Hoquiam 624 Simpson Ave.Hoquiam, WA 98550(360) 533-4747Ocean Shores 361 Damon Rd. Ocean Shores, WA 98569(360) 289-2476Downtown Aberdeen 117 N. Broadway Aberdeen, WA 98520(360) 533-4500South Aberdeen 300 N. Boone St. Aberdeen, WA 98520(360) 533-6440Montesano 210 S. Main St.Montesano, WA 98563(360) 249-4021Elma313 W. Waldrip Elma, WA 98541(360) 482-3333Toledo101 Ramsey WayToledo, WA 98591(360) 864-6102Winlock209 NE 1st St. Winlock, WA 98596(360) 785-3552Chehalis714 W. Main St.Chehalis, WA 98532(360) 740-0770Tumwater 801 Trosper Rd. SW Tumwater, WA 98512(360) 705-2863 Olympia423 Washington St. SEOlympia, WA 98501(360) 943-5496 Panorama1751 Circle Lane SELacey, WA 98503(360) 413-3891Lacey1201 Marvin Rd. NELacey, WA 98516(360) 438-1400Yelm 101 Yelm Ave. W.Yelm, WA 98597(360) 458-2221Bethel Station2419 224th St. E.Spanaway, WA 98387(253) 875-4250Puyallup (South Hill)12814 Meridian E.Puyallup, WA 98373(253) 841-4980Edgewood (North Hill)2418 Meridian E. Edgewood, WA 98371(253) 845-0999Auburn202 Auburn Way S.Auburn, WA 98002(253) 804-6177Tacoma 7805 S. Hosmer St. Tacoma, WA 98408(253) 472-4465Gig Harbor 3105 Judson St.Gig Harbor, WA 98335 (253) 851-1188Silverdale2401 NW Bucklin Hill Rd.Silverdale, WA 98383(360) 337-7727Poulsbo 20464 Viking Way NWPoulsbo, WA 98370 (360) 598-5801www.timberlandbank.comFutureHERE2017 Annual ReportPLANT YOUR Gig Harbor
Aberdeen
(2 branches)
Lewis
Winlock
Toledo
Elma
Lacey
(2 branches)
Chehalis
Dear Fellow Shareholders of Timberland Bancorp, Inc.:
On behalf of the Directors and Employees of Timberland Bancorp, Inc. and its subsidiary, Timberland
Bank, it is my privilege to invite you to attend the annual meeting for our fiscal year ended
September 30, 2017. The meeting will be convened on January 23, 2018 at the Hoquiam Grand
Central building located at 427 7th Street in Hoquiam, Washington. The meeting will begin
promptly at 1:00 p.m. During the meeting we will review the Company’s operating results for the
recently concluded fiscal year, conduct an election of Directors, vote on other matters described in
the proxy statement and respond to questions from the meeting’s attendees.
Please review the contents of the attached Form 10-K prior to the meeting to acquaint yourself with
the Company’s financial performance for its 2017 fiscal year. A portion of the year’s financial
highlights are noted below.
Fiscal year 2017 marked the 7th consecutive year the Company increased earnings per share, return
on equity, return on assets and net income. The continued improvement in the Company’s financial
results was due in large part to maintaining pricing discipline while growing revenues and carefully
managing expenses. We have also continued to position the Company to benefit from rising interest rates which we believe is the most
probable outcome of the numerous Federal Reserve meetings to be convened during the remainder of our 2018 fiscal year.
Michael R. Sand
I am pleased to report that Timberland’s shareholders were rewarded by a significant increase in the Company’s share price during the
recently concluded fiscal year – an increase which contributed to a rise in the Company’s market capitalization to a level comfortably
sufficient to qualify Timberland for addition to the Russell 2000 and 3000 indexes. Timberland’s addition to these indexes increased the
market visibility of the Company and significantly increased its average daily trading volume.
In terms of the Company’s fiscal 2017 financial performance I can also report to you that it was a year of growth, record net income and
significant improvements in numerous financial metrics. Compared to our 2016 fiscal year we achieved the following:
• Increased net income 40% to $14.17 million
• Increased earnings per diluted share 34% to $1.92
• Increased return on equity 24% to 13.65% from 11.00%
• Increased return on assets 29% to 1.53% from 1.19%
• increased net interest margin to 4.07% from 3.88%
• Improved the efficiency ratio to 57.92% from 63.89%
The increases in these financial metrics were primarily the result of the Company:
• Increasing net interest income by 14%
• Increasing non-interest income by 14%
• Managing the increase in non-interest expenses to approximately 3%
• Growing the Company to $952 million in assets
• Decreasing non-performing assets by 27% to 0.60% of total assets
During the fiscal year the Company’s book value per share increased 8% to $15.08 and tangible book value per share increased 9% to
$14.31.
We continue to operate with a seasoned and capable staff, of whom I am exceedingly proud, in a growing and vibrant Pacific Northwest
economy where we continue to see significant current and future opportunities. Thank you for participating as a shareholder in the
success of our Company. Please make plans to attend our annual meeting at the Hoquiam Grand Central building across 7th Street from
the Hoquiam Timberland Regional Library. We look forward to visiting with you there and wish you the best this holiday season.
Sincerely,
Michael R. Sand
President and CEO
FINANCIAL HIGHLIGHTS
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
The following table presents selected financial information concerning the consolidated financial position and results of operations of
Timberland Bancorp, Inc. ("Company") at and for the dates indicated. The consolidated data is derived in part from, and should be
read in conjunction with, the Consolidated Financial Statements of the Company and its subsidiary presented herein. (Dollars in
thousands except share data)
Total Assets
$952,024
$891,388
$815,815
2017
2016
2015
Loans Receivable, Net
$690,364
$663,146
$604,277
2017
2016
2015
SELECTED FINANCIAL DATA
Total Assets
Loans Receivable, Net
Total Deposits
Shareholders’ Equity
September 30,
2017
2016
2015
$ 952,024
690,364
837,898
111,000
$ 891,388
663,146
761,534
96,834
$ 815,815
604,277
678,912
89,187
OPERATING DATA
Interest and Dividend Income
Interest Expense
Net Interest Income
Recapture of Loan Losses
Net Interest Income after Recapture of Loan Losses
Non-Interest Income
Non-Interest Expense
Income before Income Taxes
Provision for Income Taxes
Net Income
$ 38,338
3,197
35,141
(1,250)
36,391
12,368
27,516
21,243
7,076
$ 34,875
4,072
30,803
–
30,803
10,889
26,637
15,055
4,901
$
31,168
3,890
27,278
(1,525)
28,803
9,522
25,841
12,484
4,192
$ 14,167
$ 10,154
$
8,292
Total Deposits
$837,898
$761,534
$678,912
NET INCOME PER COMMON SHARE
Basic
Diluted
$
1.99
1.92
$
$
1.48
1.43
1.20
1.17
2017
2016
2015
Net Income
$14,167
$10,154
KEY FINANCIAL RATIOS
Return on Average Assets
Return on Average Equity
Net Interest Margin
Efficiency Ratio
Non-Performing Assets to Total Assets (1)
Total Equity-to-Assets
$8,292
__________________
1.53%
1.19%
13.65
4.07
57.92
0.60
11.66
11.00
3.88
63.89
0.88
10.86
1.07%
9.70
3.80
70.22
1.84
10.93
2017
2016
2015
(1) Non-performing assets include non-accrual loans, loans past due 90 days or more and still accruing,
non-accrual investment securities, other real estate owned and other repossessed assets.
2017 FORM 10-K
We have included our Form 10-K, as filed with the Securities and Exchange Commission,
with our annual report to give you more complete information about our Company. A table
of contents can be found facing page one.
Written requests to obtain a copy of any exhibit listed in Part IV should be sent to
Timberland Bancorp, Inc., 624 Simpson Avenue, Hoquiam, Washington 98550, attention:
Investor Relations Department.
“This Page Intentionally Left Blank”
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2017 OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
(Exact name of registrant as specified in its charter)
Washington
(State or other jurisdiction of incorporation or organization)
91-1863696
(I.R.S. Employer Identification Number)
624 Simpson Avenue, Hoquiam, Washington
(Address of principal executive offices)
Registrant’s telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
98550
(Zip Code)
(360) 533-4747
Common Stock, par value $.01 per share
(Title of Each Class)
The Nasdaq Stock Market LLC
(Name of Each Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. YES NO X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. YES NO X
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is
not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a
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 [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Emerging growth company [ ]
Accelerated filer [X]
Smaller reporting 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 Act). YES NO X
As of November 30, 2017, the registrant had 7,364,627 shares of common stock issued and outstanding. The aggregate
market value of the common stock held by nonaffiliates of the registrant, based on the closing sales price of the registrant’s common
stock as quoted on the NASDAQ Global Market on March 31, 2017, was $164.5 million (7,345,477 shares at $22.40). For purposes
of this calculation, common stock held by officers and directors of the registrant was included.
1. Portions of Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders (Part III).
DOCUMENTS INCORPORATED BY REFERENCE
TIMBERLAND BANCORP, INC.
2017 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I.
Item 1.
Business
General
Market Area
Lending Activities
Investment Activities
Deposit Activities and Other Sources of Funds
Bank Owned Life Insurance
How We Are Regulated
Taxation
Competition
Subsidiary Activities
Personnel
Executive Officers of the Registrant
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Properties
PART II.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Selected Financial Data
General
Overview
Operating Strategy
Critical Accounting Policies and Estimates
Market Risk and Asset and Liability Management
Comparison of Financial Condition at September 30, 2017 and September 30, 2016
Comparison of Operating Results for Years Ended September 30, 2017 and 2016
Comparison of Operating Results for Years Ended September 30, 2016 and 2015
Average Balances, Interest and Average Yields/Cost
Rate/Volume Analysis
Liquidity and Capital Resources
Effect of Inflation and Changing Prices
New Accounting Pronouncements
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Item 9.
Item 9A. Controls and Procedures
Item 9B. Other Information
Financial Statements and Supplementary Data
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
PART III.
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
PART IV.
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10-K Summary
Page
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4
6
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23
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25
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33
33
33
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34
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44
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46
47
49
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52
53
54
54
55
57
60
61
63
63
65
65
65
65
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117
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120
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121
122
122
As used throughout this report, the terms "we," "our," or "us," refer to Timberland Bancorp, Inc. and its consolidated subsidiary,
unless the context otherwise requires.
2
Special Note Regarding Forward-Looking Statements
Certain matters discussed in this Annual Report on Form 10-K 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 our actual results to differ materially from the results
anticipated or implied by our forward-looking statements, including, but not limited to: the credit risks of lending activities,
including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and
provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets which may lead
to increased losses and non-performing loans in our loan portfolio, and may result in our allowance for loan losses not being
adequate to cover actual losses, and require us to materially increase our loan loss reserves; changes in general economic conditions,
either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short
and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for
loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; secondary
market conditions for loans and our ability to sell loans in the secondary market; results of examinations of us by the Board of
Governors of the Federal Reserve System and of our bank subsidiary by the Federal Deposit Insurance Corporation, the Washington
State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any
such regulatory authority may, among other things, institute a formal or informal enforcement action against us or our bank
subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital
position or affect our ability to borrow funds or maintain or increase deposits or impose additional requirements or restrictions on
us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our
business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including
as a result of Basel III; the impact of the Dodd Frank Wall Street Reform and Consumer Protection Act and implementing regulations;
our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and
expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and
result in significant declines in valuation; difficulties in reducing risks associated with the loans on our consolidated balance sheet;
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and
potential associated charges; the failure or security breach of computer systems on which we depend; our ability to retain key
members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to
implement our business strategies; our ability to successfully integrate any assets, liabilities, customers, systems, and management
personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected
time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; increased competitive pressures
among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources
to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common
stock; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes
in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting
Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new
accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory,
and technological factors affecting our operations; pricing, products and services; and other risks described elsewhere in this Form
10-K and the Company's other reports filed with or furnished to the SEC.
Any of the forward-looking statements that we make in this Form 10-K 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 annual 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 financial condition and results of operations as well as its stock price performance.
3
Item 1. Business
General
PART I
Timberland Bancorp, Inc. (“Timberland Bancorp" or the "Company”), a Washington corporation, was organized on
September 8, 1997 for the purpose of becoming the holding company for Timberland Bank (the "Bank"). At September 30, 2017,
on a consolidated basis, the Company had total assets of $952.0 million, total deposits of $837.9 million and total shareholders’
equity of $111.0 million. The Company’s business activities generally are limited to passive investment activities and oversight
of its investment in the Bank. Accordingly, the information set forth in this report, including consolidated financial statements
and related data, relates primarily to the Bank and its subsidiary, Timberland Service Corporation.
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). The Bank’s deposits are insured up to applicable legal limits by the Federal Deposit Insurance Corporation
(“FDIC”). The Bank has been a member of the Federal Home Loan Bank System since 1937. The Bank is regulated by the
Washington Department of Financial Institutions, Division of Banks (“Division” or “DFI”) and the FDIC. The Company is regulated
by the Board of Governors of the Federal Reserve System ("Federal Reserve").
The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail customers
while concentrating its lending activities on real estate mortgage loans. Lending activities have been focused primarily on the
origination of loans secured by real estate, including residential construction loans, one- to four-family residential loans, multi-
family loans, commercial real estate loans and land loans. The Bank originates adjustable-residential mortgage loans that do not
qualify for sale in the secondary market. The Bank also originates commercial business loans and other consumer loans.
The Company maintains a website at www.timberlandbank.com. The information contained on that website is not
included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own internet
access charges, the Company makes available free of charge through that website the Company’s Annual Report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable
after these materials have been electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).
Market Area
The Bank considers Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties, Washington as its primary market
areas. The Bank conducts operations from:
•
•
•
•
•
•
•
its main office in Hoquiam (Grays Harbor County);
five branch offices in Grays Harbor County (Ocean Shores, Montesano, Elma and two branches in
Aberdeen);
five branch offices in Pierce County (Edgewood, Puyallup, Spanaway, Tacoma and Gig Harbor);
five branch offices in Thurston County (Olympia, Yelm, Tumwater and two branches in Lacey);
two branch offices in Kitsap County (Poulsbo and Silverdale);
a branch office in King County (Auburn); and
three branch offices in Lewis County (Winlock, Toledo and Chehalis).
For additional information, see “Item 2. Properties.”
Hoquiam, with a population of approximately 8,400, is located in Grays Harbor County which is situated along Washington
State’s central Pacific coast. Hoquiam is located approximately 110 miles southwest of Seattle, Washington and 145 miles
northwest of Portland, Oregon.
The Bank considers its primary market area to include six sub-markets: primarily rural Grays Harbor County with its
historical dependence on the timber and fishing industries; Thurston and Kitsap counties with their dependence on state and federal
government; Pierce and King counties with their broadly diversified economic bases; and Lewis County with its dependence on
retail trade, manufacturing, industrial services and local government. Each of these markets presents operating risks to the
4
Bank. The Bank’s expansion into Pierce, Thurston, Kitsap, King and Lewis counties represents the Bank’s strategy to diversify
its primary market area to become less reliant on the economy of Grays Harbor County.
Grays Harbor County has a population of 71,600 according to the United States ("U.S.") Census Bureau 2016 estimates
and a median family income of $62,100 according to 2017 estimates from the Department of Housing and Urban Development
(“HUD”). The economic base in Grays Harbor County has been historically dependent on the timber and fishing industries. Other
industries that support the economic base are tourism, agriculture, shipping, transportation and technology. According to the
Washington State Employment Security Department, the unemployment rate in Grays Harbor County decreased to 6.1% at
September 30, 2017 from 8.2% at September 30, 2016. The median price of a resale home in Grays Harbor County for the quarter
ended September 30, 2017 increased 18.2% to $167,600 from $141,800 for the comparable prior year period. The number of
home sales increased 16.7% for the quarter ended September 30, 2017 compared to the same quarter one year earlier. The Bank
has six branches (including its home office) located throughout the county.
Pierce County is the second most populous county in the state and has a population of 861,300 according to the U.S.
Census Bureau 2016 estimates. The county’s median family income is $74,500 according to 2017 HUD estimates. The economy
in Pierce County is diversified with the presence of military related government employment (Joint Base Lewis-McChord),
transportation and shipping employment (Port of Tacoma), and aerospace related employment. According to the Washington State
Employment Security Department, the unemployment rate for the Pierce County area decreased to 4.8% at September 30, 2017
from 6.0% at September 30, 2016. The median price of a resale home in Pierce County for the quarter ended September 30, 2017
increased 28.1% to $338,400 from $264,200 for the comparable prior year period. The number of home sales increased 13.6%
for the quarter ended September 30, 2017 compared to the same quarter one year earlier. The Bank has five branches in Pierce
County, and these branches have historically been responsible for a substantial portion of the Bank’s construction lending activities.
Thurston County has a population of 275,000 according to the U.S. Census Bureau 2016 estimates and a median family
income of $76,300 according to 2017 HUD estimates. Thurston County is home of Washington State’s capital (Olympia), and its
economic base is largely driven by state government related employment. According to the Washington State Employment Security
Department, the unemployment rate for the Thurston County area decreased to 4.5% at September 30, 2017 from 5.7% at
September 30, 2016. The median price of a resale home in Thurston County for the quarter ended September 30, 2017 increased
12.5% to $289,800 from $257,700 for the same quarter one year earlier. The number of home sales increased 20.5% for the quarter
ended September 30, 2017 compared to the same quarter one year earlier. The Bank has five branches in Thurston County. This
county has historically had a stable economic base primarily attributable to the state government presence.
Kitsap County has a population of 265,000 according to the U.S. Census Bureau 2016 estimates and a median family
income of $77,100 according to 2017 HUD estimates. The Bank has two branches in Kitsap County. The economic base of Kitsap
County is largely supported by military related government employment through the U.S. Navy. According to the Washington
State Employment Security Department, the unemployment rate for the Kitsap County area decreased to 4.6% at September 30,
2017 from 5.7% at September 30, 2016. The median price of a resale home in Kitsap County for the quarter ended September 30,
2017 increased 22.2% to $326,500 from $267,100 for the same quarter one year earlier. The number of home sales increased
13.5% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.
King County is the most populous county in the state and has a population of 2.2 million according to the U.S. Census
Bureau 2016 estimates. The Bank has one branch in King County. The county’s median family income is $96,000 according to
2017 HUD estimates. King County’s economic base is diversified with many industries including shipping, transportation,
aerospace, computer technology and biotech. According to the Washington State Employment Security Department, the
unemployment rate for the King County area decreased to 3.9% at September 30, 2017 from 4.0% at September 30, 2016. The
median price of a resale home in King County for the quarter ended September 30, 2017 increased 19.2% to $658,400 from
$552,400 for the same quarter one year earlier. The number of home sales increased 8.1% for the quarter ended September 30,
2017 compared to the same quarter one year earlier.
Lewis County has a population of 77,000 according to the U.S. Census Bureau 2016 estimates and a median family
income of $62,100 according to 2017 HUD estimates. The economic base in Lewis County is supported by manufacturing, retail
trade, local government and industrial services. According to the Washington State Employment Security Department, the
unemployment rate in Lewis County decreased to 5.7% at September 30, 2017 from 7.7% at September 30, 2016. The median
price of a resale home in Lewis County for the quarter ended September 30, 2017 increased 17.1% to $211,100 from $180,200
for the same quarter one year earlier. The number of home sales increased 13.5% for the quarter ended September 30, 2017
compared to the same quarter one year earlier. The Bank currently has three branches located in Lewis County.
5
Lending Activities
General. Historically, the principal lending activity of the Bank has consisted of the origination of loans secured by first
mortgages on owner-occupied, one- to four-family residences, or by commercial real estate and loans for the construction of one-
to four-family residences. The Bank’s net loans receivable totaled $690.4 million at September 30, 2017, representing 72.5% of
consolidated total assets, and at that date commercial real estate, construction (including undisbursed loans in process), and land
loans were $521.4 million, or 66.4% of total loans. In addition, multi-family loans totaled $58.6 million, or 7.5% of total loans
at September 30, 2017. Commercial real estate, construction, multi-family, and land loans typically have higher rates of return
than one- to four-family loans; however, they also present a higher degree of risk.
The Bank’s internal loan policy limits the maximum amount of loans to one borrower to 20% of its capital plus surplus.
According to the Washington Administrative Code, capital and surplus are defined as a bank's Tier 1 capital, Tier 2 capital and
the balance of a bank's allowance for loan losses not included in the bank's Tier 2 capital as reported in the bank's call report. At
September 30, 2017, the maximum amount which the Bank could have lent to any one borrower and the borrower’s related entities
was approximately $22.8 million under this policy. At September 30, 2017, the largest amount outstanding to any one borrower
and the borrower’s related entities was $18.6 million, which was secured by multi-family properties and commercial buildings
located in King, Benton and Grant counties. These loans were all performing according to their loan repayment terms at
September 30, 2017. The next largest amount outstanding to any one borrower and the borrower’s related entities was $13.1
million (including $963,000 in undisbursed loans in process). These loans were secured by commercial real estate properties
located in Pierce and Kitsap counties and were performing according to their loan repayment terms at September 30, 2017.
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Residential One- to Four-Family Lending. At September 30, 2017, $118.1 million, or 15.1%, of the Bank’s loan
portfolio consisted of loans secured by one- to four-family residences. The Bank originates both fixed-rate loans and adjustable-
rate loans.
Generally, one- to four-family fixed-rate loans and five and seven year balloon reset loans (which are loans that are
originated with a fixed interest rate for the initial five or seven years, and thereafter incur one interest rate change in which the
new rate remains in effect for the remainder of the loan term) are originated to meet the requirements for sale in the secondary
market to the Federal Home Loan Mortgage Corporation ("Freddie Mac"). From time to time, however, a portion of these fixed-
rate loans and five and seven year balloon reset loans may be retained in the loan portfolio to meet the Bank’s asset/liability
management objectives. The Bank uses an automated underwriting program, which preliminarily qualifies a loan as conforming
to Freddie Mac underwriting standards when the loan is originated. At September 30, 2017, $29.0 million, or 24.5%, of the Bank’s
one- to four-family loan portfolio consisted of fixed-rate and five and seven year balloon reset mortgage loans.
The Bank also offers adjustable-rate mortgage (“ARM”) loans. All of the Bank’s ARM loans are retained in its loan
portfolio. The Bank offers several ARM products which adjust annually after an initial period ranging from one to five years and
are typically subject to a limitation on the annual interest rate increase of 2% and an overall limitation of 6%. These ARM products
generally are priced utilizing the weekly average yield on one year U.S. Treasury securities adjusted to a constant maturity of one
year plus a margin of 2.88% to 4.00%. The Bank also offers ARM loans tied to The Wall Street Journal prime lending rate ("Prime
Rate") or to the London Inter-Bank Offered Rate (“LIBOR”) indices which typically do not have periodic or lifetime adjustment
limits. Loans tied to these indices normally have margins ranging up to 3.5%. ARM loans held in the Bank’s portfolio do not
permit negative amortization of principal. Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the
level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can be originated
at any time is largely determined by the demand for each in a competitive environment. At September 30, 2017, $89.1 million,
or 75.5%, of the Bank’s one- to four- family loan portfolio consisted of ARM loans.
A portion of the Bank’s ARM loans are “non-conforming”, because they do not satisfy acreage limits or various other
requirements imposed by Freddie Mac. Some of these loans are also originated to meet the needs of borrowers who cannot
otherwise satisfy Freddie Mac credit requirements because of personal and financial reasons (i.e., divorce, bankruptcy, length of
time employed, etc.), and other aspects, which do not conform to Freddie Mac’s guidelines. Such borrowers may have higher
debt-to-income ratios, or the loans are secured by unique properties in rural markets for which there are no sales of comparable
properties to support the value according to secondary market requirements. These loans are known as non-conforming loans,
and the Bank may require additional collateral or lower loan-to-value ratios to reduce the risk of these loans. The Bank believes
that these loans satisfy a need in its local market area. As a result, subject to market conditions, the Bank intends to continue to
originate these types of loans.
The retention of ARM loans in the Bank’s loan portfolio helps reduce the Bank’s exposure to changes in interest
rates. There are, however, unquantifiable credit risks resulting from the potential of increased interest to be paid by the customer
as a result of increases in interest rates. It is possible that during periods of rising interest rates the risk of default on ARM loans
may increase as a result of repricing and the increased costs to the borrower. The Bank attempts to reduce the potential for
delinquencies and defaults on ARM loans by qualifying the borrower based on the borrower’s ability to repay the ARM loan
assuming that the maximum interest rate that could be charged was in effect during the loan term. Another consideration is that
although ARM loans allow the Bank to increase the sensitivity of its asset base due to changes in the interest rates, the extent of
this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Because of these considerations, the
Bank has no assurance that yield increases on ARM loans will be sufficient to offset increases in the Bank’s cost of funds.
While fixed-rate, single-family residential mortgage loans are normally originated with 15 to 30 year terms to maturity,
these loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon
sale of the property pledged as security or upon refinancing the original loan. In addition, substantially all mortgage loans in the
Bank’s loan portfolio contain due-on-sale clauses providing that the Bank may declare the unpaid amount due and payable upon
the sale of the property securing the loan. Typically, the Bank enforces these due-on-sale clauses to the extent permitted by law
and as business judgment dictates. Thus, average loan maturity is a function of, among other factors, the level of purchase and
sale activity in the real estate market, prevailing interest rates and the interest rates received on outstanding loans.
The Bank requires that fire and extended coverage casualty insurance be maintained on the collateral for all of its real
estate secured loans and flood insurance, if appropriate.
The Bank’s lending policies generally limit the maximum loan-to-value ratio on mortgage loans secured by owner-
occupied properties to 95% of the lesser of the appraised value or the purchase price. However, the Bank usually obtains private
8
mortgage insurance (“PMI”) on the portion of the principal amount that exceeds 80% of the appraised value of the security property.
The maximum loan-to-value ratio on mortgage loans secured by non-owner-occupied properties is generally 80% (90% for loans
originated for sale in the secondary market to Freddie Mac). At September 30, 2017, seven one- to four-family loans totaling
$874,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”
Multi-Family Lending. At September 30, 2017, $58.6 million, or 7.5%, of the Bank’s total loan portfolio was secured
by multi-family dwelling units (more than four units) located primarily in the Bank’s primary market area. Multi-family loans
are generally originated with variable rates of interest ranging from 1.00% to 3.50% over the one-year constant maturity U.S.
Treasury Bill Index, the Prime Rate or a matched term Federal Home Loan Bank borrowing, with principal and interest payments
fully amortizing over terms of up to 30 years. At September 30, 2017, the Bank’s largest multi-family loan had an outstanding
principal balance of $6.7 million and was secured by an apartment building located in Pierce County. At September 30, 2017,
this loan was performing according to its repayment terms.
The maximum loan-to-value ratio for multi-family loans is generally limited to not more than 80%. The Bank generally
requests its multi-family loan borrowers with loan balances in excess of $750,000 to submit financial statements and rent rolls on
the properties securing such loans. The Bank also inspects such properties annually. The Bank generally imposes a minimum
debt coverage ratio of approximately 1.20 for loans secured by multi-family properties.
Multi-family mortgage lending affords the Bank an opportunity to receive interest at rates higher than those generally
available from one- to four- family residential lending. However, loans secured by multi-family properties usually are greater in
amount, more difficult to evaluate and monitor and, therefore, may involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on the successful
operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate
market or the economy. The Bank seeks to minimize these risks by scrutinizing the financial condition of the borrower, the quality
of the collateral and the management of the property securing the loan. If the borrower is other than an individual, the Bank also
generally obtains personal guarantees from the principals based on a review of personal financial statements. At September 30,
2017, all multi-family loans were performing according to their repayment terms. See "Lending Activities - Non-performing
Loans and Delinquencies."
Commercial Real Estate Lending. Commercial real estate loans totaled $328.9 million, or 41.9%, of the total loan
portfolio at September 30, 2017. The Bank originates commercial real estate loans generally at variable interest rates with principal
and interest payments fully amortizing over terms of up to 30 years. These loans are secured by properties, such as office buildings,
retail/wholesale facilities, mini-storage facilities, motels, nursing homes, restaurants and convenience stores, located in the Bank’s
primary market area. At September 30, 2017, the largest commercial real estate loan was secured by an office building in Thurston
County, had a balance of $6.1 million and was performing according to its repayment terms. At September 30, 2017, two
commercial real estate loans totaling $213,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and
Delinquencies.”
The Bank typically requires appraisals of properties securing commercial real estate loans. For loans that are less than
$250,000, the Bank may use the tax assessed value and a property inspection in lieu of an appraisal. Appraisals are performed by
independent appraisers designated by the Bank. The Bank considers the quality and location of the real estate, the credit history
of the borrower, the cash flow of the project and the quality of management involved with the property when making these
loans. The Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for loans secured by income producing
commercial properties. Loan-to-value ratios on commercial real estate loans are generally limited to not more than 80%. If the
borrower is other than an individual, the Bank also generally obtains personal guarantees from the principals based on a review
of personal financial statements.
Commercial real estate lending affords the Bank an opportunity to receive interest at rates higher than those generally
available from one- to four-family residential lending. However, loans secured by such properties usually are greater in amount,
more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage
loans. Because payments on loans secured by commercial properties often depend upon the successful operation and management
of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. The
Bank seeks to minimize these risks by generally limiting the maximum loan-to-value ratio to 80% and scrutinizing the financial
condition of the borrower, the quality of the collateral and the management of the property securing the loan. The Bank also
generally requests annual financial information and rent rolls on the subject property from the borrowers on loans over $750,000.
Construction Lending. The Bank currently originates three types of residential construction loans: (i) custom
construction loans, (ii) owner/builder construction loans and (iii) speculative construction loans (on a limited basis). The Bank
believes that its computer tracking system has enabled it to establish processing and disbursement procedures to meet the needs
9
of its borrowers while reducing many of the risks inherent with construction lending. The Bank also originates construction loans
for the development of multi-family and commercial properties. The Bank's construction loans generally provide for the payment
of interest only during the construction phase, which is billed monthly, although during the term of some construction loans no
payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest
reserve. At September 30, 2017, the Bank's construction loans totaled $168.5 million, or 21.5% of the Bank's total loan portfolio,
including undisbursed loans in process of $82.4 million.
At September 30, 2017 and 2016, the composition of the Bank’s construction loan portfolio was as follows:
Custom and owner/builder
Speculative one-to four-family
Commercial real estate
Multi-family
Total
At September 30,
2017
2016
Outstanding
Balance
$
$
117,641
9,918
19,630
21,327
168,516
Outstanding
Percent of
Total
Balance
(Dollars in thousands)
Percent of
Total
69.81% $
5.89
11.65
12.65
100.00% $
93,049
8,106
9,365
12,590
123,110
75.58%
6.58
7.61
10.23
100.00%
Custom construction loans are made to home builders who, at the time of construction, have a signed contract with a
home buyer who has a commitment to purchase the finished home. Custom construction loans are generally originated for a term
of six to 12 months, with fixed interest rates typically ranging from 4.50% to 6.25% and with loan-to-value ratios of 80% of the
appraised estimated value of the completed property or sales price, whichever is less. All of our custom and owner/builder
construction loans are structured to convert to permanent mortgage loans once construction is completed.
Owner/builder construction loans are originated to home owners rather than home builders and are typically converted
to or refinanced into permanent loans at the completion of construction. The construction phase of an owner/builder construction
loan generally lasts up to 12 months with fixed interest rates typically ranging from 4.50% to 6.25% and with loan-to-value ratios
of 80% (or up to 95% with PMI) of the appraised estimated value of the completed property. At the completion of construction,
the loan is converted to or refinanced into either a fixed-rate mortgage loan, which conforms to secondary market standards, or
an ARM loan for retention in the Bank’s portfolio. At September 30, 2017, custom and owner/builder construction loans totaled
$117.6 million, or 69.8% of the total construction loan portfolio. At September 30, 2017, the largest outstanding custom and
owner/builder construction loan had an outstanding balance of $1.4 million (including $347,000 of undisbursed loans in process)
and was performing according to its repayment terms.
Speculative one-to four-family construction loans are made to home builders and are termed “speculative” because the
home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Bank or another lender for the finished home. The home buyer may be identified either during
or after the construction period, with the risk that the builder will have to debt service the speculative construction loan and finance
real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until
the home buyer is identified and a sale is consummated. Rather than originating lines of credit to home builders to construct
several homes at once, the Bank generally originates and underwrites a separate loan for each home. Speculative construction
loans are generally originated for a term of 12 months, with current rates generally ranging from 6.00% to 6.50%, and with a loan-
to-value ratio of no more than 80% of the appraised estimated value of the completed property. The Bank is currently originating
speculative construction loans on a limited basis. At September 30, 2017, speculative construction loans totaled $9.9 million, or
5.9% of the total construction loan portfolio. At September 30, 2017, the largest aggregate outstanding balance to one borrower
for speculative construction loans totaled $1.9 million (including $1.3 million of undisbursed loans in process) and was comprised
of ten loans that were performing according to their repayment terms.
The Bank also provides construction financing for multi-family and commercial properties. At September 30, 2017,
these loans amounted to $41.0 million, or 24.3%, of construction loans compared to $22.0 million, or 17.8%, of construction loans
at September 30, 2016. These loans are typically secured by apartment buildings, condominiums, mini-storage facilities, office
buildings, hotels and retail rental space predominantly located in the Bank’s primary market area. At September 30, 2017, the
largest outstanding multi-family construction loan was secured by an apartment building project in Thurston County and had a
balance of $6.7 million (including $6.7 million of undisbursed construction loan proceeds) and was performing according to its
repayment terms. At September 30, 2017, the largest outstanding commercial real estate construction loan was secured by an
10
assisted living facility project in King County and had a balance of $6.1 million (including $2.0 million of undisbursed loans in
process). This loan was performing according to its repayment terms at September 30, 2017.
All construction loans must be approved by a member of one of the Bank’s Loan Committees or the Bank’s Board of
Directors, or in the case of one- to four-family construction loans that meet Freddie Mac guidelines, by the Regional Manager of
Community Lending, the Loan Department Supervisor or a Bank underwriter. See “- Lending Activities - Loan Solicitation and
Processing.” Prior to approval of any construction loan application, an independent fee appraiser inspects the site and the Bank
reviews the existing or proposed improvements, identifies the market for the proposed project and analyzes the pro-forma data
and assumptions on the project. In the case of a speculative or custom construction loan, the Bank reviews the experience and
expertise of the builder. After this preliminary review, the application is processed, which includes obtaining credit reports,
financial statements and tax returns on the borrowers and guarantors, an independent appraisal of the project, and any other expert
reports necessary to evaluate the proposed project. In the event of cost overruns, the Bank generally requires that the borrower
increase the funds available for construction by paying the cost of such overruns directly or by depositing its own funds into a
secured savings account, the proceeds of which are used to pay construction costs.
Loan disbursements during the construction period are made to the builder, materials supplier or subcontractor, based on
a line item budget. Periodic on-site inspections are made by qualified independent inspectors to document the reasonableness of
draw requests. For most builders, the Bank disburses loan funds by providing vouchers to borrowers, which when used by the
borrower to purchase supplies are submitted by the supplier to the Bank for payment.
The Bank originates construction loan applications primarily through customer referrals, contacts in the business
community and occasionally real estate brokers seeking financing for their clients.
Construction lending (including custom, owner/builder and speculative construction loans) affords the Bank the
opportunity to achieve higher interest rates and fees with shorter terms to maturity than does its single-family permanent mortgage
lending. Construction lending, however, is generally considered to involve a higher degree of risk than single-family permanent
mortgage lending because funds are advanced upon the collateral for the project based on an estimate of the costs that will produce
a future value at completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value
of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately
the total funds required to complete a project and the completed project loan-to-value ratio. With regard to loans originated to
builders for speculative projects, changes in the demand, such as for new housing and higher than anticipated building costs, may
cause actual results to vary significantly for those estimated. A downturn in the housing, or the real estate market, could increase
loan delinquencies, defaults, and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral
upon foreclosure. Some builders who have borrowed from us to fund construction projects on a speculative basis have more than
one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose
us to a significantly greater risk of loss.
