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, 2018

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 1, 2018
 
Common stock, $.01 par value
7,395,927
 



INDEX

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


2


PART I.    FINANCIAL INFORMATION
Item 1.    Financial Statements (unaudited)
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
June 30, 2018 and September 30, 2017
(Dollars in thousands, except per share amounts)
 
 
June 30,
2018

 
September 30,
2017

 
(Unaudited)
 
*

Assets
 
 
 
Cash and cash equivalents:
 
 
 
Cash and due from financial institutions
$
19,552

 
$
17,447

Interest-bearing deposits in banks
137,274

 
130,741

Total cash and cash equivalents
156,826

 
148,188

 
 
 
 
Certificates of deposit (“CDs”) held for investment (at cost, which
     approximates fair value)
63,132

 
43,034

Investment securities held to maturity, at amortized cost
     (estimated fair value $8,440 and $7,744)
7,951

 
7,139

Investment securities available for sale, at fair value
1,176

 
1,241

Federal Home Loan Bank of Des Moines (“FHLB”) stock
1,190

 
1,107

Other investments, at cost
3,000

 
3,000

Loans held for sale
2,321

 
3,599

Loans receivable, net of allowance for loan losses of $9,532 and $9,553
717,324

 
690,364

Premises and equipment, net
18,515

 
18,418

Other real estate owned (“OREO”) and other repossessed assets, net
2,112

 
3,301

Accrued interest receivable
2,797

 
2,520

Bank owned life insurance (“BOLI”)
19,673

 
19,266

Goodwill
5,650

 
5,650

Mortgage servicing rights (“MSRs”), net
1,980

 
1,825

Other assets
2,736

 
3,372

Total assets
$
1,006,383

 
$
952,024

 
 
 
 
Liabilities and shareholders’ equity
 

 
 

Liabilities
 

 
 

Deposits:
 
 
 
     Non-interest-bearing demand
$
229,201

 
$
205,952

     Interest-bearing
651,526

 
631,946

Total deposits
880,727

 
837,898

 
 
 
 
Other liabilities and accrued expenses
4,762

 
3,126

Total liabilities
885,489

 
841,024

* 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, 2018 and September 30, 2017
(Dollars in thousands, except per share amounts)
 
 
June 30,
2018

 
September 30,
2017

 
(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;
7,395,927 shares issued and outstanding - June 30, 2018 7,361,077 shares issued and outstanding - September 30, 2017
14,162

 
13,286

Unearned shares issued to Employee Stock Ownership Plan (“ESOP”)
(199
)
 
(397
)
Retained earnings
107,065

 
98,235

Accumulated other comprehensive loss
(134
)
 
(124
)
Total shareholders’ equity
120,894

 
111,000

Total liabilities and shareholders’ equity
$
1,006,383

 
$
952,024

* 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, 2018 and 2017
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Three Months Ended 
 June 30,
 
Nine Months Ended 
 June 30,
 
2018

 
2017

 
2018

 
2017

Interest and dividend income
 
 
 
 
 
 
 
Loans receivable and loans held for sale
$
9,530

 
$
9,652

 
$
28,342

 
$
27,280

Investment securities
51

 
69

 
147

 
207

Dividends from mutual funds, FHLB stock and other investments
31

 
23

 
83

 
60

Interest-bearing deposits in banks and CDs
845

 
421

 
2,209

 
1,081

Total interest and dividend income
10,457

 
10,165

 
30,781

 
28,628

 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
 
Deposits
730

 
549

 
1,996

 
1,637

FHLB borrowings

 
369

 

 
979

Total interest expense
730

 
918

 
1,996

 
2,616

 
 
 
 
 
 
 
 
Net interest income
9,727

 
9,247

 
28,785

 
26,012

 
 
 
 
 
 
 
 
Recapture of loan losses

 
(1,000
)
 

 
(1,250
)
 
 
 
 
 
 
 
 
Net interest income after recapture of loan losses
9,727

 
10,247

 
28,785

 
27,262

 
 
 
 
 
 
 
 
Non-interest income
 
 
 
 
 
 
 
Recoveries (other than temporary impairment "OTTI") on investment securities
19

 

 
60

 

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

 

 
(5
)
 

Net recoveries on investment securities
19

 

 
55

 

Service charges on deposits
1,137

 
1,153

 
3,447

 
3,348

ATM and debit card interchange transaction fees
921

 
855

 
2,648

 
2,448

BOLI net earnings
134

 
133

 
407

 
406

Gain on sales of loans, net
435

 
561

 
1,427

 
1,656

Escrow fees
47

 
51

 
158

 
191

Servicing income on loans sold
121

 
106

 
354

 
302

Other, net
331

 
297

 
868

 
873

Total non-interest income, net
3,145

 
3,156

 
9,364

 
9,224



 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, 2018 and 2017
(Dollars in thousands, except per share amounts)
(Unaudited)
 
Three Months Ended 
 June 30,
 
Nine Months Ended 
 June 30,
 
2018

 
2017

 
2018

 
2017

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
3,912

 
$
3,741

 
$
11,862

 
$
11,176

Premises and equipment
795

 
764

 
2,361

 
2,295

(Gain) loss on sales of premises and equipment, net

 
3

 
(113
)
 
3

Advertising
205

 
170

 
591

 
499

OREO and other repossessed assets, net
(92
)
 
4

 
114

 
22

ATM and debit card interchange transaction fees
334

 
375

 
982

 
1,036

Postage and courier
104

 
109

 
340

 
324

State and local taxes
169

 
176

 
498

 
484

Professional fees
368

 
230

 
829

 
629

Federal Deposit Insurance Corporation ("FDIC") insurance
101

 
99

 
242

 
319

Loan administration and foreclosure
76

 
20

 
247

 
113

Data processing and telecommunications
465

 
480

 
1,427

 
1,394

Deposit operations
285

 
301

 
815

 
850

Other
400

 
466

 
1,324

 
1,462

Total non-interest expense
7,122

 
6,938

 
21,519

 
20,606

 
 
 
 
 
 
 
 
Income before income taxes
5,750

 
6,465

 
16,630

 
15,880

 
 
 
 
 
 
 
 
Provision for income taxes
1,334

 
2,188

 
4,331

 
5,328

 
 
 
 
 
 
 
 
     Net income
$
4,416

 
$
4,277

 
$
12,299

 
$
10,552

 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
Basic
$
0.60

 
$
0.59

 
$
1.68

 
$
1.49

Diluted
$
0.59

 
$
0.58

 
$
1.64

 
$
1.44

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
7,345,618

 
7,269,564

 
7,328,702

 
7,088,134

Diluted
7,535,157

 
7,432,171

 
7,518,447

 
7,348,486

 
 
 
 
 
 
 
 
Dividends paid per common share
$
0.23

 
$
0.11

 
$
0.47

 
$
0.31


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, 2018 and 2017
(Dollars in thousands)
(Unaudited) 
 
Three Months Ended 
 June 30,
 
Nine Months Ended 
 June 30,
 
2018

 
2017

 
2018

 
2017

Comprehensive income
 
 
 
 
 
 
 
Net income
$
4,416

 
$
4,277

 
$
12,299

 
$
10,552

Unrealized holding (loss) gain on investment securities available for sale, net of income taxes of ($1), $3, ($5) and ($11), respectively
(7
)
 
5

 
(32
)
 
(22
)
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, ($2) and $0, respectively

 

 
(6
)
 

Amount reclassified to credit loss for previously recorded market loss, net of income taxes of $0, $0, $1 and $0, respectively

 

 
4

 

Accretion of OTTI on investment securities held to maturity, net of income taxes of $2, $5, $8 and $18, respectively
5

 
11

 
24

 
35

Total other comprehensive (loss) income, net of income taxes
(2
)
 
16

 
(10
)
 
13

 
 
 
 
 
 
 
 
Total comprehensive income
$
4,414

 
$
4,293

 
$
12,289


$
10,565




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, 2018 and 2017
(Dollars in thousands, except per share amounts)
(Unaudited)

 
Common Stock
 
Unearned
 Shares Issued to ESOP

 
 
 
Accumulated
Other
Compre-
hensive
Loss

 
 
 
Number of Shares
 
Amount
 
 
Retained
Earnings
 
 
Total
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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2017
7,361,077

 
13,286

 
(397
)
 
98,235

 
(124
)
 
111,000

Net income

 

 

 
12,299

 

 
12,299

Other comprehensive loss

 

 

 

 
(10
)
 
(10
)
Exercise of stock options
34,850

 
292

 

 

 

 
292

Common stock dividends ($0.47 per common share)

 

 

 
(3,469
)
 

 
(3,469
)
Earned ESOP shares, net of income taxes

 
454

 
198

 

 

 
652

Stock option compensation expense

 
130

 

 

 

 
130

Balance, June 30, 2018
7,395,927

 
$
14,162

 
$
(199
)
 
$
107,065

 
$
(134
)
 
$
120,894

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, 2018 and 2017
(In thousands)
(Unaudited)

 
Nine Months Ended
June 30,
 
2018

 
2017

Cash flows from operating activities
 
 
 
Net income
$
12,299

 
$
10,552

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

 
 

Recapture of loan losses

 
(1,250
)
Depreciation
940

 
946

Earned ESOP shares
652

 
428

Stock option compensation expense
130

 
271

Net recoveries on investment securities
(55
)
 

Gain on sales of OREO and other repossessed assets, net
(217
)
 
(53
)
Provision for OREO losses
224

 
42

Gain on sales of loans, net
(1,427
)
 
(1,656
)
(Gain) loss on sales of premises and equipment, net
(113
)
 
3

Loans originated for sale
(46,256
)
 
(54,805
)
Proceeds from sales of loans
48,961

 
56,542

Amortization of MSRs
363

 
369

BOLI net earnings
(407
)
 
(406
)
Increase in deferred loan origination fees
3

 
80

Net change in accrued interest receivable and other assets, and other liabilities and accrued expenses
1,445

 
(332
)
Net cash provided by operating activities
16,542

 
10,731

 
 
 
 
Cash flows from investing activities
 

 
 

Net (increase) decrease in CDs held for investment
(20,098
)
 
11,813

Proceeds from maturities and prepayments of investment securities held to maturity
413

 
387

Purchase of investment securities held to maturity
(1,111
)
 

Proceeds from maturities and prepayments of investment securities available for sale
28

 
49

Purchase of FHLB stock
(83
)
 
