Hoquiam
624 Simpson Ave.
South Aberdeen
300 N. Boone St.
Hoquiam, WA 98550
Aberdeen, WA 98520
(360) 533-4747
Ocean Shores
361 Damon Rd.
(360) 533-6440
Montesano
210 S. Main St.
(360) 289-2476
(360) 249-4021
Downtown Aberdeen
Elma
117 N. Broadway
Aberdeen, WA 98520
(360) 533-4500
313 W. Waldrip
Elma, WA 98541
(360) 482-3333
Toledo
101 Ramsey Way
Toledo, WA 98591
(360) 864-6102
Winlock
209 NE 1st St.
(360) 785-3552
Chehalis
714 W. Main St.
Tumwater
801 Trosper Rd. SW
Tumwater, WA 98512
(360) 705-2863
Olympia
423 Washington St. SE
Olympia, WA 98501
(360) 943-5496
West Olympia
2850 Harrison Ave. NW
Chehalis, WA 98532
Olympia, WA 98502
(360) 740-0770
(360) 705-4200
Ocean Shores, WA 98569
Montesano, WA 98563
Winlock, WA 98596
PLANT
YOUR
FutureHERE
Panorama
1751 Circle Lane SE
Lacey, WA 98503
(360) 413-3891
Lacey
1201 Marvin Rd. NE
Lacey, WA 98516
(360) 438-1400
Downtown Lacey
4530 Lacey Blvd SE
Lacey, WA 98503
(360) 528-4200
Yelm
101 Yelm Ave. W.
Yelm, WA 98597
(360) 458-2221
Bethel Station
2419 224th St. E.
Spanaway, WA 98387
(253) 875-4250
Auburn
202 Auburn Way S.
Auburn, WA 98002
(253) 804-6177
Puyallup (South Hill)
Tacoma
12814 Meridian E.
Puyallup, WA 98373
(253) 841-4980
7805 S. Hosmer St.
Tacoma, WA 98408
(253) 472-4465
www.timberlandbank.com
Edgewood (North Hill)
Gig Harbor
2418 Meridian E.
3105 Judson St.
Edgewood, WA 98371
Gig Harbor, WA 98335
(253) 845-0999
(253) 851-1188
2020 Annual Report
Silverdale
2401 NW Bucklin Hill Rd.
Silverdale, WA 98383
(360) 337-7727
Poulsbo
20464 Viking Way NW
Poulsbo, WA 98370
(360) 598-5801
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, 2020. The meeting will be convened January 26, 2021 employing a
virtual format. Instructions to access the meeting are included on your proxy card and the
instructions that accompanied your proxy materials. The meeting will begin promptly at 1:00
p.m. During the meeting we will review the operating results for the Company’s recently
concluded fiscal year, conduct an election of Directors, vote on other matters described in the
proxy statement and respond to questions from shareholders.
Please review the information contained in the attached Form 10-K to acquaint yourself with
the Company’s 2020 fiscal year financial performance.
We were pleased to earn record net income for our fiscal year ended September 30, 2020 and,
for the tenth consecutive year, to report increased net income and earnings per share. Net
loans outstanding increased 14% for the year primarily as a result of Timberland’s
commitment to serving applicants seeking economic relief through the Paycheck Protection Program (“PPP”). Deposit growth,
year over year, trended well above average increasing more than 27% primarily as a result of PPP loan proceeds being placed on
deposit, organic growth in customer relationships resulting in new deposits and depositors prudently opting to build liquidity in
the midst of an uncertain economy.
Michael R. Sand
Significant efforts were directed this year toward responding to conditions dictated by the Coronavirus. For example, we assisted
more than 1,150 clients in their quest to access PPP funding to support their businesses and employees. We also appropriately
deferred loan payments for clients whose business revenues, or personal incomes, were curtailed by mandated restrictions.
Aid to businesses in the form of potentially forgivable PPP loans was released in a torrent with implementing guidance seemingly
developed as an afterthought. The Small Business Administration (“SBA”) and Treasury were charged with the unenviable task
of creating a lending program from scratch and, perhaps unavoidably, found it necessary to devise rules on the fly – which rules
occasionally struggled to find the light of day. Now, when we reflect on the positive results achieved through the program, we
feel privileged to have joined with many other community banks to collectively play an outsized role in distributing critically
needed funding to support thousands of small businesses in our respective communities. Timberland’s lenders originated more
than $127 million in PPP loans to support 1,158 borrowers through these challenging times. We are currently devoting
considerable resources to actively assist our customers with applications for loan forgiveness.
We also worked diligently this year to establish a safe working environment for our employees and customers. Offices were
“improved” in historically atypical ways such as by the addition of plexi-glass barriers and handwashing stations, and the periodic
application of antiseptic surface coatings. Branch access was temporarily restricted and front line employees were equipped with
protective equipment for personal use. We postulated, then discovered, many employees could effectively work from home using
laptops and modest amounts of technical support.
In countless ways it was an unusual and challenging year, yet in spite of significant disruptions and operational challenges,
Timberland persisted in producing continued strong financial performance. We were honored to be recognized, for the third
consecutive year, by Raymond James for our financial performance placing us in the top 10% of community banks in the
country, as measured by several financial metrics. We were also recognized, for the second consecutive year, by Piper Sandler as
one of the nation’s 35 best performing small-cap banks.
We are pleased to report the Company’s continued strong financial performance to you and thank you for participating with us
as a shareholder in the success of our Company. Please make plans to join us during our virtual annual meeting. We 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)
SELECTED FINANCIAL DATA
Total Assets
Loans Receivable, Net
Total Deposits
Shareholders’ Equity
September 30,
2018
2019
2020
$ 1,018,290
725,391
889,506
124,657
$ 1,247,132
886,662
1,068,227
171,067
$ 1,565,978
1,013,875
1,358,406
187,630
OPERATING DATA
Interest and Dividend Income
Interest Expense
Net Interest Income
Provision for Loan Losses
Net Interest Income after Provision for Loan Losses
Non-Interest Income
Non-Interest Expense
Income before Income Taxes
Provision for Income Taxes
Net Income
$ 41,833
2,778
39,055
–
39,055
12,544
29,177
22,422
5,701
$ 55,725
4,565
51,160
–
51,160
14,341
35,580
29,921
5,901
$
55,583
4,701
50,882
3,700
47,182
17,188
34,063
30,307
6,038
$ 16,721
$ 24,020
$
24,269
Total Assets
$1,565,978
$1,247,132
$1,018,290
2018
2019
2020
Loans Receivable, Net
$1,013,875
$725,391
$886,662
2018
2019
2020
Total Deposits
$1,358,406
$1,068,227
$889,506
NET INCOME PER COMMON SHARE
Basic
Diluted
$
2.28
2.22
$
$
2.89
2.84
2.91
2.88
2018
2019
2020
Net Income
$24,269
$24,020
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
$16,721
__________________
1.70%
14.27
4.23
56.55
0.36
12.24
1.96%
14.91
4.50
54.32
0.40
13.71
1.75%
13.59
3.90
50.04
0.27
11.98
2018
2019
2020
(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.
2020 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.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2020
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)
98550
(Zip Code)
Registrant’s telephone number, including area code:
(360) 533-4747
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common stock, $.01 par value
Trading Symbol(s)
TSBK
Name of each exchange on which
registered
The NASDAQ Stock Market LLC
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 ☒
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 ☒
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be
submitted 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 such files) Yes ☒ No ☐
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
☒
Emerging growth company ☐
Accelerated filer
☐
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 has filed a report on and attestation to its management's assessment of the
effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by
the registered public accounting firm that prepared or issued its audit report. ___
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of November 30, 2020 the registrant had 8,315,993 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, 2020, was $151.98 million (8,309,193 shares at $18.29). 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 2021 Annual Meeting of Shareholders (Part III).