In addition, during the term of many of our construction loans granted to builders who are building residential units for
sale, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an
interest reserve. As a result, these loans often involve the disbursement of funds with repayment substantially dependent on the
success of the ultimate project and the ability of the borrower to to sell or lease the property or obtain permanent take-out financing,
rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed
project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction
of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost
comparisons and on-site inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may
have a more pronounced effect on construction loans by rapidly increasing the end-purchasers' borrowing costs, thereby reducing
the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order
to be successfully sold which also complicates the process of working out problem construction loans. This may require us to
advance additional funds and/or contract with another builder to complete construction. Furthermore, in the case of speculative
construction loans, there is an added risk associated with identifying an end-purchaser for the finished project. At September 30,
2017 all construction loans were performing according to their repayment terms. See "Lending Activities - Non-performing Loans
and Delinquencies."
The Bank historically originated loans to real estate developers with whom it had established relationships for the purpose
of developing residential subdivisions (i.e., installing roads, sewers, water and other utilities; generally with ten to 50 lots). The
Bank is not currently originating any new land development loans and at September 30, 2017, the Bank had no land development
loans outstanding. Although the Bank is not currently originating land development loans, it may do so in the future. Historically
land development loans were secured by a lien on the property and typically were made for a period of two to five years with fixed
or variable interest rates, and were made with loan-to-value ratios generally not exceeding 75%. Land development loans were
11
generally structured so that the Bank was repaid in full upon the sale by the borrower of approximately 80% of the subdivision
lots. In addition, in the case of a corporate borrower, the Bank also generally obtained personal guarantees from corporate principals
and reviewed their personal financial statements. Land development loans secured by land under development involve greater
risks than one- to four-family residential mortgage loans because these loans are advanced upon the predicted future value of the
developed property upon completion. If the estimate of the future value proves to be inaccurate, in the event of default and
foreclosure the Bank may be confronted with a property the value of which is insufficient to assure full repayment. The Bank has
historically attempted to minimize this risk by generally limiting the maximum loan-to-value ratio on land loans to 75% of the
estimated developed value of the secured property.
Land Lending. The Bank has historically originated loans for the acquisition of land upon which the purchaser can then
build or make improvements necessary to build or to sell as improved lots. Currently the Bank is originating land loans on a
limited basis. At September 30, 2017, land loans totaled $23.9 million, or 3.0%, of the Bank’s total loan portfolio as compared
to $21.6 million, or 3.0%, of the Bank’s total loan portfolio at September 30, 2016. Land loans originated by the Bank generally
have maturities of five to ten years. The largest land loan is secured by land in Grays Harbor County, had an outstanding balance
of $2.7 million and was performing according to its repayment terms at September 30, 2017. At September 30, 2017, five land
loans totaling $566,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”
Loans secured by undeveloped land or improved lots involve greater risks than one- to four-family residential mortgage
loans because these loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in the event of default
and foreclosure the Bank may be confronted with a property the value of which is insufficient to assure full repayment. Land
loans also pose additional risk because of the lack of income being produced by the property and potential illiquid nature of the
collateral. These risks can be significantly impacted by supply and demand conditions. The Bank attempts to minimize these
risks by generally limiting the maximum loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer loans generally have shorter terms to maturity and higher interest rates than mortgage
loans. Consumer loans include home equity lines of credit, second mortgage loans, savings account loans, automobile loans, boat
loans, motorcycle loans, recreational vehicle loans and unsecured loans. Consumer loans are made with both fixed and variable
interest rates and with varying terms. At September 30, 2017, consumer loans amounted to $42.2 million, or 5.4%, of the Bank's
total loan portfolio.
At September 30, 2017, the largest component of the consumer loan portfolio consisted of second mortgage loans and
home equity lines of credit, which totaled $38.4 million, or 4.9%, of the Bank's total loan portfolio. Home equity lines of credit
and second mortgage loans are made for purposes such as the improvement of residential properties, debt consolidation and
education expenses, among others. The majority of these loans are made to existing customers and are secured by a first or second
mortgage on residential property. The loan-to-value ratio is typically 80% or less, when taking into account both the first and
second mortgage loans. Second mortgage loans typically carry fixed interest rates with a fixed payment over a term between five
and 15 years. Home equity lines of credit are generally made at interest rates tied to the Prime Rate or the 26 week U.S. Treasury
Bill. Second mortgage loans and home equity lines of credit have greater credit risk than one- to four-family residential mortgage
loans in which the Bank is in the first lien position because they are generally secured by mortgages subordinated to the existing
first mortgage on the property. For those second mortgage loans and home equity lines credit which the Bank does not hold the
existing first mortgage on the property, it is unlikely that the Bank will be successful in recovering all or a portion of the loan
balance in the event of default unless the Bank is prepared to repay the first mortgage loan and such repayment and the costs
associated with a foreclosure are justified by the value of the property.
Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are
unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted
consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the
borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s
continuing financial stability and are more likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount that can be recovered on such loans. The Bank believes that these risks are not as prevalent in the
case of the Bank’s consumer loan portfolio because a large percentage of the portfolio consists of second mortgage loans and home
equity lines of credit that are underwritten in a manner such that they result in credit risk that is substantially similar to one- to
four-family residential mortgage loans. At September 30, 2017, three consumer loans totaling $258,000 were on non-accrual
status. See “Lending Activities - Non-performing Loans and Delinquencies.”
Commercial Business Lending. Commercial business loans totaled $44.4 million, or 5.7%, of the loan portfolio at
September 30, 2017. Commercial business loans are generally secured by business equipment, accounts receivable, inventory
12
and/or other property and are made at variable rates of interest equal to a negotiated margin above the Prime Rate. The Bank also
generally obtains personal guarantees from the principals based on a review of personal financial statements. The largest commercial
business loan had an outstanding balance of $2.0 million at September 30, 2017 and was performing according to its repayment
terms. At September 30, 2017, all commercial business loans were performing according to their repayment terms. See “Lending
Activities - Non-performing Loans and Delinquencies.”
The Bank has recently increased commercial business loan originations made under the U.S. Small Business
Administration ("SBA") 7(a) program. Loans made by the Bank under the SBA 7(a) program generally are made to small businesses
to provide working capital or to provide funding for the purchase of businesses, real estate, or equipment. These loans generally
are secured by a combination of assets that may include equipment, receivables, inventory, business real property, and sometimes
a lien on the personal residence of the borrower. The terms of these loans vary by purpose and type of underlying collateral. The
loans are primarily underwritten on the basis of the borrower's ability to service the loan from income. Under the SBA 7(a) program
the loans carry a SBA guaranty up to 85% of the loan. Typical maturities for this type of loan vary up to ten years. SBA 7(a)
loans are all adjustable rate loans based on the Prime Rate. Under the SBA 7(a) program, the Bank can sell in the secondary
market the guaranteed portion of its SBA 7(a) loans and retain the related unguaranteed portion of these loans, as well as the
servicing on such loans, for which it is paid a fee. The loan servicing spread is generally a minimum of 1.00% on all SBA 7(a)
loans. The Bank generally offers SBA 7(a) loans within a range of $50,000 to $1.0 million.
Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that
are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered
to be collateral based lending with loan amounts based on predetermined loan to collateral values, and liquidation of the underlying
real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business
loans are often collateralized by equipment, inventory, accounts receivable and/or other business assets, the liquidation of collateral
in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible
and inventories and equipment may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a
secondary and often insufficient source of repayment.
Loan Maturity. The following table sets forth certain information at September 30, 2017 regarding the dollar amount
of loans maturing in the Bank’s portfolio based on their contractual terms to maturity but does not include scheduled payments
or potential prepayments. Loans having no stated maturity and overdrafts are reported as due in one year or less.
After
1 Year
Through
3 Years
Within
1 Year
After
3 Years
Through
5 Years
After
5 Years
Through
10 Years
(Dollars in thousands)
After
10 Years
Total
$
$
566
2,148
17,590
168,516
11,978
5,990
1,020
24,068
231,876
$
$
1,153
1,658
25,041
—
6,012
4,047
309
3,835
42,055
$
$
3,926
8,721
77,884
—
2,038
7,764
442
8,493
109,268
$
$
37,196
45,604
205,061
—
2,772
14,086
692
7,560
312,971
$
$
$
75,306
476
3,351
—
1,110
6,533
1,360
488
88,624
118,147
58,607
328,927
168,516
23,910
38,420
3,823
44,444
784,794
(82,411)
(2,466)
(9,553)
690,364
$
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction (1)
Land
Consumer loans:
Home equity and second
mortgage
Other
Commercial business loans
Total
Less:
Undisbursed portion of
construction loans in process
Deferred loan origination fees, net
Allowance for loan losses
Total loans receivable, net
_____________
(1)
once construction is completed.
Includes $117.6 million of construction/permanent loans, a portion of which may convert to permanent mortgage loans
13
The following table sets forth the dollar amount of all loans due after one year from September 30, 2017, which have
fixed interest rates and have floating or adjustable interest rates.
Mortgage loans:
One- to four-family
Multi-family
Commercial
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
Fixed
Rates
Floating or
Adjustable
Rates
(Dollars in thousands)
Total
$
$
28,580
1,299
40,632
4,208
9,887
2,224
10,228
97,058
$
$
89,001
55,160
270,705
7,724
22,543
579
10,148
455,860
$
$
117,581
56,459
311,337
11,932
32,430
2,803
20,376
552,918
Scheduled contractual principal repayments of loans do not reflect the actual life of these assets. The average life of
loans is substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally
give the Bank the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current
mortgage loan interest rates are substantially higher than interest rates on existing mortgage loans and, conversely, decrease when
interest rates on existing mortgage loans are substantially higher than current mortgage loan interest rates.
Loan Solicitation and Processing. Loan originations are obtained from a variety of sources, including walk-in customers
and referrals from builders and realtors. Upon receipt of a loan application from a prospective borrower, a credit report and other
data are obtained to verify specific information relating to the loan applicant’s employment, income and credit standing. An
appraisal of the real estate offered as collateral generally is undertaken by a certified appraiser retained by the Bank.
Loan applications are initiated by loan officers and are required to be approved by an authorized loan officer or Bank
underwriter, one of the Bank’s Loan Committees or the Bank’s Board of Directors. The Bank’s Consumer Loan Committee consists
of several underwriters, each of whom can approve one- to four-family mortgage loans and other consumer loans up to and
including the current Freddie Mac single-family limit. Loan officers may also be granted individual approval authority for certain
loans up to a maximum of $250,000. The approval authority for individual loan officers is granted on a case by case basis by the
Bank's Chief Credit Administrator or President. All construction loans must be approved by a member of one of the Bank's Loan
Committees or the Bank's Board of Directors, or in the case of one- to four- family construction loans that meet Freddie Mac
guidelines, by the Regional Manager of Community Lending, the Loan Department Supervisor or a Bank underwriter, subject to
their individual or Loan Committee loan limit. The Bank’s Commercial Loan Committee, which consists of the Bank’s President,
Chief Credit Administrator, Executive Vice President of Lending and Regional Manager of Community Lending, may approve
commercial real estate loans and commercial business loans up to and including $1.5 million. The Bank’s President, Chief Credit
Administrator and Executive Vice President of Lending also have individual lending authority for loans up to and including
$750,000. The Bank’s Board Loan Committee, which consists of two rotating non-employee Directors and the Bank’s President,
may approve loans up to and including $3.0 million. Loans in excess of $3.0 million, as well as loans of any amount granted to
a single borrower whose aggregate loans exceed $3.0 million, must be approved by the Bank’s Board of Directors.
Loan Originations, Purchases and Sales. During the years ended September 30, 2017, 2016 and 2015, the Bank’s total
gross loan originations were $340.6 million, $267.4 million and $262.4 million, respectively. Periodically, the Bank purchases
loan participation interests in construction, commercial real estate and multi-family loans, secured by properties generally located
in Washington State, from other banks. These participation loans are underwritten in accordance with the Bank’s underwriting
guidelines and are without recourse to the seller other than for fraud. During the years ended September 30, 2017, 2016 and 2015,
the Bank purchased loan participation interests of $13.1 million, $898,000 and $7.3 million, respectively.
Consistent with its asset/liability management strategy, the Bank’s policy generally is to retain in its portfolio all ARM
loans originated and to sell fixed rate one- to four-family mortgage loans in the secondary market to Freddie Mac; however, from
time to time, a portion of fixed-rate loans may be retained in the Bank’s portfolio to meet its asset-liability objectives. The Bank
also began selling the guaranteed portion of SBA 7(a) loans in the secondary market during the year ended September 30,
14
2016. Loans sold in the secondary market are generally sold on a servicing retained basis. At September 30, 2017, the Bank’s
loan servicing portfolio, which is not included in the Company’s consolidated financial statements, totaled $358.2 million.
The Bank also periodically sells participation interests in construction loans, commercial real estate loans, multi-family
and commercial business loans to other lenders. These sales are usually made to avoid concentrations in a particular loan type or
concentrations to a particular borrower and to generate fee income. During the years ended September 30, 2017, 2016 and 2015,
the Bank sold loan participation interests of $9.3 million, $321,000, and $3.6 million, respectively.
The following table shows total loans originated, purchased, sold and repaid during the periods indicated.
Loans originated:
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction
Land
Consumer
Commercial business loans
Total loans originated
Loans and loan participations purchased:
Mortgage loans:
One- to four-family
Construction
Commercial business
Total loans purchased
Total loans originated and purchased
Loans sold:
Loan participation interests sold
Whole loans sold
Total loans sold
Loan principal repayments
Other items, net
Net increase in loans receivable
Year Ended September 30,
2017
2016
(Dollars in thousands)
2015
$
$
88,642
7,841
58,777
144,349
14,056
21,999
4,947
340,611
—
11,100
2,000
13,100
353,711
$
74,131
18,340
43,942
95,029
4,515
22,569
8,824
267,350
—
400
498
898
268,248
83,593
12,643
35,921
100,875
6,570
15,140
7,699
262,441
313
5,500
1,500
7,313
269,754
(9,284)
(72,158)
(81,442)
(321)
(58,582)
(58,903)
(3,600)
(53,948)
(57,548)
(211,303)
(33,748)
27,218
$
(155,368)
4,892
58,869
$
(148,797)
(23,985)
39,424
$
Loan Origination Fees. The Bank receives loan origination fees on many of its mortgage loans and commercial business
loans. Loan fees are a percentage of the loan which are charged to the borrower for funding the loan. The amount of fees charged
by the Bank is generally up to 2.0% of the loan amount. Accounting principles generally accepted in the United States of America
("GAAP") require fees received and certain loan origination costs for originating loans to be deferred and amortized into interest
income over the contractual life of the loan. Net deferred fees or costs associated with loans that are prepaid are recognized as
income/expense at the time of prepayment. Unamortized net deferred loan origination fees totaled $2.5 million at September 30,
2017.
Non-performing Loans and Delinquencies. The Bank assesses late fees or penalty charges on delinquent loans of
approximately 5% of the monthly loan payment amount. A majority of loan payments are due on the first day of the month;
however, the borrower is given a 15 day grace period to make the loan payment. When a mortgage loan borrower fails to make
a required payment when due, the Bank institutes collection procedures. A notice is mailed to the borrower 16 days after the date
the payment is due. Attempts to contact the borrower by telephone generally begin on or before the 30th day of delinquency. If
15
a satisfactory response is not obtained, continuous follow-up contacts are attempted until the loan has been brought current. Before
the 90th day of delinquency, attempts are made to establish (i) the cause of the delinquency, (ii) whether the cause is temporary,
(iii) the attitude of the borrower toward repaying the debt, and (iv) a mutually satisfactory arrangement for curing the default.
If the borrower is chronically delinquent and all reasonable means of obtaining payment on time have been exhausted,
foreclosure is initiated according to the terms of the security instrument and applicable law. Interest income on loans in foreclosure
is reduced by the full amount of accrued and uncollected interest.
When a consumer loan borrower or commercial business borrower fails to make a required payment on a loan by the
payment due date, the Bank institutes similar collection procedures as for its mortgage loan borrowers. All loans becoming 90
days or more past due are placed on non-accrual status, with any accrued interest reversed against interest income, unless they are
well secured and in the process of collection.
The Bank’s Board of Directors is informed monthly as to the status of loans that are delinquent by more than 30 days
and the status of all foreclosed and repossessed property owned by the Bank.
The following table sets forth information with respect to the Company's non-performing assets at the dates indicated.
Loans accounted for on a non-accrual basis:
Mortgage loans:
One- to four-family (1)
Multi-family
Commercial
Construction
Land
Consumer loans
Total
Accruing loans which are contractually past due 90
days or more
Total of non-accrual and 90 days past due loans
2017
2016
At September 30,
2015
(Dollars in thousands)
2014
2013
$
874
—
213
—
566
258
1,911
—
1,911
$
914
—
612
367
548
432
2,873
135
3,008
$
2,368
760
1,016
—
1,558
338
6,040
151
6,191
$
4,376
—
1,468
—
4,564
501
10,909
$
6,985
—
3,435
659
2,146
385
13,610
812
11,721
436
14,046
Non-accrual investment securities
533
734
932
1,101
2,187
Other real estate owned and other repossessed assets (2)
Total non-performing assets (3)
Troubled debt restructured loans on accrual status (4)
3,301
5,745
3,342
$
$
4,117
7,859
7,629
7,854
14,977
12,485
$
$
9,092
21,914
16,804
$
$
11,720
27,953
18,573
$
$
$
$
Non-accrual and 90 days or more past due loans as a
percentage of loans receivable, net (5)
0.27%
0.45%
1.02%
2.08%
2.57%
Non-accrual and 90 days or more past due loans as a
percentage of total assets
0.20%
0.34%
0.76%
1.57%
1.88%
Non-performing assets as a percentage of total assets
0.60%
0.88%
1.84%
2.94%
3.75%
Loans receivable, net (5)
Total assets
$ 699,917
$ 952,024
$ 672,972
$ 891,388
$ 614,201
$ 815,815
$ 575,280
$ 745,565
$ 557,359
$ 745,648
16
_______________
(1)
Includes non-accrual one- to four-family properties in the process of foreclosure totaling $100, $138,
$1,105, $1,147 and $3,721 as of September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
Includes foreclosed residential real estate property totaling $875, $1,071, $2,868, $2,903, and $1,752
as of September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
Does not include troubled debt restructured loans on accrual status.
Does not include troubled debt restructured loans totaling $253, $531, $1,233, $2,284 and $4,031
recorded as non-accrual loans as of September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
Loans receivable, net for this table includes the deductions for the undisbursed portion of construction loans in process
and deferred loan origination fees and does not include the deduction for the allowance for loan losses.
(2)
(3)
(4)
(5)
The Bank’s non-accrual loans decreased by $1.0 million to $1.9 million at September 30, 2017 from $2.9 million at
September 30, 2016, primarily as a result of a $399,000 decrease in commercial real estate loans, a $367,000 decrease in construction
loans, and a $174,000 decrease in consumer loans secured by real estate, on non-accrual status. A discussion of the Bank's largest
non-performing loans is set forth below under “Asset Classification.”
Additional interest income which would have been recorded for the year ended September 30, 2017 had non-accruing
loans been current in accordance with their original terms totaled $548,000.
Other Real Estate Owned and Other Repossessed Assets. Real estate acquired by the Bank as a result of foreclosure
or by deed-in-lieu of foreclosure is classified as other real estate owned (“OREO”) until sold. When property is acquired, it is
recorded at the estimated fair market value less estimated costs to sell. At September 30, 2017, the Bank had $3.3 million of
OREO and other repossessed assets consisting of 15 individual properties and one travel trailer, a decrease of $816,000 from $4.1
million at September 30, 2016. The OREO properties consisted of 11 land parcels totaling $1.9 million, two single family homes
totaling $875,000, two commercial real estate properties totaling $533,000, and one travel trailer with a balance of $28,000. The
largest OREO property at September 30, 2017 was an undeveloped land parcel with a balance of $948,000 located in Lewis County.
Restructured Loans. Under GAAP, the Bank is required to account for certain loan modifications or restructurings as
“troubled debt restructurings” or "troubled debt restructured loans." A troubled debt restructured ("TDR") loan 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. TDR loans are considered impaired and are
individually evaluated for impairment. TDR loans are classified as either accrual or non-accrual. TDR loans are classified as
non-performing loans unless they have been performing in accordance with their modified terms for a period of at least six months.
The Bank had TDR loans at September 30, 2017 and 2016 totaling $3.6 million and $8.2 million, respectively, of which $253,000
and $531,000, respectively, were on non-accrual status. The allowance for loan losses allocated to TDR loans at September 30,
2017 and 2016 was $10,000 and $465,000, respectively.
Impaired Loans. In accordance with GAAP, a loan is considered impaired when based on current information and events
it is probable that a creditor will be unable to collect all amounts (principal and interest) when due according to the contractual
terms of the loan agreement. Smaller balance homogeneous loans, such as residential mortgage loans and consumer loans, may
be collectively evaluated for impairment. When a loan has been identified as being impaired, the amount of the impairment is
measured by using discounted cash flows, except when, as an alternative, the current estimated fair value of the collateral, reduced
by estimated costs to sell (if applicable), or observable market price is used. The valuation of real estate collateral is subjective
in nature and may be adjusted in future periods because of changes in economic conditions. Management considers third-party
appraisals, as well as independent fair market value assessments from realtors or persons involved in selling real estate, in
determining the estimated fair value of particular properties. In addition, as certain of these third-party appraisals and independent
fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred
subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes and any related adjustments
are generally recorded at the time such information is received. When the measurement of the impaired loan is less than the
recorded investment in the loan (including accrued interest and net deferred loan origination fees or costs), impairment is recognized
by creating or adjusting an allocation of the allowance for loan losses and uncollected accrued interest is reversed against interest
income. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal
balance.
The categories of non-accrual loans and impaired loans overlap, although they are not identical. The Bank considers all
circumstances regarding the loan and borrower on an individual basis when determining whether an impaired loan should be
placed on non-accrual status, such as the financial strength of the borrower, the collateral value, reasons for delay, payment record,
17
the amount past due and the number of days past due. At September 30, 2017, the Bank had $7.0 million in impaired loans. For
additional information on impaired loans, see Note 4 of the Notes to the Consolidated Financial Statements included in Item 8 of
this Annual Report on Form 10-K.
Other Loans of Concern. Loans not reflected in the table above as non-performing, but where known information about
possible credit problems of borrowers causes management to have doubts as to the ability of the borrower to comply with present
repayment terms and that may result in disclosure of such loans as non-performing assets in the future, are commonly referred to
as “other loans of concern” or “potential problem loans.” The amount included in potential problem loans results from an evaluation,
on a loan-by-loan basis, of loans classified as “substandard” and “special mention,” as those terms are defined under “Asset
Classification” below. The amount of potential problem loans (not included in the table above as non-performing) was $9.1 million
at September 30, 2017. The vast majority of these loans are collateralized by real estate. See “Asset Classification” below for
additional information regarding the Bank's problem loans.
Asset Classification. Applicable regulations require that each insured institution review and classify its assets on a
regular basis. In addition, in connection with examinations of insured institutions, regulatory examiners have authority to identify
problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard,
doubtful and loss. Substandard loans are classified as those loans that are inadequately protected by the current net worth and
paying capacity of the obligor, or of the collateral pledged. Assets classified as substandard have a well-defined weakness or
weaknesses that jeopardize the repayment of the debt. If the weakness or weaknesses are not corrected there is the distinct
possibility that some loss will be sustained. Doubtful assets have the weaknesses of substandard assets with the additional
characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and
values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little
value that continuance as an asset of the Bank is not warranted. When the Bank classifies problem assets as either substandard
or doubtful, it is required to establish allowances for loan losses in an amount deemed prudent by management. These allowances
represent loss allowances which have been established to recognize the inherent risk associated with lending activities and the
risks associated with particular problem assets. When the Bank classifies problem assets as loss, it charges off the balance of the
asset against the allowance for loan losses. Assets which do not currently expose the Bank to sufficient risk to warrant classification
in one of the aforementioned categories but possess weaknesses are designated by the Bank as special mention. Special mention
loans are defined as those credits deemed by management to have some potential weakness that deserve management’s close
attention. If left uncorrected, these potential weaknesses may result in the deterioration of the payment prospects of the loan. Assets
in this category are not adversely classified and currently do not expose the Bank to sufficient risk to warrant a substandard
classification. The Bank’s determination of the classification of its assets and the amount of its valuation allowances is subject to
review by the FDIC and the Division which can require a different classification and the establishment of additional loss allowances.
The aggregate amounts of the Bank’s classified and special mention loans (as determined by the Bank), and of the
Bank's allowances for loan losses at the dates indicated, were as follows:
Loss
Doubtful
Substandard (1)(2)
Special mention (1)
Total classified and special
mention loans
Allowance for loan losses
2017
At September 30,
2016
(Dollars in thousands)
— $
— $
—
—
5,036
3,253
15,065
7,783
11,036
9,553
$
$
20,101
9,826
$
$
2015
—
—
12,717
17,016
29,733
9,924
$
$
$
_____________
(1)
For further information concerning the change in classified assets, see “Non-performing Loans and Delinquencies"
above.
Includes non-performing loans.
(2)
Loans classified as substandard decreased by $1.8 million to $3.3 million at September 30, 2017 from $5.0 million at
September 30, 2016. At September 30, 2017, 26 loans were classified as substandard compared to 34 loans at September 30,
2016. Of the $3.3 million in loans classified as substandard at September 30, 2017, $1.9 million were on non-accrual status. The
largest loan classified as substandard at September 30, 2017 had a balance of $524,000 and was secured by a single family home
18
in Pierce County. This loan was performing according to its restructured payment terms at September 30, 2017. The next largest
loan classified as substandard at September 30, 2017 had a balance of $398,000 and was secured by a commercial building in
Pierce County. This loan was on non-accrual status at September 30, 2017.
Loans classified as special mention decreased by $7.3 million to $7.8 million at September 30, 2017 from $15.1 million
at September 30, 2016, primarily as a result of loans being upgraded to an improved risk grade category and loans being paid off
during the year ended September 30, 2017. At September 30, 2017, 19 loans were classified as special mention. The largest loan
classified as special mention at September 30, 2017 had a balance of $1.1 million and was secured by an apartment building in
Grays Harbor County. This loan was performing according to its payment terms at September 30, 2017. The next largest loan
classified as special mention at September 30, 2017 had a balance of $676,000 and was secured by land in Grays Harbor County.
This loan was performing according to its payment terms at September 30, 2017.
Allowance for Loan Losses. The allowance for loan losses is maintained to absorb probable losses inherent in the loan
portfolio. The Bank has established a comprehensive methodology for the determination of provisions for loan losses that takes
into consideration the need for an overall general valuation allowance. The Bank’s methodology for assessing the adequacy of
its allowance for loan losses is based on its historic loss experience for various loan segments; adjusted for changes in economic
conditions, delinquency rates and other factors. Using these loss estimate factors, management develops a range of probable loss
for each loan category. Certain individual loans for which full collectibility may not be assured are evaluated individually with
loss exposure based on estimated discounted cash flows or net realizable collateral values. The total estimated range of loss based
on these two components of the analysis is compared to the loan loss allowance balance. Based on this review, management will
adjust the allowance as necessary.
In originating loans, the Bank recognizes that losses will be experienced and that the risk of loss will vary with, among
other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic
conditions and, in the case of a secured loan, the quality of the security for the loan. The Bank increases its allowance for loan
losses by charging provisions for loan losses against the Bank's operating income.
The Board of Directors reviews the adequacy of the allowance for loan losses at least quarterly based on management's
assessment of current economic conditions, past loss and collection experience, and risk characteristics of the loan portfolio.
At September 30, 2017, the Bank’s allowance for loan losses totaled $9.6 million. The Bank’s allowance for loan losses
as a percentage of total loans receivable and non-performing loans was 1.36% and 499.90%, respectively, at September 30, 2017
and 1.46% and 326.66%, respectively, at September 30, 2016. The decrease in the allowance for loan losses as a percentage of
total loans receivable was primarily due to a decrease in non-performing loans and overall improvements in other underlying credit
quality metrics in the loan portfolio.
Management believes that the amount maintained in the allowance for loan losses is adequate to absorb probable losses
inherent in the portfolio. Although management believes that it uses the best information available to make its determinations,
future adjustments to the allowance for loan losses may be necessary, and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in making the determinations.
While the Bank believes it has established its existing allowance for loan losses in accordance with GAAP, there can be
no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its allowance
for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can
be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should
the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan
losses may adversely affect the Bank's financial condition and results of operations.
19
The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated.
2017
Year Ended September 30,
2015
2014
2016
2013
Allowance at beginning of year
(Recapture of) provision for loan losses
$
$
9,826
(1,250)
9,924
—
$
10,427
(1,525)
$ 11,136
—
$ 11,825
2,925
(Dollars in thousands)
Recoveries:
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction - custom and owner/builder
Construction - speculative one- to four-family
Construction - multi-family
Construction - land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total recoveries
Charge-offs:
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction - custom and owner/builder
Construction - commercial
Construction - multi-family
Construction - land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total charge-offs
Net recoveries (charge-offs)
21
—
1,061
—
6
—
—
19
—
3
—
1,110
—
—
(13)
—
—
—
—
(110)
—
(10)
—
(133)
977
56
—
—
—
2
181
—
24
—
2
5
270
(72)
—
(209)
—
—
—
—
(61)
(18)
(8)
—
(368)
(98)
264
3
4
—
2
1,125
—
37
2
4
5
1,446
(220)
—
—
—
—
—
—
(145)
(50)
(9)
—
(424)
1,022
194
—
4
—
—
251
287
418
7
2
24
1,187
(1,106)
—
(463)
—
—
—
—
(260)
(47)
(6)
(14)
(1,896)
(709)
95
—
55
26
—
—
146
54
5
—
105
486
(769)
—
(667)
(26)
—
(116)
(17)
(2,307)
(184)
(14)
—
(4,100)
(3,614)
Allowance at end of year
$
9,553
$
9,826
$
9,924
$ 10,427
$ 11,136
Allowance for loan losses as a percentage of total
loans receivable (net) outstanding at the end of
the year (1)
Net recoveries (charge-offs) as a percentage of
average loans outstanding during the year
Allowance for loan losses as a percentage of non-
performing loans at end of year
1.36%
1.46 %
1.62%
1.81 %
2.00 %
0.14%
(0.02)%
0.17%
(0.12)%
(0.65)%
499.90%
326.66 %
160.30%
88.96 %
79.28 %
______________
(1)
Loans receivable, net for this table includes the deductions for the undisbursed portion of construction loans in process
and net deferred loan origination fees and does not include the deduction for the allowance for loan losses.
20
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Investment Activities
The investment policies of the Bank are established and monitored by the Board of Directors. The policies are designed
primarily to provide and maintain liquidity, to generate a favorable return on investments without incurring undue interest rate
and credit risk, and to compliment the Bank’s lending activities. These policies dictate the criteria for classifying securities as
either available for sale or held to maturity. The policies permit investment in various types of liquid assets permissible under
applicable regulations, which include U.S. Treasury obligations, securities of various federal agencies, certificates of deposit of
insured banks, federal funds, mortgage-backed securities, municipal bonds and mutual funds. The Company's investment policy
also permits investment in equity securities in certain financial service companies.
At September 30, 2017, the Bank’s investment portfolio totaled $8.4 million, consisting of $6.0 million of U.S. Treasury
and U.S. government agency securities held to maturity, $1.1 million of mortgage-backed securities held to maturity, $952,000
of mutual funds available for sale and $289,000 of mortgage-backed securities available for sale. The Bank does not maintain a
trading account for any investments. This compares with a total investment portfolio of $8.9 million at September 30, 2016,
consisting of $6.0 million of U.S. Treasury and U.S. government agency securities held to maturity, $1.5 million of mortgage-
backed securities held to maturity, $366,000 of mortgage-backed securities available for sale and $976,000 of mutual funds
available for sale. The composition of the portfolios by type of security at the dates indicated is presented in the following table.
2017
Recorded
Amount
Percent of
Total
At September 30,
2016
Percent of
Recorded
Amount
Total
(Dollars in thousands)
2015
Recorded
Amount
Percent of
Total
6,008
1,131
71.69% $
13.50
6,006
1,505
67.84% $
17.00
6,004
1,909
64.52%
20.52
Held to Maturity:
U.S.Treasury and U.S.
government agency securities
$
Mortgage-backed securities
Available for Sale:
Mortgage-backed securities
Mutual funds
289
952
3.45
11.36
366
976
4.13
11.03
421
971
4.52
10.44
Total portfolio
$
8,380
100.0% $
8,853
100.0% $
9,305
100.0%
The following table sets forth the maturities and weighted average yields of the securities in the Bank's portfolio at
September 30, 2017. Mutual funds, which by their nature do not have maturities, are classified in the one year or less category.
One Year or Less
Yield
Amount
After One to
Five Years
After Five to
Ten Years
After Ten
Years
Amount
Yield
Amount
(Dollars in thousands)
Yield
Amount
Yield
Held to Maturity:
U.S. Treasury and U.S.
government agency
securities
$
Mortgage-backed
securities
Available for Sale:
Mortgage-backed
securities
Mutual funds
—
14
—% $
5,995
1.60% $
3.98
1
2.33
—
952
—
2.09
—
—
—
—
Total portfolio
$
966
2.12% $
5,996
1.60% $
22
—
28
—
—
28
—% $
—
—%
2.90
1,101
7.72
—
—
289
—
5.00
—
2.90% $
1,390
7.16%
There were no securities which had an aggregate book value in excess of 10% of the Bank’s total equity at September 30,
2017. At September 30, 2017, the Bank had $599,000 of private label mortgage-backed securities in the held to maturity investment
securities portfolio of which $533,000 were on non-accrual status. For additional information regarding investment securities,
see “Item 1A. Risk Factors – Our investment securities portfolio may be negatively impacted by fluctuations in market value and
interest rates and result in losses” and Note 3 of the Notes to the Consolidated Financial Statements included in Item 8 of this
Annual Report on Form 10-K.
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the Bank's funds for lending and other investment
purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are influenced significantly by general interest rates and money market conditions. Borrowings through the Federal
Home Loan Bank of Des Moines ("FHLB") and the Federal Reserve Bank of San Francisco ("FRB") may be used to compensate
for reductions in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank's depositors are residents of Washington. Deposits are attracted from
within the Bank's market area through the offering of a broad selection of deposit instruments, including money market deposit
accounts, checking accounts, regular savings accounts and certificates of deposit. Deposit account terms vary, according to the
minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In
determining the terms of its deposit accounts, the Bank considers current market interest rates, profitability to the Bank, matching
deposit and loan products and its customer preferences and concerns. The Bank actively seeks consumer and commercial checking
accounts through checking account acquisition marketing programs. The Bank also has 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. At September 30, 2017, the Bank had
$15.5 million, or 1.8% of total deposits, from businesses associated with the marijuana industry. See "Risk Factors- We operate
in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations that could
increase our costs of operations."
At September 30, 2017, the Bank had $15.6 million of jumbo certificates of deposit of $250,000 or more. The Bank had
brokered certificates of deposit totaling $3.2 million and $8.1 million in brokered money market deposits at September 30, 2017.
The Bank believes that its jumbo certificates of deposit, which represented 1.9% of total deposits at September 30, 2017, present
similar interest rate risks as compared to its other deposits.
The following table sets forth information concerning the Bank's deposits at September 30, 2017.
Category
Non-interest bearing demand
Negotiable order of withdrawal (“NOW”) checking
Savings
Money market
Subtotal
Certificates of Deposit (1)
Maturing within 1 year
Maturing after 1 year but within 2 years
Maturing after 2 years but within 5 years
Maturing after 5 years
Total certificates of deposit
Total deposits
______________________
(1)
Based on remaining maturity of certificates.