(103
)
Redemption of FHLB stock

 
1,200

Purchase of other investments

 
(3,000
)
Increase in loans receivable, net
(27,287
)
 
(23,566
)
Additions to premises and equipment
(1,387
)
 
(3,249
)
Proceeds from sales of premises and equipment
463

 

Proceeds from sales of OREO and other repossessed assets
1,506

 
1,435

Net cash used in investing activities
(47,556
)
 
(15,034
)
 
 
 
 
 
 
 
 
 
 
 
 
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, 2018 and 2017
(In thousands)
(Unaudited)

 
Nine Months Ended
June 30,
 
2018

 
2017

Cash flows from financing activities
 

 
 

Net increase in deposits
$
42,829

 
$
57,284

Repayment of FHLB borrowings

 
(30,000
)
Proceeds from exercise of stock options
292

 
265

Proceeds from exercise of stock warrant

 
2,496

Payment of dividends
(3,469
)
 
(2,243
)
Net cash provided by financing activities
39,652

 
27,802

 
 

 
 

Net increase in cash and cash equivalents
8,638

 
23,499

Cash and cash equivalents
 

 
 

Beginning of period
148,188

 
108,941

End of period
$
156,826

 
$
132,440

 
 
 
 
Supplemental disclosure of cash flow information
 

 
 

Income taxes paid
$
2,208

 
$
5,376

Interest paid
1,939

 
2,701

 
 
 
 
Supplemental disclosure of non-cash investing activities
 

 
 

Loans transferred to OREO and other repossessed assets
$
324

 
$
724

Other comprehensive (loss) income related to investment securities
(10
)
 
13

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, 2017 (“2017 Form 10-K”).  The unaudited consolidated results of operations for the nine months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the entire fiscal year ending September 30, 2018.

(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, 2018 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, 2018 and September 30, 2017 (dollars in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
June 30, 2018
 
 
 
 
 
 
 
Held to maturity
 
 
 
 
 
 
 
Mortgage-backed securities ("MBS"):
 
 
 
 
 
 
 
U.S. government agencies
$
1,466

 
$
9

 
$
(19
)
 
$
1,456

Private label residential
489

 
575

 
(1
)
 
1,063

U.S. Treasury and U.S government agency securities
5,996

 

 
(75
)
 
5,921

Total
$
7,951

 
$
584

 
$
(95
)
 
$
8,440

 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

MBS: U.S. government agencies
$
243

 
$
9

 
$

 
$
252

Mutual funds
1,000

 

 
(76
)
 
924

Total
$
1,243

 
$
9

 
$
(76
)
 
$
1,176

 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
Held to maturity
 

 
 

 
 

 
 

MBS:
 

 
 

 
 

 
 

U.S. government agencies
$
532

 
$
11

 
$
(1
)
 
$
542

Private label residential
599

 
596

 
(2
)
 
1,193

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

 
10

 
(9
)
 
6,009

Total
$
7,139

 
$
617

 
$
(12
)
 
$
7,744

 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

MBS: U.S. government agencies
$
271

 
$
18

 
$

 
$
289

Mutual funds
1,000

 

 
(48
)
 
952

Total
$
1,271

 
$
18

 
$
(48
)
 
$
1,241



12


Held to maturity and available for sale investment securities with unrealized losses were as follows for June 30, 2018 (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
$
1,010

 
$
(18
)
 
2

 
$
67

 
$
(1
)
 
5

 
$
1,077

 
$
(19
)
Private label residential

 

 

 
52

 
(1
)
 
8

 
52

 
(1
)
U.S. Treasury and U.S. government agency securities
5,921

 
(75
)
 
2

 

 

 

 
5,921

 
(75
)
     Total
$
6,931

 
$
(93
)
 
4

 
$
119

 
$
(2
)
 
13

 
$
7,050

 
$
(95
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

MBS: U.S. government agency
$
35

 
$

 
1

 
$

 
$

 

 
$
35

 
$

Mutual funds

 

 

 
924

 
(76
)
 
1

 
924

 
(76
)
     Total
$
35

 
$

 
1

 
$
924

 
$
(76
)
 
1

 
$
959

 
$
(76
)

Held to maturity and available for sale investment securities with unrealized losses were as follows for September 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
$

 
$

 

 
$
114

 
$
(1
)
 
6

 
$
114

 
$
(1
)
Private label residential

 

 

 
85

 
(2
)
 
10

 
85

 
(2
)
U.S. Treasury and U.S. government agency securities
2,984

 
(9
)
 
1

 

 

 

 
2,984

 
(9
)
     Total
$
2,984

 
$
(9
)
 
1

 
$
199

 
$
(3
)
 
16

 
$
3,183

 
$
(12
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Mutual funds
$

 
$

 

 
$
952

 
$
(48
)
 
1

 
$
952

 
$
(48
)
     Total
$

 
$

 

 
$
952

 
$
(48
)
 
1

 
$
952

 
$
(48
)

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, 2018, 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).


13


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 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, 2018 and 2017:
 
Range
 
Weighted
 
Minimum 
 
Maximum 
 
Average 
June 30, 2018
 
 
 
 
 
Constant prepayment rate
6.00
%
 
15.00
%
 
11.58
%
Collateral default rate
%
 
12.31
%
 
5.51
%
Loss severity rate
%
 
74.00
%
 
42.49
%
 
 
 
 
 
 
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
%

The following table presents the OTTI recoveries (losses) for the three and nine months ended June 30, 2018 and 2017 (dollars in thousands):

 
 
Three Months Ended
June 30, 2018
 
Three Months Ended
June 30, 2017
 
Held To
Maturity
 
Available
For Sale
 
Held To
Maturity
 
Available
For Sale
Total recoveries
$
19

 
$

 
$

 
$

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

 

 

 

Net recoveries recognized in earnings (2)
$
19

 
$

 
$

 
$

 
Nine Months Ended
June 30, 2018
 
Nine Months Ended
June 30, 2017
 
Held To
Maturity
 
Available
For Sale
 
Held To
Maturity
 
Available
For Sale
Total recoveries
$
60

 
$

 
$

 
$

Adjustment for portion of OTTI transferred from
       other comprehensive income (loss) before income taxes (1)
(5
)
 

 

 

Net recoveries recognized in earnings (2)
$
55

 
$

 
$

 
$

_________________
(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, 2018 and 2017 (dollars in thousands):
 
Nine Months Ended June 30,
 
2018

 
2017

Beginning balance of credit loss
$
1,301

 
$
1,505

Additions:
 

 
 

Additional increases to the amount
related to credit loss for which OTTI
was previously recognized
14

 

Subtractions:
 
 
 

Realized losses previously recorded
as credit losses
(69
)
 
(48
)
Recovery of prior credit loss
(55
)
 

Ending balance of credit loss
$
1,191

 
$
1,457


During the three months ended June 30, 2018, the Company recorded a $28,000 net realized loss (as a result of the securities being deemed worthless) on 16 held to maturity investment securities, of which the entire amount had been recognized previously as a credit loss. During the nine months ended June 30, 2018, the Company recorded a $69,000 net realized loss (as a result of securities being deemed worthless) on 17 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, 2017, the Company recorded a $12,000 net realized loss (as a result of the securities being deemed worthless) on 15 held to maturity investment securities, 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.

The recorded amount of investment securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits, FHLB collateral and other non-profit organization deposits totaled $7.20 million and $6.82 million at June 30, 2018 and September 30, 2017, respectively.

The contractual maturities of debt securities at June 30, 2018 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
$
3,001

 
$
2,983

 
$

 
$

Due after one year to five years
4,018

 
3,943

 

 

Due after five years to ten years
42

 
42

 

 

Due after ten years
890

 
1,472

 
243

 
252

Total
$
7,951

 
$
8,440

 
$
243

 
$
252



(3) GOODWILL

Goodwill is initially recorded when the purchase price paid in a business combination exceeds the estimated fair value of the net identified tangible and intangible assets acquired and liabilities assumed.  Goodwill is presumed to have an indefinite useful life and is analyzed annually for impairment.  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. For purposes of goodwill impairment testing, the services offered through the Bank and its subsidiary are managed as one strategic unit and represent the Company's only reporting unit.


15


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. 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.

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, 2018.

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 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, 2018, management believes that there have been no events or changes in the circumstances since May 31, 2018 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, 2018 and September 30, 2017 (dollars in thousands):
 
June 30,
2018
 
September 30,
2017
 
Amount
 
Percent
 
Amount
 
Percent
Mortgage loans:
 
 
 
 
 
 
 
One- to four-family (1)
$
114,148

 
14.4
%
 
$
118,147

 
15.1
%
Multi-family
58,169

 
7.3

 
58,607

 
7.5

Commercial
345,543

 
43.5

 
328,927

 
41.9

Construction - custom and owner/builder
113,468

 
14.3

 
117,641

 
15.0

Construction - speculative one- to four-family
10,146

 
1.3

 
9,918

 
1.2

Construction - commercial
26,347

 
3.3

 
19,630

 
2.5

Construction - multi-family
15,225

 
1.9

 
21,327

 
2.7

Construction - land development
3,190

 
0.4

 

 

Land
23,662

 
3.0

 
23,910

 
3.0

Total mortgage loans
709,898

 
89.4

 
698,107

 
88.9

 
 
 
 
 
 
 
 
Consumer loans:
 

 
 

 
 

 
 

Home equity and second mortgage
38,143

 
4.8

 
38,420

 
4.9

Other
3,674

 
0.4

 
3,823

 
0.5

Total consumer loans
41,817

 
5.2

 
42,243

 
5.4

 
 
 
 
 
 
 
 
Commercial business loans (2)
43,284

 
5.4

 
44,444

 
5.7

 
 
 
 
 
 
 
 
Total loans receivable
794,999

 
100.0
%
 
784,794

 
100.0
%
Less:
 

 
 

 
 

 
 

Undisbursed portion of construction 
loans in process
65,674

 
 

 
82,411

 
 

Deferred loan origination fees, net
2,469

 
 

 
2,466

 
 

Allowance for loan losses
9,532

 
 

 
9,553

 
 

 
77,675

 
 
 
94,430

 
 
Loans receivable, net
$
717,324

 
 

 
$
690,364

 
 

_____________________________
 
 
 
 
 
 
 
 (1) Does not include one- to four-family loans held for sale totaling $2,321 and $3,515 at June 30, 2018 and September 30, 2017, respectively.
 (2) Does not include commercial business loans held for sale totaling $0 and $84 at June 30, 2018 and September 30, 2017, respectively.
