DOCUMENTS INCORPORATED BY REFERENCE
[This page intentionally left blank.]
TIMBERLAND BANCORP, INC.
2020 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
Employees and Human Capital Resources
Executive Officers of the Registrant
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Item 3.
Item 4. Mine Safety Disclosures
Properties
Legal Proceedings
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, 2020 and September 30, 2019
Comparison of Operating Results for Years Ended September 30, 2020 and 2019
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
4
4
6
24
25
27
27
35
35
36
36
36
37
50
50
52
52
52
54
56
56
56
57
58
58
60
62
65
67
67
69
69
69
69
129
129
131
131
131
131
132
132
133
133
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.
[This page intentionally left blank.]
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
effect of the novel coronavirus of 2019 ("COVID-19") pandemic, including on the Company's credit quality and business
operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the
COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and
consumer and corporate customers, including economic activity, employment levels and market liquidity; 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; uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away
from LIBOR toward new interest rate benchmarks; 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 Federal Reserve 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; our ability to
control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates
may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risks associated with the loans
on our consolidated balance sheet; staffing fluctuations in response to product demand or the implementation of corporate
strategies that affect our work force and potential associated charges; disruptions, security breaches, or other adverse events,
failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several
of our critical processing functions; our ability to retain key members of our senior management team; costs and effects of
litigation, including settlements and judgments; our ability to implement our business strategies; our ability to manage loan
delinquency rates; increased competitive pressures among financial services companies; changes in consumer spending,
borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to
regulatory actions; our ability to pay dividends on our common stock; adverse changes in the securities markets; inability of key
third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the
financial institution regulatory agencies or the Financial Accounting Standards Board ("FASB"), including additional guidance
and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of
war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our
operations, pricing, products and services including the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES
Act"); and other risks described elsewhere in this Form 10-K and in the Company's other reports filed with or furnished to the
Securities and Exchange Commission.
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 2021 and beyond to differ materially from those expressed in any forward-looking statements by, or
on behalf of, us, and could negatively affect the Company's consolidated financial condition and results of operations as well as
its stock price performance.
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,
2020, on a consolidated basis, the Company had total assets of $1.57 billion, net loans receivable of $1.01 billion, total deposits
of $1.36 billion and total shareholders’ equity of $187.63 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 24 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").
On October 1, 2018, the Company completed the acquisition of South Sound Bank, a Washington-state chartered
bank, headquartered in Olympia, Washington ("South Sound Acquisition"). The Company acquired 100% of the outstanding
common stock of South Sound Bank, and South Sound Bank was merged into the Bank. The results of operations of the
acquired assets and assumed liabilities have been included in the Company's consolidated financial statements as of and for the
period since the acquisition date. For additional details see Note 2 of the Notes to Consolidated Financial Statements contained
in "Item 8. Financial Statements and Supplementary Data."
Timberland 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 and commercial / multi-family construction
loans, one- to four-family residential loans, multi-family loans, commercial real estate loans and land loans. The Bank
originates adjustable-rate residential mortgage loans that do not qualify for sale in the secondary market. 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);
seven branch offices in Thurston County (Tumwater, Yelm, three branches in Lacey and two
branches in Olympia);
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).
4
For additional information, see “Item 2. Properties.”
Hoquiam, with a population of approximately 8,700, 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 Bank. The Bank’s expansion into Pierce, Thurston, Kitsap, King and Lewis counties represents the Bank’s strategy
to expand and diversify its primary market area to become less reliant on the economy of Grays Harbor County.
Grays Harbor County has a population of 75,000 according to the United States ("U.S.") Census Bureau 2019
estimates and a median family income of $65,500 according to 2020 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 increased to 10.0% at September 30, 2020 from 6.7% at September 30, 2019. The median price of a resale home in
Grays Harbor County for the quarter ended June 30, 2020 increased 13.4% to $239,800 from $211,400 for the comparable prior
year period. The number of home sales increased 3.1% for the quarter ended June 30, 2020 compared to the same quarter one
year earlier. The Bank has six branches (including its home office) located in the county.
Pierce County is the second most populous county in the state and has a population of 905,000 according to the U.S.
Census Bureau 2019 estimates. The county’s median family income is $87,300 according to 2020 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 increased to 8.6% at
September 30, 2020 from 5.0% at September 30, 2019. The median price of a resale home in Pierce County for the quarter
ended June 30, 2020 increased 9.5% to $407,800 from $372,300 for the comparable prior year period. The number of home
sales decreased 5.5% for the quarter ended June 30, 2020 compared to the same quarter one year earlier. The Bank has five
branches located 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 291,000 according to the U.S. Census Bureau 2019 estimates and a median
family income of $86,700 according to 2020 HUD estimates. Thurston County is home of Washington State’s capital
(Olympia), and its economic base is largely driven by state government related employment. According to the Washington
State Employment Security Department, the unemployment rate for the Thurston County area increased to 7.1% at
September 30, 2020 from 4.8% at September 30, 2019. The median price of a resale home in Thurston County for the quarter
ended June 30, 2020 increased 8.9% to $371,100 from $340,700 for the same quarter one year earlier. The number of home
sales decreased 2.5% for the quarter ended June 30, 2020 compared to the same quarter one year earlier. The Bank has seven
branches located 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 271,000 according to the U.S. Census Bureau 2019 estimates and a median family
income of $91,700 according to 2020 HUD estimates. The Bank has two branches located 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 increased to 6.8%
at September 30, 2020 from 4.5% at September 30, 2019. The median price of a resale home in Kitsap County for the quarter
ended June 30, 2020 increased 8.0% to $411,400 from $380,800 for the same quarter one year earlier. The number of home
sales decreased 3.4% for the quarter ended June 30, 2020 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 2019 estimates. The Bank has one branch located in King County. The county’s median family income is $113,300
according to 2020 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 increased to 7.0% at September 30, 2020 from 3.0% at
September 30, 2019. The median price of a resale home in King County for the quarter ended June 30, 2020 increased 2.0% to
5
$715,400 from $701,200 for the same quarter one year earlier. The number of home sales decreased 0.5% for the quarter ended
June 30, 2020 compared to the same quarter one year earlier.
Lewis County has a population of 81,000 according to the U.S. Census Bureau 2019 estimates and a median family
income of $65,500 according to 2020 HUD estimates. The economic base in Lewis County is supported by manufacturing,
retail trade, local government and industrial services. According to the Washington State Employment Security Department,
the unemployment rate in Lewis County increased to 8.1% at September 30, 2020 from 5.9% at September 30, 2019. The
median price of a resale home in Lewis County for the quarter ended June 30, 2020 increased 12.8% to $291,400 from
$258,300 for the same quarter one year earlier. The number of home sales increased 2.4% for the quarter ended June 30, 2020
compared to the same quarter one year earlier. The Bank has three branches located in Lewis County.