23
Weighted
Average
Interest
Rate
Percentage
of Total
Deposits
Amount
(Dollars in thousands)
—% $
0.22
0.06
0.35
0.15
205,952
220,315
140,987
131,002
698,256
0.61
1.03
1.59
1.74
0.87
0.28% $
75,440
27,770
36,287
145
139,642
837,898
24.58%
26.29
16.83
15.64
83.34
9.00
3.31
4.33
0.02
16.66
100.00%
The following table indicates the amount of the Bank's jumbo certificates of deposit by time remaining until maturity as
of September 30, 2017. Jumbo certificates of deposit have principal balances of $250,000 or more, and the rates paid on these
accounts are generally negotiable.
Maturity Period
Three months or less
Over three through six months
Over six through twelve months
Over twelve months
Total
Amount
(Dollars in thousands)
2,032
$
5,857
1,598
6,114
15,601
$
Deposit Flow. The following table sets forth the balances of deposits in the various types of accounts offered by the
Bank at the dates indicated.
2017
Percent
of
Total
Increase
(Decrease)
Amount
At September 30,
2016
Percent
of
Total
(Dollars in thousands)
Amount
Increase
(Decrease)
Amount
2015
Percent
of
Total
Non-interest-bearing demand
$
205,952
24.58% $
33,669
$
172,283
22.62% $
30,895
$
141,388
20.82%
NOW checking
Savings
Money market
Certificates of deposit which
mature:
Within 1 year
After 1 year, but within 2 years
After 2 years, but within 5
years
Certificates maturing
thereafter
220,315
140,987
131,002
75,440
27,770
36,287
145
26.29
16.83
15.64
9.00
3.31
4.33
0.02
16,503
17,513
17,011
203,812
123,474
113,991
(12,620)
1,222
88,060
26,548
2,934
33,353
132
13
26.76
16.21
14.97
11.56
3.49
4.38
—
23,184
13,159
21,515
180,628
110,315
92,476
(5,822)
(6,868)
93,882
33,416
7,078
26,275
(519)
532
26.61
16.25
13.62
13.83
4.92
3.87
0.08
Total
$
837,898
100.0% $
76,364
$
761,534
100.0% $
82,622
$
678,912
100.00%
Certificates of Deposit by Rates. The following table sets forth the certificates of deposit in the Bank classified by rates
as of the dates indicated.
0.00 - 1.99%
2.00 - 3.99%
4.00 - 5.99%
Total
$
$
133,050
6,332
260
139,642
2017
At September 30,
2016
(Dollars in thousands)
$
$
144,814
2,900
260
147,974
$
$
2015
144,083
9,762
260
154,105
Certificates of Deposit by Maturities. The following table sets forth the amount and maturities of certificates of deposit
at September 30, 2017.
Amount Due
Less Than
One Year
One to
Two
Years
After
Two to
Five
Years
(Dollars in thousands)
$
$
26,546
1,066
158
27,770
$
31,021
5,266
—
36,287
After
Five Years
Total
145
—
—
145
$
$
133,050
6,332
260
139,642
$
0.00 - 1.99%
2.00 - 3.99%
4.00 - 5.99%
Total
$
$
75,338
—
102
75,440
$
$
24
Deposit Activities. The following table sets forth the deposit activities of the Bank for the periods indicated.
Beginning balance
Net deposits before interest credited
Interest credited
Net increase in deposits
Ending balance
$
$
761,534
74,146
2,218
76,364
837,898
678,912
80,581
2,041
82,622
761,534
$
$
615,116
61,792
2,004
63,796
678,912
2017
Year Ended September 30,
2016
(Dollars in thousands)
$
$
2015
Borrowings. Deposits and loan repayments are generally the primary source of funds for the Bank's lending and
investment activities and for general business purposes. The Bank has the ability to use borrowings from the FHLB to supplement
its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB functions as a central reserve bank providing
credit for member financial institutions. As a member of the FHLB, the Bank is required to own capital stock in the FHLB and
is authorized to apply for borrowings on the security of such stock and certain mortgage loans and other assets (principally securities
which are obligations of, or guaranteed by, the U.S. government) provided certain creditworthiness standards have been
met. Borrowings are made pursuant to several different credit programs. Each credit program has its own interest rate and range
of maturities. Depending on the program, limitations on the amount of borrowings are based on the financial condition of the
member institution and the adequacy of collateral pledged to secure the credit. At September 30, 2017, the Bank maintained an
uncommitted credit facility with the FHLB that provided for immediately available borrowings up to an aggregate amount to 35%
of the Bank’s total assets, limited by available collateral. The Bank had no outstanding balance on this borrowing line at September
30, 2017. The Bank also has a Letter of Credit ("LOC") of up to $22.0 million with the FHLB for the purpose of collateralizing
Washington State public deposits. The LOC amount reduces the Bank's available FHLB borrowings. The Bank maintains a short-
term borrowing line of credit with the FRB with total credit based on eligible collateral. At September 30, 2017, the Bank had no
outstanding balance and $62.8 million in unused borrowing capacity on this borrowing line of credit. A short-term borrowing line
of credit of $10.0 million is also maintained at Pacific Coast Bankers' Bank ("PCBB"). The Bank had no outstanding balance on
this borrowing line of credit at September 30, 2017.
The following table sets forth certain information regarding borrowings, including repurchase agreements, by the Bank
at the end of and during the periods indicated:
Average total borrowings
Weighted average rate paid on total borrowings
Total borrowings outstanding at end of period
$
$
At or For the
Year Ended September 30,
2016
(Dollars in thousands)
44,959
$
$
2017
17,096
2015
45,000
5.73% (1)
4.52% (2)
4.19%
—
$
30,000
$
45,000
________________________
(1) Includes a prepayment penalty of $282. The weighted average rate without the prepayment penalty was 4.08%.
(2) Includes a prepayment penalty of $138. The weighted average rate without the prepayment penalty was 4.21%.
The Bank did not have any short-term borrowings for the years ended September 30, 2017, 2016 and 2015.
Bank Owned Life Insurance
The Bank has purchased life insurance policies covering certain officers. These policies are recorded at their cash
surrender value, net of any cash surrender charges. Increases in cash surrender value, net of policy premiums, and proceeds from
death benefits are recorded in non-interest income. At September 30, 2017, the cash surrender value of bank owned life insurance
(“BOLI”) was $19.3 million.
How We Are Regulated
General. As a bank holding company, Timberland Bancorp is subject to examination and supervision by, and is required
to file certain reports with, the Federal Reserve. Timberland Bancorp is also subject to the rules and regulations of the SEC under
25
the federal securities laws. As a state-chartered savings bank, the Bank is subject to regulation and oversight by the Division and
the applicable provisions of Washington law and regulations of the Division adopted thereunder. The Bank also is subject to
regulation and examination by the FDIC, which insures the deposits of the Bank to the maximum extent permitted by law, and
requirements established by the Federal Reserve. State law and regulations govern the Bank's ability to take deposits and pay
interest thereon, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to
offer various banking services to its customers and to establish branch offices. Under state law, savings banks in Washington also
generally have all of the powers that federal savings banks have under federal laws and regulations. The Bank is subject to periodic
examination and reporting requirements by and of the Division and the FDIC.
The following is a brief description of certain laws and regulations applicable to Timberland Bancorp and the Bank.
Descriptions of laws and regulations here and elsewhere in this report do not purport to be complete and are qualified in their
entirety by reference to the actual laws and regulations. Legislation is introduced from time to time in the U.S. Congress or the
Washington State Legislature that may affect the operations of Timberland Bancorp and the Bank. In addition, the regulations
governing the Company and the Bank may be amended from time to time by the FDIC, DFI, Federal Reserve and the Consumer
Financial Protection Bureau ("CFPB"). Any such legislation or regulatory changes in the future could adversely affect the
Company's and the Bank's operations and financial condition. We cannot predict whether any such changes may occur.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted in July
2010, imposed new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository
institutions and their holding companies. Among other changes, the Dodd-Frank Act established the CFPB as an independent
bureau of the Federal Reserve. The CFPB assumed responsibility for the implementation of the federal financial consumer protection
and fair lending laws and regulations and has authority to impose new requirements. The Bank is subject to consumer protection
regulations issued by the CFPB, but as a smaller financial institution, the Bank is generally subject to supervision and enforcement
by the FDIC and the DFI with respect to its compliance with consumer financial protection laws and CFPB regulations.
Many aspects of the Dodd-Frank Act are subject to delayed effective dates and/or rulemaking by the federal banking
agencies, and their impact on operations cannot yet fully be assessed. However, it is likely that the Dodd-Frank Act will increase
regulatory burden and compliance costs for the Bank and Timberland Bancorp.
Regulation of the Bank
The Bank, as a state-chartered savings bank, is subject to regulation and oversight by the FDIC and the Division extending
to all aspects of its operations.
Federal and State Enforcement Authority and Actions. As part of its supervisory authority over Washington-chartered
savings banks, the Division may initiate enforcement proceedings to obtain a consent order to cease and desist against an institution
believed to have engaged in unsafe and unsound practices or to have violated a law, regulation, or other regulatory limit, including
a written agreement. The FDIC also has the authority to initiate enforcement actions against insured institutions for similar reasons
and may terminate the deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an
unsafe or unsound condition. Both of these agencies may utilize less formal supervisory tools to address their concerns about the
condition, operations or compliance status of a savings bank.
Insurance of Accounts and Regulation by the FDIC. The deposit insurance fund (the "DIF") of the FDIC insures
deposit accounts in the Bank up to $250,000 per separately insured depositor. As insurer, the FDIC imposes deposit insurance
premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The Bank's deposit
insurance premiums for the year ended September 30, 2017 were $362,000.
Under the FDIC's risk-based assessment system, insured institutions are assigned to one of four risk categories based on
supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution's risk category
and certain specified risk adjustments whereby stronger institutions pay lower rates while riskier institutions pay higher rates.
Assessments are based on an institution's average consolidated total assets minus average tangible equity with an assessment rate
schedule for most institutions ranging from 1.5 to 40 basis points, subject to adjustment. The FDIC has authority to increase
insurance assessments, and any significant increases would have an adverse effect on the operating expenses and results of
operations of the Bank. Management cannot predict what assessment rates will be in the future.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It
also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against banks and savings associations.
Management is not aware of any existing circumstances which would result in termination of the Bank's deposit insurance.
26
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the
late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. These assessments, which may be
revised based upon the level of DIF deposits, will continue until the bonds mature in 2019. The Financing Corporation was
chartered in 1987 solely for the purpose of functioning as a vehicle for the recapitalization or the deposit insurance system.
A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results
of operations of the Bank.
Prompt Corrective Action. Federal statutes establish a supervisory framework based on five capital categories: well
capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An
institution’s category depends upon where its capital levels are in relation to relevant capital measures, which include a risk-based
capital measure, a leverage ratio capital measure and certain other factors. An institution that is not well capitalized is subject to
certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits generally. Any institution
which is neither well capitalized nor adequately capitalized is considered undercapitalized. Under these regulations, an institution
is treated as well capitalized if it has (i) a total risk-based capital ratio of 10.0% or more, (ii) a common equity Tier 1 risk-based
capital ratio of 6.5% or more, (iii) a Tier 1 risk-based capital ratio of 8.0% or more, and (iv) a leverage ratio of 5.0% or more, and
is not subject to any of certain specified requirements to meet and maintain a specific capital level for any capital measure.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and
restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by an institution to
comply with applicable capital requirements would, if unremedied, result in progressively more severe restrictions on its activities
and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of
required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt
corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval
of any regulatory application filed for their review may be dependent on compliance with capital requirements.
At September 30, 2017, the Bank was categorized as “well capitalized” under the prompt corrective action regulations
of the FDIC. For additional information regarding the Bank's minimum regulatory capital requirements, see "Capital
Requirements" below and Note 15 of the Notes to the Consolidated Financial Statements contained in “Item 8. Financial Statements
and Supplementary Data” of this Form 10-K.
Capital Requirements. Effective January 1, 2015 (with some changes transitioned into full effectiveness over two to
four years), the Bank became subject to new capital regulations adopted by the FDIC, which created a new required ratio for
common equity Tier 1 ("CET1") capital, increased the minimum leverage and Tier 1 capital ratios, changed the risk-weightings
of certain assets for purposes of the risk-based capital ratios, created an additional capital conservation buffer over the required
capital ratios, and changed what qualifies as capital for purposes of meeting the capital requirements. The Federal Reserve adopted
parallel regulations for bank holding companies. These regulations implement the regulatory capital reforms required by the Dodd
Frank Act and the "Basel III" requirements.
Under the new capital regulations, the minimum capital level requirements are (i) a CET1 capital ratio of 4.5%; (ii) a
Tier 1 capital ratio of 6.0%; (iii) a total capital ratio of 8.0%; and (iv) a Tier 1 leverage ratio of 4.0%. CET1 generally consists
of common stock; retained earnings; accumulated other comprehensive income ("AOCI") unless an institution elects to exclude
AOCI from regulatory capital; and certain minority interests; all subject to applicable regulatory adjustments and deductions. Tier
1 capital generally consists of CET1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other
preferred stock and subordinated debt meeting certain conditions plus an amount of the allowance for loan and lease losses up to
1.25% of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer that consists of
additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations
on paying dividends, repurchasing shares and paying discretionary bonuses. The capital conservation buffer requirement is subject
to a phase-in period that began on January 1, 2016 with the requirement for a buffer of greater than 0.625% of risk-weighted assets.
This capital conservation buffer increases each year until the capital conservation buffer requirement is fully implemented on
January 1, 2019. At September 30, 2017 the conservation buffer was 1.25%.
In addition to the capital requirements, there have been a number of changes in what constitutes regulatory capital, subject
to transition periods. These changes include the phasing-out of certain instruments of qualifying capital. The Bank did not have
any of these instruments at September 30, 2017. Mortgage servicing rights and deferred tax assets over designated percentages
of CET1 are deducted from capital, subject to a four-year transition period. CET1 capital consists of Tier 1 capital less all capital
27
components that are not considered common equity. In addition, Tier 1 capital includes accumulated other comprehensive income
(loss), which includes all unrealized gains and losses on available for sale debt and equity securities, subject to a four-year transition
period. Because of the Bank's asset size, it was not considered an advanced approaches banking organization and elected in the
first quarter of calendar year 2015 to take the one-time option of deciding to permanently opt-out of the inclusion of unrealized
gains and losses on available for sale debt and equity securities in its capital calculations.
The new requirements also changed in the risk-weighting of certain assets to better reflect credit risk and other risk
exposure, including a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition development
and construction loans and for non-residential mortgage loans that are 90 days or more past due or otherwise on non-accrual status;
a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less
that is not unconditionally cancellable; and a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax
assets that are not deducted from capital.
Under the new standards, in order to be considered well-capitalized, the Bank must have a CET1 risk-based capital ratio
of 6.5% (new), a Tier 1 risk-based capital ratio of 8.0% (increased from 6.0%), a total risk-based capital ratio of 10.0% (unchanged)
and a Tier 1 leverage capital ratio of 5.0% (unchanged).
At September 30, 2017, the Bank exceeded all regulatory capital requirements and was categorized as "well capitalized"
under the regulations of the FDIC.
The following table compares the Bank's actual capital amounts at September 30, 2017 to its minimum regulatory capital
requirements at that date (Dollars in thousands):
Regulatory Minimum To
Be "Adequately
Capitalized
Regulatory Minimum To
Be "Well Capitalized"
Under Prompt Corrective
Action Provisions
Actual
Amount
Ratio
Amount
Ratio
Amount
Ratio
Leverage Capital Ratio:
Tier 1 capital
$ 104,102
11.22% $
37,116
4.00% $
46,395
5.00%
Risk-based Capital Ratios:
Common equity tier 1 capital
104,102
15.86
29,547
Tier 1 capital
104,102
15.86
39,395
Total capital
112,329
17.11
52,527
4.50
6.00
8.00
42,678
6.50
52,527
8.00
65,659
10.00
The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon a
determination that an institution's capital level is or may become inadequate in light of particular risks or circumstances.
Management of the Bank believes that, under the current regulations, the Bank will continue to meet its minimum capital
requirements in the foreseeable future.
For additional information regarding the Bank's regulatory capital requirements, see Note 15 of the Notes to the
Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Federal Home Loan Bank System. The Bank is a member of the FHLB, one of 11 regional Federal Home Loan Banks
that administer the home financing credit function of savings institutions, each serving as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members in accordance with policies and procedures, established by the Board of Directors of the
FHLB, which are subject to the oversight of the Federal Housing Finance Board. All borrowings from the FHLB are required to
be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term borrowings are required to provide
funds for residential home financing. See “Deposit Activities and Other Sources of Funds – Borrowings" above.
As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines based on the Bank's asset
size and level of borrowings from the FHLB. At September 30, 2017, the Bank had $1.1 million in FHLB stock, which was in
28
compliance with this requirement. The FHLB pays dividends quarterly, and the Bank received $49,000 in dividends during the
year ended September 30, 2017.
The Federal Home Loan Banks continue to contribute to low- and moderately-priced housing programs through direct
loans or interest subsidies on borrowings targeted for community investment and low- and moderate-income housing
projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the
future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of
the Bank's FHLB stock may result in a decrease in net income and possibly capital.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation,
guidelines for all insured depository institutions relating to: internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, compensation, fees and
benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address
problems at insured depository institutions before capital becomes impaired. Each insured depository institution must implement
a comprehensive written information security program that includes administrative, technical and physical safeguards appropriate
to the institution’s size and complexity and the nature and scope of its activities. The information security program also must be
designed to ensure the security and confidentiality of customer information, protect against any unanticipated threats or hazards
to the security or integrity of such information, protect against unauthorized access to or use of such information that could result
in substantial harm or inconvenience to any customer, and ensure the proper disposal of customer and consumer information. Each
insured depository institution must also develop and implement a risk-based response program to address incidents of unauthorized
access to customer information in customer information systems. If the FDIC determines that the Bank fails to meet any standard
prescribed by the guidelines, it may require the Bank to submit to the agency an acceptable plan to achieve compliance with the
standard. FDIC regulations establish deadlines for the submission and review of such safety and soundness compliance
plans. Management of the Bank is not aware of any conditions relating to these safety and soundness standards which would
require submission of a plan of compliance.
Real Estate Lending Standards. FDIC regulations require the Bank to adopt and maintain written policies that establish
appropriate limits and standards for real estate loans. These standards, which must be consistent with safe and sound banking
practices, must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value ratio
limits) that are clear and measurable, loan administration procedures, and documentation, approval and reporting requirements. The
Bank is obligated to monitor conditions in its real estate markets to ensure that its standards continue to be appropriate for current
market conditions. The Bank’s Board of Directors is required to review and approve the Bank’s standards at least annually. The
FDIC has published guidelines for compliance with these regulations, including supervisory limitations on loan-to-value ratios
for different categories of real estate loans. Under the guidelines, the aggregate amount of all loans in excess of the supervisory
loan-to-value ratios should not exceed 100% of total capital, and the total of all loans for commercial, agricultural, multi-family
or other non-one- to four-family residential properties in excess of the supervisory loan-to-value ratio should not exceed 30% of
total capital. Loans in excess of the supervisory loan-to-value ratio limitations must be identified in the Bank’s records and reported
at least quarterly to the Bank’s Board of Directors. The Bank is in compliance with the record and reporting requirements. As of
September 30, 2017, the Bank’s aggregate loans in excess of the supervisory loan-to-value ratios were 0.8% of total capital and
there were no loans on commercial, agricultural, multi-family or other non-one- to four-family residential properties in excess
of the supervisory loan-to-value ratios.
Activities and Investments of Insured State-Chartered Financial Institutions. Federal law generally limits the
activities and equity investments of FDIC-insured state-chartered banks to those that are permissible for national banks. An insured
state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing
as a limited partner in a partnership, the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or
new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the
bank's total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors' and
officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, and
(iv) acquiring or retaining the voting shares of a depository institution owned by another FDIC-insured institution if certain
requirements are met.
Under the law of Washington State, Washington-chartered savings banks may exercise any of the powers of Washington-
chartered commercial banks, national banks and federally-chartered savings banks, subject to the approval of the Director in certain
situations. In addition,Washington-chartered savings banks may charge the maximum interest rate allowable for loans and other
extensions of credit by federally-chartered financial institutions to Washington residents.
Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response,
Compensation and Liability Act (“CERCLA”) is a federal statute that generally imposes strict liability on all prior and present
29
"owners and operators" of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing
that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since
the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left
open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan.
To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by
properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup
costs, which costs often substantially exceed the value of the collateral property.
Federal Reserve System. The Federal Reserve requires that all depository institutions maintain reserves on transaction
accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the
regional Federal Reserve Bank. Negotiable order of withdrawal ("NOW") accounts and other types of accounts that permit
payments or transfers to third parties fall within the definition of transaction accounts and are subject to reserve requirements, as
are any non-personal time deposits at a savings bank. As of September 30, 2017, the Bank’s deposit with the Federal Reserve and
vault cash exceeded its Regulation D reserve requirements.
Affiliate Transactions. Federal laws strictly limit the ability of banks to engage in certain transactions with their affiliates,
including their bank holding companies. Transactions deemed to be a “covered transaction” under Section 23A of the Federal
Reserve Act and between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company are
limited to 10% of the bank subsidiary’s capital and surplus and, with respect to the parent company and all such nonbank subsidiaries,
to an aggregate of 20% of the bank subsidiary’s capital and surplus. Further, covered transactions that are loans and extensions
of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that covered
transactions and certain other transactions listed in Section 23B of the Federal Reserve Act between a bank and its affiliates be on
terms as favorable to the bank as transactions with non-affiliates.
Community Reinvestment Act. Banks are also subject to the provisions of the Community Reinvestment Act of 1977
(“CRA”), which requires the appropriate federal bank regulatory agency to assess a bank’s performance under the CRA in meeting
the credit needs of the community serviced by the bank, including low- and moderate-income neighborhoods. The regulatory
agency’s assessment of the bank’s record is made available to the public. Further, a bank’s performance must be considered in
connection with a bank’s application to, among other things, establish a new branch office that will accept deposits, relocate an
existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial
institution. The Bank received a “satisfactory” rating during its most recent examination.
Dividends. Dividends from the Bank constitute the major source of funds available for dividends which may be paid to
Company shareholders. The amount of dividends payable by the Bank to the Company depends upon the Bank's earnings and
capital position, and is limited by federal and state laws, regulations and policies. According to Washington law, the Bank may
not declare or pay a cash dividend on its capital stock if it would cause its net worth to be reduced below (i) the amount required
for liquidation accounts or (ii) the net worth requirements, if any, imposed by the Director of the Division. In addition, dividends
on the Bank's capital stock may not be paid in an aggregate amount greater than the aggregate retained earnings of the Bank,
without the approval of the Director of the Division. Dividends payable by the Bank can be limited or prohibited if the Bank does
not meet the capital conservation buffer requirement.
The amount of dividends actually paid during any one period will be strongly affected by the Bank's management policy
of maintaining a strong capital position. Federal law further provides that no insured depository institution may pay a cash dividend
if it would cause the institution to be “undercapitalized,” as defined in the prompt corrective action regulations. Moreover, the
federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments
should be deemed to constitute an unsafe and unsound practice.
Other Consumer Protection Laws and Regulations. The Bank is subject to a broad array of federal and state consumer
protection laws and regulations that govern almost every aspect of its business relationships with consumers. While the list set
forth below is not exhaustive, these include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act,
the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures
Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to
Financial Privacy Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit Billing Act,
the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing
consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business
practices, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain
disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits,
making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the
30
Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties,
punitive damages, and the loss of certain contractual rights.
Regulation of the Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company registered with the Federal
Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding
Company Act of 1956, as amended (“BHCA”), and the regulations promulgated thereunder. This regulation and oversight is
generally intended to ensure that the Company limits its activities to those allowed by law and that it operates in a safe and sound
manner without endangering the financial health of the Bank.
As a bank holding company, the Company is required to file quarterly reports with the Federal Reserve and any additional
information required by the Federal Reserve and is subject to regular examinations by the Federal Reserve. The Federal Reserve
also has extensive enforcement authority over bank holding companies, including the ability to assess civil money penalties, to
issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank
subsidiaries). In general, enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound
practices.
BHCA. The Company is supervised by the Federal Reserve under the BHCA. Federal Reserve policy requires that a
bank holding company serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its
operations in an unsafe or unsound manner. In addition, the Federal Reserve provides that bank holding companies should serve
as a source of strength to its subsidiary banks by being prepared to use available resources to provide adequate capital funds to
its subsidiary banks during periods of financial stress or adversity, and should maintain the financial flexibility and capital raising
capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligation
to serve as a source of strength to its subsidiary bank will generally be considered by the Federal Reserve to be an unsafe and
unsound banking practice or a violation of the Federal Reserve's regulations or both.
Under the BHCA, the Federal Reserve may approve the ownership of shares by a bank holding company in any company
the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or
controlling banks as to be a proper incident thereto. These activities generally include, among others, operating a savings institution,
mortgage company, finance company, escrow company, credit card company or factoring company; performing certain data
processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain
types of credit related insurance; leasing property on a full payout, non-operating basis; selling money orders, travelers’ checks
and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject
to certain limitations, providing securities brokerage services for customers.
Acquisitions. The BHCA prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from
engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for
its subsidiaries. A bank holding company that meets certain supervisory and financial standards and elects to be designated as a
financial holding company may also engage in certain securities, insurance and merchant banking activities and other activities
determined to be financial in nature or incidental to financial activities.
Interstate Banking. The Federal Reserve may approve an application of a bank holding company to acquire control of,
or acquire all or substantially all of the assets of, a bank located in a state other than such holding company's home state, without
regard to whether the transaction is prohibited by the laws of any state except with respect to the acquisition of a bank that has
not been in existence for the minimum time period, not exceeding five years, specified by the law of the host state. The Federal
Reserve may not approve an application if the applicant controls or would control more than 10% of the insured deposits in the
U.S. or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. Federal
law does not affect the authority of states to limit the percentage of total insured deposits in the state that may be held or controlled
by a bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding
companies. Individual states may also waive the 30% state-wide concentration limit contained in the federal law.
The federal banking agencies are authorized to approve interstate merger transactions without regard to whether such
transaction is prohibited by the law of any state, unless the home state of one of the banks adopted a law prior to June 1, 1997
which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate
acquisitions of branches will be permitted only if the law of the state in which the branch is located permits such
acquisitions. Interstate mergers and branch acquisitions will also be subject to the nationwide and statewide insured deposit
concentration amounts described above.
31
Dividends. Federal Reserve policy limits the payment of cash dividends by bank holding companies, which expresses
the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net
income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the
company's capital needs, asset quality and overall financial condition, and that it is inappropriate for a company experiencing
serious financial problems to borrow funds to pay dividends. Under Washington corporate law, the Company generally may not
pay dividends if after that payment it would not be able to pay its liabilities as they become due in the usual course of business,
or its total assets would be less than its total liabilities. The capital conservation buffer requirement can also limit dividends.
Stock Repurchases. Bank holding companies, except for certain “well-capitalized” and highly rated bank holding
companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity
securities if the consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve
may disapprove a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or
would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal
Reserve.
Capital Requirements. As a bank holding company registered with the Federal Reserve, the Company is subject to the
capital adequacy requirements of the Federal Reserve under the BHCA and the regulations of the Federal Reserve. For a bank
holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis, and the Federal Reserve
expects the holding company's subsidiary bank to be well capitalized under the prompt corrective action regulations. If the
Company were subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at September 30,
2017, the Company would have exceeded all regulatory requirements.
The following table presents the regulatory capital ratios for the Company as of September 30, 2017 (Dollars in thousands):
Actual
Amount
Ratio
Leverage Capital Ratio:
Tier 1 capital
$
107,145
11.52%
Risk-based Capital Ratios:
Common equity tier 1 capital
Tier 1 capital
Total capital
107,145
107,145
115,376
16.31
16.31
17.56
For additional information see Note 15 to the Consolidated Financial Statements contained in "Item 8. Financial Statements
and Supplementary Data" of this Form 10-K.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. On July 21, 2010, the Dodd-Frank Act
was signed into law. The Dodd-Frank-Act imposed new restrictions and an expanded framework of regulatory oversight for
financial institutions, including depository institutions, and mandated new capital regulations discussed above under “Regulation
and Supervision of the Bank - Capital Requirements.” In addition, among other changes, the Dodd-Frank Act requires public
companies, such as Timberland Bancorp, to (i) provide their shareholders with a non-binding vote (a) at least once every three
years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a “say on
pay” vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named
executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would
trigger the parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive
compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require companies
to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all
other employees. For certain of these changes, the implementing regulations have not been promulgated, so the full impact of the
Dodd-Frank Act on public companies cannot be determined at this time.
32
Taxation
Federal Taxation
General. The Company and the Bank report their operations on a fiscal year basis using the accrual method of accounting
and are subject to federal income taxation in the same manner as other corporations. The following discussion of tax matters is
intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the
Company.
Corporate Alternative Minimum Tax. The Internal Revenue Code imposes a tax on alternative minimum taxable income
(“AMTI”) at a rate of 20%. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by
an amount equal to 75% of the amount by which the Bank's adjusted current earnings exceeds its AMTI (determined without
regard to this preference and prior to reduction for net operating losses).
Dividends-Received Deduction. The Company may exclude from its income 100% of dividends received from the Bank
as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the
case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax
return, except that if the Company or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then
80% of any dividends received may be deducted.
Audits. The Company is no longer subject to U.S. federal tax examination by tax authorities for years ended on or before
September 30, 2013.
Washington Taxation
The Company and the Bank are subject to a business and occupation tax imposed under Washington law at the rate of
1.50% of gross receipts at September 30, 2017. Interest received on loans secured by mortgages or deeds of trust on residential
properties, certain residential mortgage-backed securities, and certain U.S. government and agency securities is not subject to this
tax.
Competition
The Bank operates in an intensely competitive market for the attraction of deposits (generally its primary source of
lendable funds) and in the origination of loans. Historically, its most direct competition for deposits has come from commercial
banks, thrift institutions and credit unions in its primary market area. In times of high interest rates, the Bank experiences additional
significant competition for investors' funds from short-term money market securities and other corporate and government
securities. The Bank's competition for loans comes principally from mortgage bankers, commercial banks and thrift
institutions. Such competition for deposits and the origination of loans may limit the Bank's future growth and earnings prospects.
Subsidiary Activities
The Bank has one wholly-owned subsidiary, Timberland Service Corporation (“Timberland Service”), whose primary
function is to provide escrow services.
Personnel
As of September 30, 2017, the Bank had 250 full-time employees and 24 part-time and on-call employees. The employees
are not represented by a collective bargaining unit, and the Bank believes its relationship with its employees is good.
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Executive Officers of the Registrant
The following table sets forth certain information with respect to the executive officers of the Company and the Bank.
Executive Officers of the Company and Bank
Age at
September
30, 2017
Company
Bank
Position
63
50
66
43
60
48
President and Chief Executive
Officer
President and Chief Executive Officer
Executive Vice President, Chief
Financial Officer and Secretary
Executive Vice President, Chief
Financial Officer and Secretary
Executive Vice President of Lending
Executive Vice President of Lending
Executive Vice President and
Chief Operating Officer
Executive Vice President and
Chief Operating Officer
Executive Vice President and
Chief Credit Administrator
Executive Vice President and
Chief Credit Administrator
Senior Vice President and
Treasurer
Senior Vice President and Treasurer
Name
Michael R. Sand
Dean J. Brydon
Robert A. Drugge
Jonathan A. Fischer
Edward C. Foster
Marci A. Basich
Biographical Information.
Michael R. Sand has been affiliated with the Bank since 1977 and has served as President of the Bank and the Company
since January 23, 2003. On September 30, 2003, he was appointed as Chief Executive Officer of the Bank and Company. Prior
to appointment as President and Chief Executive Officer, Mr. Sand had served as Executive Vice President and Secretary of the
Bank since 1993 and as Executive Vice President and Secretary of the Company since its formation in 1997.
Dean J. Brydon has been affiliated with the Bank since 1994 and has served as the Chief Financial Officer of the Company
and the Bank since January 2000 and Secretary of the Company and Bank since January 2004. Mr. Brydon is a Certified Public
Accountant.
Robert A. Drugge has been affiliated with the Bank since April 2006 and has served as Executive Vice President of
Lending since September 2006. Prior to joining Timberland, Mr. Drugge was employed at Bank of America as a senior officer
and most recently served as Senior Vice President and Commercial Banking Manager. Mr. Drugge began his banking career at
Seafirst in 1974, which was acquired by Bank America Corp. and became known as Bank of America.
Jonathan A. Fischer has been affiliated with the Bank since October 1997 and has served as Chief Operating Officer
since August 23, 2012. Prior to that, Mr. Fischer had served as the Chief Risk Officer since October 2010. Mr. Fischer had also
served as the Compliance Officer, Community Reinvestment Act Officer, and Privacy Officer since January 2000.
Edward C. Foster has been affiliated with the Bank and has served as Chief Credit Administrator since February 2012.
Prior to joining the Bank, Mr. Foster was employed by the FDIC, where he served as a Loan Review Specialist from January 2011
to February 2012. Mr. Foster owned a credit administration consulting business from February 2010 to January 2011. Prior to that,
Mr. Foster served as the Chief Credit Officer for Carson River Community Bank from April 2008 through February 2010. Before
joining Carson River Community Bank, Mr. Foster served as a Senior Regional Credit Officer for Omni National Bank from
September 2006 through March 2008.
Marci A. Basich has been affiliated with the Bank since 1999 and has served as Treasurer of the Company and the Bank
since January 2002. Ms. Basich is a Certified Public Accountant.
Item 1A. Risk Factors
We assume and manage a certain degree of risk in order to conduct our business strategy. In addition to the risk factors
described below, other risks and uncertainties not specifically mentioned, or that are currently known to, or deemed to be immaterial
34
by management, also may materially and adversely affect our financial position, results of operations and/or cash flows. Before
making an investment decision, you should carefully consider the risks described below together with all of the other information
included in this Form 10-K and our other filings with the SEC. If any of the circumstances described in the following risk factors
actually occur to a significant degree, the value of our common stock could decline, and you could lose all or part of your investment.
This report is qualified in its entirety by these risk factors.
Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.
Substantially all of our loans are to businesses and individuals in the state of Washington. A decline in the economies of
our local market areas of Grays Harbor, Pierce, Thurston, King, Kitsap and Lewis counties in which we operate, and which we
consider to be our primary market areas, could have a material adverse effect on our business, financial condition, results of
operations and prospects. Weakness in the global economy has adversely affected many businesses operating in our markets that
are dependent upon international trade and it is not known how the recent withdrawal by the United States from the Trans-Pacific
Partnership trade agreement may also affect these businesses.
While real estate values and unemployment rates have recently improved, a deterioration in economic conditions in the
market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our
business, financial condition and results of operations:
•
•
•
•
•
•
loan delinquencies, problem assets and foreclosures may increase;
the sale of foreclosed assets may slow;
demand for our products and services may decline possibly resulting in a decrease in our total loans or assets;
collateral for loans made may decline further in value, exposing us to increased risk loans, reducing customers’
borrowing power, and reducing the value of assets and collateral associated with existing loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
and
the amount of our low-cost or non-interest bearing deposits may decrease and the composition of our deposits
may be adversely affected.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and
capital of larger financial institutions whose real estate loans are geographically diverse. If we are required to liquidate a significant
amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely
affected.
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for
our products and services, which could have an adverse effect on our results of operations.
A return of recessionary conditions and/or negative developments in the domestic and international credit markets may
significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs
and profitability. Declines in real estate values and sales volumes and high unemployment levels may result in higher than expected
loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses
and may adversely affect our capital, liquidity, and financial condition.
Our real estate construction loans expose us to significant risks.
We make real estate construction loans to individuals and builders, primarily for the construction of residential properties.
