of increased income before federal income taxes. The Company's effective tax rate was 33.55% for the nine months ended June 30, 2017 and 32.85% for the nine months ended June 30, 2016.


Liquidity
The Company’s primary sources of funds are customer deposits, proceeds from principal and interest payments on loans, the sale of loans, maturing investment securities, maturing CDs held for investment, FHLB borrowings and other borrowings.  While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

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

The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs.  At June 30, 2017, 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 21.56%.

The Company’s total cash and cash equivalents and CDs held for investment increased by $11.69 million, or 7.2%, to $173.63 million at June 30, 2017 from $161.94 million at September 30, 2016. If the Bank requires funds that exceed its ability to generate them internally, it has additional borrowing capacity with the FHLB, the Federal Reserve Bank of San Francisco ("FRB") and Pacific Coast Bankers' Bank ("PCBB"). At June 30, 2017, the Bank maintained an uncommitted credit facility with the FHLB that provided for immediately available advances up to an aggregate amount equal to 35% of total assets, limited by available collateral. The Bank also has a Letter of Credit ("LOC") of up to $22.0 million with the FHLB for the purpose of collateralizing Washington State public deposits. Any amount pledged for public deposit under the LOC reduces the Bank's available borrowing amount under the FHLB advance agreement. At June 30, 2017, the Bank had $22.00 million pledged under the LOC, which left $283.05 million available for additional FHLB borrowings.  The Bank maintains a short-term borrowing line with the FRB with available total credit based on eligible collateral.  At June 30, 2017, the Bank had $60.45 million available for borrowings with the FRB and there was no outstanding balance on this borrowing line. The Bank also maintains a $10.00 million overnight borrowing line with PCBB. At June 30, 2017, the Bank did not have an outstanding balance on this borrowing line.

The Bank’s primary investing activity is the origination of one- to four-family mortgage loans, commercial mortgage loans, construction loans, consumer loans, and commercial business loans.  At June 30, 2017, the Bank had loan commitments totaling $84.67 million and undisbursed construction loans in process totaling $72.13 million.  The Bank anticipates that it will have sufficient funds available to meet current loan commitments.  CDs that are scheduled to mature in less than one year from June 30, 2017 totaled $76.45 million.  Historically, the Bank has been able to retain a significant amount of its non-brokered CDs as they mature.  At June 30, 2017, the Bank had $3.20 million in brokered CDs.

Capital Resources

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


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Based on its capital levels at June 30, 2017, the Bank exceeded all regulatory capital requirements as of that date. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at June 30, 2017, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status.

The following table compares the Bank’s actual capital amounts at June 30, 2017 to its minimum regulatory capital requirements at that date (dollars in thousands):
 
 Actual
 
Regulatory
Minimum To
Be “Adequately
Capitalized”
 
To Be “Well Capitalized”
Under Prompt
Corrective Action
Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
 
 
 
 
 
 
 
 
 
 
Leverage Capital Ratio:
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital

$100,254

 
10.98
%
 

$36,529

 
4.00
%
 

$45,661

 
5.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Risk-based Capital Ratios:
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital
100,254

 
15.39

 
29,323

 
4.50

 
42,355

 
6.50

 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital
100,254

 
15.39

 
39,097

 
6.00

 
52,129

 
8.00

 
 
 
 
 
 
 
 
 
 
 
 
Total capital
108,420

 
16.64

 
52,129

 
8.00

 
65,161

 
10.00


In addition to the minimum common equity Tier 1 ("CET1"), Tier 1 and total capital ratios, the Bank now has to maintain a capital conservation buffer consisting of additional CET1 capital above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of retained income that could be utilized for such actions. The new capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and increases each year until fully implemented to an amount equal to 2.5% of risk weighted assets in January 2019. At June 30, 2017, the conservation buffer was 1.25%.

Timberland Bancorp, Inc. is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary bank to be well capitalized under the prompt corrective action regulations. If Timberland Bancorp, Inc. were subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at June 30, 2017, Timberland Bancorp, Inc. would have exceeded all regulatory requirements.

The following table presents the regulatory capital ratios for Timberland Bancorp, Inc. as of June 30, 2017 (dollars in thousands):
 
Actual
 
Amount
 
Ratio
 
 
 
 
Leverage Capital Ratio:
 
 
 
Tier 1 capital

$104,696

 
11.42
%
 
 
 
 
Risk-based Capital Ratios:
 
 
 
Common equity tier 1 capital
104,696

 
16.05

 
 
 
 
Tier 1 capital
104,696

 
16.05

 

 

Total capital
112,870

 
17.30



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Key Financial Ratios and Data
(Dollars in thousands, except per share data)
 
Three Months Ended
June 30,
 
Nine Months Ended
June 30,
 
2017

 
2016

 
2017

 
2016

PERFORMANCE RATIOS:
 
 
 
 
 
 
 
Return on average assets
1.86
%
 
1.20
%
 
1.53
%
 
1.18
%
Return on average equity
16.14
%
 
10.96
%
 
13.80
%
 
10.88
%
Net interest margin
4.29
%
 
3.83
%
 
4.03
%
 
3.91
%
Efficiency ratio
55.94
%
 
63.37
%
 
58.48
%
 
63.93
%

Item 3.  Quantitative and Qualitative Disclosures About Market Risk
There were no material changes in information concerning market risk from the information provided in the Company’s Form 10-K for the fiscal year ended September 30, 2016.