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, multi-family properties, commercial real estate, or by land
and loans for the construction of one- to four-family residences. The Bank’s net loans receivable totaled $1.01 billion at
September 30, 2020, representing 64.7% of consolidated total assets, and at that date commercial real estate, construction
(including undisbursed loans in process), multi-family and land loans were $783.69 million, or 69.1% of total
loans. 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, 2020, the maximum amount which the Bank could have lent to any one borrower and the
borrower’s related entities was approximately $36.55 million under this policy. At September 30, 2020, the largest amount
outstanding to any one borrower and the borrower’s related entities was $28.88 million (including $4.05 million in available
lines of credit), which was secured by various commercial real estate and residential properties and other business assets located
primarily in King County and were performing according to their loan repayment terms at September 30, 2020. The next
largest amount outstanding to any one borrower and the borrower’s related entities was $20.59 million (including $7.34 million
of undisbursed construction loan proceeds). These loans were secured by multi-family, one- to four-family and commercial
real estate properties located primarily in Thurston County and were performing according to their loan repayment terms at
September 30, 2020.
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Residential One- to Four-Family Lending. At September 30, 2020, $118.58 million, or 10.5%, 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 are originated to meet the requirements for sale in the secondary market
to the Federal Home Loan Mortgage Corporation ("Freddie Mac") or the Federal Home Loan Bank of Des Moines
("FHLB"). From time to time, however, a portion of these fixed-rate 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, 2020, $38.29
million, or 32.3%, of the Bank’s one- to four-family loan portfolio consisted of fixed-rate mortgage loans.
The Bank also offers adjustable-rate mortgage (“ARM”) loans. All of the Bank’s ARM loans are retained in its loan
portfolio. The Bank offers several ARM products which adjust annually or every three to five years 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 re-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 2.75% to 4.00%. The Bank also offers ARM loans tied to
The Wall Street Journal prime lending rate ("Prime Rate") index which typically do not have periodic or lifetime adjustment
limits. Loans tied to the Prime Rate normally have margins ranging up to 3.0%. ARM loans held in the Bank’s portfolio do not
permit negative amortization of principal. Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of
the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest
rates and fees charged for each type of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can be
originated at any time is largely determined by the demand for each in a competitive environment. At September 30, 2020,
$80.29 million, or 67.7%, 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 a 2.0% increase in the initial interest rate. 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 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
8
80% (90% for loans originated for sale in the secondary market to Freddie Mac or the FHLB). At September 30, 2020, three
one- to four-family loans totaling $659,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and
Delinquencies.”
Multi-Family Lending. At September 30, 2020, $85.05 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 FHLB borrowing, with principal and interest payments
fully amortizing over terms of up to 30 years. At September 30, 2020, the Bank’s largest multi-family loan had an outstanding
principal balance of $7.20 million and was secured by an apartment building located in Thurston County. At September 30,
2020, 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 annually on the properties securing such loans. The Bank also inspects such properties annually. The Bank generally
imposes a minimum debt coverage ratio of 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 (with ownership interests of 20% or more)
based on a review of personal financial statements. At September 30, 2020, 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 $453.57 million, or 40.0%, of the total loan
portfolio at September 30, 2020. 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,
generally located in the Bank’s primary market area. At September 30, 2020, the largest commercial real estate loan was
secured by a medical building in Pierce County, had a balance of $7.82 million and was performing according to its repayment
terms. At September 30, 2020, four commercial real estate loans totaling $858,000 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 an evaluation provided by a third party vendor 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 (with
ownership interests of 20% or more) 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 two types of residential construction loans: (i) custom
construction and owner/builder construction loans and (ii) speculative construction loans. The Bank believes that its lengthy
experience in providing residential construction loans has enabled it to establish processing and disbursement procedures to
meet the needs of its borrowers while reducing many of the risks inherent with construction lending. The Bank also originates
9
construction loans for multi-family properties, commercial properties, and land development projects. 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, 2020, the Bank's construction loans totaled $219.50 million,
or 19.4% of the Bank's total loan portfolio, including undisbursed loans in process of $100.56 million. All construction loans
were performing according to their repayment terms at September 30, 2020. See "Lending Activities - Non-performing Loans
and Delinquencies."
At September 30, 2020 and 2019, 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
Land development
Total
At September 30,
2020
2019
Outstanding
Balance
$ 129,572
14,592
33,144
34,476
7,712
$ 219,496
Percent of
Outstanding
Balance
Total
(Dollars in thousands)
59.03% $ 128,848
16,445
6.65
39,566
15.10
36,263
15.71
2,404
3.51
100.00% $ 223,526
Percent of
Total
57.64%
7.36
17.70
16.22
1.08
100.00%
Custom and owner/builder construction loans are originated to home owners and are typically converted to or
refinanced into permanent loans at the completion of construction. The construction phase of these loans generally lasts up to
12 months with fixed interest rates typically ranging from 4.50% to 6.50% 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, 2020, custom and owner/builder construction loans totaled $129.57 million,
or 59.0% of the total construction loan portfolio. At September 30, 2020, the largest outstanding custom and owner/builder
construction loan had an outstanding balance of $6.60 million (including $53,000 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 pay 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 5.00% to 6.50%, and with a loan-to-value ratio of no more than 80% of the appraised value of the completed property. At
September 30, 2020, speculative one- to four-family construction loans totaled $14.59 million, or 6.7% of the total construction
loan portfolio. At September 30, 2020, the largest aggregate outstanding balance to one borrower for speculative one- to four-
family construction loans totaled $3.05 million (including $2.18 million of undisbursed loans in process) and was comprised of
eleven loans that were performing according to their repayment terms.
The Bank also provides construction financing for multi-family and commercial properties. At September 30, 2020,
these loans amounted to $67.62 million, or 30.8%, of construction loan balances compared to $75.83 million, or 33.9%, of
construction loan balances at September 30, 2019. 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, 2020, the largest outstanding multi-family construction loan for $8.03 million was secured by an
apartment building project in Thurston County which had not yet commenced construction. At September 30, 2020, the largest
outstanding commercial real estate construction loan was secured by an assisted living facility project in Salem, Oregon and had
a balance of $5.31 million with no remaining undisbursed funds available. This loan was performing according to its
repayment terms at September 30, 2020.
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
10
and Processing.” Prior to approval of any construction loan application, an independent fee appraiser inspects the site and
prepares an appraisal on an "as completed" basis 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 or verification of income
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, or to the extent available authorizes disbursements from a loan
contingency line in the construction budget.
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 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 from
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 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.
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). At September 30, 2020, land development loans totaled $7.71 million, or 3.5% of the total construction loan portfolio.
Currently, the Bank is originating land development loans on a limited basis. Land development loans are secured by a lien on
the property and typically are made for a period of two to five years with fixed or variable interest rates, with loan-to-value
ratios generally not exceeding 75%. Land development loans are generally structured so that the Bank is repaid in full upon the
sale by the borrower of approximately 80% of the subdivision lots. In addition, in the case of a corporate borrower, the Bank
also generally obtains personal guarantees from corporate principals (with ownership interests in the borrowing entity of 20%
or more) and reviews 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 loan funds 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
11
repayment. The Bank has historically attempted to minimize this risk by generally limiting the maximum loan-to-value ratio on
land and land development loans to 75% of the estimated developed value of the secured property.
Land Lending. The Bank originates loans for the acquisition of land upon which the purchaser can then build or make
improvements necessary to build or to use for recreational purposes. At September 30, 2020, land loans totaled $25.57 million,
or 2.3%, of the Bank’s total loan portfolio. Land loans originated by the Bank generally have maturities of one to ten
years. The largest land loan is secured by land in Clark County, had an outstanding balance of $1.70 million and was
performing according to its repayment terms at September 30, 2020. At September 30, 2020, three land loans totaling $394,000
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 may have 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, 2020, consumer loans amounted to $35.65
million, or 3.1%, of the Bank's total loan portfolio.