We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At September 30,
2017, construction loans totaled $168.5 million, or 21.5% of our total loan portfolio, of which $148.9 million were for residential
real estate projects. This compares to total construction loans of $123.1 million, or 17.0% of our total loan portfolio at September 30,
2016, or an increase of 36.9% during the past year. Approximately $117.6 million of our residential construction loans at
September 30, 2017 were made to finance the construction of owner-occupied homes and are structured to be converted to
permanent loans at the end of the construction phase. In general, construction lending involves additional risks because funds are
advanced upon estimates of costs in relation to values associated with the completed project. Construction lending involves
additional risks when compared with permanent residential lending because funds are advances upon the collateral for the project
based on an estimate of costs that will produce a future value at completion. Because of the uncertainties inherent in estimating
construction costs, as well as the market value of the complete project and the effects of governmental regulation on real property,
it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-
value ratio. Changes in demand for new housing and higher than anticipated building costs may cause actual results to vary
significantly from those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts
35
and may be concentrated with a small number of builders. A downturn in housing, or the real estate market, could increase
delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral
upon foreclosure. Some of the builders we deal with have more than one loan outstanding with us. Consequently, an adverse
development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss. In addition
during the term of some of our construction loans, no payment from the borrower is required since the accumulated interest is
added to the principal of the loan through an interest reserve. As a result, these loans often involve the disbursement of funds with
repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property
or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our
appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the
loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring
of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor.
Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-
purchaser's borrowing costs, thereby possibly reducing the homeowner's ability to finance the home upon completion or the overall
demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be
successfully sold which also complicates the process of working our problem construction loans. This may require us to advance
additional funds and/or contract with another builder to complete construction and assume the market risk of selling the project
at a future market price, which may or may not enable us to fully recover unpaid loan funds and associated construction and
liquidation costs. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying
an end-purchaser for the finished project. At September 30, 2017, $9.9 million of our construction portfolio was comprised of
speculative one- to four-family construction loans. At September 30, 2017, all construction loans were performing in accordance
to their terms. A material increase in our non-performing construction loans could have a material adverse effect on our financial
condition and results of operation.
Our emphasis on commercial real estate lending may expose us to increased lending risks.
Our current business strategy includes an emphasis on commercial real estate lending. This type of lending activity,
while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic
conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of
loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. In our primary market of western
Washington, a downturn in the real estate market could increase loan delinquencies, defaults and foreclosures, and significantly
impair the value of our collateral and our ability to sell the collateral upon foreclosure. Many of our commercial borrowers have
more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship
can expose us to a significantly greater risk of loss.
At September 30, 2017, we had $328.9 million of commercial real estate mortgage loans, representing 41.9% of our total
loan portfolio. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon
income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses
and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the
cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to
repay the loan may be impaired. Commercial real estate loans also expose a lender to greater credit risk than loans secured by
residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In
addition, many of our commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity.
Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment,
which may increase the risk of default or non-payment.
A secondary market for most types of commercial real estate loans is not readily liquid, so we have less opportunity to
mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a
commercial real estate loan, our holding period for the collateral typically is longer than for one- to four-family residential mortgage
loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial real estate loans may
be larger as a percentage of the total principal outstanding than those incurred with our residential or consumer loan portfolios.
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency have promulgated joint guidance on
sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this
guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment
to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other
factors (i) total reported loans for construction, land development and other land represent 100% or more of total capital, or (ii)
total reported loans secured by multi-family and non-farm non-residential properties, loans for construction, land development
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and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real
estate related entities, represent 300% or more of total capital. The particular focus of the guidance is on exposure to commercial
real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk
to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment
or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital
levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ
heightened risk management practices including board and management oversight and strategic planning, development of
underwriting standards, risk assessment and monitoring through market analysis and stress testing. We have concluded that we
have a concentration in commercial real estate lending under the foregoing standards because our balance in commercial real
estate loans at September 30, 2017 represents more than 300% of total capital. While we believe we have implemented policies
and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could
require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in
additional costs to us.
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable,
and the collateral securing these loans may fluctuate in value.
At September 30, 2017, we had $44.4 million, or 5.7%, of total loans in commercial business loans. Commercial business
lending involves risks that are different from those associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values
and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower
default. Our commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the
underlying collateral provided by the borrower. The borrowers' cash flow may be unpredictable, and collateral securing these
loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts
receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment
because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other
things. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of
the borrower and secondarily on the underlying collateral provided by the borrower.
Our business may be adversely affected by credit risk associated with residential property.
At September 30, 2017, $156.6 million, or 20.0%, of our total loan portfolio was secured by one- to four-family mortgage
loans and home equity loans. This type of lending is generally sensitive to regional and local economic conditions that significantly
impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A decline in
residential real estate values resulting from a downturn in the Washington housing market may reduce the value of the real estate
collateral securing these types of loans and increase our risk of loss if borrowers default on their loans.
Many of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little
or no equity because either we originated the loan with a relatively high combined loan-to-value ratio or because of the decline
in home values in our market areas subsequent to when the loans were originated. Residential loans with combined higher loan-
to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore
may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers
may be unable to repay their loans in full from the sale proceeds. Further, a significant amount of our home equity lines of credit
consist of second mortgage loans. For those home equity lines secured by a second mortgage, it is unlikely that we will be successful
in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan
and such repayment and the costs associated with a foreclosure are justified by the value of the property. For these reasons, we
may experience higher rates of delinquencies, default and losses on our residential loans.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business, and each loan carries a certain risk that it will not be repaid in
accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by,
among other things:
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•
•
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the cash flow of the borrower and/or the project being financed;
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
the duration of the loan;
the credit history of a particular borrower; and
changes in economic and industry conditions.
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We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged
against operating income, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this
allowance is determined by our management through periodic comprehensive reviews and consideration of several factors,
including, but not limited to:
•
•
•
•
•
•
•
an ongoing review of the quality, size and diversity of the loan portfolio;
evaluation of non-performing loans;
historical default and loss experience;
existing economic conditions and management's expectations of future events;
risk characteristics of the various classifications of loans;
the amount and quality of collateral, including guarantees, securing the loans; and
regulatory requirements and expectations.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity
and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the
creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many
of our loans. In determining the amount of the allowance for loan losses, we review our loans and the loss experience and evaluate
economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material
changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan
portfolio, resulting in the need for increases in our allowance for loan losses through the provision for losses on loans which is
charged against income. Further, the Financial Accounting Standards Board has adopted a new accounting standard that will be
effective for our fiscal year beginning October 1, 2020. This standard, referred to as Current Expected Credit Loss ("CECL") will
require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected
credit losses as allowances for credit losses. This will change the current method of providing allowances for credit losses that
are probable, which may require us to increase our allowance for loan losses, and may greatly increase the types of data we would
need to collect and review to determine the appropriate level of the allowance for credit losses.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of
additional problem loans and other factors, both within and outside of our control, may also require an increase in the allowance
for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase
in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different from those of
management. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to replenish
the allowance for loan losses. Any additional provisions will result in a decrease in net income and possibly capital, and may have
a material adverse effect on our financial condition and results of operations.
If our non-performing assets increase, our earnings will be adversely affected.
At September 30, 2017 our non-performing assets (which consist of non-accruing loans, accruing loans 90 days or more
past due, non-accrual investment securities, and OREO and other repossessed assets) were $5.7 million, or 0.60% of total assets.
Our non-performing assets adversely affect our net income in various ways:
• We do not record interest income on non-accrual loans or non-performing investment securities, except on a cash basis
when the collectibility of the principal is not in doubt.
• We must provide for probable loan losses through a current period charge to the provision for loan losses.
• Non-interest expense increases when we must write down the value of properties in our OREO portfolio to reflect changing
market values.
• Non-interest income decreases when we must recognize other-than-temporary impairment on non-performing investment
securities.
• There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance,
and maintenance costs related to our OREO.
• The resolution of non-performing assets requires the active involvement of management, which can distract them from
more profitable activity.
If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our non-
performing assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our
financial condition and results of operations. In addition to the non-performing loans, there were $3.3 million in loans classified
as performing troubled debt restructurings at September 30, 2017.
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If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to
increase our valuation allowances, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and
the property is taken in as OREO, and at certain other times during the asset's holding period. Our net book value (“NBV”) in the
loan at the time of foreclosure and thereafter is compared to the updated estimated market value of the foreclosed property less
estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation
process is incorrect or if the property declines in value after foreclosure, the fair value of our OREO may not be sufficient to
recover our NBV in such assets, resulting in the need for a valuation allowance.
In addition, bank regulators periodically review our OREO and may require us to recognize further valuation
allowances. Significant charge-offs to our OREO may have a material adverse effect on our financial condition and results of
operations.
Our investment securities portfolio may be negatively impacted by fluctuations in market value and interest rates and result
in losses.
Our investment securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated
other comprehensive income (loss) and/or earnings. Fluctuations in market value may be caused by changes in market interest
rates, lower market prices for investment securities and limited investor demand. Our investment securities portfolio is evaluated
for other-than-temporary-impairment ("OTTI"). If this evaluation shows impairment to the actual or projected cash flows associated
with one or more investment securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse
effect on our financial condition, as our available-for-sale investment securities are reported at their estimated fair value, and
therefore are impacted by fluctuations in interest rates. We increase or decrease our shareholders' equity by the amount of change
in the estimated fair value of the available-for-sale investment securities, net of income taxes.
During the year ended September 30, 2017, we recognized a $33,000 recovery of OTTI charges on private label mortgage
backed securities we hold for investment. During the year ended September 30, 2016, we recognized $168,000 of OTTI charges
on private label mortgage backed securities we hold for investment. During the year ended September 30, 2015, we recognized
$13,000 of OTTI charges on private label mortgage backed securities we hold for investment. At September 30, 2017, our remaining
private label mortgage backed securities portfolio totaled $599,000 of which $533,000 was on non-accrual status.
The valuation of our investment securities also is influenced by additional external market and other factors, including
implementation of Securities and Exchange Commission and Financial Accounting Standards Board guidance on fair value
accounting, default rates on residential mortgage securities and rating agency actions. Accordingly, there can be no assurance that
future declines in the market value of our private label mortgage backed securities or other investment securities will not result
in additional OTTI of these assets and lead to accounting charges that could have an adverse effect on our results of operations.
An increase in interest rates, change in the programs offered by Freddie Mac or our ability to qualify for their programs may
reduce our mortgage revenues, which would negatively impact our non-interest income.
The sale of residential mortgage loans to Freddie Mac provides a significant portion of our non-interest income. Any
future changes in their program, our eligibility to participate in such program, the criteria for loans to be accepted or laws that
significantly affect the activity of Freddie Mac could, in turn, materially adversely affect our results of operations if we could not
find other purchasers. Mortgage banking is generally considered a volatile source of income because it depends largely on the
level of loan volume which, in turn, depends largely on prevailing market interest rates. In a rising or higher interest rate
environment, the demand for mortgage loans, particularly refinancing of existing mortgage loans, tends to fall and our originations
of mortgage loans may decrease, resulting in fewer loans that are available to be sold. This would result in a decrease in mortgage
revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount
of non-interest expense associated with our loan sale activities, such as salaries and employee benefits, occupancy, equipment and
data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be
adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. In
addition, although we sell loans to Freddie Mac or into the secondary market without recourse, we are required to give customary
representations and warranties about the loans we sell. If we breach those representations and warranties, we may be required
to repurchase the loans and we may incur a loss on the repurchase.
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Our real estate lending also exposes us to the risk of environmental liabilities.
In the course of our business, we may foreclose and take title to real estate, and we could be subject to environmental
liabilities with respect to these properties. We may be held liable by a governmental entity or by third persons for property damage,
personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or
may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated
with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site,
we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination
emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition
and results of operations could be materially and adversely affected.
Fluctuating interest rates can adversely affect our profitability.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to
many factors that are beyond our control, including general economic conditions and policies of various governmental and
regulatory agencies and, in particular, the Federal Reserve Board. In an attempt to help the overall economy, the Federal Reserve
Board has kept interest rates low through its targeted Fed Funds rate. Beginning in December 2016, the Federal Reserve Board
has increased the Fed Funds rate by 75 basis points to a range of 1.00% to 1.25% in September 2017 and indicated a likelihood
for a further increase of 25 basis points during 2017 subject to economic conditions. As the Federal Reserve Board increases the
Fed Funds rate, overall interest rates will likely rise, which may negatively impact both the housing markets by reducing refinancing
activity and new home purchases and the U.S. economic recovery.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans
and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect: (1) our ability
to originate and/or sell loans and obtain deposits; (2) the fair value of our financial assets and liabilities, which could negatively
impact shareholders’ equity, and our ability to realize gains from the sale of such assets; (3) our ability to obtain and retain deposits
in competition with other available investment alternatives; (4) the ability of our borrowers to repay adjustable or variable rate
loans; and (5) the average duration of our investment securities portfolio and other interest-earning assets. If the interest rates
paid on deposits and borrowings increase at a faster rate than the interest received on loans and other investments, our net interest
income, and therefore earnings, could be adversely affected.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers
to repay their current loan obligations or by reducing our margins and profitability. Our net interest margin is the difference
between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in
interest rates (up or down) could adversely affect our net interest margin and, as a result, our net interest income. Although the
yield we earn on our assets and our funding costs tends to move in the same direction in response to changes in interest rates, one
can rise or fall faster than the other, causing our net interest margin to expand or contract. Changes in the slope of the "yield
curve", or the spread between short-term and long-term interest rates, could also reduce our net interest margin. Normally the
yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter
in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin
as our cost of funds increases relative to the yield we can earn on our assets. Also, interest rate decreases can lead to increased
prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs. Under these
circumstances we are subject to reinvestment risk as we may have to redeploy such repayment proceeds into lower yielding
investments, which would likely negatively impact our income.
A sustained increase in market interest rates could adversely affect our earnings. As a result of the exceptionally low
interest rate environment, an increasing percentage of our deposits have been comprised of deposits bearing no or a relatively low
rate of interest and having a shorter duration than our assets. At September 30, 2017, we had $75.4 million in certificates of deposit
that mature within one year and $698.3 million in non-interest bearing, NOW checking, savings and money market accounts. We
would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates paid on deposits
and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income,
and therefore earnings, could be adversely affected. In addition, a substantial amount of our residential mortgage loans and home
equity lines of credit have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising
interest rate environment.
Changes in interest rates also affects the value of our interest-earning assets and in particular our investment securities
portfolio. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains
and losses on investment securities available for sale are reported as a separate component of equity, net of tax. Decreases in the
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fair value of investment securities available for sale resulting from increases in interest rates could have an adverse effect on
stockholders' equity.
Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our
financial condition, liquidity and results of operations. Also, our interest rate risk modeling techniques and assumptions likely
may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results. For
further discussion of how changes in interest rates could impact us, see "Part II, Item 7A. Quantitative and Qualitative Disclosures
About Market Risk" for additional information about our interest rate risk management.
The financial services market is undergoing rapid technological changes, and if we are unable to stay current with those
changes, we may not be able to effectively compete.
The financial services market, including banking services, is undergoing rapid changes with frequent introductions of
new technology-driven products and services. Our future success will depend, in part, on our ability to keep pace with the
technological changes and to use technology to satisfy and grow customer demand for our products and services and to create
additional efficiencies in our operations. We expect that we will need to make substantial investments in our technology and
information systems to compete effectively and to stay current with technological changes. Some of our competitors have
substantially greater resources to invest in technological improvements and will be able to invest more heavily in developing and
adopting new technologies, which may put us at a competitive disadvantage. We may not be able to effectively implement new
technology-driven products and services or be successful in marketing these products and services to our customers. As a result,
our ability to effectively compete to retain or acquire new business may be impaired, and our business, financial condition or
results of operations may be adversely affected.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other
sources could have a substantial negative effect on our liquidity. We rely on customer deposits and borrowings from the FHLB,
borrowings from the FRB and other borrowings to fund our operations. At September 30, 2017, we had no FHLB borrowings
outstanding and a letter of credit with an available balance of $22.0 million and an additional $360.5 million of available borrowing
capacity through the FHLB and the FRB. Deposit flows, calls of wholesale borrowings, and the prepayment of loans and mortgage-
related securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived,
and the competition for deposits and loans in the markets we serve. Further, changes to the FHLB's underwriting guidelines for
wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse
impact on our liquidity. Although we have historically been able to replace maturing deposits and borrowings if desired, we may
not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB
or FRB, or market conditions change. Our access to funding sources in amounts adequate to finance our activities or on terms
which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in
general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial
services industry. Additional factors that could detrimentally impact our access to liquidity sources include a decrease in the level
of our business activity as a result of a downturn in the Washington markets where our deposits are concentrated or adverse
regulatory action against us.
Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate
financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds
adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional
borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If additional financing
sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future
prospects could be materially adversely affected. Finally, if we are required to rely more heavily on more expensive funding
sources to support future growth, our income may not increase proportionately to cover our costs.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations
that could increase our costs of operations.
The banking industry is extensively regulated. Federal banking regulations are designed primarily to protect the deposit
insurance funds and consumers, not to benefit a company's shareholders. These regulations may sometimes impose significant
limitations on our operations. The significant federal and state banking regulations that affect us are described in this report under
the heading "Item 1. Business-How We Are Regulated". These regulations, along with the currently existing tax, accounting,
securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which
financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and
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disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change
significantly over time. Any new regulations or legislation, change in existing regulation or oversight, whether a change in
regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material impact on our operations,
increase our costs of regulatory compliance and of doing business and adversely affect our profitability. In this regard, the U.S.
Department of the Treasury's Financial Crimes Enforcement Network ("FinCEN"), published guidelines in 2014 for financial
institutions servicing state legal marijuana businesses. These guidelines allow us to work with marijuana-related businesses that
are operating in accordance with state laws and regulations, so long as we comply with required regulatory oversight of their
accounts with us. At September 30, 2017, approximately 1.8% of our total deposits and a portion of our service charges from
deposits are from legal marijuana-related businesses. Any adverse change in this FinCEN guidance, any new regulations or
legislation, any change in existing regulations or oversight, whether a change in regulatory policy or a change in a regulator's
interpretation of a law or regulation, could have a negative impact on our non-interest income, as well as the cost of our operations,
increasing our cost of regulatory compliance and of doing business and/or otherwise affect us, which may materially affect our
profitability.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions
and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial
institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are
obligated to file suspicious activity reports with FinCEN. These rules require financial institutions to establish procedures for
identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations
could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions. Recently several banking institutions
have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures
designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures
will be effective in preventing violations of these laws and regulations.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when
it is needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. At
some point, we may need to raise additional capital to support our growth or replenish future losses. Our ability to raise additional
capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial
condition and performance. If we are able to raise capital it may not be on terms that are acceptable to us. Accordingly, we cannot
make assurances that we will be able to raise additional capital. If we cannot raise additional capital when needed, our operations
could be materially impaired and our financial condition and liquidity could be materially and adversely affected. As a result, we
may have to raise additional capital on terms that may be dilutive to our shareholders.
We may experience future goodwill impairment, which could reduce our earnings.
We performed our test for goodwill impairment for fiscal year 2017, and the test concluded that recorded goodwill was
not impaired. Our test of goodwill for potential impairment is based on a qualitative assessment by management that takes into
consideration macroeconomic conditions, industry and market conditions, cost or margin factors, financial performance and share
price. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If our judgment was incorrect, or
if events or circumstances change, and an impairment of goodwill was deemed to exist, we would be required to write down our
goodwill resulting in a charge against operations, which would adversely affect our results of operations, perhaps materially;
however, it would have no impact on our liquidity, operations or regulatory capital.
We may experience decreases in the fair value of our mortgage servicing rights, which could reduce our earnings.
Mortgage servicing rights (“MSRs”) are capitalized at estimated fair value when acquired through the origination of loans
that are subsequently sold with servicing rights retained. At September 30, 2017, our MSRs totaled $1.8 million. MSRs are
amortized to servicing income on loans sold over the period of estimated net servicing income. The estimated fair value of MSRs
at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key
assumptions for servicing income and costs and prepayment rates on the underlying loans. On a quarterly basis, we evaluate the
fair value of MSRs for impairment by comparing actual cash flows and estimated cash flows from the servicing assets to those
estimated at the time servicing assets were originated. Our methodology for estimating the fair value of MSRs is highly sensitive
to changes in assumptions, such as prepayment speeds. The effect of changes in market interest rates on estimated rates of loan
prepayments represents the predominant risk characteristic underlying the MSRs portfolio. For example, a decrease in mortgage
interest rates typically increases the prepayment speeds of MSRs and therefore decreases the fair value of the MSRs. Future
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decreases in mortgage interest rates could decrease the fair value of our MSRs below their recorded amount, which would decrease
our earnings.
Our framework for managing risks may not be effective in mitigating risk and loss to us.
We have established processes and procedures intended to identify, measure, monitor, report, analyze and control the
types of risk to which we are subject. These risks include liquidity risk, credit risk, market risk, interest rate risk, operational risk,
legal and compliance risk, and reputational risk, among others. We also maintain a compliance program to identify, measure,
assess, and report on our adherence to applicable laws, policies and procedures. While we assess and improve these programs on
an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls,
will effectively mitigate all risk and limit losses in our business. As with any risk management framework, there are inherent
limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately
anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses which could
have a material adverse effect on our financial condition and results of operations.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber attack. Communications and information
systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general
ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of
confidential and other information in our computer systems and networks. Although we take protective measures and endeavor
to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to
breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber attacks that could have a security
impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information
processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or
malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant
additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we
may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance
maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation.
Any compromise of our security also could deter customers from using our internet banking services that involve the transmission
of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to
effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security
measures and could result in significant legal liability and significant damage to our reputation and our business.
Our security measures may not protect us from system failures or interruptions. While we have established policies and
procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not
occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and
other operational functions to certain third-party providers. If our third-party providers encounter difficulties, or if we have
difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our
business operations could be adversely impacted. Threats to information security also exist in the processing of customer
information through various other vendors and their personnel.
The occurrence of any failures or interruptions may require us to identify alternative sources of such services, and we
cannot assure you that we could negotiate terms that are as favorable to us or could obtain services with similar functionality as
found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems
failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional
regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our
financial condition and results of operations.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to
the risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have
increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures
designed to prevent such losses, there can be no assurance that such losses will not occur.
43
We are dependent on key personnel, and the loss of one or more of those key personnel may materially and adversely affect
our prospects.
Competition for qualified employees and personnel in the banking industry is intense, and there are a limited number of
qualified persons with knowledge of, and experience in, the community banking industry where the Bank conducts its business. The
process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy.
Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance,
administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In
particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our President,
and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our
directors, and we may not be able to identify and attract suitable candidates to replace such directors.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally,
unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies
and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and
promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business,
employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a
decline in revenues and increased governmental regulation.
We rely on other companies to provide key components of our business infrastructure.
Third-party vendors provide key components of our business infrastructure such as internet connections, network access
and core application processing. While we have selected these third-party vendors carefully, we do not control their actions. Any
problems caused by these third-parties, including as a result of their not providing us their services for any reason or their performing
their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our
business efficiently and effectively. Replacing these third-party vendors could also entail significant delay and expense.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
At September 30, 2017, the Bank operated 22 full service facilities. The following table sets forth certain information
regarding the Bank’s offices, all of which are owned, except for the Tacoma office and the Lacey office at 1751 Circle Lane SE,
which are leased.
44
Location
Main Office:
624 Simpson Avenue
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street
Aberdeen, Washington 98520
201 Main Street South
Montesano, Washington 98563
361 Damon Road
Ocean Shores, Washington 98569
2418 Meridian Avenue East
Edgewood, Washington 98371
202 Auburn Way South
Auburn, Washington 98002
12814 Meridian Avenue East (South Hill)
Puyallup, Washington 98373
1201 Marvin Road, N.E.
Lacey, Washington 98516
101 Yelm Avenue W.
Yelm, Washington 98597
20464 Viking Way NW
Poulsbo, Washington 98370
2419 224th Street E.
Spanaway, Washington 98387
801 Trosper Road SW
Tumwater, Washington 98512
Year Opened
Approximate
Square Footage
Deposits at
September 30, 2017
(In thousands)
1966
1974
2004
1977
1980
1994
1996
1997
1999
1999
1999
2001
7,700
$
66,284
3,400
3,200
2,100
2,400
4,200
4,200
4,400
3,400
1,800
3,900
3,300
35,227
37,354
32,641
48,415
36,170
41,102
26,567
28,780
22,330
41,985
36,177
(table continued on the following page)
45
Location
7805 South Hosmer Street
Tacoma, Washington 98408
2401 Bucklin Hill Road
Silverdale, Washington 98383
423 Washington Street SE
Olympia, Washington 98501
3105 Judson Street
Gig Harbor, Washington 98335
117 N. Broadway
Aberdeen, Washington 98520
313 West Waldrip Street
Elma, Washington 98541
1751 Circle Lane SE
Lacey, Washington 98503
101 2nd Street
Toledo, Washington 98591
209 NE 1st Street
Winlock, Washington 98586
714 W. Main Street
Chehalis, Washington 98532
Loan Center/Data Center:
120 Lincoln Street
Hoquiam, Washington 98550
Administrative Offices:
305 8th Street
Hoquiam, Washington 98550
Year Opened
Approximate
Square Footage
Deposits at
September 30, 2017
(In thousands)
2001
2003
2003
2004
2004
2004
2004
2004
2004
2009
2003
2004
5,000
$
4,000
3,000
2,700
3,700
5,900
900
1,800
3,400
4,600
6,000
4,100
61,365
46,532
52,537
36,711
39,178
30,671
18,356
36,600
18,408
44,508
N/A
N/A
Management believes that all facilities are appropriately insured and are adequately equipped for carrying on the business
of the Bank.
At September 30, 2017, the Bank operated 22 proprietary ATMs that are part of a nationwide cash exchange network.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Company, such as claims to enforce liens,
condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing
of real property loans and other issues incident to the Company's business. The Company is not a party to any pending legal
proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.
Item 4. Mine Safety Disclosures
Not applicable.
46
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
The Company's common stock is traded on the Nasdaq Global Market under the symbol “TSBK.” As of November 30,
2017, there were 7,364,627 shares of common stock issued and approximately 435 shareholders of record. The following table
sets forth the high and low sales prices of, and dividends paid on, the Company's common stock for each quarter during the years
ended September 30, 2017 and 2016. The high and low price information was provided by the Nasdaq Stock Market.
Fiscal 2017
First Quarter
Second Quarter
Third Quarter
Fourth Quarter (1)
Fiscal 2016
First Quarter (2)
Second Quarter
Third Quarter
Fourth Quarter
High
Low
Dividends per
Common Share
$
$
$
$
20.95
22.70
25.52
25.27
High
13.49
12.99
15.73
15.75
$
$
15.71
20.30
21.81
31.58
10.22
12.16
12.77
14.71
Low
0.09
0.11
0.11
0.19
Dividends per
Common Share
0.12
0.08
0.08
0.09
____________
(1) Includes a special dividend of $0.08 in addition to the regular quarterly dividend.
(2) Includes a special dividend of $0.05 in addition to the regular quarterly dividend.
Dividends
The timing and amount of cash dividends paid on our common stock depends on our earnings, capital requirements,
financial condition and other relevant factors and is subject to the discretion of our board of directors. There can be no assurance
that we will pay dividends on our common stock in the future.
Dividend payments by the Company are dependent primarily on dividends received by the Company from the
Bank. Under federal regulations, the dollar amount of dividends the Bank may pay is dependent upon its capital position and
recent net income. Generally, if the Bank satisfies its regulatory capital requirements, it may make dividend payments up to the
limits prescribed in the FDIC regulations. However, an institution that has converted to a stock form of ownership may not declare
or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution
to be reduced below the amount required for the liquidation account which was established in connection with the mutual to stock
conversion.
The DFI has the power to require any bank to suspend the payment of any and all dividends. In addition, under Washington
law, no bank may declare or pay any dividend in an amount greater than its retained earnings without the prior approval of the
DFI. Further, under Washington law, Timberland Bancorp is prohibited if, after making such dividend payment, it would be unable
to pay its debts as they become due in the usual course of business, or if its total liabilities, plus the amount that would be needed,
in the event Timberland Bancorp were to be dissolved at the time of the dividend payment, to satisfy preferential rights on dissolution
of holders of preferred stock ranking senior in right of payment to the capital stock on which the applicable distribution is to be
made, exceed our total assets.
In addition to the foregoing regulatory considerations, there are numerous governmental requirements and regulations
that affect our business activities. A change in applicable statutes, regulations or regulatory policy may have a material effect on
our business and on our ability to pay dividends on our common stock.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d) in Part III, Item 12. of this Form 10-K is
incorporated herein by reference.
47
Stock Repurchases
The Company is subject to certain restrictions on its ability to repurchase its common stock. The Company is required
to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the consideration
for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the
preceding 12 months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove a purchase or
redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation,
Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.
The Company has had various stock repurchase programs since January 1998. On July 28, 2015, the Company announced
a plan to repurchase 352,681 shares of the Company's common stock. This marked the Company's 17th stock repurchase plan.
There were no shares repurchased during the year ended September 30, 2017 and 221,893 shares were available to be repurchased
under the current repurchase program.
As of September 30, 2017, the Company has repurchased 130,788 of these shares at an average price of $11.69 per share.
Cumulatively, since January 1998 the Company has repurchased 7,914,722 shares at an average price of $9.02 per share.
The following table sets forth the Company's repurchases of its outstanding Common Stock during the fourth quarter of
the year ended September 30, 2017.
Total
Number of
Shares
Purchased
Average Price
Paid per Share
Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans
Maximum
Number (or
Approximate
Dollar Value) of
Shares that May
Yet Be Purchased
Under the Plans
— $
—
—
— $
—
—
—
—
—
—
—
—
221,893
221,893
221,893
221,893
Period
July 1, 2017 - July 31, 2017
August 1, 2017 - August 31, 2017
September 1, 2017 - September 30, 2017
Total
Five-Year Stock Performance Graph
The following graph compares the cumulative total shareholder return on our common stock with the cumulative total
return on the Nasdaq U.S. Companies Index and with the SNL $500 million to $1 Billion Asset Thrift Index, peer group
indices. Total return assumes the reinvestment of all dividends and that the value of the Company’s Common Stock and each
index was $100 on September 30, 2012.
48
Index
Timberland Bancorp
NASDAQ Composite
SNL $500M-$1B Thrift Index *
$
9/30/2012
9/30/2013
9/30/2014
9/30/2015
9/30/2016
100.00 $
100.00
100.00
151.61 $
122.77
123.23
180.32 $
148.08
136.44
190.57 $
153.99
161.11
283.21 $
179.29
183.36
9/30/2017
576.19
221.75
264.21
Year Ended
* Source: S&P Global Market Intelligence
Item 6. Selected Financial Data
The following table sets forth certain information concerning the consolidated financial position and results of operations
of the Company and its subsidiary at and for the dates indicated. The consolidated data is derived in part from, and should be
read in conjunction with, the Consolidated Financial Statements of the Company and its subsidiary presented herein.
49
2017
2016
At September 30,
2015
(Dollars in thousands)
2014
2013
SELECTED FINANCIAL CONDITION DATA:
Total assets
$ 952,024
$ 891,388
$ 815,815
$ 745,565
$ 745,648
Loans receivable, net
Investment securities held to maturity
Investment securities available for sale
FHLB stock
Other investments
Cash and due from financial institutions and
interest-bearing deposits in banks
Certificates of deposit held for investment
OREO and other repossessed assets, net
Deposits
FHLB borrowings
Shareholders' equity
SELECTED OPERATING DATA:
Interest and dividend income
Interest expense
Net interest income
(Recapture of) provision for loan losses
Net interest income after (recapture of) provision
for loan losses
Non-interest income
Non-interest expense
Income before income taxes
Provision for income taxes
Net income
Preferred stock dividends
Preferred stock discount accretion
Discount on redemption of preferred stock
Net income to common shareholders
Net income per common share:
Basic
Diluted
Dividends per common share
Dividend payout ratio (1)
690,364
7,139
1,241
1,107
3,000
148,188
43,034
3,301
837,898
—
111,000
663,146
7,511
1,342
2,204
—
108,941
53,000
4,117
761,534
30,000
96,834
604,277
7,913
1,392
2,699
—
92,289
48,611
7,854
678,912
45,000
89,187
564,853
5,298
2,857
5,246
—
72,354
35,845
9,092
615,116
45,000
82,778
546,193
2,737
4,101
5,452
—
94,496
30,042
11,720
608,262
45,000
89,688
Year Ended September 30,
2017
2016
2015
2014
2013
(Dollars in thousands, except per share data)
$
38,338
$
3,197
35,141
(1,250)
36,391
12,368
27,516
21,243
7,076
14,167
—
—
—
$
14,167
$
34,875
4,072
30,803
—
30,803
10,889
26,637
15,055
4,901
10,154
—
—
—
10,154
$
$
$
$
$
$
1.99
1.92
0.50
25.70%
1.48
1.43
0.37
25.39%
$
$
$
$
$
$
$
$
$
$
31,168
3,890
27,278
(1,525)
28,803
9,522
25,841
12,484
4,192
8,292
—
—
—
8,292
1.20
1.17
0.24
20.42%
$
$
$
$
$
29,857
3,939
25,918
—
25,918
8,530
25,798
8,650
2,800
5,850
(136)
(70)
—
5,644
0.82
0.80
0.16
19.97%
30,237
4,439
25,798
2,925
22,873
10,262
25,864
7,271
2,514
4,757
(710)
(283)
255
4,019
0.59
0.58
—
15.78%
_______________
(1)
Cash dividends to common shareholders divided by net income to common shareholders.
50
OTHER DATA:
2017
2016
At September 30,
2015
2014
2013
Number of real estate loans outstanding
Deposit accounts
Full-service offices
2,593
54,707
22
2,615
53,611
22
2,545
52,343
22
2,525
52,656
22
2,524
54,809
22
2017
At or For the Year Ended September 30,
2015
2016
2014
2013
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average assets (1)
Return on average equity (2)
Interest rate spread (3)
Net interest margin (4)
Average interest-earning assets to average interest-
bearing liabilities
Non-interest expense as a percent of average total
assets
1.53%
1.19%
1.07%
0.79%
0.64%
13.65
3.93
4.07
11.00
3.72
3.88
9.70
3.66
3.80
7.08
3.71
3.84
5.27
3.69
3.82
137.75
131.69
126.41
122.04
119.93
2.98
3.13
3.33
3.50
3.49
Efficiency ratio (5)
57.92
63.89
70.22
74.89
71.72
Asset Quality Ratios:
Non-accrual and 90 days or more past due loans as a
percent of total loans receivable, net
0.28%
0.45%
1.02%
2.08%
2.57%
Non-performing assets as a percent of total assets (6)
Allowance for loan losses as a percent of total loans
receivable, net (7)
0.60
1.36
0.88
1.46
1.84
1.62
Allowance for loan losses as a percent of non-
performing loans (8)
Net charge-offs (recoveries) to average outstanding
loans
Capital Ratios:
Total equity-to-assets ratio
Average equity to average assets
499.90
326.66
160.30
(0.14)
0.02
(0.17)
11.66%
11.25
10.86%
10.84
10.93%
11.01
11.10%
11.20
12.03%
12.19
2.94
1.81
88.96
0.12
3.75
2.00
79.28
0.65
__________________
(1)
(2)
(3)
Net income divided by average total assets.
Net income divided by average total equity.
Difference between weighted average yield on interest-earning assets and weighted average cost of interest-bearing
liabilities.
Net interest income before provision for (recapture of) loan losses as a percentage of average interest-earning assets.
Non-interest expenses divided by the sum of net interest income and non-interest income.
Non-performing assets include non-accrual loans, loans past due 90 days or more and still accruing, non-accrual investment
securities, OREO and other repossessed assets.
Loans receivable is before the allowance for loan losses.
Non-performing loans include non-accrual loans and loans past due 90 days or more and still accruing. TDR loans that
are on accrual status are not included.