17






Allowance for Loan Losses
The following tables set forth information for the three and nine months ended June 30, 2018 and 2017 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):

 
Three Months Ended June 30, 2018
 
Beginning
Allowance
 
Provision for
(Recapture of) Loan Losses
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
One- to four-family
$
1,060

 
$
(33
)
 
$

 
$

 
$
1,027

Multi-family
386

 
21

 

 

 
407

Commercial
4,198

 
(15
)
 

 

 
4,183

Construction – custom and owner/builder
705

 
(38
)
 

 

 
667

Construction – speculative one- to four-family
99

 
34

 

 

 
133

Construction – commercial
445

 
74

 

 

 
519

Construction – multi-family
284

 
(137
)
 

 

 
147

Construction – land development
48

 
32

 

 

 
80

Land
691

 
64

 
(16
)
 
5

 
744

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
945

 
1

 

 

 
946

Other
120

 
2

 
(1
)
 

 
121

Commercial business loans
563

 
(5
)
 

 

 
558

Total
$
9,544

 
$

 
$
(17
)
 
$
5

 
$
9,532


 
Nine Months Ended June 30, 2018
 
Beginning
Allowance
 
Provision for
(Recapture of) Loan Losses
 
Charge-
offs
 
Recoveries
 
Ending
Allowance
Mortgage loans:
 
 
 
 
 
 
 
 
 
One-to four-family
$
1,082

 
$
(55
)
 
$

 
$

 
$
1,027

Multi-family
447

 
(40
)
 

 

 
407

Commercial
4,184

 
27

 
(28
)
 

 
4,183

Construction – custom and owner/builder
699

 
(32
)
 

 

 
667

Construction – speculative one- to four-family
128

 
(6
)
 

 
11

 
133

Construction – commercial
303

 
216

 

 

 
519

Construction – multi-family
173

 
(26
)
 

 

 
147

Construction – land development

 
80

 

 

 
80

Land
918

 
(172
)
 
(16
)
 
14

 
744

Consumer loans:
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
983

 
(37
)
 

 

 
946

Other
121

 
2

 
(3
)
 
1

 
121

Commercial business loans
515

 
43

 

 

 
558

Total
$
9,553

 
$

 
$
(47
)
 
$
26

 
$
9,532

 
 
 
 
 
 
 
 
 
 


18


 
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

 
 
 
 
 
 
 
 
 
 


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, 2018 and September 30, 2017 (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, 2018
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$

 
$
1,027

 
$
1,027

 
$
1,873

 
$
112,275

 
$
114,148

Multi-family

 
407

 
407

 

 
58,169

 
58,169

Commercial

 
4,183

 
4,183

 
2,801

 
342,742

 
345,543

Construction – custom and owner/builder

 
667

 
667

 

 
66,651

 
66,651

Construction – speculative one- to four-family

 
133

 
133

 

 
5,312

 
5,312

Construction – commercial

 
519

 
519

 

 
21,640

 
21,640

Construction –  multi-family

 
147

 
147

 

 
6,526

 
6,526

Construction – land development

 
80

 
80

 

 
2,573

 
2,573

Land

 
744

 
744

 
540

 
23,122

 
23,662

Consumer loans:
 

 
 
 
 

 
 

 
 

 
 

Home equity and second mortgage
297

 
649

 
946

 
570

 
37,573

 
38,143

Other

 
121

 
121

 


 
3,674

 
3,674

Commercial business loans
61

 
497

 
558

 
174

 
43,110

 
43,284

Total
$
358

 
$
9,174

 
$
9,532

 
$
5,958

 
$
723,367

 
$
729,325

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
$

 
$
1,082

 
$
1,082

 
$
1,443

 
$
116,704

 
$
118,147

Multi-family

 
447

 
447

 

 
58,607

 
58,607

Commercial
26

 
4,158

 
4,184

 
3,873

 
325,054

 
328,927

Construction – custom and owner/builder

 
699

 
699

 

 
63,538

 
63,538

Construction – speculative one- to four-family

 
128

 
128

 

 
4,639

 
4,639

Construction – commercial

 
303

 
303

 

 
11,016

 
11,016

Construction – multi-family

 
173

 
173

 

 
6,912

 
6,912

Land
125

 
793

 
918

 
1,119

 
22,791

 
23,910

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
325

 
658

 
983

 
557

 
37,863

 
38,420

Other

 
121

 
121

 

 
3,823

 
3,823

Commercial business loans

 
515

 
515

 

 
44,444

 
44,444

Total
$
476

 
$
9,077

 
$
9,553

 
$
6,992

 
$
695,391

 
$
702,383



20


The following tables present an analysis of loans by aging category and portfolio segment at June 30, 2018 and September 30, 2017 (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, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$

 
$

 
$
1,361

 
$

 
$
1,361

 
$
112,787

 
$
114,148

Multi-family

 

 

 

 

 
58,169

 
58,169

Commercial
103

 

 
598

 

 
701

 
344,842

 
345,543

Construction – custom and owner/builder

 

 

 

 

 
66,651

 
66,651

Construction – speculative one- to four- family

 

 

 

 

 
5,312

 
5,312

Construction – commercial

 

 

 

 

 
21,640

 
21,640

Construction – multi-family

 

 

 

 

 
6,526

 
6,526

Construction – land development

 

 

 

 

 
2,573

 
2,573

Land
42

 

 
295

 

 
337

 
23,325

 
23,662

Consumer loans:
 

 
 

 
 

 
 

 


 
 
 
 
Home equity and second mortgage
34

 

 
278

 
428

 
740

 
37,403

 
38,143

Other
4

 

 

 

 
4

 
3,670

 
3,674

Commercial business loans
110

 

 
174

 

 
284

 
43,000

 
43,284

Total
$
293

 
$

 
$
2,706

 
$
428

 
$
3,427

 
$
725,898

 
$
729,325

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 

 
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
$
193

 
$

 
$
874

 
$

 
$
1,067

 
$
117,080

 
$
118,147

Multi-family

 

 

 

 

 
58,607

 
58,607

Commercial

 
107

 
213

 

 
320

 
328,607

 
328,927

   Construction – custom and owner/
       builder

 

 

 

 

 
63,538

 
63,538

Construction – speculative one- to four- family

 

 

 

 

 
4,639

 
4,639

Construction – commercial

 

 

 

 

 
11,016

 
11,016

Construction – multi-family

 

 

 

 

 
6,912

 
6,912

Land

 

 
566

 

 
566

 
23,344

 
23,910

Consumer loans:
 

 
 

 
 

 
 

 
 
 
 

 
 
Home equity and second mortgage
56

 

 
258

 

 
314

 
38,106

 
38,420

Other
36

 

 

 

 
36

 
3,787

 
3,823

Commercial business loans
110

 

 

 

 
110

 
44,334

 
44,444

Total
$
395

 
$
107

 
$
1,911

 
$

 
$
2,413

 
$
699,970

 
$
702,383

______________________
(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, 2018 and September 30, 2017, there were no loans classified as loss.


22


The following tables present an analysis of loans by credit quality indicator and portfolio segment at June 30, 2018 and September 30, 2017 (dollars in thousands):
 
Loan Grades
 
 
June 30, 2018
Pass
 
Watch
 
Special
Mention
 
Substandard
 
Total
Mortgage loans:
 
 
 
 
 
 
 
 
 
One- to four-family
$
110,784

 
$
888

 
$
587

 
$
1,889

 
$
114,148

Multi-family
58,169

 

 

 

 
58,169

Commercial
335,497

 
5,961

 
3,199

 
886

 
345,543

Construction – custom and owner/builder
65,739

 
912

 

 

 
66,651

Construction – speculative one- to four-family
5,312

 

 

 

 
5,312

Construction – commercial
21,640

 

 

 

 
21,640

Construction – multi-family
6,526

 

 

 

 
6,526

Construction – land development
2,573

 

 

 

 
2,573

Land
20,610

 
996

 
1,761

 
295

 
23,662

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
37,559

 
144

 

 
440

 
38,143

Other
3,639

 

 

 
35

 
3,674

Commercial business loans
43,037

 
24

 
49

 
174

 
43,284

Total
$
711,085

 
$
8,925

 
$
5,596

 
$
3,719

 
$
729,325

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 

 
 

 
 

 
 

 
 

Mortgage loans:
 
 
 

 
 

 
 

 
 

One- to four-family
$
115,481

 
$
422

 
$
644

 
$
1,600

 
$
118,147

Multi-family
56,857

 

 
1,750

 

 
58,607

Commercial
318,717

 
6,059

 
3,540

 
611

 
328,927

Construction – custom and owner/builder
63,210

 
328

 

 

 
63,538

Construction – speculative one- to four-family
4,639

 

 

 

 
4,639

Construction – commercial
11,016

 

 

 

 
11,016

Construction – multi-family
6,912

 

 

 

 
6,912

Land
20,528

 
1,022

 
1,794

 
566

 
23,910

Consumer loans:
 

 
 

 
 

 
 

 
 
Home equity and second mortgage
37,828

 
152

 

 
440

 
38,420

Other
3,787

 

 

 
36

 
3,823

Commercial business loans
43,416

 
973

 
55

 

 
44,444

Total
$
682,391

 
$
8,956

 
$
7,783

 
$
3,253

 
$
702,383


Impaired Loans
A loan is considered impaired when it is probable that the Company 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

23


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.  

24


The following table is a summary of information related to impaired loans by portfolio segment as of June 30, 2018 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
$
1,873

 
$
2,020

 
$

 
$
1,596

 
$
1,514

 
$
21

 
$
62

 
$
18

 
$
53

Commercial
2,801

 
2,801

 

 
2,690

 
2,374

 
38

 
114

 
31

 
93

Land
540

 
644

 

 
493

 
332

 
5

 
11

 
5

 
10

Consumer loans:
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
195

 
195

 

 
190

 
173

 

 
3

 

 
3

Subtotal
5,409

 
5,660

 

 
4,969

 
4,393

 
64

 
190

 
54

 
159

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family

 

 

 

 
11

 

 

 

 

Commercial

 

 

 

 
950

 

 
27

 

 
21

Land

 


 

 
98

 
479

 

 
9

 

 
8

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
375

 
375

 
297

 
335

 
350

 
5

 
16

 
3

 
13

Commercial business loans
174

 
174

 
61

 
178

 
134

 

 

 

 

Subtotal
549

 
549

 
358

 
611

 
1,924

 
5

 
52

 
3

 
42

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans:
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
1,873

 
2,020

 

 
1,596

 
1,525

 
21

 
62

 
18

 
53

Commercial
2,801

 
2,801

 

 
2,690

 
3,324

 
38

 
141

 
31

 
114

Land
540

 
644

 

 
591

 
811

 
5

 
20

 
5

 
18

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
570

 
570

 
297

 
525

 
523

 
5

 
19

 
3

 
16

Commercial business loans
174

 
174

 
61

 
178

 
134

 

 

 

 

Total
$
5,958

 
$
6,209

 
$
358

 
$
5,580

 
$
6,317

 
$
69

 
$
242

 
$
57

 
$
201

______________________________________________
(1)
For the three months ended June 30, 2018.
(2)
For the nine months ended June 30, 2018.