Item 4.  Controls and Procedures
(a)
Evaluation of Disclosure Controls and Procedures:  An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this report.  The Company’s Chief Executive Officer and Chief Financial Officer concluded that as of June 30, 2017 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
(b)
Changes in Internal Controls:  There have been no changes in our internal control over financial reporting (as defined in 13a-15(f) of the Exchange Act) that occurred during the quarter ended June 30, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  The Company continued, however, to implement suggestions from its internal auditor and independent auditors to strengthen existing controls.  The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors and fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; as over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

PART II.   OTHER INFORMATION
Item 1.       Legal Proceedings
Neither the Company nor the Bank is a party to any material legal proceedings at this time.  From time to time,
the Bank is involved in various claims and legal actions arising in the ordinary course of business.

Item 1A.    Risk Factors
There have been no material changes in the Risk Factors previously disclosed in Item 1A of the Company’s
2016 Form 10-K.

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


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(a)    Not applicable

(b)    Not applicable

(c)    Stock Repurchases

There were no shares repurchased by the Company during the quarter ended June 30, 2017. On July 28, 2015 the Company announced a plan to repurchase 352,681 shares of the Company's common stock. As of June 30, 2017, a total of 130,788 shares had been repurchased at an average price of $11.69 per share and there were 221,893 shares still authorized to be repurchased under the plan. All shares were repurchased through open market broker transactions and no shares were directly repurchased from directors or officers of the Company.
 
 
 
 
 
 
 
 
 

Item 3.      Defaults Upon Senior Securities
Not applicable.

Item 4.     Mine Safety Disclosures
Not applicable.

Item 5.     Other Information
None to be reported.

Item 6.         Exhibits

(a)   Exhibits
 
3.1
Articles of Incorporation of the Registrant (1) 
 
3.3
Amended and Restated Bylaws of the Registrant (2) 
 
4.1
Warrant to purchase shares of Company’s common stock dated December 23, 2008 (3) 
 
4.2
Letter Agreement (including Securities Purchase Agreement Standard Terms attached as Exhibit A) dated December 23, 2008 between the Company and the United States Department of the Treasury (3)
 
10.1
Employee Severance Compensation Plan, as revised (4) 
 
10.2
Employee Stock Ownership Plan (4) 
 
10.3
1999 Stock Option Plan (5) 
 
10.4
Management Recognition and Development Plan (5) 
 
10.5
2003 Stock Option Plan (6) 
 
10.6
Form of Incentive Stock Option Agreement (7) 
 
10.7
Form of Non-qualified Stock Option Agreement (7) 
 
10.8
Form of Management Recognition and Development Award Agreement (7) 
 
10.9
Employment Agreement with Michael R. Sand (8)
 
10.10
Employment Agreement with Dean J. Brydon (8)
 
10.11
Timberland Bancorp, Inc. 2014 Equity Incentive Plan (9)
 
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes OxleyAct
 
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act
 
32
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes Oxley Act
 
101
The following materials from Timberland Bancorp Inc's Quarterly Report 10-Q for the quarter ended June 30, 2017, formatted on Extensible Business Reporting Language (XBRL) (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Shareholders' Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Unaudited Consolidated Financial Statements
_________________
(1)
Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (333-35817).
(2)
Incorporated by reference to the Registrant's Current Report on Form 8-K filed on June 1, 2017.

50


(3)
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on December 23, 2008.
(4)
Incorporated by reference to the Registrant’s Current Report on Form 8-K dated April 16, 2007.
(5)
Incorporated by reference to the Registrant’s 1999 Annual Meeting Proxy Statement dated December 15, 1998.
(6)
Incorporated by reference to the Registrant’s 2004 Annual Meeting Proxy Statement dated December 24, 2003.
(7)
Incorporated by reference to the Exhibit 99.2 included in the Registrant's Registration Statement on Form S-8 (333-1161163).
(8)
Incorporated by reference to the Registrant's Current Report on Form 8-K filed on March 29, 2013.
(9)
Attached as Appendix A to the Registrant's Annual Meeting Proxy Statement filed on December 19, 2014.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 

 
 
Timberland Bancorp, Inc. 
 
 
 
 
Date: August 7, 2017
By:  /s/ Michael R. Sand                                   
 
Michael R. Sand 
 
Chief Executive Officer 
 
(Principal Executive Officer) 
 
 
 
 
Date: August 7, 2017
By:  /s/ Dean J. Brydon                                    
 
Dean J. Brydon 
 
Chief Financial Officer
 
(Principal Financial Officer)

52


EXHIBIT INDEX
 

 
Exhibit No. 
Description of Exhibit 
 
 
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 
32
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act 
101
The following materials from Timberland Bancorp Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted on Extensible Business Reporting Language (XBRL) (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Unaudited Consolidated Financial Statements





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