At September 30, 2020, the largest component of the consumer loan portfolio consisted of second mortgage loans and
home equity lines of credit, which totaled $32.08 million, or 2.8%, 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 90% 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. 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, 2020, seven consumer loans
totaling $564,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”
Commercial Business Lending. Commercial business loans (excluding SBA PPP loans) totaled $69.54 million, or
6.1%, of the loan portfolio at September 30, 2020. Commercial business loans are generally secured by business equipment,
accounts receivable, inventory 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 $2.33 million at September 30, 2020
and was performing according to its repayment terms. At September 30, 2020, six commercial business loans totaling $430,000
were on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”
The Bank has 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
12
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 for up to 85% of the loan. Typical maturities for this type of loan vary
but can be 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 $1.50
million.
Within Timberland's commercial business loan portfolio are restaurant loans totaling $16.82 million at September 30,
2020 that were originated in conjunction with a third party firm. As additional security for these loans, the Company holds cash
collateral of 25% of the outstanding loan balance. Unless prior arrangements are made, and the Company consents, loans
falling more than four weeks delinquent are eligible for purchase in accordance with a Marketing and Servicing Agreement in
existence since March 6, 2014. As an accommodation, the Company has agreed to temporarily extend the purchase
requirement to 12 weeks before a purchase is required from the loan portfolio.
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.
SBA PPP Lending. The CARES Act authorized the SBA to temporarily guarantee loans under a new loan program
called the Paycheck Protection Program. As a qualified SBA lender, the Company was automatically authorized to originate
PPP loans upon commencement of the program in April 2020 through its conclusion on August 8, 2020. PPP loans have: (a) an
interest rate of 1.0%, (b) a two-year loan term to maturity for loans approved by the SBA prior to June 5, 2020 and a five-year
maturity for loans approved thereafter, and (c) principal and interest payments deferred for at least six months from the date of
disbursement. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the
borrower's PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA. SBA PPP loans totaled
$126.82 million, or 11.2% of the loan portfolio at September 30, 2020. The largest SBA PPP loan had an outstanding balance
of $4.56 million at September 30, 2020.
Loan Maturity. The following table sets forth certain information at September 30, 2020 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.
13
After
1 Year
Through
3 Years
Within
1 Year
After
After
5 Years
3 Years
Through
Through
10 Years
5 Years
(Dollars in thousands)
After
10 Years
Total
643 $
276
22,599
219,496
14,427
3,679 $
6,282
37,062
—
5,162
10,970 $
9,194
49,491
—
3,112
37,788 $
59,801
334,000
—
1,823
65,500 $ 118,580
85,053
9,500
453,574
10,422
219,496
—
25,571
1,047
4,910
998
10,805
—
5,216
239
23,079
120,898
$ 274,154 $ 201,617 $
4,030
296
7,178
5,922
90,193 $ 469,304 $
10,949
640
24,303
—
6,972
1,399
4,175
—
99,015
32,077
3,572
69,540
126,820
1,134,283
(100,558)
(6,436)
(13,414)
$ 1,013,875
$
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction (1)
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business
SBA PPP
Total
Less:
Undisbursed portion of
construction loans in process
Deferred loan origination fees, net
Allowance for loan losses
Total loans receivable, net
_____________
(1)
loans once construction is completed.
Includes $129.57 million of construction/permanent loans, a portion of which may convert to permanent mortgage
The following table sets forth the dollar amount of all loans due after one year from September 30, 2020, 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
SBA PPP
Total
Fixed
Rates
Floating or
Adjustable
Rates
(Dollars in thousands)
Total
$
37,786 $
6,468
107,843
7,257
80,151 $ 117,937
84,777
78,309
430,975
323,132
11,144
3,887
7,474
1,429
24,020
126,820
27,167
2,574
58,735
126,820
$ 319,097 $ 541,032 $ 860,129
19,693
1,145
34,715
—
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
14
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, a commercial underwriter,
and two Senior Vice Presidents of Commercial Lending, may approve commercial real estate loans and commercial business
loans up to and including $3.00 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 $5.00
million. Loans in excess of $5.00 million, as well as loans of any amount granted to a single borrower whose aggregate loans
exceed $5.00 million, must be approved by the Bank’s Board of Directors.
Loan Originations, Purchases and Sales. During the years ended September 30, 2020, 2019 and 2018, the Bank’s
total gross loan originations were $597.19 million, $356.04 million and $329.59 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, 2020, the Bank did not purchase any loan participation interests. During the years ended September 30, 2019
and 2018, the Bank purchased loan participation interests of $8.66 million and $8.40 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 some of its SBA 7(a) loans in the secondary market during the year ended
September 30, 2016. Loans sold in the secondary market are generally sold on a servicing retained basis. At September 30,
2020, the Bank’s loan servicing portfolio, which is not included in the Company’s consolidated financial statements, totaled
$426.58 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, 2020, 2019 and
2018, the Bank sold loan participation interests of $6.26 million, $5.43 million and $253,000, respectively.
15
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
SBA PPP loans
Total loans originated
Loans acquired in the South Sound Acquisition (net of fair value discount)
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction
Consumer
Commercial business loans
Total loans acquired
Loans and loan participations purchased:
Mortgage loans:
Commercial
Construction
Commercial business
Total loans purchased
Total loans originated, acquired 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
2020
Year Ended September 30,
2019
(Dollars in thousands)
2018
$ 172,838 $
12,237
74,927
158,366
4,955
19,259
27,071
127,535
597,188
91,669 $
12,503
48,040
160,693
9,540
20,999
12,591
—
356,035
81,313
10,362
68,443
125,683
16,300
20,151
7,339
—
329,591
—
—
—
—
—
—
—
—
—
—
—
597,188
10,190
7,807
64,967
11,730
3,918
22,932
121,544
2,946
5,717
—
8,663
486,242
—
—
—
—
—
—
—
—
7,548
855
8,403
337,994
(6,255)
(160,987)
(167,242)
(5,431)
(67,600)
(73,031)
(253)
(66,131)
(66,384)
(287,039)
(15,694)
(241,656)
(10,284)
$ 127,213 $ 161,271 $
(235,609)
(974)
35,027
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 (excluding SBA PPP loans) is generally up to 2.0% of the loan amount. In addition to the 1.0%
interest earned on SBA PPP loans, the SBA pays bank fees for processing PPP loans in the following amounts: (i) five percent
of loans of not more than $350,000; (ii) three percent for loans more than $350,000 and less than $2,000,000; and (iii) one
percent of loans of at least $2,000,000. Banks may not collect any fees from the SBA PPP loan applicants.
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 $6.44 million (including $3.72 million for SBA PPP loans)
at September 30, 2020.
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
16
a required payment when due, the Bank institutes collection procedures. A notice is mailed to the borrower 16 days after the
date the payment is due. Attempts to contact the borrower by telephone generally begin on or before the 30th day of
delinquency. If a satisfactory response is not obtained, continuous follow-up contacts are attempted until the loan has been
brought current. Before the 90th day of delinquency, attempts are made to establish (i) the cause of the delinquency, (ii)
whether the cause is temporary, (iii) the attitude of the borrower toward 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 updated 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.
In late March 2020, the Bank announced loan modification programs to support and provide relief for its borrowers
during the COVID-19 pandemic. Loans subject to payment forbearance under the Bank's COVID-19 loan modification
program are not reported as delinquent during the forbearance time period. For additional information, see "COVID-19 Loan
Modifications" below.