(4)
(5)
(6)
(7)
(8)
51
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in
understanding the consolidated financial condition and results of operations of the Company. The information contained in this
section should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto included in
Item 8 of this Annual Report on Form 10-K.
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 September 30, 2017, the Company had total assets of $952.02 million and total shareholders’ equity of $111.00
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 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.
The profitability of the Company’s operations depends primarily on its net interest income after provision for (recapture of)
loan losses. Net interest income is the difference between interest income, which is the income that the Company earns on
interest-earning assets, which are primarily loans and investments, and interest expense, the amount the Company pays on its
interest-bearing liabilities, which are primarily deposits and borrowings (as needed). 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 attempts 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 year ended September 30, 2017, non-
interest income consisted primarily of service charges on deposit accounts, gain on sales of loans, ATM and debit card
interchange transaction fees, an increase in the cash surrender value of BOLI, servicing income on loans sold and other
operating income. Non-interest income is also 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, postage and courier expenses, state and local
taxes, professional fees, FDIC insurance premiums, loan administration and foreclosure expenses, data processing and
telecommunication expenses, deposit operation expenses and other non-interest expenses. Non-interest income and non-
interest expenses are affected by the growth of the Company's operations and growth in the number of loan and deposit
accounts.
Results of operations may be affected significantly by general and local economic and competitive conditions, changes in
market interest rates, governmental policies and actions of regulatory authorities.
52
Operating Strategy
The Company is a bank holding company which operates primarily through its subsidiary, the Bank. The Company's
primary objective is to operate the Bank as a well capitalized, profitable, independent, community-oriented financial institution,
serving customers in its primary market area of Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties. The Company's
strategy is to provide innovative products and superior service to small businesses, industry and geographic niches, and individuals
located in its primary market area.
The Company's goal is to deliver returns to shareholders by increasing higher-yielding assets (in particular commercial
real estate, construction, and commercial business loans), increasing core deposit balances, managing problem assets, efficiently
managing expenses, and exploring expansion opportunities. The Company seeks to achieve these results by focusing on the
following objectives:
Expand our presence within our existing market areas by capturing opportunities resulting from changes in the
competitive environment. We currently conduct our business primarily in western Washington. We have a community bank
strategy that emphasizes responsive and personalized service to our customers. As a result of consolidation of banks in our market
areas, we believe there is an opportunity for a community and customer focused bank to expand its customer base. By offering
timely decision making, delivering appropriate banking products and services, and providing customer access to our senior
managers we believe community banks, such as Timberland Bank, can distinguish themselves from larger banks operating in our
market areas. We believe we have a significant opportunity to attract additional borrowers and depositors and expand our market
presence and market share within our extensive branch footprint.
Portfolio diversification. In recent years, we have limited the origination of speculative construction loans and land
loans in favor of loans that possess credit profiles representing less risk to the Bank. We continue originating owner/builder and
custom construction loans, multi-family loans, commercial business loans and certain commercial real estate loans which offer
higher risk adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations than fixed rate one-to four-family
loans. We anticipate capturing more of each customer's banking relationship by cross selling our loan and deposit products and
offering additional services to our customers.
Increase core deposits and other retail deposit products. We focus on establishing a total banking relationship with
our customers with the intent of internally funding our loan portfolio. We anticipate that the continued focus on customer
relationships will increase our level of core deposits. In addition to our retail branches, we maintain technology based products
such as business cash management and a business remote deposit product that enables us to compete effectively with banks of all
sizes.
Limit exposure to increasing interest rates. For many years, the majority of the loans the Bank has retained in its
portfolio have generally possessed periodic interest rate adjustment features or have been relatively short term in nature. Loans
originated for portfolio retention have generally included ARM loans, short term construction loans, and to a lesser extent
commercial business loans with interest rates tied to a market index such as the Prime Rate. Longer term fixed-rate mortgage
loans have generally been originated for sale into the secondary market.
Continue generating revenues through mortgage banking operations. The substantial majority of the fixed-rate
residential mortgage loans we originate are sold into the secondary market with servicing retained. This strategy produces gains
on the sale of such loans and reduces the interest rate and credit risk associated with fixed-rate residential lending. We continue
to originate custom construction and owner builder loans for sale into the secondary market upon the completion of construction.
Maintaining strong asset quality. We believe that strong asset quality is a key to our long-term financial success. The
percentage of non-performing loans to loans recevable, net was 0.27% and 0.45% at September 30, 2017 and 2016, respectively.
The Company's percentage of non-performing assets to total assets at September 30, 2017 was 0.60% compared to 0.88% at
September 30, 2016. Non-performing assets have decreased from $28.0 million at September 30, 2013, to $5.7 million at September
30, 2017. We continue to seek to reduce the level of non-performing assets through collections, write-downs, modifications and
sales of OREO. We also take proactive steps to resolve our non-performing loans, including negotiating payment plans,
forbearances, loan modifications and loan extensions and accepting short payoffs on delinquent loans when such actions have
been deemed appropriate. We have also accepted short payoffs on delinquent loans, particularly when such payoffs result in a
smaller loss to us than foreclosure. Although the Company plans to continue to place emphasis on certain lending products, such
as commercial real estate loans, construction loans, and commercial business loans, the Company expects to continue to manage
its credit exposures through the use of experienced bankers and an overall conservative approach to lending.
53
Critical Accounting Policies and Estimates
The Company has established various accounting policies that govern the application of GAAP in the preparation of the
Company's Consolidated Financial Statements. The Company has identified five policies that as a result of judgments, estimates
and assumptions inherent in those policies, are critical to an understanding of the Company's Consolidated Financial Statements.
These policies relate to the methodology for the determination of the allowance for loan losses, the valuation of MSRs, the
determination of any other than temporary impairment ("OTTI") in the fair value of investment securities, the valuation of goodwill
for potential impairment and the valuation of OREO. These policies and the judgments, estimates and assumptions are described
in greater detail in the notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. In particular, Note
1 to the Consolidated Financial Statements, “Summary of Significant Accounting Policies,” generally describes the Company's
accounting policies. Management believes that the judgments, estimates and assumptions used in the preparation of the Company's
Consolidated Financial Statements are appropriate given the factual circumstances at the time. However, given the sensitivity of
the Company's Consolidated Financial Statements to these critical policies, the use of other judgments, estimates and assumptions
could result in material differences in the Company's results of operations or financial condition.
Market Risk and Asset and Liability Management
General. Market risk is the risk of loss from adverse changes in market prices and rates. The Bank's market risk arises
primarily from interest rate risk inherent in its lending, investment, deposit and borrowing activities. The Bank, like other financial
institutions, is subject to interest rate risk to the extent that its interest-earning assets reprice differently than its interest-bearing
liabilities. Management actively monitors and manages its interest rate risk exposure. Although the Bank manages other risks,
such as credit quality and liquidity risk, in the normal course of business management considers interest rate risk to be its most
significant market risk that could potentially have the largest material effect on the Bank's financial condition and results of
operations. The Bank does not maintain a trading account for any class of financial instruments nor does it engage in hedging
activities. Furthermore, the Bank is not subject to foreign currency exchange rate risk or commodity price risk.
Qualitative Aspects of Market Risk. The Bank's principal financial objective is to achieve long-term profitability while
reducing its exposure to fluctuating market interest rates. The Bank has sought to reduce the exposure of its earnings to changes
in market interest rates by attempting to manage the difference between asset and liability maturities and interest rates. The
principal element in achieving this objective is to increase the interest rate sensitivity of the Bank's interest-earning assets by
retaining in its portfolio, short-term loans and loans with interest rates subject to periodic adjustments. The Bank relies on retail
deposits as its primary source of funds. As part of its interest rate risk management strategy, the Bank promotes transaction accounts
and certificates of deposit with terms of up to five years.
The Bank has adopted a strategy that is designed to substantially match the interest rate sensitivity of assets relative to
its liabilities. The primary elements of this strategy involve originating ARM loans for its portfolio, maintaining residential
construction loans as a portion of total net loans receivable because of their generally shorter terms and higher yields than other
one- to four-family residential mortgage loans, matching asset and liability maturities, investing in short-term securities, and
originating fixed-rate loans for retention or sale in the secondary market while retaining the related MSRs.
Sharp increases or decreases in interest rates may adversely affect the Bank's earnings. Management of the Bank monitors
the Bank's interest rate sensitivity through the use of a model provided by FIMAC Solutions, LLC (“FIMAC”), a company that
specializes in providing interest rate risk and balance sheet management services to the financial services industry. Based on a
rate shock analysis prepared by FIMAC based on data at September 30, 2017, an immediate increase in interest rates of 100 basis
points would increase the Bank’s projected net interest income by approximately 4.2%, primarily because a larger portion of the
Bank's interest rate sensitive assets than interest rate sensitive liabilities would reprice within a one year period. Conversely, an
immediate decrease in interest rates of 100 basis points would decrease the Bank's projected net interest income by approximately
7.7%. See “Quantitative Aspects of Market Risk” below for additional information. Management has sought to sustain the match
between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Pursuant to this strategy, the
Bank actively originates adjustable-rate loans for retention in its loan portfolio. Fixed-rate mortgage loans with maturities greater
than seven years generally are originated for the immediate or future resale in the secondary mortgage market. Although the Bank
has sought to originate ARM loans, the ability to originate such loans depends to a great extent on market interest rates and
borrowers' preferences. In lower interest rate environments, borrowers often prefer fixed-rate loans.
Consumer, commercial business and construction loans typically have shorter terms and higher yields than permanent
residential mortgage loans, and accordingly reduce the Bank’s exposure to fluctuations in interest rates. At September 30, 2017,
the consumer, commercial business and construction portfolios amounted to $42.2 million, $44.4 million and $168.5 million, or
5.4%, 5.7% and 21.5% of total loans receivable, respectively.
54
Quantitative Aspects of Market Risk. The model provided for the Bank by FIMAC estimates the changes in net portfolio
value ("NPV") and net interest income in response to a range of assumed changes in market interest rates. The model first estimates
the level of the Bank's NPV (market value of assets, less market value of liabilities, plus or minus the market value of any off-
balance sheet items) under the current rate environment. In general, market values are estimated by discounting the estimated
cash flows of each instrument by appropriate discount rates. The model then recalculates the Bank's NPV under different interest
rate scenarios. The change in NPV under the different interest rate scenarios provides a measure of the Bank's exposure to interest
rate risk. The following table is provided by FIMAC based on data at September 30, 2017.
Hypothetical
Interest Rate
Scenario (3)
(Basis Points)
+400
+300
+200
+100
BASE
-100
-200
Net Interest Income (1)(2)
$ Change
from Base
Estimated
Value
% Change
from Base
Estimated
Value
(Dollars in thousands)
Current Market Value
$ Change
from Base
% Change
from Base
$
$
42,148
40,584
39,028
37,475
35,976
33,198
31,858
6,172
4,608
3,052
1,499
—
(2,778)
(4,118)
17.16% $
12.81
8.48
4.17
—
(7.72)
(11.45)
230,997
221,515
211,334
200,300
188,860
171,762
156,249
$
$
42,137
32,655
22,474
11,440
—
(17,098)
(32,611)
22.31%
17.29
11.90
6.06
—
(9.05)
(17.27)
___________
(1)
(2)
(3)
Does not include loan fees.
Includes BOLI income, which is included in non-interest income in the Consolidated Financial Statements.
No rates in the model are allowed to go below zero. Given the relatively low level of market interest rates, a
calculation for a decrease of greater than 200 basis points has not been prepared.
Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including
relative levels of market interest rates, loan repayments and deposit decay, and should not be relied upon as indicative of actual
results. Furthermore, the computations do not reflect any actions management may undertake in response to changes in interest
rates.
In the event of a 100 basis point decrease in interest rates, the Bank would be expected to experience a 9.1% decrease in
NPV and a 7.7% decrease in net interest income. In the event of a 100 basis point increase in interest rates, a 6.1% increase in
NPV and a 4.2% increase in net interest income would be expected. Based upon the modeling described above, the Bank's asset
and liability structure generally results in increases in net interest income and NPV in a rising interest rate scenario and decreases
in net interest income and NPV in a declining interest rate scenario.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing,
they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes
in market rates. Additionally, certain assets have features which restrict changes in interest rates on a short-term basis and over
the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals
from certificates of deposit could possibly deviate significantly from those assumed in calculating the table.
Comparison of Financial Condition at September 30, 2017 and September 30, 2016
The Company's total assets increased by $60.64 million, or 6.8%, to $952.02 million at September 30, 2017 from $891.39
million at September 30, 2016. The increase was primarily attributable to increases in cash and cash equivalents and net loans
receivable, which were partially offset by a decrease in certificates of deposit ("CDs") held for investment.
Net loans receivable increased by $27.22 million, or 4.1%, to $690.36 million at September 30, 2017 from $663.15
million at September 30, 2016, primarily as a result of increases in custom and owner/builder construction loans, commercial real
estate loans, commercial construction loans and multi-family construction loans. These increases in net loans receivable were
partially offset by an increase in the undisbursed portion of construction loans in process.
55
The Company's total liabilities increased by $46.47 million, or 5.8%, to $841.02 million at September 30, 2017 from
$794.55 million at September 30, 2016 primarily due to an increase in total deposits, which was partially offset by the repayment
of all FHLB borrowings. Total deposits increased by $76.36 million, or 10.0%, to $837.90 million at September 30, 2017 from
$761.53 million at September 30, 2016, primarily as a result of increases in non-interest bearing, savings, money market, and
NOW checking account balances. These increases were partially offset by a decrease in CD account balances.
Shareholders' equity increased by $14.17 million, or 14.6%, to $111.00 million at September 30, 2017 from $96.83 million
at September 30, 2016. The increase was primarily due to net income for the year ended September 30, 2017 of $14.17 million
and $2.50 million received from the exercise of a stock warrant to purchase 370,699 shares of the Company's common stock at
an exercise price of $6.73 per share, which was partially offset by dividends paid to shareholders of $3.64 million. As of
September 30, 2017, the Company exceeded all regulatory capital requirements required for bank holding company regulatory
purposes. For additional details see Note 15 of the Notes to Consolidated Financial Statements contained in "Item 8. Financial
Statements and Supplementary Data" and "Item 1. Business - Regulation of the Company - Capital Requirements."
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 $29.28 million, or 18.1%, to $191.22 million at September 30, 2017 from $161.94 million at September 30, 2016.
The increase was due to a $39.25 million increase in total cash and cash equivalents which was partially offset by a $9.97 million
decrease in CDs held for investment. The Company continued to maintain high levels of liquidity primarily for asset-liability
management purposes.
Investment Securities: Investment securities decreased by $473,000, or 5.3%, to $8.38 million at September 30, 2017
from $8.85 million at September 30, 2016. The decrease was primarily due to scheduled amortization and prepayments. For
additional details on investment securities, see "Item 1. Business - Investment Activities" and Note 3 to the Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
FHLB Stock: FHLB stock decreased by $1.10 million, or 49.8%, to $1.11 million at September 30, 2017 from $2.20
million at September 30, 2016, due to stock redemptions by the FHLB. The required investment in FHLB stock decreased primarily
due to the decrease in FHLB borrowings.
Other Investments: Other investments increased by $3.00 million at September 30, 2017 from none at September 30,
2016 due to the Company investing in the Solomon Hess SBA Loan Fund LLC. This investment is utilized to help satisfy
compliance with the Company's Community Reinvestment Act ("CRA") investment test requirements.
Loans Held for Sale: Loans held for sale remained level at $3.60 million at both September 30, 2017 and September
30, 2016. The Company sells longer-term fixed-rate residential loans and the guaranteed portion of SBA commercial business
loans for asset-liability management purposes and to generate non-interest income. The Company sold $81.40 million in loans
during the year ended September 30, 2017 compared to $58.90 million for the year ended September 30, 2016.
Loans Receivable, Net of Allowance for Loan Losses: Net loans receivable increased by $27.22 million, or 4.1%, to
$690.36 million at September 30, 2017 from $663.15 million at September 30, 2016. The increase was primarily a result of a
$24.59 million increase in custom and owner/builder construction loans, a $16.40 million increase in commercial real estate loans,
a $10.27 million increase in commercial construction loans, an $8.74 million increase in multi-family construction loans, a $2.61
million increase in commercial business loans, a $2.28 million increase in land loans, and a $1.81 million increase in speculative
one- to four-family construction loans. These increases were partially set offset by a $33.78 million increase in the undisbursed
portion of construction loans in process, a $3.70 million decrease in multi-family loans, a $1.62 million decrease in consumer
loans, and a $413,000 decrease in one- to four-family loans.
Loan originations increased by 27.4% to $340.61 million for the year ended September 30, 2017 from $267.35 million
for the year ended September 30, 2016. The increase in loan originations was primarily due to increased demand for construction
loans and the hiring of additional loan officers. For additional information on loans, see "Item 1. Business - Lending Activities"
and Note 4 to the Consolidated Financial Statements contained in "Item 8, Financial Statements and Supplementary Data."
Premises and Equipment: Premises and equipment increased by $2.26 million, or 14.0%, to $18.42 million at
September 30, 2017 from $16.16 million at September 30, 2016. The increase was primarily due to the purchase of the building
which had been leased for the Gig Harbor branch for $1.84 million in December 2016 and a remodel of the Bank's Edgewood
branch office. These additions were partially offset by normal depreciation. For additional information on premises and equipment,
56
see "Item 2. Properties" and Note 5 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and
Supplementary Data."
OREO and Other Repossessed Assets: OREO and other repossessed assets decreased by $816,000, or 19.8%, to $3.30
million at September 30, 2017 from $4.12 million at September 30, 2016. The decrease was primarily due to the disposition of
$1.53 million in OREO properties and other repossessed assets and OREO valuation write-downs of $42,000. These decreases
in OREO and other repossessed assets were partially offset by the addition of $751,000 in OREO properties and other repossessed
assets. At September 30, 2017, the OREO balance was comprised of 15 individual properties and one other repossessed asset. The
properties consisted of 11 land parcels totaling $1.87 million, two single family homes totaling $875,000, two commercial real
estate properties totaling $533,000 and one travel trailer with a balance of $28,000. The largest OREO property at September 30,
2017 was an undeveloped land parcel located in Lewis County with a balance of $948,000. For additional information on OREO
and other repossessed assets, see "Item 1. Business - Lending Activities - Other Real Estate Owned and Other Repossessed Assets"
and Note 6 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
Bank Owned Life Insurance ("BOLI"): BOLI increased by $545,000, or 2.9%, to $19.27 million at September 30,
2017 from $18.72 million at September 30, 2016 due to net BOLI earnings, representing the increase in cash surrender value.
Goodwill: The recorded amount of goodwill of $5.65 million at September 30, 2017 remained unchanged from
September 30, 2016. The Company performed its annual review of goodwill during the quarter ended June 30, 2017 and determined
that there was no impairment. For additional information on goodwill, see Note 1 to the Consolidated Financial Statements
contained in "Item 8. Financial Statements and Supplementary Data."
MSRs: MSRs increased by $252,000, or 16.0%, to $1.83 million at September 30, 2017 from $1.57 million at
September 30, 2016, primarily due to the addition of $739,000 in capitalized MSRs for new loans being serviced, which was
partially offset by amortization of $487,000. The principal amount of loans serviced for Freddie Mac and the SBA increased by
$18.24 million, or 5.4%, to $358.87 million at September 30, 2017 from $340.63 million at September 30, 2016. For additional
information on MSRs, see Note 7 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and
Supplementary Data."
Deposits: Deposits increased by $76.36 million, or 10.0%, to $837.90 million at September 30, 2017 from $761.53
million at September 30, 2016. The increase was primarily a result of a $33.67 million increase in non-interest-bearing demand
account balances, a $17.51 million increase in savings account balances, a $17.01 million increase in money market account
balances, and a $16.50 million increase in NOW checking account balances. These increases were partially offset by an $8.33
million decrease in CD account balances. The increase in non-interest bearing demand account and NOW checking account
balances was primarily due to increased commercial and consumer checking accounts as the Company continued to emphasize
increasing its transaction accounts base. The Company also experienced deposit inflows due to a number of customers transferring
funds from other financial institutions during the year ended September 30, 2017. The decrease in CD account balances was
primarily due to a managed run off as the Company continued to reduce CDs balances by competing slightly less aggressively on
certain CD term interest rates. For additional information on deposits, see "Item 1. Business - Deposit Activities and Other Sources
of Funds" and Note 8 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary
Data."
FHLB Borrowings: There were no FHLB borrowings at September 30, 2017 and $30.00 million at September 30, 2016
as the Company prepaid on April 26, 2017 FHLB borrowings with a weighted average cost of 3.98% and incurred prepayment
penalties of $282,000. Prepaying the FHLB borrowings reduced future interest expense by approximately $100,000 per month.
For additional information on borrowings, see "Item 1. Business - Deposit Activities and Other Sources of Funds - Borrowings"
and Note 9 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
Shareholders' Equity: Total shareholders' equity increased by $14.17 million, or 14.6%, to $111.00 million at
September 30, 2017 from $96.83 million at September 30, 2016. The increase was primarily due to net income of $14.17 million
for the year ended September 30, 2017 and the exercise of a stock warrant for $2.50 million, which was partially offset by the
payment of $3.64 million in dividends to common shareholders. The Company did not repurchase any shares of its common stock
during the year ended September 30, 2017. For additional information on shareholders' equity, see the Consolidated Statements
of Shareholders' Equity contained in "Item 8. Financial Statements and Supplementary Data."
Comparison of Operating Results for the Years Ended September 30, 2017 and 2016
Net income for the year ended September 30, 2017 increased by $4.01 million, or 39.5%, to $14.17 million from $10.15
million for the year ended September 30, 2016. Net income per diluted common share increased by $0.49, or 34.3%, to $1.92 for
57
the year ended September 30, 2017 from $1.43 for the year ended September 30, 2016. The increase in net income was primarily
due to increases in net interest income, non-interest income, and the recapture of loan losses (which added approximately $0.11
to diluted earnings per share), which was partially offset by an increase in non-interest expense and an increase in the provision
for income taxes.
A more detailed explanation of the income statement categories is presented below.
Net Interest Income: Net interest income increased by $4.34 million, or 14.1%, to $35.14 million for the year ended
September 30, 2017 from $30.80 million for the year ended September 30, 2016. 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 $3.46 million, or 9.9%, to $38.34 million for the year ended September 30,
2017 from $34.88 million for the year ended September 30, 2016, primarily due to a $69.44 million increase in the average balance
of total interest-bearing assets to $864.16 million from $794.72 million and an increase in the average yield on interest-earning
assets to 4.44% from 4.39%. Interest income on loans receivable and loans held for sale increased by $2.80 million, to $36.39
million for the year ended September 30, 2017 from $33.58 million for the year ended September 30, 2016, primarily due to an
increase in the average balance of net loans receivable and loans held for sale of $48.58 million during the year and an increase
in the average yield on loans receivable and loans held for sale to 5.26% from 5.22%. Also contributing to the increase in interest
and dividend income (and average yields) was a $255,000 increase in non-accrual interest and prepayment penalties collected
during the year ended September 30, 2017. During the year ended September 30, 2017, a total of $1.05 million in non-accrual
interest and prepayment penalties was collected compared to a total of $795,000 for the year ended September 30, 2016.
Total interest expense decreased by $875,000 to $3.20 million, or 21.5%, for the year ended September 30, 2017 from
$4.07 million for the year ended September 30, 2016, primarily due to a $1.05 million decrease in interest expense on FHLB
borrowings, which was partially offset by a $177,000 increase in interest expense on deposits. The decrease in FHLB borrowing
expense was primarily due to a $27.86 million decrease in the average balance of borrowings to $17.10 million for the year ended
September 30, 2017 from $44.96 million for the year ended September 30, 2016 partially offset by prepayment penalties of
$282,000 incurred for paying off the borrowings before their scheduled maturities. During the year ended September 30, 2017,
the Company repaid all remaining FHLB borrowings. The increase in interest expense on deposits was primarily due to a $51.75
million increase in average interest-bearing deposits to $610.26 million for the year ended September 30, 2017 from $558.52
million for the year ended September 30, 2016.
As a result of these changes, the net interest margin increased 19 basis points to 4.07% for the year ended September 30,
2017 from 3.88% for the year ended September 30, 2016.
Provision for (Recapture of) Loan Losses: No provision for loan losses was made for the years ended September 30,
2017 and 2016. There was a recapture of loan losses of $1.25 million for the year ended September 30, 2017 mainly due to the
Bank's recovery on previously charged-off commercial real estate loans and improvement in other underlying credit quality metrics
in the loan portfolio. There were net recoveries of $977,000 for the year ended September 30, 2017 compared to net charge-offs
of $98,000 for the year ended September 30, 2016. The net charge-offs (recoveries) to average outstanding loans ratio was (0.14%)
for the year ended September 30, 2017 and 0.02% for the year ended September 30, 2016. The level of delinquent loans (loans
30 or more days past due) decreased by $1.06 million, or 30.5%, to $2.41 million at September 30, 2017 from $3.47 million at
September 30, 2016 and the level of loans graded substandard decreased by $1.78 million, or 35.4%, to $3.25 million at
September 30, 2017 from $5.04 million at September 30, 2016. Non-accrual loans decreased by $962,000, or 33.5%, to $1.91
million at September 30, 2017 from $2.87 million at September 30, 2016.
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, historic 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 subject to an impairment analysis to determine an appropriate reserve or
write-down to be applied against each loan. The aggregate principal impairment amount determined at September 30, 2017 was
$476,000 compared to $776,000 at September 30, 2016.
Based on the comprehensive methodology, management believes the allowance for loan losses of $9.55 million at
September 30, 2017 (1.36% of loans receivable and 499.9% of non-performing loans) was adequate to provide for probable losses
based on an evaluation of known and inherent risks in the loan portfolio at that date. 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
58
future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans
deteriorate. Any material increase in the allowance for loan losses would adversely affect the Company's financial condition and
results of operations. For additional information, see "Item 1. Business - Lending Activities -- Allowance for Loan Losses."
Non-interest Income: Total non-interest income increased by $1.48 million, or 13.6%, to $12.37 million for the year
ended September 30, 2017 from $10.89 million for the year ended September 30, 2016. This increase was primarily due to a
$549,000 increase in service charges on deposits, a $376,000 increase in gain on sales of loans, a $201,000 change in net OTTI,
a $151,000 increase in servicing income on loans sold, and smaller increases and decreases in several other categories.
The increase in service charges on deposits was primarily due to an increase in the amount of service charges collected
on checking accounts owned by businesses associated with the marijuana (or Initiative-502) industry in Washington State. It is
permissible in Washington State to handle accounts associated with this industry in compliance with federal regulatory guidelines.
The increase in gain on sales of loans was primarily due to increases in the dollar volume of fixed-rate one- to four-family loans
and of the guaranteed portion of SBA loans sold during the year. The change in net OTTI was a result of $33,000 net recovery
for the year ended September 30, 2017 compared to a net OTTI expense of $168,000 for the year ended September 30, 2016. The
increase in servicing income on loans sold was primarily due to an increase in the dollar amount of loans serviced for Freddie
Mac and a decrease in the amortization of MSRs.
Non-interest Expense: Total non-interest expense increased by $879,000, or 3.3%, to $27.52 million for the year ended
September 30, 2017 from $26.64 million for the year ended September 30, 2016. This increase was primarily due to a $987,000
increase in salaries and employee benefits expense and smaller increases in several other categories. These increases were partially
offset by a $640,000 decrease in OREO and other repossessed assets expense, and smaller decreases in several other categories.
The increase in salaries and employee benefits expense was primarily due to annual salary adjustments and the hiring of
additional lending and operations personnel. The decrease in OREO and other repossessed assets expense was primarily due to
a decrease in the level of valuation write-downs based on updated appraisals received on OREO properties. The efficiency ratio
for the year ended September 30, 2017 improved to 57.92% from 63.89% for the year ended September 30, 2016 as the increases
in net interest income and non-interest income outpaced the increase in non-interest expense.
Provision for Income Taxes: The provision for income taxes increased by $2.18 million, or 44.4% to $7.08 million for
the year ended September 30, 2017 from $4.90 million for the year ended September 30, 2016, primarily due to increased income
before income taxes. The Company's effective income tax rate was 33.3% for the year ended September 30, 2017 compared to
32.6% for the year ended September 30, 2016. For additional information on income taxes, see Note 11 of the Consolidated
Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
59
Comparison of Operating Results for the Years Ended September 30, 2016 and 2015
Net income for the year ended September 30, 2016 increased by $1.86 million, or 22.5%, to $10.15 million from $8.29
million for the year ended September 30, 2015. Net income per diluted common share increased by $0.26, or 22.2%, to $1.43 for
the year ended September 30, 2016 from $1.17 for the year ended September 30, 2015. The increase in net income was primarily
due to increases in net interest income and non-interest income, which was partially offset by a decrease in the recapture of loan
losses, an increase in non-interest expense, and an increase in the provision for federal income taxes.
A more detailed explanation of the income statement categories is presented below.
Net Interest Income: Net interest income increased by $3.53 million, or 12.9%, to $30.80 million for the year ended
September 30, 2016 from $27.28 million for the year ended September 30, 2015. The increase in net interest income was due to
an increase in interest income, which was partially offset by an increase in interest expense.
Total interest and dividend income increased by $3.71 million, or 11.9%, to $34.88 million for the year ended
September 30, 2016 from $31.17 million for the year ended September 30, 2015, primarily due to a $76.84 million increase in the
average balance of total interest-bearing assets to $794.7 million from $717.9 million. Interest income on loans receivable and
loans held for sale increased by $3.18 million, to $33.58 million for the year ended September 30, 2016 from $30.40 million for
the year ended September 30, 2015, primarily due to an increase in the average balance of net loans receivable and loans held for
sale of $46.95 million during the year. Average loan yields increased thirteen basis points compared to the year ended September
30, 2016, as the percentage of higher yielding nonresidential mortgage loans as a percentage of total mortgage loans increased.
Also contributing to the increase in the average loan yield and the increase in interest and dividend income was a $454,000 increase
in non-accrual interest and prepayment penalties collected during the year ended September 30, 2016.
Total interest expense increased by $182,000 to $4.07 million, or 4.7%, for the year ended September 30, 2016 from
$3.89 million for the year ended September 30, 2015, primarily due to a $138,000 prepayment penalty on a $15.00 million FHLB
borrowing (that was repaid before its scheduled maturity date of December 21, 2016) and a $35.58 million increase in average
interest-bearing liabilities to $603.48 million for the year ended September 30, 2016 from $567.89 million for the year ended
September 30, 2015. Partially offsetting these increases was a decrease in the average rate paid on interest-bearing liabilities to
0.67% for the year ended September 30, 2016 from 0.68% for the year ended September 30, 2015.
The net interest margin increased eight basis points to 3.88% for the year ended September 30, 2016 from 3.80% for the
year ended September 30, 2015, as the yield on interest-bearing assets increased to 4.39% for the year ended September 30, 2016
from 4.34% for the year ending September 30, 2015. The net interest margin for the year was also increased by the collection of
$454,000 of non-accrual interest and prepayment penalties, which was partially offset by the payment of a $138,000 FHLB
borrowing prepayment penalty.
Provision for (Recapture of) Loan Losses: There was no provision for (recapture of) loan losses for the year ended
September 30, 2016 compared to a recapture of loan losses of $1.53 million for the year ended September 30, 2015. There were
net charge-offs of $98,000 for the year ended September 30, 2016 compared to net recoveries of $1.02 million for the year ended
September 30, 2015. The net charge-offs (recoveries) to average outstanding loans ratio was 0.02% for the year ended
September 30, 2016 and (0.17)% for the year ended September 30, 2015. The recapture of loan losses for the year ended September
30, 2015 was primarily due to the level of net recoveries and improvements in other underlying credit quality metrics in the loan
portfolio. The level of delinquent loans (loans 30 or more days past due) decreased by $3.70 million, or 51.6%, to $3.47 million
at September 30, 2016 from $7.17 million at September 30, 2015 and the level of loans graded substandard decreased by $7.68
million, or 60.4%, to $5.04 million at September 30, 2016 from $12.72 million at September 30, 2015. Non-accrual loans decreased
by $3.17 million, or 52.4%, to $2.87 million at September 30, 2016 from $6.04 million at September 30, 2015.
Based on the Company's comprehensive methodology for determining the allowance for loan losses, management deemed
the allowance for loan losses of $9.83 million at September 30, 2016 (1.46% of loans receivable and 326.7% of non-performing
loans) was adequate to provide for probable losses based on an evaluation of known and inherent risks in the loan portfolio at that
date.
Non-interest Income: Total non-interest income increased by $1.37 million, or 14.4%, to $10.89 million for the year
ended September 30, 2016 from $9.52 million for the year ended September 30, 2015. This increase was primarily due to a
$597,000 increase in ATM and debit card interchange transaction fees, a $354,000 increase in service charges on deposits, a
$270,000 increase in servicing income on loans sold, a $171,000 increase in gain on sales of loans, and smaller increases in several
other categories, which was partially offset by a $155,000 increase in OTTI on investment securities.
60
The increase in ATM and debit card interchange transaction fees was primarily due to an increase in debit card transactions
and the receipt of a one-time $262,000 incentive payment from the Company's debit card issuer for meeting certain sales and
retention targets since the conversion to the new card issuer in 2014. 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. The increase in servicing income on loans sold was primarily due to
a decrease in the amortization of MSRs. The increase in gain on sales of loans was primarily due to an increase in the dollar
volume of fixed-rate one- to four-family loans and the sale of the guaranteed portion of SBA loans sold during the year. The
increase in OTTI expense was primarily due to the recognition of additional credit loss on three private label mortgage-backed
securities.
Non-interest Expense: Total non-interest expense increased by $796,000, or 3.1%, to $26.64 million for the year ended
September 30, 2016 from $25.84 million for the year ended September 30, 2015. This increase was primarily due to a $721,000
increase in salaries and employee benefits expense, a $303,000 difference in the loss (gain) on sales/dispositions of premises and
equipment, a $156,000 increase in ATM and debit card interchange transaction fees expense, and smaller increases in several other
categories. These increases were partially offset by a $256,000 decrease in OREO and other repossessed assets expense, a $172,000
decrease in professional fees expense, and smaller decreases in several other categories.
The increase in salaries and employee benefits expense was primarily due to annual salary adjustments and the hiring of
additional lending and operations personnel. The difference in the loss (gain) on sales/dispositions of premises and equipment
was primarily due to a $299,000 gain on the sale of excess land adjacent to the Company's Lacey branch during the year ended
September 30, 2015. The increase in ATM and debit card interchange transaction fees expense was primarily due to increased
debit card transaction volume and the recognition of costs associated with the Company's upcoming conversion to EMV chip
cards. The decrease in OREO and other repossessed assets expense was primarily due to a decrease in the level of valuation write-
downs based on updated appraisals received on OREO properties. The decrease in professional fees was primarily due to the
recovery of expenses on several non-accrual loans that were paid off during the year ended September 30, 2016.
Provision for Income Taxes: The provision for income taxes increased by $709,000, or 16.9% to $4.90 million for the
year ended September 30, 2016 from $4.19 million for the year ended September 30, 2015, primarily due to increased income
before income taxes. The Company's effective income tax rate was 32.6% for the year ended September 30, 2016 compared to
33.6% for the year ended September 30, 2015.
Average Balances, Interest and Average Yields/Cost
The earnings of the Company depend largely on the spread between the yield on interest-earning assets and the cost of
interest-bearing liabilities, as well as the relative amount of the Company's interest-earning assets and interest- bearing liability
portfolios.
61
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Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on net interest income on the
Company. Information is provided with respect to the (i) effects on interest income attributable to changes in volume (changes
in volume multiplied by prior rate), (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 both rate and volume have been allocated to rate
and volume variances based on the absolute values of each.