25


The following table is a summary of information related to impaired loans by portfolio segment as of and for the year ended September 30, 2017 (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
$
1,443

 
$
1,589

 
$

 
$
1,108

 
$
68

 
$
62

Commercial
1,967

 
1,967

 

 
3,901

 
188

 
143

Construction – custom and owner/builder

 

 

 
147

 
7

 
7

Land
297

 
410

 

 
512

 
8

 
6

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
123

 
123

 

 
284

 

 

Commercial business loans

 

 

 
11

 

 

Subtotal
3,830

 
4,089

 

 
5,963

 
271

 
218

 
 
 
 
 
 
 
 
 
 
 
 
With an allowance recorded:
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family

 

 

 
721

 
50

 
38

Commercial
1,906

 
1,906

 
26

 
3,326

 
182

 
144

Land
822

 
881

 
125

 
666

 
35

 
29

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
434

 
434

 
325

 
530

 
29

 
26

Other

 

 

 
17

 

 

Subtotal
3,162

 
3,221

 
476

 
5,260

 
296

 
237

Total:
 

 
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

 
 

One- to four-family
1,443

 
1,589

 

 
1,829

 
118

 
100

Commercial
3,873

 
3,873

 
26

 
7,227

 
370

 
287

Construction – custom and owner/builder

 

 

 
147

 
7

 
7

Land
1,119

 
1,291

 
125

 
1,178

 
43

 
35

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
557

 
557

 
325

 
814

 
29

 
26

Other

 

 

 
17

 

 

Commercial business loans

 

 

 
11

 

 

Total
$
6,992

 
$
7,310

 
$
476

 
$
11,223

 
$
567

 
$
455

______________________________________________
(1) For the year ended September 30, 2017.


A troubled debt restructured loan ("TDR") is a loan for which the Company, for reasons related to a borrower’s financial difficulties, grants a 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.  TDRs are considered impaired and are individually evaluated for impairment.  TDRs are classified as non-accrual (and considered to be non-performing) unless they have been performing in accordance with modified terms for a period of at least six months. The Company had $3.12 million and $3.60 million in TDRs included in impaired loans at June 30, 2018 and September 30, 2017, respectively, and had no commitments at these dates to lend additional funds on these loans.  The allowance for loan losses allocated to TDRs at June 30, 2018 and September 30, 2017 was $0 and $10,000, respectively. There were no TDRs for which there was a payment default within the first 12 months of the modification during the nine months ended June 30, 2018.




26


The following tables set forth information with respect to the Company’s TDRs by interest accrual status as of June 30, 2018 and September 30, 2017 (dollars in thousands):

 
June 30, 2018
 
Accruing
 
Non-
Accrual
 
Total
Mortgage loans:
 
 
 
 
 
One- to four-family
$
512

 
$

 
$
512

Commercial
2,203

 

 
2,203

Land
245

 
155

 
400

Total
$
2,960

 
$
155

 
$
3,115


 
September 30, 2017
 
Accruing
 
Non-
Accrual
 
Total
Mortgage loans:
 
 
 
 
 
One- to four-family
$
569

 
$

 
$
569

Commercial
2,219

 

 
2,219

Land
554

 
253

 
807

Total
$
3,342

 
$
253

 
$
3,595


There was one new TDR during the nine months ended June 30, 2018 as a result of a reduction in the face amount of the debt on a land loan. This TDR had a pre-modification balance of $214,000, a post-modification balance of $155,000 and a balance at June 30, 2018 of $155,000. There were no new TDRs during the year ended September 30, 2017.



27


(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, 2018 and 2017, there were 45,999 and 79,032 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, 2018 and 2017 is as follows (dollars in thousands, except share and per share amounts):
 
Three Months Ended 
 June 30,
 
Nine Months Ended 
 June 30,
 
2018

 
2017

 
2018

 
2017

Basic net income per common share computation
 
 
 
 
 
 
 
Numerator – net income
$
4,416

 
$
4,277

 
$
12,299

 
$
10,552

 
 
 
 
 
 
 
 
Denominator – weighted average common shares outstanding
7,345,618

 
7,269,564

 
7,328,702

 
7,088,134

 
 
 
 
 
 
 
 
Basic net income per common share
$
0.60

 
$
0.59

 
$
1.68

 
$
1.49

 
 
 
 
 
 
 
 
Diluted net income per common share computation
 
 
 
 
 

 
 

Numerator – net income
$
4,416

 
$
4,277

 
$
12,299

 
$
10,552

 
 
 
 
 
 
 
 
Denominator – weighted average common shares outstanding
7,345,618

 
7,269,564

 
7,328,702

 
7,088,134

Effect of dilutive stock options (1)
189,539

 
162,607

 
189,745

 
153,941

Effect of dilutive stock warrant (2)

 

 

 
106,411

Weighted average common shares outstanding - assuming dilution
7,535,157

 
7,432,171

 
7,518,447

 
7,348,486

 
 
 
 
 
 
 
 
Diluted net income per common share
$
0.59

 
$
0.58

 
$
1.64

 
$
1.44

____________________________________________
(1) For the three months ended June 30, 2018, all outstanding options were included in the computation of diluted net income per share. For the nine months ended June 30, 2018, average options to purchase 38,709 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 and nine months ended June 30, 2017, all outstanding options were included in the computation of diluted net income 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"). 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.


28


(6) ACCUMULATED OTHER COMPREHENSIVE LOSS

The changes in accumulated other comprehensive loss ("AOCI") by component during the three and nine months ended June 30, 2018 and 2017 are as follows (dollars in thousands):
 
Three Months Ended June 30, 2018
 
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
$
(44
)
 
$
(88
)
 
$
(132
)
Net change
(7
)
 
5

 
(2
)
Balance of AOCI at the end of period
$
(51
)
 
$
(83
)
 
$
(134
)
 
Nine Months Ended June 30, 2018
 
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
$
(19
)
 
$
(105
)
 
$
(124
)
Net change
(32
)
 
22

 
(10
)
Balance of AOCI at the end of period
$
(51
)
 
$
(83
)
 
$
(134
)
 
 
 
 
 
 
 
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
)
 
 
 
 
 
 
__________________________
(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 10 years from

29


the date of grant. At June 30, 2018, there were 117,366 shares of common stock available which may be awarded as options or restricted stock pursuant to future grant under the 2014 Equity Incentive Plan.

At both June 30, 2018 and 2017, there were no unvested restricted stock awards. There were no restricted stock grants awarded during the nine months ended June 30, 2018 and 2017.

Stock option activity for the nine months ended June 30, 2018 and 2017 is summarized as follows:
 
Nine Months Ended
June 30, 2018
 
Nine Months Ended
June 30, 2017
 
 Number of Shares

 
Weighted
Average
Exercise
Price

 
 Number of Shares

 
Weighted
Average
Exercise
Price

Options outstanding, beginning of period
380,120

 
$
13.23

 
373,130

 
$
9.82

Exercised
(34,850
)
 
8.39

 
(39,810
)
 
6.65

Forfeited
(5,150
)
 
13.39

 
(4,950
)
 
6.28

Options outstanding, end of period
340,120

 
$
13.73

 
328,370

 
$
10.26


The aggregate intrinsic value of options exercised during the nine months ended June 30, 2018 and 2017 was $741,000 and $545,000, respectively.

At June 30, 2018, there were 183,150 unvested options with an aggregate grant date fair value of $454,000, all of which the Company assumes will vest. The aggregate intrinsic value of unvested options at June 30, 2018 was $3.61 million.  There were 43,900 options with an aggregate grant date fair value of $104,000 that vested during the nine months ended June 30, 2018.

At June 30, 2017, there were 201,100 unvested options with an aggregate grant date fair value of $393,000. There were 48,600 options with an aggregate grant date fair value of $111,000 that vested during the nine months ended June 30, 2017.
 
 
Additional information regarding options outstanding at June 30, 2018 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
 
6,000

 
$
4.28

 
2.4
 
6,000

 
$
4.28

 
2.4
   5.86 - 6.00
 
30,300

 
5.96

 
4.3
 
30,300

 
5.96

 
4.3
   9.00
 
72,800

 
9.00

 
5.3
 
54,600

 
9.00

 
5.3
 10.26 - 10.71
 
121,320

 
10.58

 
6.8
 
57,470

 
10.54

 
6.7
 15.67
 
52,200

 
15.67

 
8.3
 
8,600

 
15.67

 
8.3
 29.69
 
57,500

 
29.69

 
9.3
 

 
N/A

 
NA
 
 
340,120

 
$
13.73

 
6.8
 
156,970

 
$
9.16

 
5.7

The aggregate intrinsic value of options outstanding at June 30, 2018 and 2017 was $8.03 million and $4.93 million, respectively.

As of June 30, 2018, unrecognized compensation cost related to non-vested stock options was $358,000, which is expected to be recognized over a weighted average life of 2.10 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:

30



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, 2018 and September 30, 2017. The Company's assets measured at estimated fair value on a recurring basis at June 30, 2018 and September 30, 2017 were as follows (dollars in thousands):
June 30, 2018
Estimated Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale investment securities
 
 
 
 
 
 
 
MBS: U.S. government agencies
$

 
$
252

 
$

 
$
252

Mutual funds
924

 

 

 
924

Total
$
924

 
$
252

 
$

 
$
1,176

September 30, 2017
Estimated Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Available for sale investment securities
 
 
 
 
 
 
 
MBS: U.S. government agencies
$

 
$
289

 
$

 
$
289

Mutual funds
952

 

 

 
952

Total
$
952

 
$
289

 
$

 
$
1,241


There were no transfers among Level 1, Level 2 and Level 3 during the nine months ended June 30, 2018 and the year ended September 30, 2017.