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)
Commercial
Construction
Land
Consumer loans
Commercial business loans
Total
Accruing loans which are contractually past due 90
days or more
Total of non-accrual and 90 days or more past due loans
Non-accrual investment securities
Other real estate owned and other repossessed assets (2)
Total non-performing assets (3)
Troubled debt restructured loans on accrual status (4)
Non-accrual and 90 days or more past due loans as a
percentage of loans receivable, net (5)
Non-accrual and 90 days or more past due loans as a
percentage of total assets
Non-performing assets as a percentage of total assets
2020
2019
At September 30,
2018
(Dollars in thousands)
2017
2016
$
$
$
659
858
—
394
564
430
2,905
—
2,905
209
1,050
4,164
2,868
$
$
$
699
779
—
204
626
725
3,033
—
3,033
294
1,683
5,010
2,903
$
$
$
545
—
—
243
359
170
1,317
—
1,317
406
1,913
3,636
2,955
$
$
$
874
213
—
566
258
—
1,911
—
1,911
533
3,301
5,745
3,342
$
$
$
914
612
367
548
432
—
2,873
135
3,008
734
4,117
7,859
7,629
0.28%
0.34%
0.18%
0.27%
0.45%
0.19%
0.27%
0.24%
0.13%
0.20%
0.34%
0.40%
0.36%
0.60%
0.88%
Loans receivable, net (5)
Total assets
$ 1,027,289
$ 1,565,978
$ 896,352
$ 1,247,132
$ 734,921
$ 1,018,290
$ 699,917
$ 952,024
$ 672,972
$ 891,388
17
_______________
(1)
Includes non-accrual one- to four-family properties in the process of foreclosure totaling $0, $150,
$0, $100 and $138 as of September 30, 2020, 2019, 2018, 2017 and 2016, respectively.
Includes foreclosed residential real estate property totaling $0, $0, $0, $875 and $1,071
as of September 30, 2020, 2019, 2018, 2017 and 2016, respectively.
Does not include troubled debt restructured loans on accrual status.
Does not include troubled debt restructured loans totaling $203, $366, $323, $253 and $531
recorded as non-accrual loans as of September 30, 2020, 2019, 2018, 2017 and 2016, 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 $128,000 to $2.91 million at September 30, 2020 from $3.03 million at
September 30, 2019, primarily as a result of a $295,000 decrease in commercial business loans, a $62,000 decrease in consumer
loans, and a $40,000 decrease in one- to four-family mortgage loans, on non-accrual status. These decreases were partially
offset by a $190,000 increase in land loans and a $79,000 increase on commercial real estate loans 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, 2020 had non-accruing
loans been current in accordance with their original terms totaled $574,000.
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, 2020, the Bank had
$1.05 million of OREO and other repossessed assets, a decrease of $633,000 from $1.68 million at September 30, 2019. The
OREO properties consisted of six land parcels totaling $1.05 million at September 30, 2020. The largest OREO property at
September 30, 2020 was an undeveloped land parcel with a balance of $702,000 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 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 either accrual or non-accrual. TDRs 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 TDRs at September 30, 2020 and 2019 totaling $3.07 million and $3.27 million, respectively, of which
$203,000 and $366,000, respectively, were on non-accrual status. The allowance for loan losses allocated to TDR loans at
September 30, 2020 and 2019 was $3,000 and $56,000, respectively. As previously noted, in late March 2020, the Bank
announced COVID-19 loan modification programs to support and provide relief for its borrowers during the COVID-19
pandemic. The Company has followed the CARES Act and interagency guidance from the federal banking agencies when
determining if a borrower's modification is subject to TDR classification. See "COVID-19 Loan Modifications" below.
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.
18
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, the amount past due and the number of days past due. At September 30, 2020, the Bank had $5.77 million in impaired
loans. For additional information on impaired loans, see Note 5 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 $6.61 million at September 30, 2020. The vast majority of these loans are collateralized by real estate. See
“Asset Classification” below for additional information regarding the Bank's problem loans.
COVID-19 Loan Modifications. The CARES Act provided guidance around the modification of loans as a result of
the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to
borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term
modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are
insignificant. Borrowers are considered current under the CARES Act and related regulatory guidance if they are less than 30
days past due on their contractual payments at the time a modification program is implemented. During the year ended
September 30, 2020, the Company made COVID-19 pandemic related modifications on 212 loans aggregating to $136.36
million. The majority of these borrowers had resumed making payments as of September 30, 2020 and only five loans totaling
$5.87 million remained on deferral status as of that date. Loan modifications in accordance with the CARES Act and related
regulatory guidance are still subject to an evaluation in regard to determining whether or not a loan is deemed to be impaired.
See Note 1 and Note 5 of the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form
10-K for additional information.
The following table sets forth the information with respect to loans still on COVID-19 modification status as of
September 30, 2020 (dollars in thousands):
COVID-19 Loan Modifications
Mortgage loans
One- to four-family
Commercial
Construction - commercial
Total mortgage loans
Consumer loans
Home equity and second mortgage
Total consumer loans
Total COVID-19 modifications
Number
Balance
Percent
1
2
1
4
1
1
5
$
$
467
3,951
1,402
5,820
50
50
5,870
8.0%
67.2
23.9
99.1
0.9
0.9
100.0%
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
19
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 the
allowance 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
2020
At September 30,
2019
(Dollars in thousands)
— $
— $
—
—
5,320
3,649
2,547
5,864
2018
—
—
3,182
3,123
9,513 $
7,867 $
6,305
13,414 $
9,690 $
9,530
$
$
$
_____________
(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 $1.67 million to $3.65 million at September 30, 2020 from $5.32 million
at September 30, 2019. At September 30, 2020, 33 loans were classified as substandard. Of the $3.65 million in loans
classified as substandard at September 30, 2020, $2.91 million were on non-accrual status. The largest loan classified as
substandard at September 30, 2020 had a balance of $391,000 and was secured by a commercial real estate property in Grays
Harbor County and equipment. This loan was on non-accrual status at September 30, 2020. The next largest loan classified as
substandard at September 30, 2020 had a balance of $346,000 and was secured by a single family home in Pierce County. This
loan was performing according to its payment terms at September 30, 2020.
Loans classified as special mention increased by $3.32 million to $5.86 million at September 30, 2020 from $2.55
million at September 30, 2019, primarily as a result of two participation loans being downgraded to special mention status. At
September 30, 2020, nine loans were classified as special mention. The largest loan classified as special mention at September
30, 2020 had a balance of $2.88 million and was secured by a hotel in Clackamas County, Oregon. The next largest loan
classified as special mention at September 30, 2020 had a balance of $1.40 million and was secured by the same hotel in
Clackamas County, Oregon. Both of these loans were subject to COVID-19 related loan modification agreements at September
30, 2020.
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. When determining
the appropriate loss factors in fiscal 2020, management took into consideration the impact of the COVID-19 pandemic on such
factors as the national and state unemployment rates and related trends, the amount of and timing of financial assistance
provided by the government, consumer spending levels and trends, industries significantly impacted by the COVID-19
pandemic, and the Bank's COVID-19 loan modification program.
20
Based on this review, management increased the qualitative factors for all loan categories due to deterioration of
economic conditions as a result of the COVID-19 pandemic. The increase in factors resulted in an increase in the allowance for
loan losses during the current fiscal year. Management will continue to closely monitor economic conditions and will work
with borrowers as necessary to assist them through this challenging economic climate. If economic conditions worsen or do
not improve in the near term, and if future government programs, if any, do not provide adequate relief to borrowers, it is
possible the Bank's allowance for loan losses will need to increase in future periods.