Year Ended September 30,
2017 Compared to Year
Ended September 30, 2016
Increase (Decrease)
Due to
Year Ended September 30,
2016 Compared to Year
Ended September 30, 2015
Increase (Decrease)
Due to
Rate
Volume
Net
Change
(Dollars in thousands)
Rate
Volume
Net
Change
$
2,552
(8)
$
2,805
(8)
(2)
151
(18)
684
747
$
2,436
$
3,183
1
74
251
37
1
160
38
75
411
2,693
3,463
1,073
2,634
3,707
Interest-earning assets:
Loans receivable (1)
Investment securities
Dividends from mutual funds,
FHLB stock and other investments
Interest-bearing deposits in banks
and CDs
Total net change in income on
interest-earning assets
Interest-bearing liabilities:
Savings accounts
Money market accounts
NOW accounts
Certificates of deposit
FHLB borrowings
$
253
$
—
(16)
533
770
4
43
(10)
54
(127)
11
64
14
(3)
(925)
15
107
4
51
(1,052)
4
20
(10)
—
144
158
915
6
33
16
(32)
1
24
$
2,610
$
10
53
6
(32)
145
182
3,525
Total net change in expense on
interest-bearing liabilities
Net change in net interest income
$
(36)
806
$
(839)
3,532
$
(875)
4,338
$
______________
(1)
Excludes interest on loans on non-accrual status. Includes loans held for sale and interest earned on loans held for
sale.
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on loans,
the sale of loans, maturing investment securities and FHLB borrowings. While the 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.
The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund loan originations
and deposit withdrawals, to satisfy other financial commitments and to take advantage of investment opportunities. The Bank
generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2017, the
Bank's regulatory liquidity ratio (net cash, and short-term and marketable assets, as a percentage of net deposits and short-term
liabilities) was 23.4%. At September 30, 2017, the Bank maintained an uncommitted credit facility with the FHLB that provided
for immediately available borrowings up to an aggregate amount equal to 35% of total assets, limited by available collateral. The
Bank had $297.7 million available for additional borrowings with the FHLB at September 30, 2017. The Bank also has a LOC
of up to $22.0 million with the FHLB for the purpose of collateralizing Washington State public deposits, all of which was available
to be drawn upon at September 30, 2017. The LOC amount reduces the Bank's available borrowings under the FHLB advance
63
agreement. The Bank maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. At
September 30, 2017, the Bank had no outstanding balance on this borrowing line, under which $62.8 million was available for
future borrowings. The Bank also maintains a $10.0 million overnight borrowing line with PCBB. At September 30, 2017, the
Bank did not have an outstanding balance on this borrowing line.
Liquidity management is both a short and long-term responsibility of the Bank's management. The Bank adjusts its
investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii)
expected deposit flows, and (iv) yields available on interest-bearing deposits. Excess liquidity is invested generally in interest-
bearing overnight deposits, CDs held for investment and short-term government and agency obligations. If the Bank requires
funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB, the FRB and PCBB.
The Bank's primary investing activity is the origination of loans. During the years ended September 30, 2017, 2016 and
2015, the Bank originated $340.6 million, $267.4 million and $262.4 million of loans, respectively. At September 30, 2017, the
Bank had loan commitments totaling $71.2 million and undisbursed loans in process totaling $82.4 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 September 30, 2017 totaled $75.4 million. Historically, the Bank has been able to retain a significant amount of its
deposits as they mature.
The Bank’s liquidity is also affected by the volume of loans sold and loan principal payments. During the years ended
September 30, 2017, 2016 and 2015, the Bank sold $81.4 million, $58.9 million and $57.5 million in loans and loan participation
interests, respectively. During the years ended September 30, 2017, 2016 and 2015, the Bank received $211.3 million, $155.4
million and $148.8 million in principal repayments, respectively.
The Bank’s liquidity has been impacted by increases in deposit levels. During the years ended September 30, 2017, 2016
and 2014, deposits increased by $76.4 million, $82.6 million and $63.8 million, respectively.
Cash and cash equivalents, CDs held for investment and investment securities increased to $199.6 million at September 30,
2017 from $170.8 million at September 30, 2016.
Timberland Bancorp is a separate legal entity from the Bank and must provide for its own liquidity and pay its own
operating expenses. Sources of capital and liquidity for Timberland Bancorp include principal and interest payments on the loan
receivable from the Employee Stock Ownership Plan ("ESOP"), distributions from the Bank and the issuance of debt or equity
securities. At September 30, 2017, Timberland Bancorp (on an unconsolidated basis) had liquid assets of $2.3 million.
Bank holding companies and federally-insured state-chartered banks are required to maintain minimum levels of
regulatory capital. At September 30, 2017, Timberland Bancorp and the Bank were in compliance with all applicable capital
requirements. For additional details see Note 15 to the Consolidated Financial Statements contained in “Item 8. Financial
Statements and Supplementary Data” and “Item 1. Business - Regulation of the Bank - Capital Requirements.”
Contractual obligations. The following table presents, as of September 30, 2017, the Company’s significant fixed and
determinable contractual operating lease obligations by payment date. There were no other fixed determinable contractual
obligations outstanding at September 30, 2017.
Contractual obligations
Operating lease obligations
Total contractual obligations
Less than
1 year
$
$
206
206
$
$
1 year
through
3 years
Payments due by period
After
3 years
through
5 years
(Dollars in thousands)
$
$
124
124
$
$
365
365
After
5 years
Total
— $
— $
695
695
Off-Balance Sheet Activities. The Company is a party to financial instruments with off-balance sheet risk in the
normal course of business in order to meet the financial needs of its customers. For information regarding our commitments
and off-balance sheet arrangements, see Note 14 of the Notes to Consolidated Financial Statements included in Item 8.
"Financial Statements and Supplementary Data" of this Form 10-K.
64
A summary of the Company's commitments at September 30, 2017 and 2016 is as follows (in thousands):
Undisbursed portion of construction loans in process
Undisbursed lines of credit
Commitments to extend credit
Total commitments
Effect of Inflation and Changing Prices
2017
2016
$
$
82,411
51,420
19,673
153,504
$
$
48,627
47,949
20,681
117,257
The consolidated financial statements and related financial data presented herein have been prepared in accordance with
GAAP which require the measurement of financial position and operating results in terms of historical dollars, without considering
the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operation
of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities
of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial
institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the
same extent as the prices of goods and services.
New Accounting Pronouncements
For a discussion of new accounting pronouncements and their impact on the Company, see Note 1 to the Consolidated
Financial Statements contained in "Item 8. Financial Statements and Supplementary Data".
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under “Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Market Risk and Asset and Liability Management” of this Form 10-K is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of September 30, 2017 and 2016
Consolidated Statements of Income for the Years Ended
September 30, 2017, 2016 and 2015
Consolidated Statements of Comprehensive Income for the
Years Ended September 30, 2017, 2016 and 2015
Consolidated Statements of Shareholders' Equity for the
Years Ended September 30, 2017, 2016 and 2015
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2017, 2016 and 2015
Notes to Consolidated Financial Statements
65
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66
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5 0 3 6 9 7 4 1 1 8 — D E L A P C P A . C O M — 5 8 8 5 M E A D O W S R O A D , N o . 2 0 0 — L A K E O S W E G O , O R 9 7 0 3 5
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66
(cid:3)
Consolidated Balance Sheets
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Assets
Cash and cash equivalents:
Cash and due from financial institutions
Interest-bearing deposits in banks
Total cash and cash equivalents
Certificates of deposit (“CDs”) held for investment (at cost, which
approximates fair value)
Investment securities held to maturity, at amortized cost (estimated fair value $7,744 and
$8,395)
Investment securities available for sale, at fair value
Federal Home Loan Bank of Des Moines (“FHLB”) stock
Other investments, at cost
Loans held for sale
Loans receivable, net of allowance for loans losses of $9,553 and $9,826
Premises and equipment, net
Other real estate owned (“OREO”) and other repossessed assets, net
Accrued interest receivable
Bank owned life insurance (“BOLI”)
Goodwill
Mortgage servicing rights (“MSRs”), net
Other assets
Total assets
Liabilities and shareholders’ equity
Liabilities
Deposits:
Non-interest-bearing demand
Interest-bearing
Total deposits
FHLB borrowings
Other liabilities and accrued expenses
Total liabilities
Commitments and contingencies (See Note 14)
See notes to consolidated financial statements
67
2017
2016
$
17,447
$
130,741
148,188
16,686
92,255
108,941
43,034
53,000
7,139
1,241
1,107
3,000
3,599
690,364
18,418
3,301
2,520
19,266
5,650
1,825
3,372
952,024
205,952
631,946
837,898
—
3,126
841,024
$
$
7,511
1,342
2,204
—
3,604
663,146
16,159
4,117
2,348
18,721
5,650
1,573
3,072
891,388
172,283
589,251
761,534
30,000
3,020
794,554
$
$
Consolidated Balance Sheets (continued)
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Shareholders’ equity
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued
2017
— $
2016
—
$
Common stock, $0.01 par value; 50,000,000 shares authorized;
7,361,077 shares issued and outstanding - September 30, 2017
6,943,868 shares issued and outstanding - September 30, 2016
Unearned shares issued to Employee Stock Ownership Plan (“ESOP”)
Retained earnings
Accumulated other comprehensive loss
Total shareholders’ equity
Total liabilities and shareholders’ equity
See notes to consolidated financial statements
13,286
(397)
98,235
(124)
111,000
9,961
(661)
87,709
(175)
96,834
$
952,024
$
891,388
68
Consolidated Statements of Income
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2017, 2016 and 2015
2017
2016
2015
Interest and dividend income
Loans receivable and loans held for sale
Investment securities
Dividends from mutual funds, FHLB stock and other investments
Interest-bearing deposits in banks and CDs
Total interest and dividend income
$
$
36,385
279
88
1,586
38,338
$
33,580
287
106
902
34,875
30,397
249
31
491
31,168
2,004
1,886
3,890
2,218
979
3,197
2,041
2,031
4,072
35,141
30,803
27,278
(1,250)
—
(1,525)
Interest expense
Deposits
FHLB borrowings
Total interest expense
Net interest income
Recapture of loan losses
Net interest income after recapture of loan losses
36,391
30,803
28,803
Non-interest income
Recoveries (other than temporary impairment “OTTI”)
on investment securities
Adjustment for portion of OTTI transferred from
other comprehensive income (before income taxes)
Net recoveries (OTTI) on investment securities
Gain on sales of investment securities
Service charges on deposits
ATM and debit card interchange transaction fees
BOLI net earnings
Gain on sales of loans, net
Escrow fees
Servicing income (loss) on loans sold
Fee income from non-deposit investment sales
Other, net
Total non-interest income, net
38
(5)
33
—
4,518
3,343
545
2,157
242
417
63
1,050
12,368
(29)
(139)
(168)
—
3,969
3,261
551
1,781
214
266
111
904
10,889
—
(13)
(13)
45
3,615
2,664
538
1,610
206
(4)
41
820
9,522
See notes to consolidated financial statements
69
Consolidated Statements of Income (continued)
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2017, 2016 and 2015
Non-interest expense
Salaries and employee benefits
Premises and equipment
Loss (gain) on sales/dispositions of premises and equipment, net
Advertising
OREO and other repossessed assets, net
ATM and debit card interchange transaction fees
Postage and courier
State and local taxes
Professional fees
Federal Deposit Insurance Corporation ("FDIC") insurance
Loan administration and foreclosure
Data processing and telecommunications
Deposit operations
Other
Total non-interest expense, net
Income before income taxes
Provision for income taxes
Net income
Net income per common share
Basic
Diluted
2017
2016
2015
$
14,908
$
13,921
$
13,200
3,082
5
698
22
1,405
435
609
887
362
205
1,870
1,074
1,954
27,516
3,130
7
753
662
1,377
413
572
657
448
321
1,896
912
1,568
26,637
3,053
(296)
779
918
1,221
429
561
829
593
269
1,767
812
1,706
25,841
21,243
15,055
12,484
7,076
14,167
1.99
1.92
$
$
$
4,901
10,154
1.48
1.43
$
$
$
$
$
$
4,192
8,292
1.20
1.17
See notes to consolidated financial statements
70
Consolidated Statements of Comprehensive Income
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2017, 2016 and 2015
Comprehensive income
Net income
2017
2016
2015
$
14,167
$
10,154
$
8,292
Unrealized holding (loss) gain on investment securities available for
sale, net of income taxes of ($12), $0 and ($2), respectively
Reclassification adjustment for gain on sale of investment securities
available for sale included in net income, net of income taxes of $0,
$0 and ($15), respectively
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 $12, $7 and $7, respectively
Amount reclassified to credit loss for previously recorded
market loss, net of income taxes of $2, $49 and $4, respectively
Accretion of OTTI on investment securities held to maturity, net of
income taxes of $26, $18 and $20, respectively
Total other comprehensive income, net of income taxes
Total comprehensive income
(23)
—
22
3
49
51
14,218
$
$
1
—
12
90
35
$
$
138
10,292
$
$
(4)
(30)
13
9
38
26
8,318
See notes to consolidated financial statements
71
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Consolidated Statements of Cash Flows
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2017, 2016 and 2015
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation
Deferred income taxes
Amortization of core deposit intangible ("CDI")
Earned ESOP shares
Stock option compensation expense
Gain on sales of investment securities
Net (recoveries) OTTI on investment securities
Gain on sales of OREO and other repossessed assets, net
Provision for OREO losses
Gain on sales of loans, net
Loss (gain) on sales/dispositions of premises and equipment, net
Recapture of loan losses
Loans originated for sale
Proceeds from sales of loans
Amortization of MSRs
BOLI net earnings
Increase in deferred loan origination fees
Net change in accrued interest receivable and other assets, and other
liabilities and accrued expenses
Net cash provided by operating activities
Cash flows from investing activities
Net decrease (increase) in CDs held for investment
Purchase of investment securities held to maturity
Proceeds from maturities and prepayments of investment securities
held to maturity
Proceeds from maturities and prepayments of investment securities
available for sale
Proceeds from sales of investment securities available for sale
Purchase of FHLB stock
Proceeds from redemption of FHLB stock
Purchase of other investments
Increase in loans receivable, net
Additions to premises and equipment
Capitalized improvements to OREO
Proceeds from sales of OREO and other repossessed assets
Proceeds from sales/dispositions of premises and equipment
Net cash used in investing activities
2017
2016
2015
$
14,167
$
10,154
$
8,292
1,262
385
—
605
156
—
(33)
(54)
42
(2,157)
5
(1,250)
(69,996)
72,158
487
(545)
237
(1,610)
13,859
9,966
—
609
68
—
(103)
1,200
(3,000)
(26,956)
(3,526)
—
1,579
—
(20,163)
1,328
283
—
404
190
—
168
(47)
435
(1,781)
7
—
(57,354)
58,582
555
(551)
36
(592)
11,817
1,356
196
3
336
127
(45)
13
(110)
644
(1,610)
(296)
(1,525)
(54,490)
53,948
841
(538)
447
36
7,625
(4,389)
—
(12,766)
(2,988)
489
509
53
—
(105)
600
—
(59,212)
(640)
(142)
3,798
—
(59,548)
242
1,219
—
2,547
—
(40,016)
(700)
(3)
2,377
465
(49,114)
See notes to consolidated financial statements
74
Consolidated Statements of Cash Flows (continued)
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2017, 2016 and 2015
Cash flows from financing activities
Net increase in deposits
Repayment of FHLB borrowings
Proceeds from exercise of stock options
Proceeds from exercise of stock warrant
Repurchase of common stock
Payment of dividends
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents
Beginning of period
End of period
Supplemental disclosure of cash flow information
Income taxes paid
Interest paid
Supplemental disclosure of non-cash investing activities
Loans transferred to OREO and other repossessed assets
Other comprehensive income related to investment securities
Loans originated to facilitate the sale of OREO
$
$
$
$
2017
2016
2015
$
76,364
(30,000)
332
2,496
—
(3,641)
45,551
$
82,622
(15,000)
159
—
(820)
(2,578)
64,383
63,796
—
30
—
(709)
(1,693)
61,424
39,247
16,652
19,935
108,941
148,188
7,596
3,283
$
$
751
$
51
—
$
$
$
92,289
108,941
4,412
3,976
307
138
—
72,354
92,289
3,663
3,899
2,120
26
450
See notes to consolidated financial statements
75
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Timberland Bancorp, Inc. (“Timberland
Bancorp”); its wholly owned subsidiary, Timberland Bank (the “Bank”); and the Bank’s wholly owned subsidiary, Timberland
Service Corp. (collectively, the "Company”). All significant intercompany transactions and balances have been eliminated in
consolidation.
Nature of Operations
Timberland Bancorp is a bank holding company which operates primarily through its subsidiary, the Bank. The Bank was
established in 1915 and, through its 22 branches located in Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties in
Washington State, attracts deposits from the general public, and uses those funds, along with other borrowings, primarily to
provide residential real estate, construction, commercial real estate, commercial business and consumer loans to borrowers
primarily in western Washington.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the
United States of America ("U.S.") (“GAAP”) and prevailing practices within the banking industry. The preparation of
consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, and the disclosure of contingent assets and liabilities, as of the date of the consolidated balance sheets, and
the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the
allowance for loan losses, the determination of the estimated fair value of investment securities, the valuation of deferred tax
assets, the valuation of MSRs, the valuation of OREO and the valuation of goodwill for potential impairment.
Certain prior year amounts have been reclassified to conform to the 2017 fiscal year presentation with no change to previously
reported net income or shareholders’ equity.
Segment Reporting
The Company has one reportable operating segment which is defined as community banking in western Washington under the
operating name “Timberland Bank.”
Cash and Cash Equivalents and Cash Flows
The Company considers amounts included in the consolidated balance sheets’ captions “Cash and due from financial
institutions” and “Interest-bearing deposits in banks,” all of which mature within ninety days, to be cash equivalents for
purposes of reporting cash flows.
Interest-bearing deposits in banks as of September 30, 2017 and 2016 included deposits with the Federal Reserve Bank of San
Francisco ("FRB") of $127,128,000 and $88,420,000, respectively. The Company also maintains balances in correspondent
bank accounts which, at times, may exceed the FDIC insurance limit of $250,000 per correspondent bank. Management
believes that its risk of loss associated with such balances is minimal due to the financial strength of the FRB and the
correspondent banks.
CDs Held for Investment
CDs held for investment include amounts invested with other FDIC-insured financial institutions for a stated interest rate and
with a fixed maturity date. Such CDs generally have maturities of 12 to 24 months from the date of purchase by the Company.
Early withdrawal penalties may apply; however, the Company intends to hold these CDs to maturity. The Company generally
limits its purchases of CDs to a maximum of $250,000 (the FDIC insurance coverage limit) with any single financial institution.
76
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Investment Securities
Investment securities are classified upon acquisition as either held to maturity or available for sale. Investment securities that
the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reflected at amortized
cost. Investment securities classified as available for sale are reflected at fair value, with unrealized gains and losses excluded
from earnings and reported in other comprehensive income (loss), net of income tax effects. Premiums and discounts are
amortized to earnings using the interest method over the contractual lives of the securities. Gains and losses on sales of
investment securities are recognized on the trade date and determined using the specific identification method.
In estimating whether there are any OTTI losses, management considers (1) the length of time and the extent to which the fair
value has been less than amortized cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of
changes in market interest rates and (4) the intent and ability of the Company to retain its investment for a period of time
sufficient to allow for any anticipated recovery in fair value.
Declines in the fair value of individual investment securities available for sale that are deemed to be other than temporary are
reflected in earnings when identified. The fair value of the investment security then becomes the new cost basis. For individual
investment securities that are held to maturity which the Company does not intend to sell, and it is not more likely than not that
the Company will be required to sell before recovery of its amortized cost basis, the other than temporary decline in the fair
value of the investment security related to: (1) credit loss is recognized in earnings and (2) market or other factors is recognized
in other comprehensive income (loss). Credit loss is recorded if the present value of expected future cash flows is less than the
amortized cost. For individual investment securities which the Company intends to sell or more likely than not will not recover
all of its amortized cost, the OTTI is recognized in earnings equal to the entire difference between the investment security’s cost
basis and its fair value at the consolidated balance sheet date. For individual investment securities for which credit loss has
been recognized in earnings, interest accruals and amortization and accretion of premiums and discounts are suspended when
the credit loss is recognized. Interest received after accruals have been suspended is recognized on a cash basis.
FHLB Stock
The Bank, as a member of the FHLB, is required to maintain an investment in capital stock of the FHLB in an amount equal to
0.12% of the Bank's total assets plus 4.00% of borrowings from the FHLB. No ready market exists for this stock, and it has no
quoted market value. However, redemption of FHLB stock has historically been at par value. The Company's investment in
FHLB stock is carried at cost, which approximates fair value.
The Company evaluates its FHLB stock for impairment as needed. The Company's determination of whether this investment is
impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in
value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the
significance of any decline in net assets of the FHLB as compared with the capital stock amount and the length of time any
decline has persisted; (2) commitments by the FHLB to make payments required by law or regulation and the level of such
payments in relation to the operating performance of the FHLB; (3) the impact of legislative and regulatory changes on
institutions and, accordingly, the customer base of the FHLB; and (4) the liquidity position of the FHLB. Based on its
evaluation, the Company determined that there was no impairment of FHLB stock at September 30, 2017 and 2016.
Other Investments
The Bank invests in the Solomon Hess SBA Loan Fund LLC - a private investment fund - to help satisfy compliance with the
Bank's Community Reinvestment Act ("CRA") investment test requirements. Shares in this fund are not publicly traded and
therefore have no readily determinable fair market value. The Bank's investment in the fund is recorded at cost. An investor can
have its investment in the fund redeemed for the balance of its capital account at any quarter end with a 60 day notice to the
fund.
Loans Held for Sale
Mortgage loans and commercial business loans originated and intended for sale in the secondary market are stated in the
aggregate at the lower of cost or estimated fair value. Net unrealized losses, if any, are recognized through a valuation
allowance by charges to income. Gains or losses on sales of loans are recognized at the time of sale. The gain or loss is the
77
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
difference between the net sales proceeds and the recorded value of the loans, including any remaining unamortized deferred
loan origination fees.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed portion of construction loans in process, net
deferred loan origination fees and the allowance for loan losses.
Interest on loans is accrued daily based on the principal amount outstanding. Generally, the accrual of interest on loans is
discontinued when, in management’s opinion, the borrower may be unable to make payments as they become due or when they
are past due 90 days as to either principal or interest (based on contractual terms), unless the loan is well secured and in the
process of collection. In determining whether a borrower may be able to make payments as they become due, management
considers circumstances such as the financial strength of the borrower, the estimated collateral value, reasons for the delays in
payments, payment record, the amounts past due and the number of days past due. All interest accrued but not collected for
loans that are placed on non-accrual status or charged off is reversed against interest income. Subsequent collections on a cash
basis are applied proportionately to past due principal and interest, unless collectability of principal is in doubt, in which case
all payments are applied to principal. Loans are returned to accrual status when the loan is deemed current, and the
collectability of principal and interest is no longer doubtful, or, in the case of one- to four-family loans, when the loan is less
than 90 days delinquent. The categories of non-accrual loans and impaired loans overlap, although they are not identical.
The Company charges fees for originating loans. These fees, net of certain loan origination costs, are deferred and amortized to
income on the level-yield basis over the loan term. If the loan is repaid prior to maturity, the remaining unamortized deferred
loan origination fee is recognized in income at the time of repayment.
Troubled Debt Restructured Loans
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.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to provide for probable losses inherent in the loan
portfolio. The allowance is provided based upon management's comprehensive analysis of the pertinent factors underlying the
quality of the loan portfolio. These factors include changes in the amount and composition of the loan portfolio, delinquency
levels, actual loan loss experience, current economic conditions, and a detailed analysis of individual loans for which full
collectability may not be assured. The detailed analysis includes methods to estimate the fair value of loan collateral and the
existence of potential alternative sources of repayment. The allowance consists of specific and general components. The
specific component relates to loans that are deemed impaired. For such loans that are classified as impaired, an allowance is
established when the discounted cash flows, collateral value less selling costs (if applicable), or observable market price of the
impaired loan is lower than the recorded value of that loan. The general component covers non-impaired loans and is based on
historical loss experience adjusted for qualitative factors. The Company's historical loss experience is determined by evaluating
the average net charge-offs over the most recent economic cycle, but not to exceed six years. Qualitative factors are determined
by loan type and allow management to adjust reserve levels to reflect the current general economic environment and portfolio
performance trends including recent charge-off trends. Allowances are provided based on management’s continuing evaluation
of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan
portfolio, actual loan loss experience, current economic conditions, collateral values, geographic concentrations, seasoning of
the loan portfolio, specific industry conditions, the duration of the current business cycle, and regulatory requirements and
expectations. The appropriateness of the allowance for loan losses is estimated based upon these factors and trends identified
by management at the time the consolidated financial statements are prepared.
78
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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
measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest and net deferred
loan origination fees or costs), impairment is recognized by creating or adjusting an allocation of the allowance for loan losses
and uncollected accrued interest is reversed against interest income. If ultimate collection of principal is in doubt, all cash
receipts on impaired loans are applied to reduce the principal balance.
A provision for (recapture of) loan losses is charged (credited) to operations and is added to (deducted from) the allowance for
loan losses based on a quarterly comprehensive analysis of the loan portfolio. The allowance for loan losses is allocated to
certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan
portfolio. While management has allocated the allowance for loan losses to various loan portfolio segments, the allowance is
general in nature and is available for the loan portfolio in its entirety.
The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. These factors may
result in losses or recoveries differing significantly from those provided in the consolidated financial statements. If real estate
values decline and as updated appraisals are received on collateral for impaired loans, the Company may need to increase the
allowance for loan losses appropriately. In addition, regulatory agencies, as an integral part of their examination process,
periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance
based on their judgment about information available to them at the time of their examinations.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed using the straight-line method over the following
estimated useful lives: buildings and improvements - five to 40 years and furniture and equipment - three to seven years. The
cost of maintenance and repairs is charged to expense as incurred. Gains and losses on dispositions are reflected in earnings.
Impairment of Long-Lived Assets
Long-lived assets, consisting of premises and equipment, are reviewed for impairment whenever events or changes in
circumstances indicate that the recorded amount of an asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the recorded amount of an asset to undiscounted future net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the
amount by which the recorded amount of the assets exceeds the discounted recovery amount or estimated fair value of the
assets. No events or changes in circumstances have occurred during the years ended September 30, 2017 or 2016 that would
cause management to evaluate the recoverability of the Company’s long-lived assets.
OREO and Other Repossessed Assets
OREO and other repossessed assets consist of properties or assets acquired through or in lieu of foreclosure, and are recorded
initially at the estimated fair value of the properties less estimated costs of disposal, establishing a new cost basis. These assets
are subsequently accounted for at lower of cost or fair value less estimated costs to sell. When the property is acquired, any
excess of the loan balance over the estimated net realizable value is charged to the allowance for loan losses. The valuation of
real estate 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
79
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
changes and any related adjustments are generally recorded at the time such information is received. Costs relating to
development and improvement of the properties or assets are capitalized, while costs relating to holding the properties or assets
are expensed.
BOLI
BOLI policies are recorded at their cash surrender value less applicable cash surrender charges. Income from BOLI is
recognized when earned.
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.
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, 2017.
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 September 30, 2017, management believes that there had been no events or changes in the circumstances since May 31,
2017 that would indicate a potential impairment of goodwill. No assurances can be given, however, that the Company will not
record an impairment loss on goodwill in the future.
MSRs
The Company holds rights to service (1) loans that it has originated and sold to the Federal Home Loan Mortgage Corporation
(“Freddie Mac”) and (2) the guaranteed portion of U.S. Small Business Administration ("SBA") loans sold in the secondary
market. MSRs are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold
with the servicing rights retained. MSRs are amortized to servicing income on loans sold approximately in proportion to and
80
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
over the period of estimated net servicing income. The value of MSRs at the date of the sale of loans is estimated based on the
discounted present value of expected future cash flows using key assumptions for servicing income and costs and expected
prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing
actual cash flows and estimated future cash flows from the servicing assets to those estimated at the time the servicing assets
were originated. Fair values are estimated using expected future discounted cash flows based on current market rates of
interest. For purposes of measuring impairment, the MSRs must be stratified by one or more predominant risk characteristics
of the underlying loans. The Company stratifies its capitalized MSRs based on product type and term of the underlying
loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the MSRs exceeds their fair
value. Impairment, if deemed temporary, is recognized through a valuation allowance to the extent that fair value is less than
the recorded amount.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee
obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred
assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase
them before their maturity.
Income Taxes
The Company files a consolidated federal and various state income tax returns. The Bank provides for income taxes separately
and remits to (receives from) Timberland Bancorp amounts currently due (receivable).
Deferred income taxes result from temporary differences between the tax basis of assets and liabilities, and their reported
amounts in the consolidated financial statements. These temporary differences will result in differences between income for tax
purposes and income for financial reporting purposes in future years. As changes in tax laws or rates are enacted, deferred tax
assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established to reduce the net
recorded amount of deferred tax assets if it is determined to be more likely than not that all or some portion of the potential
deferred tax asset will not be realized.
With respect to accounting for uncertainty in incomes taxes, a tax provision is recognized as a benefit only if it is “more likely
than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The
amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized upon examination. For tax
positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest and/or
penalties related to income tax matters as income tax expense. The Company is no longer subject to U.S. federal income tax
examination by tax authorities for years ended on or before September 30, 2013.
ESOP
The Bank sponsors a leveraged ESOP. The debt of the ESOP is payable to Timberland Bancorp, is recorded as other borrowed
funds of the Bank, and is eliminated in the consolidated financial statements. The shares of the Company's common stock
pledged as collateral for the ESOP's debt are reported as unearned shares issued to the ESOP in the consolidated financial
statements. As shares are released from collateral, compensation expense is recorded equal to the average market price of the
shares for the period, and the shares become available for net income per common share calculations. Dividends paid on
unallocated shares reduce the Company’s cash contributions to the ESOP.
Advertising
Costs for advertising and marketing are expensed as incurred.
Stock-Based Compensation
The Company measures compensation cost for all stock-based awards based on the grant-date fair value of the stock-based
awards and recognizes compensation cost over the service period of stock-based awards. The fair value of stock options is
determined using the Black-Scholes valuation model. Stock option forfeitures are accounted for as they occur.
81
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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 Timberland Bancorp's common stock during the period. Common stock equivalents
arise from the assumed conversion of outstanding stock options and outstanding warrants 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 net
income per common share.
Related Party Transactions
The Chairman of the Board of the Bank and Timberland Bancorp is a member of the law firm that provides general counsel to
the Company. Legal and other fees paid to this law firm for the years ended September 30, 2017, 2016 and 2015 totaled
$99,000, $127,000 and $164,000, respectively.
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.
82
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU
includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented
in the financial statements. The ASU is effective for annual periods, and interim periods within those annual periods, beginning
after December 31, 2016, with early adoption permitted. The Company adopted ASU No. 2016-09 during the fourth quarter
ended September 30, 2017. The most significant impact of the amended guidance resulted in recognition of excess tax benefits
within provision for income taxes, which resulted in an increase in net income and earnings per share. Previously, excess tax
benefits were recorded as a component of shareholders' equity. Adoption of this ASU resulted in a cumulative effect adjustment
to common stock and provision for income taxes of $131,000 during the quarter ended September 30, 2017. In addition, the
guidance increases average diluted shares, since the Company no longer includes such excess tax benefits in the calculation of
diluted shares. Adoption of the ASU did not affect the Company's total equity, book value per share, or regulatory capital
ratios.
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
expects to begin developing and implementing processes and procedures to ensure it is fully compliant with the amendments at
the 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 will be effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15,
2019. Early application of this ASU is permitted for interim or annual goodwill impairment tests performed on testing dates
after January 1, 2017. The adoption of ASU No. 2017-04 is not expected to have a material impact on the Company's future
consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20):
Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable
debt securities held at a premium. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2018. The adoption of ASU No. 2017-08 is not expected to have a material impact on the Company's future
consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, Compensation--Stock Compensation (Topic 718): Scope of Modification
Accounting. This ASU was issued to provide clarity as to when to apply modification accounting when there is a change in the
terms or conditions of a share-based payment award. According to 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
83
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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.
Note 2 - Restricted Assets
Federal Reserve regulations require that the Bank maintain certain minimum reserve balances on hand or on deposit with the
FRB, based on a percentage of transaction account deposits. The amounts of the reserve requirement balances as of September
30, 2017 and 2016 were $1,658,000 and $1,542,000, respectively.
Note 3 - Investment Securities
Held to maturity and available for sale investment securities were as follows as of September 30, 2017 and 2016 (dollars in
thousands):
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
532
599
6,008
7,139
271
1,000
1,271
670
835
6,006
7,511
336
1,000
1,336
$
$
$
$
$
$
$
$
11
596
10
617
18
—
18
18
762
107
887
30
—
30
$
$
$
$
$
$
$
$
(1) $
(2)
(9)
(12) $
— $
(48)
(48) $
(1) $
(2)
—
(3) $
— $
(24)
(24) $
542
1,193
6,009
7,744
289
952
1,241
687
1,595
6,113
8,395
366
976
1,342
September 30, 2017
Held to Maturity
Mortgage-backed securities ("MBS"):
U.S. government agencies
Private label residential
U.S. Treasury and U.S. government agency securities
Total
Available for Sale
MBS: U.S. government agencies
Mutual funds
Total
September 30, 2016
Held to Maturity
MBS:
U.S. government agencies
Private label residential
U.S. Treasury and U.S. government agency securities
Total
Available for Sale
MBS: U.S. government agencies
Mutual funds
Total
$
$
$
$
$
$
$
$
84
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2017
(dollars in thousands):
Less Than 12 Months
12 Months or Longer
Total
Estimated
Fair
Value
Gross
Unrealized
Losses
Qty
Estimated
Fair
Value
Gross
Unrealized
Losses
Estimated
Fair
Value
Gross
Unrealized
Losses
Qty
Held to Maturity
MBS:
U.S. government agencies $
— $
— — $
114
$
(1)
6
$
114
$
Private label residential
—
— —
U.S. Treasury and U.S.
government agency
securities
Total
Available for Sale
Mutual funds
Total
$
$
$
2,984
2,984
$
(9)
(9)
1
1
$
— $
— $
— — $
— — $
85
—
199
952
952
$
$
$
(2)
10
85
— —
(3)
16
(48)
(48)
1
1
$
$
$
2,984
3,183
952
952
$
$
$
(1)
(2)
(9)
(12)
(48)
(48)
Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2016
(dollars in thousands):
Less Than 12 Months
12 Months or Longer
Total
Estimated
Fair
Value
Gross
Unrealized
Losses
Qty
Estimated
Fair
Value
Gross
Unrealized
Losses
Estimated
Fair
Value
Gross
Unrealized
Losses
Qty
Held to Maturity
MBS:
U.S. government agencies $
Private label residential
Total
Available for Sale
Mutual funds
Total
$
$
9
$
1
10
$
—
— $
—
—
—
1
1
2
$
$
— —
— — $
96
$
112
208
976
976
$
$
(1)
(2)
(3)
(24)
(24)
5
$
105
$
10
15
1
1
$
$
113
218
976
976
$
$
(1)
(2)
(3)
(24)
(24)
The Company has evaluated the investment securities in the above tables and has determined that the decline in their value is
temporary. The unrealized losses are primarily due to changes in market interest rates and spreads in the market for mortgage-
related products. The fair value of these securities is expected to recover as the securities approach their maturity dates and/or
as the pricing spreads narrow on mortgage-related securities. The Company has the ability and the intent to hold the
investments until the market value recovers. Furthermore, as of September 30, 2017, management does not have the intent to
sell any of the securities classified as available for sale where the estimated fair value is below the recorded value and believes
that it is more likely than not that the Company will not have to sell such securities before a recovery of cost (or recorded value
if previously written down).
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).