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 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,

31


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, 2018 (dollars in thousands):
 
Estimated Fair Value
 
Level 1
 
Level 2
 
Level 3
Impaired loans:
 
 
 
 
 
Consumer loans:
 
 
 
 
 
Home equity and second mortgage
$

 
$

 
$
78

Commercial business loans

 

 
113

Total impaired loans

 

 
191

Investment securities – held to maturity:
 

 
 

 
 

MBS - private label residential

 
1

 

 
 
 
 
 
 
OREO and other repossessed assets

 

 
2,112

Total
$

 
$
1

 
$
2,303


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, 2018 (dollars in thousands):
 
 Estimated
Fair Value
 
 Valuation
Technique(s)
 
 Unobservable Input(s)
 
 Range
Impaired loans
$
191

 
Market approach
 
Appraised value less selling costs
 
NA
 
 
 
 
 
 
 
 
OREO and other repossessed assets
$
2,112

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

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

 
$

 
$
1,880

Land

 

 
697

Consumer loans:
 

 
 

 
 

Home equity and second mortgage

 

 
109

Total impaired loans

 

 
2,686

Investment securities – held to maturity:
 

 
 

 
 

MBS - private label residential

 
125

 

OREO and other repossessed assets

 

 
3,301

Total
$

 
$
125

 
$
5,987



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, 2017 (dollars in thousands):
 
 Estimated
Fair Value
 
 Valuation
Technique(s)
 
 Unobservable Input(s)
 
 Range
Impaired loans
$
2,686

 
Market approach
 
Appraised value less selling costs
 
NA
 
 
 
 
 
 
 
 
OREO and other repossessed assets
$
3,301

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


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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, 2018 and September 30, 2017.  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 and 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 LLC. Shares in the fund 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 balance of its capital account at any quarter end with 60 days notice to the fund.

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.

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.

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.

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.


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The recorded amounts and estimated fair values of financial instruments were as follows as of June 30, 2018 and September 30, 2017 (dollars in thousands):
 
June 30, 2018
 
 
 
Fair Value Measurements Using:
 
Recorded
Amount
 
 Estimated Fair Value
 
 
Level 1
 
 
Level 2
 
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
156,826

 
$
156,826

 
$
156,826

 
$

 
$

CDs held for investment
63,132

 
63,132

 
63,132

 

 

Investment securities
9,127

 
9,616

 
3,862

 
5,754

 

FHLB stock
1,190

 
1,190

 
1,190

 

 

Other investments
3,000

 
3,000

 
3,000

 

 

Loans held for sale
2,321

 
2,366

 
2,366

 

 

Loans receivable, net
717,324

 
713,173

 

 

 
713,173

Accrued interest receivable
2,797

 
2,797

 
2,797

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 
 
 

Non-interest-bearing demand
229,201

 
229,201

 
229,201

 

 

Interest-bearing
651,526

 
650,884

 
510,536

 

 
140,348

Total deposits
880,727

 
880,085

 
739,737

 

 
140,348

Accrued interest payable
218

 
218

 
218

 

 

 
September 30, 2017
 
 
 
Fair Value Measurements Using:
 
Recorded
Amount
 
 Estimated Fair Value
 
 
Level 1
 
 
Level 2
 
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
148,188

 
$
148,188

 
$
148,188

 
$

 
$

CDs held for investment
43,034

 
43,034

 
43,034

 

 

Investment securities
8,380

 
8,985

 
3,954

 
5,031

 

FHLB stock
1,107

 
1,107

 
1,107

 

 

Other investments
3,000

 
3,000

 
3,000

 

 

Loans held for sale
3,599

 
3,619

 
3,619

 

 

Loans receivable, net
690,364

 
688,332

 

 

 
688,332

Accrued interest receivable
2,520

 
2,520

 
2,520

 

 

 
 
 
 
 
 
 
 
 
 
Financial liabilities
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 
 
 

Non-interest-bearing demand
205,952

 
205,952

 
205,952

 

 

Interest-bearing
631,946

 
632,629

 
492,305

 

 
140,324

Total deposits
837,898

 
838,581

 
698,257

 

 
140,324

Accrued interest payable
161

 
161

 
161

 

 


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

34


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 future 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. Management is in the planning stages of developing processes and procedures to comply with the disclosure requirements of this ASU, which could impact the disclosures the Company makes related to the fair value of its financial instruments; however, the adoption of ASU No. 2016-01 is not expected to have a material impact on the Company's future consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements. The principal change required by this ASU relates to lessee accounting, and is that for operating leases, a lessee is required to (1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position, (2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis, and (3) classify all cash payments within operating activities in the statement of cash flows. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. This ASU also changes disclosure requirements related to leasing activities and requires certain qualitative disclosures along with specific quantitative disclosures. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early application of the amendments in this ASU is permitted. The 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 non-cancelable 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 June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses. This ASU replaces the existing incurred losses methodology with a current expected 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 as 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 GAAP and expands disclosure requirements. ASU No. 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Upon adoption, the Company expects a change in the processes and procedures to calculate the allowance for loan losses, including changes in the assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. In addition, the current policy for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach. The Company is reviewing the requirements of ASU No. 2016-13 and has begun developing and implementing processes and procedures to ensure it is fully compliant with the amendments at the

35


adoption date. At this time, the Company anticipates the allowance for loan losses will increase as a result of the implementation of this ASU; however, until its evaluation is complete, the magnitude of the increase will be unknown.

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 of its assets and liabilities (including unrecognized assets and liabilities) at the impairment testing date 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 is 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 the 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 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.

In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This ASU was issued to expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. Previously, these awards were recorded at the fair value of consideration received or the fair value of the equity instruments issued and was measured at the earlier of the commitment date or the date performance was completed. The amendments in this ASU require nonemployee share-based payment awards to be measured at the grant-date fair value of the equity instrument. ASU No. 2018-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, but no earlier than an entity's adoption of Topic 606. The adoption of ASU No. 2018-07 is not expected to have a material impact on the Company's future consolidated financial statements.

(10) U.S. TAX REFORM

On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act significantly revises the future ongoing U.S. corporate income tax by, among other things, decreasing U.S. corporate income tax rate to 21.0% from 35.0%. As the Company has a September 30 fiscal year-end, the lower corporate income tax rate will be phased in, resulting in a blended U.S. statutory federal rate of approximately 24.5% for the Company's fiscal year ending September 30, 2018, and 21.0% for subsequent fiscal years. In addition, the reduction of the corporate tax rate required the Company to revalue its deferred tax assets and liabilities based on the lower federal tax rate of 21.0%.

As a result of the new legislation, during the quarter ended December 31, 2017, the Company recorded a one-time income tax expense of $548,000 in conjunction with writing down its net deferred tax assets. The impact of using the 24.5% blended federal tax rate for the nine months ended June 30, 2018 versus a 35.0% rate reduced the provision for income taxes by approximately $1.62 million, which was partially offset by the $548,000 one-time net deferred tax asset write-down.





36


(11) DEFINITIVE AGREEMENT

On May 23, 2018, the Company announced the signing of a definitive agreement and plan of merger (the "Agreement") with South Sound Bank, a Washington-state chartered bank, pursuant to which South Sound Bank will merge with and into Timberland Bank. Under the terms of the Agreement, based on 1,213,027 shares of South Sound Bank outstanding as of the date of the Agreement, South Sound Bank shareholders will receive 904,918 shares of the Company's common stock and $6.90 million in cash (fixed per share consideration of (i) 0.7460 of a share of the Company's common stock and (ii) $5.68825 in cash). The transaction is expected to close during the fourth calendar quarter of 2018, subject to approval by South Sound Bank shareholders, the receipt of all required regulatory approvals, and the satisfaction of customary closing conditions.


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, 2018.  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 expected cost savings, synergies and other financial benefits from our pending acquisition of South Sound Bank
(“merger”) might not be realized within the expected time frames or at all; governmental approval of the merger may not be obtained or adverse regulatory conditions may be imposed in connection with governmental approvals of the merger; conditions to the closing of the merger may not be satisfied; the shareholders of South Sound Bank may fail to approve the consummation of the merger; the integration of the combined company, including personnel changes/retention, might not proceed as planned; and the combined company might not perform as well as expected; 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; disruptions, security

37


breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; 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 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 10-Q and in the Company's other reports filed with or furnished to the Securities and Exchange Commission, including our 2017 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 2018 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, 2018, the Company had total assets of $1.01 billion and total shareholders’ equity of $120.89 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 any 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, 2018, 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 increased by net recoveries on investment securities and 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 expenses in certain periods are reduced by gains on the sale of premises and equipment and gains on the sale of OREO. 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.


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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.

On May 23, 2018, the Company announced the signing of a definitive merger agreement pursuant to which South Sound Bank will merge with and into Timberland Bank. The transaction is expected to close during the fourth calendar quarter of 2018, subject to approval by South Sound Bank shareholders, the receipt of all required regulatory approvals, and the satisfaction of customary closing conditions. South Sound Bank, a Washington-state chartered bank, operates two branch locations located in Lacey and Olympia, Washington. South Sound Bank reported $186.9 million in total assets at March 31, 2018. For additional information regarding the proposed transaction, see Note (11), Definitive Agreement.


Critical Accounting Policies and Estimates

The Company has identified several accounting policies that as a result of judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company’s Consolidated Financial Statements. Critical accounting policies and estimates are discussed in the Company’s 2017 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 2017 Form 10-K.

Comparison of Financial Condition at June 30, 2018 and September 30, 2017

The Company’s total assets increased by $54.36 million, or 5.7%, to $1.01 billion at June 30, 2018 from $952.02 million at September 30, 2017.  The increase in total assets was primarily due to an increase in net loans receivable, CDs held for investment and total cash and cash equivalents. The increase in total assets was funded primarily by an increase in total deposits.

Net loans receivable increased by $26.96 million, or 3.9%, to $717.32 million at June 30, 2018 from $690.36 million at September 30, 2017.  The increase was primarily due to increases in commercial real estate loans and construction loans. These increases to net loans receivable were partially offset primarily by decreases in one- to four-family loans.