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, 2020, the Bank’s allowance for loan losses totaled $13.41 million. The Bank’s allowance for loan
losses as a percentage of total loans receivable and non-performing loans was 1.31% and 461.76%, respectively, at
September 30, 2020 and 1.08% and 319.49%, respectively, at September 30, 2019. The increase in the allowance for loan
losses during the year ended September 30, 2020 was primarily due to the deteriorating economic conditions and probable loan
losses driven by the impact of the COVID-19 pandemic on the U.S. and global economies. The $126.82 million balance of
SBA PPP loans was omitted from the allowance for loan loss calculation at September 30, 2020 as these loans are fully
guaranteed by the SBA and management expects that the great majority of PPP borrowers will seek full or partial forgiveness of
their loan obligations from the SBA within a short time frame, which will in turn reimburse the Bank for the amount forgiven.
In accordance with GAAP, loans acquired in the South Sound Acquisition were recorded at their estimated fair value,
which resulted in a net discount to the loan's contractual amount, of which a portion reflects a discount for possible credit
losses. Credit discounts are included in the determination of fair value and as a result no allowance for loans losses is recorded
for acquired loans at the acquisition date. The discount recorded on acquired loans is not reflected in the allowance for loan
losses or the related allowance coverage ratios, however we believe it should be considered when comparing the current ratios
to similar ratios in periods prior to the South Sound Acquisition. The remaining fair value discount on loans acquired in the
South Sound Acquisition was $790,000 at September 30, 2020.
Based on its comprehensive analysis, 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. A further decline in national and local economic conditions, as a result
of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses which may
adversely affect the Company's financial condition and results of operations.
21
The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated:
Allowance at beginning of year
Provision for (recapture of) loan losses
$ 9,690
3,700
$
2020
2019
Year Ended September 30,
2018
(Dollars in thousands)
9,553
$
—
$
9,530
—
2017
9,826
(1,250)
Recoveries:
Mortgage loans:
One- to four-family
Multi-family
Commercial
Construction - custom and owner/builder
Construction - speculative one- to four-family
Construction - multi-family
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total recoveries
Charge-offs:
Mortgage loans:
One- to four-family
Commercial
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total charge-offs
Net recoveries (charge-offs)
2
—
6
5
—
—
20
15
3
—
51
—
—
—
—
(12)
(15)
(27)
24
104
—
166
2
—
—
18
—
6
25
321
—
—
(49)
(5)
(5)
(102)
(161)
160
—
—
—
—
13
—
19
—
1
—
33
—
(28)
(22)
—
(6)
—
(56)
(23)
21
—
1,061
—
6
—
19
—
3
—
1,110
—
(13)
(110)
—
(10)
—
(133)
977
2016
$
9,924
—
56
—
—
—
2
181
24
—
2
5
270
(72)
(209)
(61)
(18)
(8)
—
(368)
(98)
Allowance at end of year
$ 13,414
$
9,690
$
9,530
$
9,553
$
9,826
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
1.31%
1.08%
1.30%
1.36%
1.46%
—%
0.02%
—%
0.14%
(0.02) %
461.76%
319.49%
723.61%
499.90%
326.66%
______________
(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.
22
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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
investments in debt 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.
Investments in equity securities are stated at fair value. Prior to October 1, 2018, changes in the fair value of
investments in equity securities were excluded from earnings and reported in other comprehensive income (loss), net of income
tax effects. On October 1, 2018, the Company adopted ASU 2016-01 and reclassified its mutual funds as investments in equity
securities. Beginning October 1, 2018, changes in the fair value of investments in equity securities are recorded in other non-
interest income.
At September 30, 2020, the Bank’s portfolio of investments in debt securities totaled $85.80 million, consisting of
$27.39 million of mortgage-backed securities held to maturity, $500,000 bank issued trust preferred securities held to maturity
and $57.91 million 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 $53.63 million at September 30, 2019, consisting of $3.00
million of U.S. Treasury and U.S. government agency securities held to maturity, $28.10 million of mortgage-backed securities
held to maturity, and $22.53 million of mortgage-backed securities available for sale. The composition of the portfolios by type
of security at the dates indicated is presented in the following table:
2020
Recorded
Amount
Percent of
Total
At September 30,
2019
Percent of
Recorded
Amount
Total
(Dollars in thousands)
2018
Recorded
Amount
Percent of
Total
Held to Maturity:
U.S.Treasury and U.S.
government agency securities
$
Mortgage-backed securities
Bank issued trust preferred
securities
Available for Sale:
—
27,390
—% $
31.93
2,999
28,103
5.59% $
52.40
10,965
1,845
78.52%
13.21
500
0.58
—
—
—
—
Mortgage-backed securities
Mutual funds
57,907
—
67.49
—
22,532
—
42.01
—
237
917
1.70
6.57
Total portfolio
$
85,797
100.00% $
53,634
100.00% $
13,964
100.00%
The following table sets forth the maturities and weighted average yields of the debt securities in the Bank's portfolio
at September 30, 2020.
One Year or Less
After One to
Five Years
After Five to
Ten Years
After Ten
Years
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
(Dollars in thousands)
Held to Maturity:
Mortgage-backed
securities
Bank issued trust
preferred securities
Available for Sale:
Mortgage-backed
securities
Total portfolio
$
—
—
$
$
830
830
—% $
126
3.30% $ 6,657
3.17% $ 20,607
2.94%
—
—
—
500
4.75
—
—
1.12
3,261
1.78
18,491
0.57
35,325
0.61
1.12% $ 3,387
1.84% $ 25,648
1.32% $ 55,932
1.47%
24
There were no securities which had an aggregate book value in excess of 10% of the Bank’s total equity at
September 30, 2020. At September 30, 2020, the Bank had $229,000 of private label mortgage-backed securities in the held to
maturity investment securities portfolio of which $209,000 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 4 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 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 generally
permissible in Washington State to handle accounts associated with this industry in compliance with federal regulatory
guidelines. At September 30, 2020, the Bank had $34.68 million, or 2.6% of total deposits, from businesses associated with the
marijuana industry. See "Item 1A. 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, 2020, the Bank had $28.95 million of jumbo certificates of deposit of $250,000 or more. The Bank
had $11.30 million in brokered reciprocal money market deposits at September 30, 2020. The Bank believes that its jumbo
certificates of deposit, which represented 2.1% of total deposits at September 30, 2020, 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, 2020:
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
Total certificates of deposit
Total deposits
______________________
(1)
Based on remaining maturity of certificates.
Percentage
of Total
Amount
Deposits
(Dollars in thousands)
$ 441,889
376,899
219,869
161,225
1,199,882
32.53%
27.75
16.18
11.87
88.33
102,862
29,355
26,307
158,524
$ 1,358,406
7.57
2.16
1.94
11.67
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, 2020. Jumbo certificates of deposit have principal balances of $250,000 or more, and the rates paid on
these accounts are generally negotiable.