85
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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 September 30, 2017, 2016 and 2015:
September 30, 2017
Constant prepayment rate
Collateral default rate
Loss severity rate
September 30, 2016
Constant prepayment rate
Collateral default rate
Loss severity rate
September 30, 2015
Constant prepayment rate
Collateral default rate
Loss severity rate
Range
Minimum
Maximum
Weighted
Average
6.00%
0.03%
1.00%
6.00%
0.07%
1.00%
6.00%
0.16%
3.92%
15.00%
10.75%
62.00%
15.00%
14.45%
73.00%
15.00%
14.65%
65.00%
10.40%
4.84%
41.75%
11.29%
5.47%
42.26%
11.49%
6.08%
39.83%
The following table presents the OTTI recoveries (losses) for the years ended September 30, 2017, 2016 and 2015 (dollars in
thousands):
2017
2016
2015
Held To
Maturity
Available
For Sale
Held To
Maturity
Available
For Sale
Held To
Maturity
Available
For Sale
Total recoveries (OTTI)
Adjustment for portion of OTTI
transferred from other
comprehensive income (before
income taxes)(1)
Net recoveries (OTTI) recognized
in earnings (2)
$
$
38
$
— $
(29) $
— $
— $
(5)
—
(139)
—
(13)
33
$
— $
(168) $
— $
(13) $
—
—
—
________________________
(1) Represents OTTI related to all other factors.
(2) Represents OTTI related to credit losses.
86
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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 years ended September 30,
2017, 2016 and 2015 (dollars in thousands):
Balance, beginning of year
Additions:
Additional increases to the amount
related to credit loss for which OTTI
was previously recognized
Subtractions:
Realized losses previously recorded
as credit losses
Recovery of prior credit loss
Balance, end of year
2017
2016
$
1,505
$
1,576
$
2015
1,654
18
170
13
(171)
(51)
1,301
$
(239)
(2)
1,505
$
(91)
—
1,576
$
During the year ended September 30, 2017, the Company recorded a $171,000 net realized loss (as a result of investment
securities being deemed worthless) on twenty-two held to maturity investment securities, all of which had been recognized
previously as a credit loss. During the year ended September 30, 2016, the Company recorded a $239,000 net realized loss (as a
result of investment securities being deemed worthless) on twenty held to maturity investment securities, all of which had been
recognized previously as a credit loss. During the year ended September 30, 2015, the Company recorded a $91,000 net
realized loss (as a result of investment securities being deemed worthless) on fifteen held to maturity investment securities, all
of which had been recognized previously 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 $6,824,000 and $7,039,000 at September 30, 2017
and 2016, respectively.
The contractual maturities of debt securities at September 30, 2017 are as follows (dollars in thousands). Expected maturities
may differ from scheduled maturities due to the prepayment of principal or call provisions.
Due within one year
Due after one year to five years
Due after five years to ten years
Due after ten years
Total
Held to Maturity
Available for Sale
Amortized
Cost
Estimated
Fair
Value
Amortized
Cost
Estimated
Fair
Value
$
$
14
5,996
28
1,101
7,139
$
$
14
5,996
29
1,705
7,744
$
$
— $
—
—
271
271
$
—
—
—
289
289
87
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Note 4 - Loans Receivable and Allowance for Loan Losses
Loans receivable by portfolio segment consisted of the following at September 30, 2017 and 2016 (dollars in thousands):
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/builder
Construction – speculative one- to four-family
Construction – commercial
Construction – multi-family
Land
Total mortgage loans
Consumer loans:
Home equity and second mortgage
Other
Total consumer loans
Commercial business loans
Total loans receivable
Less:
Undisbursed portion of construction loans in process
Deferred loan origination fees, net
Allowance for loan losses
Loans receivable, net
Significant Concentrations of Credit Risk
2017
2016
$
$
118,147
58,607
328,927
117,641
9,918
19,630
21,327
23,910
698,107
38,420
3,823
42,243
44,444
784,794
82,411
2,466
9,553
94,430
690,364
$
$
118,560
62,303
312,525
93,049
8,106
9,365
12,590
21,627
638,125
39,727
4,139
43,866
41,837
723,828
48,627
2,229
9,826
60,682
663,146
Most of the Company’s lending activity is with customers located in the state of Washington and involves real estate. At
September 30, 2017, the Company had $736,527,000 (including $82,411,000 of undisbursed construction loans in process) in
loans secured by real estate, which represented 93.8% of total loans receivable. The real estate loan portfolio is primarily
secured by one- to four-family properties, multi-family properties, land, and a variety of commercial real estate property
types. At September 30, 2017, there were no concentrations of real estate loans to a specific industry or secured by a specific
collateral type that equaled or exceeded 20% of the Company’s total loan portfolio, other than loans secured by one-to four-
family properties. The ultimate collectability of a substantial portion of the loan portfolio is susceptible to changes in economic
and market conditions in the region and the impact of those changes on the real estate market. The Company typically
originates real estate loans with loan-to-value ratios of no greater than 90%. Collateral and/or guarantees are required for all
loans.
88
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Certain related parties of the Company, principally Bank directors and officers, are loan customers of the Bank in the ordinary
course of business. Such related party loans were performing according to their repayment terms at September 30, 2017 and
2016. Activity in related party loans during the years ended September 30, 2017, 2016 and 2015 was as follows (dollars in
thousands):
Balance, beginning of year
New loans or borrowings
Repayments and reclassifications
Balance, end of year
Loan Segment Risk Characteristics
2017
230
592
(81)
741
$
$
2016
630
66
(466)
230
$
$
2015
927
112
(409)
630
$
$
The Company believes that its loan classes are the same as its loan segments.
One- To Four-Family Residential Lending: The Company originates both fixed-rate and adjustable-rate loans secured by
one- to four-family residences. A portion of the fixed-rate one- to four-family loans are sold in the secondary market for asset/
liability management purposes and to generate non-interest income. The Company’s lending policies generally limit the
maximum loan-to-value on one- to four-family loans to 90% of the lesser of the appraised value or the purchase
price. However, the Company usually obtains private mortgage insurance on the portion of the principal amount that exceeds
80% of the appraised value of the property.
Multi-Family Lending: The Company originates loans secured by multi-family dwelling units (more than four units). Multi-
family lending generally affords the Company an opportunity to receive interest at rates higher than those generally available
from one- to four-family residential lending. However, loans secured by multi-family properties usually are greater in amount,
more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential
mortgage loans. Because payments on loans secured by multi-family properties are often dependent on the successful operation
and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or
economy. The Company attempts to minimize these risks by scrutinizing the financial condition of the borrower, the quality of
the collateral and the management of the property securing the loan.
Commercial Mortgage Lending: The Company originates commercial real estate loans secured by properties such as office
buildings, retail/wholesale facilities, motels, restaurants, mini-storage facilities and other commercial properties. Commercial
real estate lending generally affords the Company an opportunity to receive interest at higher rates than those available from
one- to four-family residential lending. However, loans secured by such properties usually are greater in amount, more difficult
to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans.
Because payments on loans secured by commercial properties are often dependent on the successful operation and management
of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or economy. The
Company attempts to mitigate these risks by generally limiting the maximum loan-to-value ratio to 80% and scrutinizing the
financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.
Construction Lending: The Company currently originates the following types of construction loans: custom construction
loans, owner/builder construction loans, speculative construction loans, commercial real estate construction loans and multi-
family construction loans.
Construction lending affords the Company the opportunity to achieve higher interest rates and fees with shorter terms to
maturity than does its single-family permanent mortgage lending. Construction lending, however, is generally considered to
involve a higher degree of risk than one- to four family residential lending because of the inherent difficulty in estimating both
a property’s value at completion of the project and the estimated cost of the project. The nature of these loans is such that they
are generally more difficult to evaluate and monitor. If the estimated cost of construction proves to be inaccurate, the Company
may be required to advance funds beyond the amount originally committed to complete the project. If the estimate of value
upon completion proves to be inaccurate, the Company may be confronted with a project whose value is insufficient to assure
full repayment, and the Company may incur a loss. Projects may also be jeopardized by disagreements between borrowers and
builders and by the failure of builders to pay subcontractors. Loans to construct homes for which no purchaser has been
identified carry more risk because the payoff for the loan depends on the builder’s ability to sell the property prior to the time
89
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
that the construction loan is due. The Company attempts to mitigate these risks by adhering to its underwriting policies,
disbursement procedures and monitoring practices.
Construction Lending – Custom and Owner/Builder: Custom construction loans are made to home builders who, at the
time of construction, have a signed contract with a home buyer who has a commitment to purchase the finished home. Owner/
builder construction loans are originated to home owners rather than home builders and are typically refinanced into permanent
loans at the completion of construction.
Construction Lending – Speculative One- To Four-Family: Speculative one-to four-family construction loans are made to
home builders and are termed “speculative” because the home builder does not have, at the time of the loan origination, a
signed contract with a home buyer who has a commitment for permanent financing with the Company or another lender for the
finished home. The home buyer may be identified either during or after the construction period. The Company is currently
originating speculative one-to four-family construction loans on a limited basis.
Construction Lending – Commercial: Commercial construction loans are originated to construct properties such as office
buildings, hotels, retail rental space and mini-storage facilities.
Construction Lending – Multi-Family: Multi-family construction loans are originated to construct apartment buildings and
condominium projects.
Land Lending: The Company has historically originated loans for the acquisition of land upon which the purchaser can then
build or make improvements necessary to build or to sell as improved lots. Currently, the Company is originating new land
loans on a limited basis. Loans secured by undeveloped land or improved lots involve greater risks than one- to four-family
residential mortgage loans because these loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in
the event of default or foreclosure, the Company may be confronted with a property value which is insufficient to assure full
repayment. The Company attempts to minimize this risk by generally limiting the maximum loan-to-value ratio on land loans
to 75%.
Consumer Lending – Home Equity and Second Mortgage: The Company originates home equity lines of credit and second
mortgage loans. Home equity lines of credit and second mortgage loans have a greater credit risk than one- to four-family
residential mortgage loans because they are secured by mortgages subordinated to the existing first mortgage on the property,
which may or may not be held by the Company. The Company attempts to mitigate these risks by adhering to its underwriting
policies in evaluating the collateral and the credit-worthiness of the borrower.
Consumer Lending – Other: The Company originates other consumer loans, which include automobile loans, boat loans,
motorcycle loans, recreational vehicle loans, savings account loans and unsecured loans. Other consumer loans generally have
shorter terms to maturity than mortgage loans. Other consumer loans generally involve a greater degree of risk than do
residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating
assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or
depreciation. The Company attempts to mitigate these risks by adhering to its underwriting policies in evaluating the credit-
worthiness of the borrower.
Commercial Business Lending: The Company originates commercial business loans which are generally secured by business
equipment, accounts receivable, inventory or other property. The Company also generally obtains personal guarantees from the
business owners based on a review of personal financial statements. Commercial business lending generally involves risks that
are different from those associated with residential and commercial real estate lending. Real estate lending is generally
considered to be collateral based lending with loan amounts based on predetermined loan to collateral values, and liquidation of
the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although
commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the
liquidation of collateral in the event of a borrower default is often an insufficient source of repayment, because accounts
receivable may be uncollectible and inventories and equipment may be obsolete or of limited use. Accordingly, the repayment
of a commercial business loan depends primarily on the credit-worthiness of the borrower (and any guarantors), while the
liquidation of collateral is a secondary and potentially insufficient source of repayment. The Company attempts to mitigate
these risks by adhering to its underwriting policies in evaluating the management of the business and the credit-worthiness of
the borrowers and the guarantors.
90
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Allowance for Loan Losses
The following table sets forth information for the year ended September 30, 2017 regarding activity in the allowance for loan
losses by portfolio segment (dollars in thousands):
Beginning
Allowance
Provision for
(Recapture of)
Loan Losses
Charge-
offs
Recoveries
Ending
Allowance
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/builder
Construction – speculative one- to four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
1,239
473
4,384
619
130
268
316
820
939
156
482
9,826
$
$
(178) $
(26)
(1,248)
80
(8)
35
(143)
189
44
(28)
33
(1,250) $
— $
—
(13)
—
—
—
—
(110)
—
(10)
—
(133) $
21
—
1,061
—
6
—
—
19
—
3
—
1,110
$
$
1,082
447
4,184
699
128
303
173
918
983
121
515
9,553
The following table sets forth information for the year ended September 30, 2016 regarding activity in the allowance for loan
losses by portfolio segment (dollars in thousands):
Beginning
Allowance
Provision for
(Recapture of)
Loan Losses
Charge-
offs
Recoveries
Ending
Allowance
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/builder
Construction – speculative one- to four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
1,480
392
4,065
451
123
426
283
1,021
1,073
187
423
9,924
$
$
(225) $
81
528
168
5
(158)
(148)
(164)
(116)
(25)
54
— $
(72) $
—
(209)
—
—
—
—
(61)
(18)
(8)
—
(368) $
56
—
—
—
2
—
181
24
—
2
5
270
$
$
1,239
473
4,384
619
130
268
316
820
939
156
482
9,826
The following table sets forth information for the year ended September 30, 2015 regarding activity in the allowance for loan
losses by portfolio segment (dollars in thousands):
91
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Beginning
Allowance
Provision for
(Recapture of)
Loan Losses
Charge-
offs
Recoveries
Ending
Allowance
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/builder
Construction – speculative one- to four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
$
1,650
387
4,836
450
52
78
25
1,434
879
176
460
10,427
$
(214) $
2
(775)
1
69
348
(867)
(305)
242
16
(42)
(1,525) $
(220) $
—
—
—
—
—
—
(145)
(50)
(9)
—
(424) $
264
3
4
—
2
—
1,125
37
2
4
5
1,446
$
$
1,480
392
4,065
451
123
426
283
1,021
1,073
187
423
9,924
The following table presents information on the loans evaluated individually and collectively for impairment in the allowance for
loan losses by portfolio segment at September 30, 2017 (dollars in thousands):
Allowance for Loan Losses
Recorded Investment in Loans
Individually
Evaluated
for
Impairment
Collectively
Evaluated
for
Impairment
Individually
Evaluated
for
Impairment
Collectively
Evaluated
for
Impairment
Total
Total
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/
builder
Construction – speculative one- to
four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
— $
—
26
$
1,082
447
4,158
$
1,082
447
4,184
$
1,443
—
3,873
116,704
58,607
325,054
$118,147
58,607
328,927
—
—
—
—
125
325
—
—
476
699
128
303
173
793
699
128
303
173
918
658
121
515
9,077
983
121
515
9,553
$
$
$
—
63,538
63,538
—
—
—
1,119
557
—
—
6,992
4,639
11,016
6,912
22,791
4,639
11,016
6,912
23,910
37,863
3,823
44,444
695,391
38,420
3,823
44,444
$702,383
$
92
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
The following table presents information on the loans evaluated individually and collectively for impairment in the allowance for
loan losses by portfolio segment at September 30, 2016 (dollars in thousands):
Allowance for Loan Losses
Recorded Investment in Loans
Individually
Evaluated
for
Impairment
Collectively
Evaluated
for
Impairment
Individually
Evaluated
for
Impairment
Collectively
Evaluated
for
Impairment
Total
Total
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/
builder
Construction – speculative one- to
four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
$
70
—
413
$
1,169
473
3,971
$
1,239
473
4,384
$
2,264
—
11,309
116,296
62,303
301,216
$118,560
62,303
312,525
—
—
—
—
53
227
13
—
776
619
130
268
316
767
619
130
268
316
820
367
51,662
52,029
—
—
—
1,268
4,074
6,841
11,539
20,359
4,074
6,841
11,539
21,627
712
143
482
9,050
939
156
482
9,826
$
$
999
30
—
16,237
$
38,728
4,109
41,837
658,964
39,727
4,139
41,837
$675,201
$
The following table presents an analysis of loans by aging category and portfolio segment at 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
Mortgage loans:
One- to four-family
$
193
$
— $
Multi-family
Commercial
Construction – custom and owner/
builder
Construction – speculative one- to
four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
—
—
—
—
—
—
—
Home equity and second mortgage
Other
Commercial business loans
Total
56
36
110
395
$
$
—
107
—
—
—
—
—
—
—
—
107
874
—
213
—
—
—
—
566
$
— $
1,067
$ 117,080
$ 118,147
—
—
—
—
—
—
—
—
320
58,607
328,607
58,607
328,927
—
63,538
63,538
—
—
—
566
4,639
11,016
6,912
23,344
4,639
11,016
6,912
23,910
258
—
—
1,911
$
$
—
—
—
— $
314
36
110
2,413
38,106
3,787
44,334
$ 699,970
38,420
3,823
44,444
$ 702,383
__________________
(1)
Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual.
93
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2016 (dollars in
thousands):
30-59
Days
Past Due
60-89
Days
Past Due
Non-
Accrual(1)
Past Due
90 Days
or More
and Still
Accruing
Total
Past Due Current
Total
Loans
$
— $
—
113
$
207
—
—
$
— $
—
1,121
—
$ 117,439
62,303
$ 118,560
62,303
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner/
builder
Construction – speculative one- to
four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
914
—
612
367
—
—
—
548
402
30
—
2,873
$
$
—
—
—
—
—
37
31
37
218
$
—
—
—
—
—
—
—
38
245
—
—
—
—
—
—
135
—
—
135
725
311,800
312,525
367
51,662
52,029
—
—
—
548
574
61
4,074
6,841
11,539
21,079
4,074
6,841
11,539
21,627
39,153
4,078
39,727
4,139
75
3,471
41,762
$ 671,730
41,837
$ 675,201
$
___________________
(1)
Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual.
Credit Quality Indicators
The Company uses credit risk grades which reflect the Company’s assessment of a loan’s risk or loss potential. The Company
categorizes loans into risk grade categories based on relevant information about the ability of borrowers to service their debt
such as: current financial information, historical payment experience, credit documentation, public information and current
economic trends, among other factors such as the estimated fair value of the collateral. The Company uses the following
definitions for credit risk ratings as part of the on-going monitoring of the credit quality of its loan portfolio:
Pass: Pass loans are defined as those loans that meet acceptable quality underwriting standards.
Watch: Watch loans are defined as those loans that still exhibit acceptable quality but have some concerns that justify greater
attention. If these concerns are not corrected, a potential for further adverse categorization exists. These concerns could relate
to a specific condition peculiar to the borrower, its industry segment or the general economic environment.
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 an asset 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 September 30,
2017 and 2016, there were no loans classified as loss.
94
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
The following table presents an analysis of loans by credit quality indicators and portfolio segment, at September 30, 2017
(dollars in thousands).
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner / builder
Construction – speculative one- to four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
Pass
Watch
Loan Grades
Special
Mention
Substandard
Total
$
$
115,481
56,857
318,717
63,210
4,639
11,016
6,912
20,528
37,828
3,787
43,416
682,391
$
$
422
—
6,059
328
—
—
—
1,022
152
—
973
8,956
$
$
644
1,750
3,540
—
—
—
—
1,794
—
—
55
7,783
$
$
1,600
—
611
—
—
—
—
566
440
36
—
3,253
$
$
118,147
58,607
328,927
63,538
4,639
11,016
6,912
23,910
38,420
3,823
44,444
702,383
The following table presents an analysis of loans by credit quality indicators and portfolio segment, at September 30, 2016
(dollars in thousands):
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction – custom and owner / builder
Construction – speculative one- to four-family
Construction – commercial
Construction – multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
Pass
Watch
Loan Grades
Special
Mention
Substandard
Total
$
$
115,131
60,504
292,756
51,432
4,074
6,841
11,539
18,010
38,261
4,078
41,797
644,423
$
$
$
364
—
8,411
229
—
—
—
1,043
590
—
40
10,677
$
661
1,799
10,746
—
—
—
—
1,859
—
—
—
15,065
$
$
2,404
—
612
368
—
—
—
715
876
61
—
5,036
$
$
118,560
62,303
312,525
52,029
4,074
6,841
11,539
21,627
39,727
4,139
41,837
675,201
95
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Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
TDRs are considered impaired loans and are individually evaluated for impairment. TDRs can be classified as either accrual or
non-accrual. The Company had $3,595,000 in TDRs included in impaired loans at September 30, 2017 and had no
commitments to lend additional funds on these loans. The Company had $8,160,000 in TDRs included in impaired loans at
September 30, 2016 and had no commitments to lend additional funds on these loans. The allowance for loan losses allocated
to TDRs at September 30, 2017 and 2016 was $10,000 and $465,000, respectively.
The following tables set forth information with respect to the Company’s TDRs by interest accrual status as of September 30,
2017 and 2016 (dollars in thousands):
Mortgage loans:
One- to four-family
Commercial
Land
Total
Mortgage loans:
One- to four-family
Commercial
Land
Consumer loans:
Home equity and second mortgage
Total
2017
Non-
Accrual
Total
Accruing
$
$
$
$
569
2,219
554
3,342
Accruing
1,350
5,268
720
291
7,629
$
$
$
$
— $
—
253
253
$
569
2,219
807
3,595
2016
Non-
Accrual
Total
126
—
253
152
531
$
$
1,476
5,268
973
443
8,160
There were no new TDRs during the years ended September 30, 2017 and 2016. The following table sets forth information with
respect to the Company’s TDRs, by portfolio segment, during the year ended September 30, 2015 (dollars in thousands):
2015
One- to four-family (1)
Total
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment
End of
Period
Balance
48
48
$
$
48
48
$
$
48
48
Number of
Contracts
1
$
1 $
________________
(1) Modification was a result of a reduction in the stated interest rate.
There were no TDRs for which there was a payment default within the first 12 months of modification during the years ended
September 30, 2017, 2016 or 2015.
Note 5 - Premises and Equipment
Premises and equipment consisted of the following at September 30, 2017 and 2016 (dollars in thousands):
99
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Land
Buildings and improvements
Furniture and equipment
Property held for future expansion
Construction and purchases in progress
Less accumulated depreciation
Premises and equipment, net
2017
4,402
20,167
7,935
129
149
32,782
14,364
18,418
$
$
$
$
2016
3,926
17,709
7,732
129
237
29,733
13,574
16,159
The Company leases certain premises under operating lease agreements. Certain leases contain renewal options from five to
ten years and escalation clauses. Total rental expense was $275,000, $287,000 and $280,000 for the years ended September 30,
2017, 2016 and 2015, respectively, which is included in premises and equipment expense in the accompanying consolidated
statements of income.
Minimum net rental commitments under non-cancellable leases having an original or remaining term of more than one year for
fiscal years ending subsequent to September 30, 2017 are as follows (dollars in thousands):
2018
2019
2020
2021
Total minimum payments required
Note 6 – OREO and Other Repossessed Assets
$
$
206
200
165
124
695
The following table presents the activity related to OREO and other repossessed assets for the years ended September 30, 2017
and 2016 (dollars in thousands):
Balance, beginning of year
Additions to OREO and other repossessed assets
Capitalized improvements
Writedowns
Sales of OREO and other repossessed assets
Balance, end of year
2017
2016
Amount
4,117
751
—
(42)
(1,525)
3,301
$
$
Number
23
4
—
—
(11)
16
$
$
Amount
7,854
307
142
(435)
(3,751)
4,117
Number
35
4
—
—
(16)
23
At September 30, 2017, OREO and other repossessed assets consisted of 15 OREO properties and one other repossessed asset
in Washington, with balances ranging from $13,000 to $948,000. At September 30, 2016, OREO consisted of 22 OREO
properties and one other repossessed asset in Washington, with balances ranging from $6,000 to $957,000. The Company
recorded net gains on sales of OREO and other repossessed assets of $54,000, $47,000, and $110,000 for the years ended
September 30, 2017, 2016 and 2015, respectively. Gains and losses on sales of OREO and other repossessed assets are recorded
in the OREO and other repossessed assets, net category in non-interest expense in the accompanying consolidated statements of
income.
At September 30, 2017, the recorded amount of foreclosed residential real estate properties held in OREO as a result of
obtaining physical possession was $875,000 and the amount of one- to four-family properties in the process of foreclosure
totaled $100,000.
100
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Note 7 - MSRs
The Company services loans for Freddie Mac and - beginning in 2016 - for secondary market purchasers of the guaranteed
portion of SBA loans; such loans are not included in the accompanying consolidated balance sheets. The principal amount of
loans serviced for Freddie Mac at September 30, 2017, 2016 and 2015 was $358,173,000, $340,308,000 and $331,494,000,
respectively. The guaranteed principal amount of SBA loans serviced for others at September 30, 2017 and 2016 was $697,000
and $319,000, respectively.
The following is an analysis of the changes in MSRs for the years ended September 30, 2017, 2016 and 2015 (dollars in
thousands):
Balance, beginning of year
Additions
Amortization
Balance, end of year
2017
1,573
739
(487)
1,825
$
$
2016
1,478
650
(555)
1,573
$
$
2015
1,684
635
(841)
1,478
$
$
At September 30, 2017, 2016 and 2015, the estimated fair value of MSRs totaled $3,556,000, $2,865,000 and $3,095,000,
respectively. The Freddie Mac MSRs' fair values at September 30, 2017, 2016 and 2015 were estimated using discounted cash
flow analyses with average discount rates of 9.52%, 9.52% and 9.52%, respectively, and average prepayment speed factors of
159, 209 and 174, respectively. At September 30, 2017 and 2016, the SBA MSRs were insignificant. At September 30, 2017,
2016 and 2015, there were no valuation allowances on MSRs.
Note 8 - Deposits
Deposits consisted of the following at September 30, 2017 and 2016 (dollars in thousands):
Non-interest-bearing demand
NOW checking
Savings
Money market
Certificates of deposit
Total
2017
205,952
220,315
140,987
131,002
139,642
837,898
$
$
$
$
2016
172,283
203,812
123,474
113,991
147,974
761,534
Individual certificates of deposit in amounts of $250,000 or greater totaled $15,601,000 and $16,439,000 at September 30, 2017
and 2016, respectively. The Company had brokered deposits totaling $11,322,000 and $10,113,000 at September 30, 2017 and
2016, respectively.
Scheduled maturities of certificates of deposit for future years ending September 30 are as follows (dollars in thousands):
2018
2019
2020
2021
2022
Thereafter
Total
$
$
75,440
27,770
11,298
12,261
12,728
145
139,642
101
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Interest expense on deposits by account type was as follows for the years ended September 30, 2017, 2016 and 2015 (dollars in
thousands):
NOW checking
Savings
Money market
Certificates of deposit
Total
2017
460
78
434
1,246
2,218
$
$
2016
456
64
327
1,194
2,041
$
$
2015
450
53
274
1,227
2,004
$
$
Note 9 – FHLB Borrowings and Other Borrowings
The Bank has long- and short-term borrowing lines with the FHLB with total credit on the lines equal to 35% of the Bank’s
total assets, limited by available collateral. Borrowings are considered short-term when the original maturity is less than one
year. The Bank had no long-term FHLB borrowings outstanding at September 30, 2017 and $30,000,000 outstanding at
September 30, 2016. During the year ended September 30, 2017, the Company incurred a $282,000 prepayment penalty on two
$15,000,000 FHLB borrowings that were repaid before their scheduled maturity dates. Under the Advances, Pledge and
Security Agreement entered into with the FHLB ("FHLB Borrowing Agreement"), virtually all of the Bank’s assets, not
otherwise encumbered, are pledged as collateral for borrowings.
The Bank also has a letter of credit ("LOC") with the FHLB for the purpose of collateralizing Washington State public deposits.
The LOC amount reduces the Bank's available borrowings under the FHLB Borrowing Agreement. The LOC had a limit of
$22,000,000 as of September 30, 2017, all of which was available to draw upon.
The Bank also maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. At
September 30, 2017 the Bank had a borrowing capacity on this line of $62,774,000. The Bank had no outstanding borrowings
on this line at September 30, 2017 and 2016.
The Bank has a short-term $10,000,000 overnight borrowing line with Pacific Coast Bankers' Bank. The borrowing line may be
reduced or withdrawn at any time. The Bank had no outstanding borrowings on this line at September 30, 2017 and 2016.
The Bank had no short-term borrowings outstanding during the years ended September 30, 2017, 2016 and 2015.
Note 10 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses were comprised of the following at September 30, 2017 and 2016 (dollars in thousands):
Accrued deferred compensation, profit sharing plans and bonuses payable
Accrued interest payable on deposits and borrowings
Accounts payable and accrued expenses - other
Total other liabilities and accrued expenses
2017
1,134
161
1,831
3,126
$
$
2016
987
247
1,786
3,020
$
$
102
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Note 11 - Income Taxes
The components of the provision for income taxes for the years ended September 30, 2017, 2016 and 2015 were as follows
(dollars in thousands):
Current:
Federal
State
Deferred
Provision for income taxes
2017
2016
2015
$
$
6,656
35
385
7,076
$
$
4,618
—
283
4,901
$
$
3,996
—
196
4,192
At September 30, 2017 the Company had income taxes receivable of $559,000, which is included in other assets in the
accompanying 2017 consolidated balance sheet. At September 30, 2016 the Company had income taxes payable of $197,000,
which is included in other liabilities in the accompanying 2016 consolidated balance sheet.
The components of the Company’s deferred tax assets and liabilities at September 30, 2017 and 2016 were as follows (dollars
in thousands):
Deferred Tax Assets
Allowance for loan losses
Allowance for OREO losses
Unearned ESOP shares
CDI
OTTI credit impairment on investment securities
Accrued interest on loans
Net unrealized losses on investment securities
Deferred compensation and bonuses
Reserve for loan commitments
Other
Total deferred tax assets
Deferred Tax Liabilities
Goodwill
MSRs
Depreciation
FHLB stock dividends
Prepaid expenses
Other
Total deferred tax liabilities
Net deferred tax assets
$
2017
2016
$
3,380
443
148
103
173
29
66
94
75
39
4,550
1,714
639
480
137
140
35
3,145
3,508
519
224
151
174
31
90
90
54
34
4,875
1,549
539
403
419
145
6
3,061
$
1,405
$
1,814
The provision for income taxes for the years ended September 30, 2017, 2016 and 2015 differs from that computed at the
federal statutory corporate tax rate as follows (dollars in thousands):
103
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Expected federal income tax provision at statutory rate
BOLI income
Dividends on ESOP
Other - net
Provision for income taxes
2017
7,435
(191)
(102)
(66)
7,076
$
$
2016
5,160
(189)
(83)
13
4,901
$
$
2015
4,268
(184)
(58)
166
4,192
$
$
No valuation allowance for net deferred tax assets was recorded as of September 30, 2017 and 2016, as management believes
that it is more likely than not that all of the net deferred tax assets will be realized based on management's expectations of
future taxable income and/or because they were supported by recoverable taxes paid in prior years.
Note 12 – Employee Stock Ownership and 401(k) Plan
The Timberland Bank Employee Stock Ownership and 401(k) Plan (“KSOP”) is comprised of two components, the ESOP and
the 401(k) Plan. The KSOP benefits employees with at least one year of service who are 21 years of age or older. The Bank
may fund the ESOP with contributions of cash or stock, and may fund the 401(k) Plan with contributions of cash. Employee
vesting occurs over six years.
ESOP
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase 1,058,000 shares of common stock of the
Company. The loan is being repaid primarily from the Bank’s contributions to the ESOP and is scheduled to be fully repaid by
March 31, 2019. The interest rate on the loan is 8.5%. Interest expense on the ESOP debt was $96,000, $136,000 and
$173,000 for the years ended September 30, 2017, 2016 and 2015, respectively. The balance of the loan at September 30, 2017
was $821,000.
The amount of the Bank's annual contribution is discretionary, except that it must be sufficient to enable the ESOP to service its
debt. All dividends received by the ESOP are used to pay debt service. Dividends of $293,000, $243,000 and $170,000 were
used to service the debt during the years ended September 30, 2017, 2016 and 2015, respectively. As the Plan makes each
payment of principal and interest, an appropriate percentage of stock is released and allocated annually to eligible employee
accounts, in accordance with applicable regulations. As of September 30, 2017, 515,430 ESOP shares, which were previously
released for allocation to participants, had been distributed to participants.
Shares held by the ESOP as of September 30, 2017, 2016 and 2015 were classified as follows:
Unallocated shares
Shares released for allocation
Total ESOP shares
2017
52,905
489,665
542,570
2016
88,171
535,927
624,098
2015
123,436
554,745
678,181
The approximate fair market value of the ESOP’s unallocated shares at September 30, 2017, 2016 and 2015 was $1,658,000,
$1,389,000 and $1,344,000, respectively. Compensation expense recognized under the ESOP for the years ended
September 30, 2017, 2016 and 2015 was $495,000, $233,000, and $203,000, respectively.
401(k) Plan
Eligible employees may contribute a portion of their wages to the 401(k) Plan up to the maximum established under the Internal
Revenue Code. Contributions by the Bank are at the discretion of the Board except for a safe harbor contribution of 3% of
eligible employees' wages, which is mandatory according to the plan document. Bank contributions totaled $358,000,
$333,000 and $313,000 for the years ended September 30, 2017, 2016 and 2015, respectively.
104
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Note 13 - Stock Compensation Plans
Under the Company’s 2003 Stock Option Plan, the Company was able to grant options for up to 300,000 shares of common
stock to employees, officers, directors and directors emeriti. Under the Company's 2014 Equity Incentive Plan, the Company is
able to grant options and awards of restricted stock (with or without performance measures) for up to 352,366 shares of
common stock to employees, officers, directors and directors emeriti. Shares issued may be purchased in the open market or
may be issued from authorized and unissued shares. The exercise price of each option equals the fair market value of the
Company’s common stock on the date of grant. Generally, options and restricted stock vest in 20% annual installments on each
of the five anniversaries from the date of the grant, and options generally have a maximum contractual term of ten years. At
September 30, 2017, there were 113,616 shares of common stock available which may be awarded as options or restricted stock
pursuant to future grants under the 2014 Equity Incentive Plan.
At both September 30, 2017 and 2016 there were no unvested restricted stock awards. There were no restricted stock grants
awarded during the years ended September 30, 2017, 2016 and 2015.
Stock option activity for the years ended September 30, 2017, 2016 and 2015 is summarized as follows:
Outstanding September 30, 2014
Options granted
Options exercised
Options forfeited
Outstanding September 30, 2015
Options granted
Options exercised
Options forfeited
Outstanding September 30, 2016
Options granted
Options exercised
Options forfeited
Outstanding September 30, 2017
$
Weighted
Average
Exercise
Price
7.49
10.62
4.84
4.55
8.73
Number of
Shares
221,400
128,000
(6,300)
(1,800)
341,300
55,750
(21,020)
(2,900)
373,130
58,250
(46,310)
(4,950)
380,120
$
15.67
7.56
9.96
9.82
29.69
7.17
6.28
13.23
The aggregate intrinsic value of options exercised during the years ended September 30, 2017 and 2016 was $659,000 and
$124,000, respectively.
The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the weighted
average assumptions noted in the following table. The risk-free interest rate is based on the rate of a U.S. Treasury security
with a similar term as the expected life of the stock option at the particular grant date. The expected life is based on historical
data, vesting terms and estimated exercise dates. The expected dividend yield is based on the most recent quarterly dividend on
an annualized basis in effect at the time the options were granted, adjusted, if appropriate, for management's expectations
regarding future dividends. The expected volatility is based on historical volatility of the Company’s stock price. There were
128,000 options granted during the year ended September 30, 2015 with an aggregate grant date fair value of $241,000. There
were 55,750 options granted during the year ended September 30, 2016 with an aggregate grant date fair value of $81,000.
There were 58,250 options granted during the year ended September 30, 2017 with an aggregate grant date fair value of
$224,000.
The weighted average assumptions for options granted during the years ended September 30, 2017, 2016 and 2015 were as
follows:
105
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Expected volatility
Expected life (in years)
Expected dividend yield
Risk free interest rate
Grant date fair value per share
2017
16%
5
1.85%
1.89%
3.84
$
2016
16%
5
3.00%
1.12%
1.46
$
2015
28%
5
3.31%
1.43%
1.88
$
There were 69,800 options that vested during the year ended September 30, 2017 with a total fair value of $145,000. There
were 65,100 options that vested during the year ended September 30, 2016 with a total fair value of $144,000. There were
42,900 options that vested during the year ended September 30, 2015 with a total fair value of $100,000.