Total deposits increased by $42.83 million, or 5.1%, to $880.73 million at June 30, 2018 from $837.90 million at September 30, 2017. The increase was a result of increases in non-interest bearing demand account balances, money market account balances, savings account balances, N.O.W. checking account balances and certificates of deposit account balances.
 
Shareholders’ equity increased by $9.89 million, or 8.9%, to $120.89 million at June 30, 2018 from $111.00 million at September 30, 2017.  The increase in shareholders' equity was primarily due to net income for the nine months ended June 30, 2018 and was partially offset by the payment of cash 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 $28.74 million, or 15.0%, to $219.96 million at June 30, 2018 from $191.22 million at September 30, 2017.  The increase was primarily due to a $20.10 million increase CDs held for investment and a $6.53 million increase in interest-bearing deposits in banks.

Investment Securities:  Investment securities increased by $747,000, or 8.9%, to $9.13 million at June 30, 2018 from $8.38 million at September 30, 2017. This increase was primarily due to the purchase of a $1.11 million U.S. government agency investment security, which was partially offset by 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.”


39


Other Investments: Other investments consist solely of the Company's investment in the Solomon Hess SBA Loan Fund LLC which was unchanged at $3.00 million at both June 30, 2018 and September 30, 2017. This investment is utilized to help satisfy compliance with the Bank's Community Reinvestment Act investment test requirements.

Loans: Net loans receivable increased by $26.96 million, or 3.9%, to $717.32 million at June 30, 2018 from $690.36 million at September 30, 2017.  The increase in the portfolio was primarily a result of a $16.74 million decrease in the amount of undisbursed construction loans in process, a $16.62 million increase in commercial real estate loans, a $6.72 million increase in commercial construction loans, a $3.19 million increase in land development loans, and smaller increases in other categories. These increases were partially offset by a $6.10 million decrease in multi-family construction loans, a $4.17 million decrease in custom and owner/building construction loans, a $4.00 million decrease in one-to four-family mortgage loans, a $1.16 million decrease in commercial business loans and smaller decreases in other categories.

Loan originations decreased by $30.61 million, or 11.7%, to $231.97 million for the nine months ended June 30, 2018 from $262.58 million for the nine months ended June 30, 2017.  The Company continued to sell longer-term fixed rate one- to four-family mortgage loans for asset liability management purposes and to generate non-interest income. 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 decreased by $7.58 million, or 13.4%, to $48.96 million for the nine months ended June 30, 2018 compared to $56.54 million for the nine months ended June 30, 2017.

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 $97,000, or 0.5%, to $18.52 million at June 30, 2018 from $18.42 million at September 30, 2017.  The increase was primarily due the purchase of a building that will be used as the Company's data center facility in the future, which was partially offset by the sale of excess land and normal depreciation.

OREO (Other Real Estate Owned): OREO and other repossessed assets decreased by $1.19 million, or 36.0%, to $2.11 million at June 30, 2018 from $3.30 million at September 30, 2017. The decrease was primarily due to the disposition of four OREO properties and one recreational vehicle.  At June 30, 2018, total OREO and other repossessed assets consisted of 13 individual real estate properties. The properties consisted of 11 land parcels totaling $1.66 million and two commercial real estate properties with a carrying value of $448,000.

Goodwill:  The recorded amount of goodwill of $5.65 million at June 30, 2018 was unchanged from September 30, 2017.  

Deposits: Deposits increased by $42.83 million, or 5.1%, to $880.73 million at June 30, 2018 from $837.90 million at September 30, 2017. This increase was primarily due to a $23.25 million increase in non-interest bearing demand account balances, an $8.64 million increase in money market account balances, a $7.70 million increase in savings account balances, a $1.89 million increase in N.O.W. checking account balances and a $1.35 million increase in certificates of deposit account balances.

Deposits consisted of the following at June 30, 2018 and September 30, 2017 (dollars in thousands):
 
June 30, 2018
 
September 30, 2017
 
Amount
 
Percent
 
Amount
 
Percent
Non-interest-bearing demand
$
229,201

 
26.0
%
 
$
205,952

 
24.5
%
N.O.W. checking
222,203

 
25.2
%
 
220,315

 
26.3
%
Savings
148,690

 
16.9
%
 
140,987

 
16.8
%
Money market
129,559

 
14.7
%
 
122,877

 
14.7
%
Money market - brokered
10,084

 
1.1
%
 
8,125

 
1.0
%
Certificates of deposit under $250
120,156

 
13.7
%
 
120,844

 
14.4
%
Certificates of deposit $250 and over
17,637

 
2.0
%
 
15,601

 
1.9
%
Certificates of deposit - brokered
3,197

 
0.4
%
 
3,197

 
0.4
%
Total
$
880,727

 
100.0
%
 
$
837,898

 
100.0
%


Shareholders’ Equity:  Total shareholders’ equity increased by $9.89 million, or 8.9%, to $120.89 million at June 30, 2018 from $111.00 million at September 30, 2017.  The increase was primarily due to net income of $12.30 million for the nine

40


months ended June 30, 2018, which was partially offset by the payment of $3.47 million in cash 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, 2018.

Asset Quality: The non-performing assets to total assets ratio improved to 0.56% at June 30, 2018 from 0.60% at September 30, 2017 as total non-performing assets decreased by $66,000, or 1.1%, to $5.68 million at June 30, 2018 from $5.75 million at September 30, 2017. The decrease was primarily due to a $1.19 million decrease in OREO and other repossessed assets, which was partially offset by a $795,000 increase in non-accrual loans which is primarily a result of two one- to four-family loans becoming delinquent and a $428,000 increase in accruing loans which are contractually past due 90 days or more.

TDRs on accrual status (which are not included in the non-performing asset totals) decreased by $382,000, or 11.4%, to $2.96 million at June 30, 2018 from $3.34 million at September 30, 2017.


41


The following table sets forth information with respect to the Company’s non-performing assets at June 30, 2018 and September 30, 2017 (dollars in thousands):
 
June 30,
2018

 
September 30,
2017

Loans accounted for on a non-accrual basis:
 
 
 
Mortgage loans:
 
 
 
    One- to four-family (1)
$
1,361

 
$
874

    Commercial
598

 
213

    Land
295

 
566

Consumer loans:
 

 
 

    Home equity and second mortgage
278

 
258

Commercial business loans
174

 

       Total loans accounted for on a non-accrual basis
2,706

 
1,911

 
 
 
 
Accruing loans which are contractually
past due 90 days or more
428

 

 
 
 
 
Total of non-accrual and 90 days past due loans
3,134

 
1,911

 
 
 
 
Non-accrual investment securities
433

 
533

 
 
 
 
OREO and other repossessed assets, net (2)
2,112

 
3,301

       Total non-performing assets (3)
$
5,679

 
$
5,745

 
 
 
 
TDRs on accrual status (4)
$
2,960

 
$
3,342

 
 
 
 
Non-accrual and 90 days or more past due loans as a percentage of loans receivable
0.43
%
 
0.27
%
 
 
 
 
Non-accrual and 90 days or more past due loans as a percentage of total assets
0.31
%
 
0.20
%
 
 
 
 
Non-performing assets as a percentage of total assets
0.56
%
 
0.60
%
 
 
 
 
Loans receivable (5)
$
726,856

 
$
699,917

 
 
 
 
Total assets
$
1,006,383

 
$
952,024

___________________________________
(1) As of June 30, 2018 and September 30, 2017, the balance of non-accrual one- to-four family properties included $15 and $100, respectively, in the process of foreclosure.
(2) As of June 30, 2018 and September 30, 2017, the balance of OREO included $0 and $875, respectively, of foreclosed residential real estate property recorded as a result of obtaining physical possession of the property.
(3) Does not include TDRs on accrual status.
(4) Does not include TDRs totaling $155 and $253 reported as non-accrual loans at June 30, 2018 and September 30, 2017, 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, 2018 and 2017

Net income increased by $139,000, or 3.2%, to $4.42 million for the quarter ended June 30, 2018 from $4.28 million for the quarter ended June 30, 2017. Net income per diluted common share increased $0.01, or 1.7%, to $0.59 for the quarter ended June 30, 2018 from $0.58 for the quarter ended June 30, 2017.


42


Net income increased by $1.75 million, or 16.6%, to $12.30 million for the nine months ended June 30, 2018 from $10.55 million for the nine months ended June 30, 2017. Net income per diluted common share increased $0.20, or 13.9%, to $1.64 for the nine months ended June 30, 2018 from $1.44 for the nine months ended June 30, 2017.

The increase in net income for the three months ended June 30, 2018 was primarily due to an increase in net interest income and a decrease in the Company's effective income tax rate. These increases to net income were partially offset by a decrease in the recapture of loan losses and an increase in non-interest expense. The increase in net income for the nine months ended June 30, 2018 was primarily due to increases in net interest income and non-interest income and a decrease in the Company's effective income tax rate. These increases to net income were partially offset by a decrease in the recapture of loan losses and 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 $480,000, or 5.2%, to $9.73 million for the quarter ended June 30, 2018 from $9.25 million for the quarter ended June 30, 2017. The increase in net interest income was due to an increase in interest income and a decrease in interest expense. 

Total interest and dividend income increased by $292,000, or 2.9%, to $10.46 million for the quarter ended June 30, 2018 from $10.17 million for the quarter ended June 30, 2017, primarily due to an increase the average balance of interest-earning assets, which was partially offset by a decrease in the average yield earned on interest-earning assets. Average total interest-earning assets increased by $67.39 million, or 7.8%, to $930.31 million for the quarter ended June 30, 2018 from $862.92 million for the quarter ended June 30, 2017. Average loans receivable increased by $33.88 million, or 4.9%, and average interest-earning deposits in banks and CDs increased by $32.61 million, or 20.8%, between the periods. The average yield on interest-earning assets decreased to 4.50% for the quarter ended June 30, 2018 from 4.71% for the quarter ended June 30, 2017, primarily due to a decrease in the amount of non-accrual interest and loan pre-payment penalties collected. During the quarter ended June 30, 2018, a total of $10,000 in non-accrual interest and loan pre-payment penalties was collected compared to $819,000 for the quarter ended June 30, 2017. Partially offsetting the decrease in the average yield on loans receivable, was an increase in the average yield on interest-earning deposits in banks and CDs to 1.79% from 1.08%, primarily due to increases in the Fed Funds target rate. Total interest expense decreased by $188,000, or 20.5%, to $730,000 for the quarter ended June 30, 2018 from $918,000 for the quarter ended June 30, 2017. The decrease in interest expense was primarily due to a $369,000 decrease in interest expense on FHLB borrowings, as the Company repaid all of its FHLB borrowings during the quarter ended June 30, 2017. The decrease in interest expense on FHLB borrowings was partially offset by a $181,000 increase in interest expense on deposits as both the average balance and average cost of interest-bearing deposits increased during the quarter ended June 30, 2018 compared to the quarter ended June 30, 2017. The average cost of interest-bearing liabilities decreased to 0.45% for the quarter ended June 30, 2018 from 0.59% for the quarter ended June 30, 2017. The net interest margin ("NIM") decreased to 4.18% for the quarter ended June 30, 2018 from 4.29% for the quarter ended June 30, 2017, however, the NIM for the quarter ended June 30, 2017 was increased approximately 22 basis points due to the net effect of collecting $748,000 of non-accrual interest and paying $282,000 in FHLB borrowings prepayment penalties.