25
Maturity Period
Three months or less
Over three through six months
Over six through twelve months
Over twelve months
Total
Amount
(Dollars in thousands)
5,502
$
8,657
4,652
10,134
28,945
$
Deposit Flow. The following table sets forth the balances of deposits in the various types of accounts offered by the
Bank at the dates indicated:
At September 30,
2020
Percent
of
Total
Increase
(Decrease)
Amount
2019
Percent
of
Total
Increase
(Decrease)
Amount
2018
Percent
of
Total
(Dollars in thousands)
32.53% $ 145,417 $ 296,472
297,055
79,844
27.75
164,506
55,363
16.18
144,539
16,686
11.87
27.75% $
27.81
15.40
13.53
63,214 $ 233,258
225,290
71,765
151,404
13,102
137,746
6,793
26.22%
25.33
17.02
15.49
Amount
$ 441,889
376,899
219,869
161,225
Non-interest-bearing demand
NOW checking
Savings
Money market
Certificates of deposit which
mature:
Within 1 year
After 1 year, but within 2 years
102,862
29,355
After 2 years, but within 5
years
26,307
7.57
2.16
1.94
10,596
(9,369)
92,266
38,724
(8,358)
34,665
8.64
3.63
3.24
16,109
6,720
76,157
32,004
1,018
33,647
8.56
3.60
3.78
Total
$ 1,358,406
100.00% $ 290,179 $ 1,068,227
100.00% $ 178,721 $ 889,506
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
$
$
2020
At September 30,
2019
(Dollars in thousands)
82,953 $
78,274
4,428
165,655 $
99,150 $
59,114
260
158,524 $
2018
108,527
33,016
265
141,808
Certificates of Deposit by Maturities. The following table sets forth the amount and maturities of certificates of
deposit by rate at September 30, 2020:
Amount Due
Less Than
One Year
One to
Two
Years
After
Five Years
Total
After
Two to
Five
Years
(Dollars in thousands)
9,783 $
16,264
260
26,307 $
18,988 $
10,367
—
29,355 $
— $
—
—
— $
99,150
59,114
260
158,524
0.00 - 1.99%
2.00 - 3.99%
4.00 - 5.99%
Total
$
$
70,379 $
32,483
—
102,862 $
26
Deposit Activities. The following table sets forth the deposit activities of the Bank for the periods indicated:
Beginning balance
Deposits acquired in South Sound Acquisition
Net deposits before interest credited
Interest credited
Net increase in deposits
Ending balance
2020
2018
Year Ended September 30,
2019
(Dollars in thousands)
$ 1,068,227 $ 889,506 $ 837,898
—
48,830
2,778
51,608
$ 1,358,406 $ 1,068,227 $ 889,506
151,538
22,618
4,565
178,721
—
285,544
4,635
290,179
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,
2020, the Bank maintained an uncommitted credit facility with the FHLB that provided for immediately available borrowings
up to an aggregate amount to 45% of the Bank’s total assets, limited by available collateral, under which $10.0 million in
borrowings were outstanding. The Bank maintains a short-term borrowing line of credit with the FRB with total credit based
on eligible collateral. At September 30, 2020, the Bank had no outstanding balance and $71.90 million in unused borrowing
capacity on this borrowing line of credit. A short-term borrowing line of credit of $50.00 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, 2020.
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
At or For the
Year Ended September 30,
2019
(Dollars in thousands)
$ —
2020
$ 5,685
2018
$ —
Weighted average rate paid on total borrowings
1.16%
—%
—%
Total borrowings outstanding at end of period
$ 10,000
$ —
$ —
________________________
The Bank did not have any short-term borrowings for the years ended September 30, 2020, 2019 and 2018.
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, 2020, the cash surrender value of bank owned life
insurance (“BOLI”) was $21.60 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 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
27
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 Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act") established the Consumer Financial Protection
Bureau ("CFPB") as an independent bureau of the Federal Reserve with responsibility for the implementation of federal
financial consumer protection and fair lending laws and regulations. The Bank is subject to consumer protection regulations
issued by the CFPB, but as a smaller financial institution, is generally subject to supervision and enforcement by the FDIC and
DFI with respect to its compliance with federal and state consumer financial protection laws and regulations.
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 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.
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 deposit ownership right or category. 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, 2020 were $204,000.
Under the FDIC's system for assessing insurance premiums, insured institutions that do not have assets of $10 billion
are assessed based on CAMELS component ratings and certain financial ratios. For these institutions, total base assessment
rates range from 3 to 30 basis points, subject to adjustment. Stronger institutions pay lower rates, while riskier institutions pay
higher rates. Assessments are applied to an institution's assessment base, which is its average consolidated total assets minus
average tangible equity. 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.
A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results
of operations of the Bank.
Capital Requirements. Federally insured financial institutions, such as the Bank, are required to maintain a minimum
level of regulatory capital.
The Bank is subject to capital regulations adopted by the FDIC, which establish minimum required ratios for common
equity Tier 1 ("CET1"), leverage and Tier 1 capital ratios, and require an additional capital conservation buffer over the
required minimum capital ratios, and defines what qualifies as capital for purposes of meeting the capital requirements. The
28
Federal Reserve has 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 capital regulations, the required minimum capital level ratios 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 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. The leverage ratio is the ratio of Tier 1 capital to average
consolidated assets as reported on Call Reports, minus certain items deducted from Tier 1 capital. To be considered "well
capitalized," a depository institution must have a (i) a total risk-based capital ratio of 10.0% or more, (ii) a CET1 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.
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 risk-based capital ratios in order
to avoid limitations on paying dividends, repurchasing shares and paying certain discretionary bonuses. At September 30,
2020, the Bank met the requirements to be "well capitalized" and the Bank's CET1 capital exceeded the required conservation
buffer.
The following table compares the Bank's actual capital amounts at September 30, 2020 to its minimum regulatory
capital requirements at that date (Dollars in thousands):
Actual
Regulatory Minimum To
Be "Adequately
Capitalized
Amount
Ratio
Amount
Ratio
Regulatory Minimum To
Be "Well Capitalized"
Under Prompt Corrective
Action Provisions
Ratio
Amount
$ 168,937
11.1%
$ 60,993
4.0% $
76,241
5.0%
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
CET1 capital
168,937
19.7
38,504
Tier 1 capital
168,937
19.7
51,339
Total capital
179,671
21.0
68,452
4.5
6.0
8.0
55,618
68,452
6.5
8.0
85,566
10.0
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 18 of the Notes to the
Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
In September 2019, the FDIC and other federal banking agencies adopted a final rule, effective January 1, 2020,
creating a community bank leverage ratio ("CBLR") for institutions that have total consolidated assets of $10 billion or less and
meet other qualifying criteria. The CBLR provides a simple measure of capital adequacy for qualifying institutions. Qualifying
institutions that elect to use the CBLR framework and that maintain a leverage capital ratio of greater than 9% will be
considered to have satisfied the general applicable risk-based and leverage capital requirements in the regulatory agencies'
capital rules and to have met the well-capitalized ratio requirements. The Bank has not elected to use the CBLR framework as
of September 30, 2020.
The Financial Accounting Standards Board has adopted a new accounting standard for GAAP that will be effective for
us for our first fiscal year beginning after December 15, 2022. This standard, referred to as Current Expected Credit Loss, or
CECL, requires FDIC-insured institutions and their holding companies (banking organizations) to recognize credit losses
29
expected over the life of certain financial assets. CECL covers a broader range of assets than the current method of recognizing
credit losses and generally results in earlier recognition of credit losses. Upon adoption of CECL, a banking organization must
record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the
difference, if any, between the amount of credit loss allowances under the current methodology and the amount required under
CECL. For a banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect other
items, in a manner that reduces its regulatory capital.
The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC) have
adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of
CECL on its regulatory capital.
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.