At September 30, 2017 there were 231,850 unvested options with an aggregate grant date fair value of $569,000, all of which
the Company assumes will vest. The unvested options had an aggregate intrinsic value of $3,562,000 at September 30,
2017. At September 30, 2016 there were 250,450 unvested options with an aggregate grant date fair value of $506,000.
Additional information regarding options outstanding at September 30, 2017 is as follows:
Range of
Exercise
Prices ($)
$ 4.01 - 4.55
5.86 - 6.00
9.00
10.26 - 10.71
15.67
29.69
Options Outstanding
Options Exercisable
Weighted
Average
Exercise
Price
4.28
5.93
9.00
10.58
15.67
29.69
13.23
Weighted
Average
Remaining
Contractual
Life (Years)
3.1
5.0
6.1
7.5
9.0
10.0
7.4
Number
10,000
40,600
80,800
136,270
54,200
58,250
380,120
$
$
Weighted
Average
Exercise
Price
4.28
5.92
9.00
10.57
15.67
N/A
8.95
Weighted
Average
Remaining
Contractual
Life (Years)
3.1
5.0
6.1
7.5
9.0
N/A
6.3
Number
10,000
35,100
42,400
50,570
10,200
—
148,270
$
$
The aggregate intrinsic value of options outstanding at September 30, 2017, 2016 and 2015 was $6,882,000, $2,212,000, and
$738,000, respectively.
As of September 30, 2017, unrecognized compensation cost related to non-vested stock options was $490,000, which is
expected to be recognized over a weighted average 2.37 years.
Note 14 - Commitments and Contingencies
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments include commitments to extend credit. These instruments
involve, to varying degrees, elements of credit risk not recognized in the consolidated balance sheets. The Company’s exposure
to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as
it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established
in the contract. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer’s credit-worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit
evaluation of the party. However, such loan to value ratios will subsequently change, based on increases and decreases in the
supporting collateral values. Collateral held varies, but may include accounts receivable, inventory, property and equipment,
residential real estate, land and income-producing commercial properties.
106
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
A summary of the Company’s commitments at September 30, 2017 and 2016 is as follows (dollars in thousands):
Undisbursed portion of construction loans in process (see Note 4)
Undisbursed lines of credit
Commitments to extend credit
$
$
2017
82,411
51,420
19,673
2016
48,627
47,949
20,681
The Company maintains a separate reserve for losses related to unfunded loan commitments. Management estimates the
amount of probable losses related to unfunded loan commitments by applying the loss factors used in the allowance for loan
loss methodology to an estimate of the expected amount of funding and applies this adjusted factor to the unused portion of
unfunded loan commitments. The reserve for unfunded loan commitments totaled $214,000 and $157,000 at September 30,
2017 and 2016, respectively. These amounts are included in other liabilities and accrued expenses in the accompanying
consolidated balance sheets. Increases (decreases) in the reserve for unfunded loan commitments are recorded in non-interest
expense in the accompanying consolidated statements of income.
The Bank has an employee severance compensation plan which expires in 2027 and which provides severance pay benefits to
eligible employees in the event of a change in control of Timberland Bancorp or the Bank (as defined in the plan). In general,
all employees with two or more years of service will be eligible to participate in the plan. Under the plan, in the event of a
change in control of Timberland Bancorp or the Bank, eligible employees who are terminated or who terminate employment
(but only upon the occurrence of events specified in the plan) within 12 months of the effective date of a change in control
would be entitled to a payment based on years of service or officer rank with the Bank. The maximum payment for any eligible
employee would be equal to 18 months of the employee’s current compensation.
The Company has employment agreements with the Chief Executive Officer and the Chief Financial Officer which provide for
a severance payment and other benefits if the officers are involuntarily terminated following a change in control of the
Company or the Bank. The maximum value of the severance benefits under the employment agreements is 2.99 times the
officer's average annual compensation during the five-year period prior to the effective date of the change in control.
Because of the nature of its activities, the Company is subject to various pending and threatened legal actions which arise in the
ordinary course of business. In the opinion of management, liabilities arising from these claims, if any, will not have a material
effect on the consolidated financial position of the Company.
Note 15 - Regulatory Matters
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. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional discretionary actions by bank regulators that, if undertaken,
could have a direct material effect on the Company's consolidated financial statements.
The minimum requirements are a common equity Tier 1 ("CET1") capital ratio of 4.5%, a Tier 1 capital ratio of 6.0%, a total
capital ratio of 8.0% and a leverage ratio of 4.0%. In addition to the minimum regulatory capital ratios, the Bank must 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
eligible retained income that could be utilized for such actions. This capital conservation buffer requirement was phased in
beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year to an amount equal to 2.5% of risk-
weighted assets when fully implemented in January 2019. At September 30, 2017, the conservation buffer was 1.25%.
At September 30, 2017 and 2016 the Bank exceeded all regulatory capital requirements. The Bank was categorized as "well
capitalized" at September 30, 2017 and 2016 under the regulations of the FDIC. The following tables compare the Bank’s
actual capital amounts at September 30, 2017 and 2016 to its minimum regulatory capital requirements and "Well Capitalized"
regulatory capital at those dates (dollars in thousands):
107
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
September 30, 2017
Actual
Regulatory
Minimum To Be
"Adequately
Capitalized"
Regulatory
MinimumTo Be
"Well Capitalized"
Under Prompt
Corrective Action
Provisions
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
Common equity Tier 1 capital
Tier 1 capital
Total capital
Amount
Ratio
Amount
Ratio
Amount
Ratio
$104,102
11.2% $ 37,116
4.0% $ 46,395
5.0%
104,102
104,102
112,329
15.9
15.9
17.1
29,547
39,395
52,527
4.5
6.0
8.0
42,678
52,527
6.5
8.0
65,659
10.0
September 30, 2016
Actual
Regulatory
Minimum To Be
"Adequately
Capitalized"
Regulatory
Minimum To Be
"Well Capitalized"
Under Prompt
Corrective Action
Provisions
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
Common equity Tier 1 capital
Tier 1 capital
Total capital
Amount
Ratio
Amount
Ratio
Amount
Ratio
$ 90,266
10.3% $ 35,183
4.0% $ 43,979
5.0%
90,266
90,266
98,158
14.3
14.3
15.6
28,318
37,758
50,344
4.5
6.0
8.0
40,904
50,344
6.5
8.0
62,930
10.0
Timberland Bancorp is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to
capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the
regulations of the Federal Reserve. For a bank holding company with less than $1.0 billion in assets, the capital guidelines
apply on a bank only basis, and the Federal Reserve expects the holding company's subsidiary bank to be well capitalized under
the prompt corrective action regulations. If Timberland Bancorp were subject to regulatory guidelines for bank holding
companies with $1.0 billion or more in assets at September 30, 2017, Timberland Bancorp would have exceeded all regulatory
requirements.
The following table presents the regulatory capital ratios for Timberland Bancorp at September 30, 2017 and 2016 (dollars in
thousands):
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
Common equity Tier 1 capital
Tier 1 capital
Total capital
2017
Actual
2016
Actual
Amount
Ratio
Amount
Ratio
$ 107,145
11.5%
$
92,860
10.5%
107,145
107,145
115,376
108
16.3
16.3
17.6
92,860
92,860
100,755
14.8
14.8
16.0
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Note 16 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30, 2017 and 2016
(dollars in thousands)
Assets
Cash and cash equivalents:
Cash and due from financial institutions
Interest-bearing deposits in banks
Total cash and cash equivalents
Loan receivable from ESOP
Investment in Bank
Other assets
Total assets
Liabilities and shareholders’ equity
Accrued expenses
Shareholders’ equity
Total liabilities and shareholders’ equity
2017
2016
$
$
$
$
485
1,797
2,282
821
107,957
14
111,074
74
111,000
111,074
$
$
$
$
278
1,029
1,307
1,314
94,240
13
96,874
40
96,834
96,874
Condensed Statements of Income - Years Ended September 30, 2017, 2016 and 2015
(dollars in thousands)
Operating income
Interest on deposits in banks
Interest on loan receivable from ESOP
Dividends from Bank
Total operating income
Operating expenses
Income before income taxes and equity in undistributed
income of Bank
Benefit for income taxes
Income before undistributed income of Bank
Equity in undistributed income of Bank
Net income
2017
2016
2015
$
$
27
96
1,390
1,513
467
$
3
136
3,039
3,178
430
1,046
(385)
2,748
(183)
1,431
2,931
12,736
14,167
7,223
10,154
—
173
2,698
2,871
445
2,426
(150)
2,576
5,716
8,292
109
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Condensed Statements of Cash Flows - Years Ended September 30, 2017, 2016 and 2015
(dollars in thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
2017
2016
2015
$
14,167
$
10,154
$
8,292
Equity in undistributed income of Bank
Earned ESOP shares
Stock option compensation expense
Other, net
Net cash provided by operating activities
Cash flows from investing activities
Investment in Bank
Principal repayments on loan receivable from ESOP
Net cash used in investing activities
Cash flows from financing activities
Proceeds from exercise of stock options
Proceeds from exercise of stock warrant
Repurchase of common stock
Payment of dividends
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents
Beginning of period
End of period
Note 17 - Net Income Per Common Share
(12,736)
605
156
33
2,225
(930)
493
(437)
332
2,496
—
(3,641)
(813)
975
(7,223)
404
190
(65)
3,460
(616)
452
(164)
159
—
(820)
(2,578)
(3,239)
57
(5,716)
336
127
162
3,201
(491)
417
(74)
30
—
(709)
(1,693)
(2,372)
755
1,307
2,282
$
1,250
1,307
$
495
1,250
$
Information regarding the calculation of basic and diluted net income per common share for the years ended September 30, 2017,
2016 and 2015 is as follows (dollars in thousands, except per share amounts):
Basic net income per common share computation
Numerator - net income to common shareholders
2017
2016
2015
$
14,167
$
10,154
$
8,292
Denominator - weighted average common shares outstanding
7,136,690
6,842,614
6,897,270
Basic net income per common share
Diluted net income per common share computation
Numerator - net income to common shareholders
Denominator - weighted average common shares outstanding
Effect of dilutive stock options (1)
Effect of dilutive stock warrant (2)
$
$
1.99
$
1.48
$
1.20
14,167
$
10,154
$
8,292
7,136,690
163,773
6,842,614
78,910
6,897,270
36,863
79,590
183,825
134,955
Weighted average common shares outstanding-assuming dilution
7,380,053
7,105,349
7,069,088
Diluted net income per common share
$
1.92
$
1.43
$
1.17
110
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
___________________
(1) For the years ended September 30, 2017, 2016 and 2015, average options to purchase 1,117, 42,801 and 155,152 shares of
common stock, respectively, were outstanding but not included in the computation of diluted net income per common share
because their effect would have been anti-dilutive.
(2) Represented a warrant to purchase 370,899 shares of the Company's common stock at an exercise price of $6.73 per share
(subject to anti-dilution adjustments) at any time through December 23, 2018 (the "Warrant"). The Warrant was granted on
December 23, 2008 to the U.S. Treasury Department ("Treasury") as part of the Company's participation in the Treasury's
Troubled Asset Relief Program. On June 12, 2013, the Treasury sold the Warrant to private investors. On January 31, 2017, the
Warrant was exercised and 370,899 shares of the Company's common stock were issued in exchange for $2,496,000.
Note 18 - Accumulated Other Comprehensive Income (Loss)
The changes in accumulated other comprehensive income (loss) ("AOCI") by component during the years ended September 30,
2017, 2016 and 2015 are as follows (dollars in thousands):
Changes in fair
value of available
for sale securities [1]
Other-than-temporary
impairment on held to
maturity securities [1]
Total [1]
2017
Balance of AOCI at the beginning of period
Net change
Balance of AOCI at the end of period
2016
Balance of AOCI at the beginning of period
Net change
Balance of AOCI at the end of period
2015
Balance of AOCI at the beginning of period
Net change
Balance of AOCI at the end of period
___________________
[1] All amounts are net of income taxes.
Note 19 - Fair Value Measurements
$
$
$
$
$
$
$
4
(23)
(19) $
3
1
4
37
(34)
3
$
$
$
$
(179) $
74
(105) $
(316) $
137
(179) $
(376) $
60
(316) $
(175)
51
(124)
(313)
138
(175)
(339)
26
(313)
GAAP defines fair value and establishes a framework for measuring fair value. Fair value is the price that would be received
for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. The
three levels for categorizing assets and liabilities under GAAP's fair value measurement requirements are as follows:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting
entity has the ability to access at the measurement date.
Level 2: Significant observable inputs other than quoted prices included within Level 1, such as quoted prices for
similar (as opposed to identical) assets or liabilities in active markets, quoted prices for identical or similar assets or
liabilities in markets that are not active, and inputs other than quoted prices that are observable or
can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the
111
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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 value of MBS are based upon market prices of similar securities or observable inputs (Level 2). The estimated
fair value of mutual funds are based upon quoted market prices (Level 1).
The Company had no liabilities measured at fair value on a recurring basis at September 30, 2017 and 2016. The Company's
assets measured at estimated fair value on a recurring basis at September 30, 2017 and 2016 are as follows (dollars in
thousands):
September 30, 2017
Available for sale investment securities
MBS: U.S. government agencies
Mutual funds
Total
September 30, 2016
Available for sale investment securities
MBS: U.S. government agencies
Mutual funds
Total
Level 1
Estimated Fair Value
Level 3
Level 2
Total
$
$
$
$
— $
952
952
$
— $
976
976
$
289
—
289
366
—
366
$
$
$
$
— $
—
— $
289
952
1,241
— $
—
— $
366
976
1,342
There were no transfers among Level 1, Level 2 and Level 3 during the years ended September 30, 2017 and 2016.
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis
in accordance with GAAP. These include assets that are measured at the lower of cost or market value that were recognized at
fair value below cost at the end of the period.
The Company uses the following methods and significant assumptions to estimate fair value of such assets 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,
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).
112
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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):
Impaired loans:
Mortgage loans:
Commercial
Land
Consumer loans:
Home equity and second mortgage
Total impaired loans
Investment securities – held to maturity:
MBS - Private label residential
OREO and other repossessed assets
Total
Level 1
Estimated Fair Value
Level 2
Level 3
$
$
— $
—
—
—
—
—
— $
— $
—
—
—
125
—
125
$
1,880
697
109
2,686
—
3,301
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
OREO and other repossessed
assets
3,301 Market approach
Appraised value less selling
costs
Lower of appraised value or
listing price less selling costs
NA
NA
The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at September
30, 2016 (dollars in thousands):
Impaired loans:
Mortgage loans:
One- to four-family
Commercial
Land
Consumer loans:
Home equity and second mortgage
Other
Total impaired loans
Investment securities – held to maturity:
MBS - Private label residential
OREO and other repossessed assets
Total
Estimated Fair Value
Level 1
Level 2
Level 3
$
— $
— $
—
—
—
—
—
—
—
— $
$
—
—
—
—
—
20
—
20
$
1,280
3,330
522
370
17
5,519
—
4,117
9,636
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured
at fair value on a non-recurring basis as of September 30, 2016 (dollars in thousands):
113
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
Estimated
Fair Value
Valuation
Technique(s)
Impaired loans
$
5,519 Market approach
OREO and other repossessed
assets
4,117 Market approach
Unobservable Input(s)
Appraised value less selling
costs
Lower of appraised value or
listing price less selling costs
NA
NA
Range
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 September 30, 2017 and
2016. Because GAAP excludes certain items from fair value disclosure requirements, any aggregation of the fair value
amounts presented would not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating fair value of its other financial instruments:
Cash and Cash Equivalents 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 fund redeemed for the balance of its capital 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 SBA loans (made to small businesses under SBA's 7(a) loan programs). Quoted market prices are
obtained from 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.
FHLB Borrowings: The estimated fair value of FHLB borrowings is computed by discounting the future cash flows of
the borrowings at a rate which approximates the current offering rate of the borrowings with a comparable remaining
life.
Off-Balance-Sheet Instruments: Since the majority of the Company’s off-balance-sheet instruments consist of
variable-rate commitments, the Company has determined that they do not have a distinguishable estimated fair value.
114
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
The recorded amounts and estimated fair values of financial instruments were as follows as of September 30, 2017 (dollars in
thousands):
Financial Assets
Cash and cash equivalents
CDs held for investment
Investment securities
FHLB stock
Other investments
Loans held for sale
Loans receivable, net
Accrued interest receivable
Financial Liabilities
Deposits:
Non-interest-bearing demand
Interest-bearing
Total deposits
Accrued interest payable
Recorded
Amount
Estimated
Fair Value
Fair Value Measurements Using:
Level 1
Level 2
Level 3
$
$
148,188
43,034
8,380
1,107
3,000
3,599
690,364
2,520
205,952
631,946
837,898
161
$
148,188
43,034
8,985
1,107
3,000
3,619
688,332
2,520
205,952
632,629
838,581
161
148,188
43,034
3,954
1,107
3,000
3,619
—
2,520
205,952
492,305
698,257
161
$
— $
—
5,031
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
688,332
—
—
140,324
140,324
—
The recorded amounts and estimated fair values of financial instruments were as follows as of September 30, 2016 (dollars in
thousands):
Financial Assets
Cash and cash equivalents
CDs held for investment
Investment securities
FHLB stock
Loans held for sale
Loans receivable, net
Accrued interest receivable
Financial Liabilities
Deposits:
Non-interest-bearing demand
Interest-bearing
Total deposits
FHLB borrowings
Accrued interest payable
Recorded
Amount
Estimated
Fair Value
Fair Value Measurements Using:
Level 1
Level 2
Level 3
$
$
108,941
53,000
8,853
2,204
3,604
663,146
2,348
172,283
589,251
761,534
30,000
247
$
108,941
53,000
9,737
2,204
3,714
671,017
2,348
172,283
589,762
762,045
30,684
247
108,941
53,000
4,029
2,204
3,714
—
2,348
172,283
441,277
613,560
—
247
$
— $
—
5,708
—
—
—
—
—
—
—
—
—
671,017
—
—
—
—
30,684
—
—
148,485
148,485
—
—
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
115
Notes to Consolidated Financial Statements_________________________________________________________________
Timberland Bancorp, Inc. and Subsidiary
September 30, 2017 and 2016
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.
Note 20 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data is presented for the quarters ended (dollars in thousands, except per share amounts):
Interest and dividend income
Interest expense
Net interest income
Recapture of loan losses (1)
Non-interest income
Non-interest expense
Income before income taxes
Provision for income taxes
Net income
Net income per common share
Basic
Diluted (2)
$
September 30,
2017
9,711
(582)
9,129
—
3,145
(6,911)
5,363
1,748
3,615
0.50
0.48
$
$
$
June 30,
2017
10,165
(918)
9,247
(1,000)
3,156
(6,938)
6,465
2,188
4,277
0.59
0.58
$
$
$
$
March 31,
2017
9,299
(847)
8,452
$
December 31,
2016
9,163
(850)
8,313
(250)
2,851
(6,857)
4,696
1,568
3,128
0.44
0.42
$
$
$
—
3,216
(6,810)
4,719
1,572
3,147
0.46
0.43
$
$
$
$
__________________________________________
(1) During the quarters ended March 31, 2017 and June 30, 2017 the Company recorded recaptures of loan losses of $250 and
$1,000, respectively, primarily as a result of significant recoveries on loans which had previously been charged off in prior
years and improvements in other credit quality metrics.
(2) The net income per common share amounts for the quarters do not add to the total for the fiscal year due to rounding.
Interest and dividend income
Interest expense
Net interest income
Non-interest income
Non-interest expense
Income before income taxes
Provision for income taxes
Net income
Net income per common share
Basic (1)
Diluted (1)
$
September 30,
2016
8,938
(1,132)
7,806
3,109
(6,961)
3,954
1,255
2,699
0.40
0.38
$
$
$
$
$
$
$
June 30,
2016
8,596
(980)
7,616
2,749
(6,568)
3,797
1,250
2,547
0.37
0.36
$
$
$
$
March 31,
2016
8,650
(979)
7,671
$
December 31,
2015
8,691
(981)
7,710
2,513
(6,629)
3,555
1,175
2,380
0.35
0.34
$
$
$
2,518
(6,479)
3,749
1,221
2,528
0.37
0.36
__________________________________________
(1) The net income per common share amounts for the quarters do not add to the total for the fiscal year due to rounding.
116
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and
procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the
supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members
of the Company’s senior management as of the end of the period covered by this annual report. The Company’s Chief Executive
Officer and Chief Financial Officer concluded that as of September 30, 2017 the Company’s disclosure controls and procedures
were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer
and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms.
(b) Changes in Internal Controls: There have been no changes in our internal control over financial reporting (as
defined in 13a-15(f) of the Exchange Act) that occurred during the quarter ended September 30, 2017, that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting. The Company continued, however, to
implement suggestions from its internal auditor and independent auditor on ways to strengthen existing controls. The Company
does not expect that its disclosure controls and procedures and internal controls over financial reporting will prevent all 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; over time, controls become inadequate
because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
Management’s Report on Internal Control Over Financial Reporting
Management of Timberland Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate
internal control over financial reporting as defined in Rule 13(a)-15(f) of the Securities Exchange Act of 1934. The Company's
internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
To comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the Company designed and
implemented a structured and comprehensive assessment process to evaluate its internal control over financial reporting across
the enterprise. The assessment of the effectiveness of the Company's internal control over financial reporting was based on criteria
established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
The Company's internal control over financial reporting includes policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations
of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Also, 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. Additionally, in designing disclosure controls and procedures, our management was required to apply its judgment in
evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and
procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that
117
any design will succeed in achieving its stated goals under all potential future conditions. As a result of these inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Furthermore, projections of any evaluation of
effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions or that
the degree of compliance with the policies or procedures may deteriorate.
Based on its assessment, management has concluded that the Company's internal control over financial reporting was
effective as of September 30, 2017.
The effectiveness of internal control over financial reporting as of September 30, 2017, has been audited by Delap LLP,
the independent registered public accounting firm who also audited the Company's consolidated financial statements. Delap LLP's
attestation report on the Company's internal control over financial reporting follows.
The management of the Company has assessed the Company's compliance with the Federal laws and regulations pertaining
to insider loans and the Federal and, if applicable, State laws and regulations pertaining to dividend restrictions during the fiscal
year that ended on September 30, 2017. Management has concluded that the Company complied with the Federal laws and
regulations pertaining to insider loans and the Federal and, if applicable, State laws and regulations.
Date: December 8, 2017
/s/ Michael R. Sand
Michael R. Sand
President and Chief Executive Officer
/s/ Dean J. Brydon
Dean J. Brydon
Chief Financial Officer
Report of Independent Registered Public Accounting Firm
We have audited the internal control over financial reporting of Timberland Bancorp, Inc. and Subsidiary (collectively, "the
Company") as of September 30, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by
the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over
financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included
performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September
30, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
118
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
Company's consolidated balance sheet as of September 30, 2017, and the related consolidated statements of income, comprehensive
income, shareholders' equity, and cash flows for the year then ended, and our report dated December 8, 2017, expressed an
unqualified opinion on those consolidated financial statements.
/s/ Delap LLP
Lake Oswego, Oregon
December 8, 2017
119
Item 9B. Other Information
None.
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The information required by this item is contained under the section captioned “Proposal I - Election of Directors” in the
Company’s Definitive Proxy Statement for the 2017 Annual Meeting of Stockholders (“Proxy Statement”) and is incorporated
herein by reference.
For information regarding the executive officers of the Company and the Bank, see “Item 1. Business - Executive Officers
of the Registrant.”
Compliance with Section 16(a) of the Exchange Act
The information required by this item is contained under the section captioned “Section 16(a) Beneficial Ownership
Reporting Compliance” included in the Company’s Proxy Statement and is incorporated herein by reference.
Audit Committee Matters and Audit Committee Financial Expert
The Company has a separately designated standing Audit Committee, which as of September 30, 2017 was composed
of Directors Stoney, Smith and Goldberg. Effective October 24, 2017 Director Davis was also appointed to the Audit Committee.
Each member of the Audit Committee is “independent” as defined in the Nasdaq Stock Market listing standards. The Company’s
Board of Directors has designated Director Stoney as the Audit Committee financial expert, as defined in the SEC’s Regulation
S-K. Directors Stoney, Smith, Goldberg and Davis are independent as that term is used in Item 7(c) of Schedule 14A promulgated
under the Exchange Act.
Code of Ethics
The Board of Directors ratified its Code of Ethics for the Company’s officers (including its senior financial officers),
directors and employees during the year ended September 30, 2017. The Code of Ethics requires the Company’s officers, directors
and employees to maintain the highest standards of professional conduct. The Company’s Code of Ethics was filed as an exhibit
to its Annual Report on Form 10-K for the year ended September 30, 2003 and is available on our website at
www.timberlandbank.com.
Nomination Procedures
There have been no material changes to the procedures by which stockholders may recommend nominees to the Company’s
Board of Directors.
Item 11. Executive Compensation
The information required by this item is contained under the sections captioned “Executive Compensation” and “Directors’
Compensation” included in the Company’s Proxy Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a)
Security Ownership of Certain Beneficial Owners.
The information required by this item is contained under the section captioned “Security Ownership of Certain Beneficial Owners
and Management” included in the Company’s Proxy Statement and is incorporated herein by reference.
(b)
Security Ownership of Management.
The information required by this item is contained under the sections captioned “Security Ownership of Certain Beneficial Owners
and Management” and “Proposal I - Election of Directors” included in the Company’s Proxy Statement and is incorporated herein
by reference.
120
(c) Changes In Control.
The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation
of which may at a subsequent date result in a change in control of the Company.
(d) Equity Compensation Plan Information. The following table summarizes share and exercise price information
about the Company’s equity compensation plans as of September 30, 2017.
Plan category
Equity compensation plans
approved by security holders:
2003 Stock Option Plan
Timberland Bancorp, Inc. 2014
Equity Incentive Plan
Equity compensation plans
not approved by security holders
Total
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights
(a)
Weighted-average exercise
price of outstanding
options, warrants and
rights
(b)
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
151,400
$
228,720
$
—
380,120
$
8.04
16.67
—
13.23
—
113,616
—
113,616
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is contained under the sections captioned “Meetings and Committees of the Board of
Directors And Corporate Governance Matters - Corporate Governance - Related Party Transactions” and “Meetings and
Committees of the Board of Directors and Corporate Governance Matters - Corporate Governance - Director Independence”
included in the Company's Proxy Statement and are incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
The information required by this item is contained under the section captioned “Proposal 3-Ratification of Selection of
Independent Auditor” included in the Company’s Proxy Statement and is incorporated herein by reference.
121
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
PART IV
3.1
3.3
4.2
10.1
10.2
10.5
10.6
10.7
10.8
10.9
10.10
10.11
Articles of Incorporation of the Registrant (1)
Amended and Restated Bylaws of the Registrant (2)
Letter Agreement (including Securities Purchase Agreement Standard Terms attached as Exhibit A) dated December
23, 2008 between the Company and the United States Department of the Treasury (3)
Employee Severance Compensation Plan, as revised (4)
Employee Stock Ownership Plan (4)
2003 Stock Option Plan (5)
Form of Incentive Stock Option Agreement (6)
Form of Non-qualified Stock Option Agreement (6)
Form of Management Recognition and Development Award Agreement (6)
Employment Agreement with Michael R. Sand (7)
Employment Agreement with Dean J. Brydon (7)
Timberland Bancorp, Inc. 2014 Equity Incentive Plan (8)
14 Code of Ethics (9)
21 Subsidiaries of the Registrant*
23.1 Consent of Delap LLP*
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act*
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act*
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act*
101 The following materials from Timberland Bancorp, Inc.’s Annual Report on Form 10-K for the year ended
September 30, 2017, formatted in 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
Consolidated Financial Statements
____________
*
Copies of these exhibits are available upon written request to Dean J. Brydon, Secretary, Timberland Bancorp, Inc.,
624 Simpson Avenue, Hoquiam, Washington 98550.
Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (333-35817) and incorporated by reference.
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed June 1, 2017.
Incorporated by reference to the Registrant’s Current Report on Form 8-K filed on December 23, 2008.
Incorporated by reference to the Registrant's Current Report on Form 8-K filed April 16, 2007.
Incorporated by reference to the Registrant's 2004 Annual Meeting Proxy Statement dated December 24, 2003.
Incorporated by reference to Exhibit 99.2 included in the Registrant’s Registration Statement on Form S-8
(333-1161163)
Incorporated by reference to the Registrant’s Current Report of Form 8-K filed on March 29, 2013.
Attached as Appendix A to the Registrant's Annual Meeting Proxy Statement filed on December 19, 2014.
Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended September 30, 2003.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Item 16. Form 10-K Summary
None.
122
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: December 8, 2017
TIMBERLAND BANCORP, INC.
By:
/s/Michael R. Sand
Michael R. Sand
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
/s/Michael R. Sand
Michael R. Sand
/s/Jon C. Parker
Jon C. Parker
/s/Dean J. Brydon
Dean J. Brydon
/s/Andrea M. Clinton
Andrea M. Clinton
/s/James A. Davis
James A. Davis
/s/Larry D. Goldberg
Larry D. Goldberg
/s/Kathy D. Leodler
Kathy D. Leodler
/s/David A. Smith
David A. Smith
/s/Michael J. Stoney
Michael J. Stoney
TITLE
President, Chief Executive Officer and
Director
(Principal Executive Officer)
Chairman of the Board
Chief Financial Officer
(Principal Financial and Accounting Officer)
Director
Director
Director
Director
Director
Director
DATE
December 8, 2017
December 8, 2017
December 8, 2017
December 8, 2017
December 8, 2017
December 8, 2017
December 8, 2017
December 8, 2017
December 8, 2017
123
DIRECTORS AND OFFICERS
TIMBERLAND BANCORP, INC.
Edward C. Foster
Executive Vice President
Marci A. Basich
Senior Vice President
OFFICERS:
Michael R. Sand
President and Chief Executive Officer
Dean J. Brydon
Executive Vice President
Robert A. Drugge
Executive Vice President
Jonathan A. Fischer
Executive Vice President
DIRECTORS:
DIRECTORS:
Jon C. Parker is Chairman of the Board of the Company and the Bank. Mr. Parker is the majority
Jon C. Parker is Chairman of the Board of the Company and the Bank. Mr. Parker is the majority
shareholder/owner of the law firm Parker, Winkelman & Parker, P.S., Hoquiam, Washington, which serves
shareholder/owner of the law firm Parker, Winkelman & Parker, P.S., Hoquiam, Washington, which serves
as general counsel to the Bank and the Company.
as general counsel to the Bank and the Company.
Michael R. Sand has been affiliated with the Bank since 1977 and has served as President of the Bank
Michael R. Sand has been affiliated with the Bank since 1977 and has served as President of the Bank
and the Company since January 23, 2003. On September 30, 2003, he was appointed as Chief Executive
and the Company since January 23, 2003. On September 30, 2003, he was appointed as Chief Executive
Officer of the Bank and Company. Prior to appointment as President and Chief Executive Officer, Mr.
Officer of the Bank and Company. Prior to appointment as President and Chief Executive Officer, Mr.
Sand had served as Executive Vice President of the Bank since 1993 and as Executive Vice President of
Sand had served as Executive Vice President of the Bank since 1993 and as Executive Vice President of
the Company since its formation in 1997.
the Company since its formation in 1997.
Andrea M. Clinton, an interior designer, is the owner of AMC Interiors at Home and AMC Interiors,
Andrea M. Clinton, an interior designer, is the owner of AMC Interiors at Home and AMC Interiors,
both of which are located in Olympia, Washington.
both of which are located in Olympia, Washington.
James A. Davis is retired, having served as Chief Executive Officer of Verified Person, a background
James A. Davis is retired, having served as Chief Executive Officer of Verified Person, a background
verification company from 2006 until its acquisition in 2016.
verification company from 2006 until its acquisition in 2016.
Larry D. Goldberg is the retired principal partner of Goldberg Furniture Company, Aberdeen,
Larry D. Goldberg is the retired principal partner of Goldberg Furniture Company, Aberdeen,
Washington.
Washington.
Kathy D. Loedler is the founder and Chief Executive Officer of the Rampart Group LLC, a business
Kathy D. Loedler is the founder and Chief Executive Officer of the Rampart Group LLC, a business
consulting company based in Seattle, Washington that provides security and investigation services to law
consulting company based in Seattle, Washington that provides security and investigation services to law
firms, businesses, and individuals.
firms, businesses, and individuals.
David A. Smith is a pharmacist and the owner of Harbor Drug, Inc., a retail pharmacy located in
David A. Smith is a pharmacist and the owner of Harbor Drug, Inc., a retail pharmacy located in
Hoquiam, Washington.
Hoquiam, Washington.
Michael J. Stoney, a Certified Public Accountant, is a member of the accounting firm Easter & Stoney,
Michael J. Stoney, a Certified Public Accountant, is a member of the accounting firm Easter & Stoney,
P.S., with offices in Elma and Aberdeen, Washington.
P.S., with offices in Elma and Aberdeen, Washington.
CORPORATE INFORMATION
MAIN OFFICE
INDEPENDENT AUDITORS
624 Simpson Avenue
Hoquiam, Washington 98550
Telephone: (360) 533-4747
GENERAL COUNSEL
Parker, Winkelman & Parker, PS
Hoquiam, Washington
TRANSFER AGENT
Delap LLP
Lake Oswego, Oregon
SPECIAL COUNSEL
Breyer & Associates PC
McLean, Virginia
For shareholder inquiries concerning dividend checks, transferring ownership, address changes or lost or
stolen certificates please contact our transfer agent:
American Stock Transfer & Trust Company
59 Maiden Lane
New York, New York 10038
(800) 937-5449
ANNUAL MEETING
The Annual Meeting of Shareholders will be held at the Hoquiam Grand Central, 427 7th Street,
Hoquiam, WA 98550 on Tuesday, January 23, 2018 at 1:00 p.m., Pacific Time.
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Gig Harbor
Aberdeen
(2 branches)
Lewis
Winlock
Toledo
Elma
Lacey
(2 branches)
Chehalis
Hoquiam 624 Simpson Ave.Hoquiam, WA 98550(360) 533-4747Ocean Shores 361 Damon Rd. Ocean Shores, WA 98569(360) 289-2476Downtown Aberdeen 117 N. Broadway Aberdeen, WA 98520(360) 533-4500South Aberdeen 300 N. Boone St. Aberdeen, WA 98520(360) 533-6440Montesano 210 S. Main St.Montesano, WA 98563(360) 249-4021Elma313 W. Waldrip Elma, WA 98541(360) 482-3333Toledo101 Ramsey WayToledo, WA 98591(360) 864-6102Winlock209 NE 1st St. Winlock, WA 98596(360) 785-3552Chehalis714 W. Main St.Chehalis, WA 98532(360) 740-0770Tumwater 801 Trosper Rd. SW Tumwater, WA 98512(360) 705-2863 Olympia423 Washington St. SEOlympia, WA 98501(360) 943-5496 Panorama1751 Circle Lane SELacey, WA 98503(360) 413-3891Lacey1201 Marvin Rd. NELacey, WA 98516(360) 438-1400Yelm 101 Yelm Ave. W.Yelm, WA 98597(360) 458-2221Bethel Station2419 224th St. E.Spanaway, WA 98387(253) 875-4250Puyallup (South Hill)12814 Meridian E.Puyallup, WA 98373(253) 841-4980Edgewood (North Hill)2418 Meridian E. Edgewood, WA 98371(253) 845-0999Auburn202 Auburn Way S.Auburn, WA 98002(253) 804-6177Tacoma 7805 S. Hosmer St. Tacoma, WA 98408(253) 472-4465Gig Harbor 3105 Judson St.Gig Harbor, WA 98335 (253) 851-1188Silverdale2401 NW Bucklin Hill Rd.Silverdale, WA 98383(360) 337-7727Poulsbo 20464 Viking Way NWPoulsbo, WA 98370 (360) 598-5801www.timberlandbank.comFutureHERE2017 Annual ReportPLANT YOUR