Net interest income increased by $2.77 million, or 10.7%, to $28.79 million for the nine months ended June 30, 2018 from $26.01 million for the nine months ended June 30, 2017. The increase in net interest income was due to an increase in interest income and a decrease in interest expense. 

Total interest and dividend income increased by $2.15 million, or 7.5%, to $30.78 million for the nine months ended June 30, 2018 from $28.63 million for the nine months ended June 30, 2017, primarily due to increases in both the average balance and average yield earned on interest-earning assets. Average total interest-earning assets increased by $55.67 million, or 6.5%, to $916.51 million for the nine months ended June 30, 2018 from $860.84 million for the nine months ended June 30, 2017. Average loans receivable increased by $29.16 million, or 4.2%, and average interest-earning deposits in banks and CDs increased by $24.95 million, or 15.5%, between periods. The average yield on interest-earning assets increased to 4.48% for the nine months ended June 30, 2018 from 4.43% for the nine months ended June 30, 2017, primarily due to increases in short-term interest rates by the Federal Reserve. Partially offsetting the increase in the average yield on interest-earnings assets was a decrease in the amount of non-accrual interest and loan pre-payment penalties collected during the current period. During the nine months ended June 30, 2018, a total of $291,000 in non-accrual interest and loan pre-payment penalties was collected compared to $1.07 million for the nine months ended June 30, 2017. Total interest expense decreased by $620,000, or 23.7%, to $2.00 million for the nine months ended June 30, 2018 from $2.62 million for the nine months ended June 30, 2017. The decrease in interest expense was primarily due to a $979,000 decrease in interest expense on FHLB borrowings, as the Company repaid all of its FHLB borrowings during the quarter ended June 30, 2017. The decrease in interest expense on FHLB borrowings was partially offset by a $359,000 increase in interest expense on deposits as both the average balance and average cost of interest-bearing deposits increased during the nine months ended June 30, 2018 compared to the nine months ended June 30, 2017. The average cost of interest-bearing liabilities decreased to 0.42% for the nine months ended June 30,

43


2018 from 0.55% for the nine months ended June 30, 2017. As a result of these the changes, the NIM increased to 4.19% for the nine months ended June 30, 2018 from 4.03% for the nine months ended June 30, 2017.

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,
 
2018
 
2017
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable (1)(2)
$
727,807

 
$
9,530

 
5.24
%
 
$
693,931

 
$
9,652

 
5.58
%
Investment securities (2)
8,277

 
51

 
2.46

 
7,610

 
69

 
3.63

Dividends from mutual funds, FHLB stock and other investments
5,101

 
31

 
2.43

 
4,872

 
23

 
1.89

Interest-earning deposits in banks and CDs
189,120

 
845

 
1.79

 
156,507

 
421

 
1.08

Total interest-earning assets
930,305

 
10,457

 
4.50

 
862,920

 
10,165

 
4.71

Non-interest-earning assets
60,395

 
 

 
 

 
57,841

 
 

 
 

     Total assets
$
990,700

 
 

 
 

 
$
920,761

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Savings
$
147,881

 
22

 
0.06

 
$
137,108

 
20

 
0.06

Money market
142,557

 
202

 
0.57

 
125,787

 
110

 
0.35

N.O.W. checking
214,256

 
110

 
0.21

 
207,060

 
113

 
0.22

Certificates of deposit
142,285

 
396

 
1.12

 
141,254

 
306

 
0.87

Long-term borrowings (3)

 

 

 
8,571

 
369

 
17.27

Total interest-bearing liabilities
646,979

 
730

 
0.45

 
619,780

 
918

 
0.59

Non-interest-bearing deposits
220,511

 
 
 
 
 
190,631

 
 
 
 
Other liabilities
4,456

 
 

 
 

 
4,379

 
 

 
 

Total liabilities
871,946

 
 

 
 

 
814,790

 
 

 
 

Shareholders' equity
118,754

 
 

 
 

 
105,971

 
 

 
 

Total liabilities and
 
 
 

 
 

 
 
 
 

 
 

shareholders' equity
$
990,700

 
 
 
 
 
$
920,761

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
9,727

 
 
 
 

 
$
9,247

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread
 
 
 
 
4.05
%
 
 

 
 

 
4.12
%
Net interest margin (4)
 
 
 
 
4.18
%
 
 

 
 

 
4.29
%
Ratio of average interest-earning
   assets to average interest-bearing
   liabilities
 
 
 
 
142.88
%
 
 

 
 

 
139.23
%

44


 
Nine Months Ended June 30,
 
2018
 
2017
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
 
Average
Balance
 
Interest and
Dividends
 
Yield/
Cost
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable (1)(2)
$
718,099

 
$
28,342

 
5.26
%
 
$
688,936

 
$
27,280

 
5.29
%
Investment securities (2)
7,936

 
147

 
2.47

 
7,717

 
207

 
3.58

Dividends from mutual funds, FHLB stock and other investments
5,067

 
83

 
2.18

 
3,730

 
60

 
2.15

Interest-earning deposits in banks and CDs
185,405

 
2,209

 
1.59

 
160,458

 
1,081

 
0.90

Total interest-earning assets
916,507

 
30,781

 
4.48

 
860,841

 
28,628

 
4.43

Non-interest-earning assets
59,704

 
 

 
 

 
58,324

 
 

 
 

     Total assets
$
976,211

 
 

 
 

 
$
919,165

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Savings
$
144,191

 
63

 
0.06

 
$
132,922

 
57

 
0.06

Money market
140,186

 
520

 
0.50

 
124,650

 
314

 
0.34

N.O.W. checking
214,828

 
334

 
0.21

 
206,037

 
346

 
0.22

Certificates of deposit
140,194

 
1,079

 
1.03

 
144,249

 
920

 
0.85

Long-term borrowings (3)

 

 

 
22,857

 
979

 
5.73

Total interest-bearing liabilities
639,399

 
1,996

 
0.42

 
630,715

 
2,616

 
0.55

Non-interest-bearing deposits
217,388

 
 
 
 
 
182,117

 
 
 
 
Other liabilities
3,997

 
 

 
 

 
4,368

 
 

 
 

Total liabilities
860,784

 
 

 
 

 
817,200

 
 

 
 

Shareholders' equity
115,427

 
 

 
 

 
101,965

 
 

 
 

Total liabilities and
 
 
 

 
 

 
 
 
 

 
 

shareholders' equity
$
976,211

 
 

 
 

 
$
919,165

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
 
$
28,785

 
 

 
 

 
$
26,012

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest rate spread
 

 
 

 
4.06
%
 
 

 
 

 
3.88
%
Net interest margin (4)
 

 
 

 
4.19
%
 
 

 
 

 
4.03
%
Ratio of average interest-earning
   assets to average interest-bearing
   liabilities
 

 
 

 
143.34
%
 
 

 
 

 
136.49
%
 
 
 
 
 
 
 
 
 
 
 
 
_______________
(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.
(4)
Net interest income divided by total average interest-earning assets, annualized.

45


Rate Volume Analysis
The following table sets forth the effects of changing rates and volumes on the net interest income of the Company.   Information is provided with respect to the (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate), (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) the net change (sum of the prior columns).  Changes in rate/volume have been allocated to rate and volume variances based on the absolute values of each (in thousands):
 
Three months ended June 30, 2018
compared to three months
ended June 30, 2017
increase (decrease) due to
 
Nine months ended June 30, 2018
compared to nine months
ended June 30, 2017
increase (decrease) due to
 
Rate
 
Volume
 
Net
Change
 
Rate
 
Volume
 
Net
Change
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans receivable and loans held for sale
$
(581
)
 
$
459

 
$
(122
)
 
$
39

 
$
1,023

 
$
1,062

Investment securities
(24
)
 
6

 
(18
)
 
(57
)
 
(3
)
 
(60
)
Dividends from mutual funds, FHLB stock and other investments
7

 
1

 
8

 
1

 
22

 
23

  Interest-earning deposits
322

 
102

 
424

 
939

 
189

 
1,128

Total net increase in income on interest-earning assets
(276
)
 
568

 
292

 
922

 
1,231

 
2,153

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 
 
 
 
 
Savings

 
2

 
2

 
1

 
5

 
6

Money market
75

 
17

 
92

 
148

 
58

 
206

N.O.W. checking
(7
)
 
4

 
(3
)
 
(12
)
 

 
(12
)
Certificates of deposit
88

 
2

 
90

 
147

 
12

 
159

   Long term FHLB borrowings
(184
)
 
(185
)
 
(369
)
 
(392
)
 
(587
)
 
(979
)
Total net decrease in expense on interest-bearing liabilities
(28
)
 
(160
)
 
(188
)
 
(108
)
 
(512
)
 
(620
)
 
 
 
 
 
 
 
 
 
 
 
 
Net increase in net interest income
$
(248
)
 
$
728

 
$
480

 
$
1,030

 
$
1,743

 
$
2,773


Provision for Loan Losses:  There was no provision for (recapture of) loan losses for the quarter ended June 30, 2018 compared to a $1.0 million recapture of loan losses for the quarter ended June 30, 2017. The recapture of loan losses during quarter ended June 30, 2017 was primarily due to net recoveries and overall improvements in other credit quality metrics. For the quarter ended June 30, 2018 there were net charge-offs of $12,000 compared to net charge-offs of $21,000 for the quarter ended March 31, 2018 and net recoveries of $1.02 million for the quarter ended June 30, 2017. Non-accrual loans increased by $795,000, or 41.6%, to $2.71 million at June 30, 2018, from $1.91 million at September 30, 2017 and increased by $651,000, or 31.6%, from $2.06 million at June 30, 2017. Total delinquent loans (past due 30 days or more) and non-accrual loans increased by $1.02 million or 42.0%, to $3.43 million at June 30, 2018, from $2.41 million at September 30, 2017 and increased by $985,000, or 40.4%, from $2.44 million one year ago. 

For the nine months ended June 30, 2018 there was no provision for (recapture of) loan losses compared to a $1.25 million recapture of loan losses for the nine months ended June 30, 2017. Net charge-offs for the nine months ended June 30, 2018 were $21,000 compared to net recoveries of $1.03 million for the nine months ended June 30, 2017.

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.  These 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. 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, 2018 was $358,000 compared to $476,000 at September 30, 2017 and $429,000 at June 30, 2017


46


Based on its comprehensive analysis, management believes the allowance for loan losses of $9.53 million at June 30, 2018 (1.31% of loans receivable and 304.1% 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.  The allowance for loan losses was $9.55 million (1.36% of loans receivable and 499.9% of non-performing loans) at September 30, 2017 and $9.61 mil1ion (1.38% of loans receivable and 467.6% of non-performing loans) at June 30, 2017. While the Company believes it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that bank regulators, in reviewing the Company's loan portfolio, will not request the Company to increase significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that a substantial increase will not be necessary should the quality of any loans deteriorate. Any material increase in the allowance for loan losses would adversely affect the Company's financial condition and results of operations. For additional information, see Note 4 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”

Non-interest Income: Total non-interest income decreased slightly by $11,000, or 0.3%, to $3.15 million for the quarter ended June 30, 2018 from $3.16 million for the quarter ended June 30, 2017. The decrease in non-interest income was primarily due to a $126,000 decrease in gain on sales of loans, which was partially offset by a $66,000 increase in ATM and debit card interchange transaction fees and smaller increases in several other categories. The decrease in gain on sales of loans was primarily due to a decrease in the dollar volume of fixed-rate one- to four-family loans sold during the quarter. The increase in ATM and debit card interchange transaction fees was primarily due to an increase in the volume of debit card transactions.

Total non-interest income increased by $140,000 or 1.5%, to $9.36 million for the nine months ended June 30, 2018 from $9.22 million for the nine months ended June 30, 2017. The increase in non-interest income was primarily due to a $200,000 increase in ATM and debit card interchange transaction fees, a $99,000 increase in services charges on deposits and smaller increases in in several other categories. These increases were partially offset by a $229,000 decrease in gains on sales of loans, net and smaller decreases in several other categories. The increase in ATM and debit card interchange transaction fees was primarily due to an increase in the volume of debit card transactions. 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 decrease in gain on sale of loans was primarily due to a decrease in the dollar volume of fixed-rate one- to four-family loans sold during the nine months ended June 30, 2018.

Non-interest Expense:  Total non-interest expense increased by $184,000, or 2.7%, to $7.12 million for the quarter ended June 30, 2018 from $6.94 million for the quarter ended June 30, 2017.  The increased expense was primarily due to a $171,000 increase in salaries and employee benefits expense, a $138,000 increase in professional fees and smaller increases in several other categories. These increases were partially offset by a $96,000 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. The increase in professional fees was primarily due to $147,000 in merger related expenses associated with the Company's announced acquisition of South Sound Bank. The decrease in OREO and other repossessed assets expense was primarily due to a $124,000 gain on the sale of an OREO property during the current quarter.

Total non-interest expense increased by $913,000, or 4.4%, to $21.52 million for the nine months ended June 30, 2018 from $20.61 million for the nine months ended June 30, 2017. The increased expense was primarily due to a $686,000 increase in salaries and employee benefits expense, a $200,000 increase in professional fees and smaller increases in several other categories. These increases were partially offset by a $113,000 gain on disposition of premises and equipment, net and smaller decreases in several other categories.

The efficiency ratio for the current quarter improved to 55.33% from 55.94% for the comparable quarter one year ago. The efficiency ratio for the nine months ended June 30, 2018 improved to 56.41% from 58.48% for the nine months ended June 30, 2017 as increases in revenue outpaced the increase in non-interest expense.

Provision for Income Taxes: The provision for income taxes decreased by $854,000, or 39.0%, to $1.33 million for the quarter ended June 30, 2018 from $2.19 million for the quarter ended June 30, 2017, and decreased by $997,000, or 18.7%, to $4.33 million for the nine months ended June 30, 2018 from $5.33 million for the nine months ended June 30, 2017. The decrease in the provision for income taxes was primarily due to a lower effective federal corporate income tax rate as a result of the Tax Act that was enacted on December 22, 2017. As a result of the Tax Act (which decreases the federal corporate income tax rate to 21.0% from 35.0%), the Company recorded a one-time income tax expense of $548,000 in conjunction with writing down its net deferred tax assets during the quarter ended December 31, 2017 and began using a blended federal tax rate of 24.5% for the fiscal year ending September 30, 2018. Since the Company is a September 30th fiscal year-end corporation, it

47


will use a blended federal tax rate of 24.5% to calculate income tax expense for the fiscal year ending September 30, 2018 and then use a 21.0% tax rate thereafter. The Company's effective tax rate was 23.20% for the quarter ended June 30, 2018 and 33.84% for the quarter ended June 30, 2017. The Company's effective tax rate was 26.04% for the nine months ended June 30, 2018 and 33.55% for the nine months ended June 30, 2017.

For additional information, see Note 10 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.”


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 and FHLB borrowings (if needed).  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, 2018, 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 24.98%.

The Company’s total cash and cash equivalents and CDs held for investment increased by $28.74 million, or 15.0%, to $219.96 million at June 30, 2018 from $191.22 million at September 30, 2017. 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, 2018, 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 $19.00 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, 2018, the Bank had $19.00 million pledged under the LOC, which left $281.80 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, 2018, the Bank had $71.35 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, 2018, 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, 2018, the Bank had loan commitments totaling $75.32 million and undisbursed construction loans in process totaling $65.67 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, 2018 totaled 73.36 million.  Historically, the Bank has been able to retain a significant amount of its non-brokered CDs as they mature.  At June 30, 2018, the Bank had $3.20 million in brokered CDs.

Capital Resources

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

Based on its capital levels at June 30, 2018, 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, 2018, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status.

48



The following table compares the Bank’s actual capital amounts at June 30, 2018 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

$113,394

 
11.53
%
 

$39,351

 
4.00
%
 

$49,189

 
5.00
%
 
 
 
 
 
 
 
 
 
 
 
 
Risk-based Capital Ratios:
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 capital
113,394

 
16.56

 
30,817

 
4.50

 
44,513

 
6.50

 
 
 
 
 
 
 
 
 
 
 
 
Tier 1 capital
113,394

 
16.56

 
41,089

 
6.00

 
54,785

 
8.00

 
 
 
 
 
 
 
 
 
 
 
 
Total capital
121,968

 
17.81

 
54,785

 
8.00

 
68,481

 
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 to an amount more than 0.625% of risk-weighted assets and increases each year until fully implemented to an amount more than 2.5% of risk weighted assets in January 2019. At June 30, 2018, the conservation buffer was an amount more than 1.875%.

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 (as of June 30th of the preceding year), 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, 2018, 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, 2018 (dollars in thousands):
 
Actual
 
Amount
 
Ratio
 
 
 
 
Leverage Capital Ratio:
 
 
 
Tier 1 capital

$116,401

 
11.80
%
 
 
 
 
Risk-based Capital Ratios:
 
 
 
Common equity tier 1 capital
116,401

 
16.98

 
 
 
 
Tier 1 capital
116,401

 
16.98

 

 

Total capital
124,982

 
18.24



49


Key Financial Ratios and Data
(Dollars in thousands, except per share data)
 
Three Months Ended June 30,
 
Nine Months Ended
June 30,
 
2018

 
2017

 
2018

 
2017

PERFORMANCE RATIOS:
 
 
 
 
 
 
 
Return on average assets
1.78
%
 
1.86
%
 
1.68
%
 
1.53
%
Return on average equity
14.87
%
 
16.14
%
 
14.21
%
 
13.80
%
Net interest margin
4.18
%
 
4.29
%
 
4.19
%
 
4.03
%
Efficiency ratio
55.33
%
 
55.94
%
 
56.41
%
 
58.48
%

Item 3.  Quantitative and Qualitative Disclosures About Market Risk
There were no material changes in information concerning market risk from the information provided in the Company’s Form 10-K for the fiscal year ended September 30, 2017.

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, 2018 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, 2018, 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
2017 Form 10-K.


50


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

(a)    Not applicable

(b)    Not applicable

(c)    Stock Repurchases

There were no shares repurchased by the Company during the quarter ended June 30, 2018. On July 28, 2015 the Company announced a plan to repurchase 352,681 shares of the Company's common stock. As of June 30, 2018, 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
 
2.1
 
3.1
 
3.3
 
10.1
 
10.2
 
10.4
 
10.5
 
10.6
 
10.8
 
10.9
 
10.10
 
31.1
 
31.2
 
32
 
101
The following materials from Timberland Bancorp Inc's Quarterly Report 10-Q for the quarter ended June 30, 2018, 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 Current Report on Form 8-K filed on May 23, 2018.
(2)
Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (333-35817).
(3)
Incorporated by reference to the Registrant's Current Report on Form 8-K filed on June 1, 2017.
(4)
Incorporated by reference to the Registrant's Current Report on Form 8-K filed on April 16, 2007.
(5)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997.
(6)
Incorporated by reference to the Registrant’s 2004 Annual Meeting Proxy Statement dated December 24, 2003.

51


(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.

52


SIGNATURES

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

 
 
Timberland Bancorp, Inc. 
 
 
 
 
Date: August 6, 2018
By:  /s/ Michael R. Sand                                   
 
Michael R. Sand 
 
Chief Executive Officer 
 
(Principal Executive Officer) 
 
 
 
 
Date: August 6, 2018
By:  /s/ Dean J. Brydon                                    
 
Dean J. Brydon 
 
Chief Financial Officer
 
(Principal Financial Officer)

53


EXHIBIT INDEX
 

 
Exhibit No. 
Description of Exhibit 
 
 
31.1
31.2
32
101
The following materials from Timberland Bancorp Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2018, formatted on Extensible Business Reporting Language (XBRL) (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Unaudited Consolidated Financial Statements





54