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, 2020, 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" above and Note 18 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. The FHLB 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 based on the Bank's asset size and
level of borrowings from the FHLB. At September 30, 2020, the Bank had $1.92 million in FHLB stock, which was in
compliance with this requirement. The FHLB pays dividends quarterly, and the Bank received $52,000 in dividends during the
year ended September 30, 2020.
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
30
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, 2020, the Bank’s aggregate loans in excess of the supervisory
loan-to-value ratios were 0.3% of total capital and the Bank's loans on commercial, agricultural, multi-family or other non-one-
to four-family residential properties in excess of the supervisory loan-to-value ratios were 0.1% of total capital.
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
"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. In response to the COVID-19 pandemic, the Federal
Reserve reduced the reserve requirement ratios to zero percent effective on March 26, 2020, to support lending to households
and businesses. At September 30, 2020, the Bank was in compliance with the reserve requirements in place at that time.
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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 between a bank and its affiliates listed in Section 23B of
the Federal Reserve Act and related regulations must 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 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.
32
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. The Dodd-Frank Act
essentially codified this policy.
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. 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. 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. The Federal Reserve much approve the acquisition (or acquisition of control) of a bank or other FDIC-
insured depository institution by a bank holding company, and the appropriate federal banking regulator must approve a bank's
acquisition (or acquisition of control) of another bank or other FDIC-insured institution.
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 are also generally subject to the nationwide and statewide insured
deposit concentration amounts described above.
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.
33
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 $3.00 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 $3.00 billion or more in assets, at
September 30, 2020, the Company would have exceeded all regulatory requirements.
The following table presents the regulatory capital ratios for the Company as of September 30, 2020 (Dollars in
thousands):
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
CET1 capital
Tier 1 capital
Total capital
Actual
Amount
Ratio
$
172,000
11.3%
172,000
172,000
182,805
20.1
20.1
21.3
For additional information see Note 18 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. Among other requirements, 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.
2018 Regulatory Reform. In May 2018 the Economic Growth, Regulatory Relief and Consumer Protection Act (the
“2018 Act”), was enacted to modify or remove certain financial reform rules and regulations, including some of those
implemented under the Dodd-Frank Act. While the 2018 Act maintains most of the regulatory structure established by the
Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than
$10 billion and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful
regulatory changes for community banks such as the Bank, and their holding companies.
The 2018 Act, among other matters, expands the definition of qualified mortgages which may be held by a financial
institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total
consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single CBLR of between
8 and 10 percent, as described above. Any qualifying depository institution or its holding company that exceeds the CBLR will
be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying
depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action
rules.
34
The 2018 Act also expands the category of holding companies that may rely on the “Small Bank Holding Company
and Savings and Loan Holding Company Policy Statement” by raising the maximum amount of assets a qualifying holding
company may have from $1 billion to $3 billion. A major effect of this change is to exclude such holding companies from the
minimum capital requirements of the Dodd-Frank Act. In addition, the 2018 Act includes regulatory relief for community
banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage
disclosures and risk weights for certain high-risk commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the 2018 Act will ultimately be applied to us
or what specific impact the 2018 Act and the yet-to-be-written implementing rules and regulations will have on community
banks.
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.
On December 22, 2017, the U.S. Government enacted comprehensive tax legislation commonly referred to as the Tax
Cuts and Jobs Act (the “Tax Act”). The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies,
credits, and deductions for individuals and businesses. For businesses, the Tax Act reduced the corporate federal income tax
rate from a maximum of 35.0% to a flat 21.0%. The corporate federal income tax rate reduction was effective January 1, 2018.
Since the Company has a fiscal year end of September 30, the reduced federal corporate income tax rate for fiscal year 2018
was the result of the application of a blended federal statutory tax rate of 24.5%, which was based on the applicable tax rates
before and after the Tax Act and corresponding number of days in the fiscal year before and after enactment, and then a 21.0%
federal corporate income tax rate for fiscal 2019 and thereafter. The Tax Act also required a revaluation of the Company’s
deferred tax assets and liabilities to account for the future impact of lower corporate income tax rates and other provisions of the
legislation. As a result of the Company’s revaluation, the net deferred tax asset (“DTA”) was reduced through an increase to
the provision for income taxes. The revaluation of the DTA balance resulted in a one-time increase for the fiscal year ended
September 30, 2018 to federal income tax of $548,000. For additional details see Note 14 of the Notes to Consolidated
Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
Dividends-Received Deduction. The Company may exclude from its income 100.0% of dividends received from the
Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70.0%
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 20.0% of the stock of a corporation distributing
a dividend, then 80.0% 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, 2016.
Washington Taxation
The Company and the Bank are subject to a business and occupation tax imposed under Washington law at the rate of
1.8% of gross receipts at September 30, 2020. 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, thrift
35
institutions and credit unions. 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.
Employees and Human Capital Resources
As of September 30, 2020, the Company had 267 full-time employees and 19 part-time and on-call employees. The
employees are not represented by a collective bargaining unit, and the Company believes its relationship with its employees is
good. We believe our ability to attract and retain employees is a key to our success. Accordingly, we strive to offer
competitive salaries and employee benefits to all employees and monitor salaries in our market areas.
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, 2020
66
53
69
46
63
51
Company
Bank
Position
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 Credit Administrator
Senior Vice President and
Treasurer
Executive Vice President and
Chief Operating Officer
Executive Vice President and
Chief Credit Administrator
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.
36
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 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.
Risks Related to the COVID-19 Pandemic and Associated Economic Slowdown
The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our
financial results and those of our customers. The ultimate impact will depend on future developments, which are highly
uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental
authorities in response to the pandemic.
The COVID-19 pandemic has significantly adversely affected our operations and the way we provide banking services
to businesses and individuals, many of whom are currently under some level of government restrictions. As an essential
business, we continue to provide banking and financial services to our customers with drive-thru access available at the
majority of our branch locations and in-person services available by appointment. We have also opened several branch lobbies
with modified access. In addition, we continue to provide access to banking and financial services through online banking,
ATMs and by telephone. If the COVID-19 pandemic worsens it could limit or disrupt our ability to provide banking and
financial services to our customers.
A number of our employees currently are working remotely to enable us to continue to provide banking services to our
customers. Heightened cybersecurity, information security and operational risks may result from these remote work-from-
home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become
unavailable due to the effects and restrictions of the COVID-19 pandemic. We also rely upon our third-party vendors to
conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us
with these services, it could negatively impact our ability to serve our customers. Although we have business continuity plans
and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years
following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of
uncertainty in estimating the impact of the pandemic on credit quality, revenues and asset values. To date, the COVID-19
pandemic has resulted in changes in the demand for certain loan types, including government sponsored programs such as the
Paycheck Protection Program ("PPP") through August 2020, deposit availability, market interest rates and negatively impacted
many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and
the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including a
continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest
margin will be adversely affected. Many of our borrowers have become unemployed or may face unemployment, and certain
businesses are at risk of insolvency as their revenues decline precipitously, especially in businesses related to travel, hospitality,
leisure and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty
37
regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the
speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms
that will take place.
The impact of the pandemic is expected to continue to adversely affect us during the 2021 fiscal year and possibly
longer as the ability of many of our customers to make loan payments has been significantly affected. Although the Company
makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates
involve significant judgment and are made in the context of significant uncertainty as to the impact the pandemic will have on
the credit quality of our loan portfolio. Consistent with guidance provided by banking regulators, we have modified loans by
providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic. Notwithstanding these
modifications, not all of these borrowers may be able to resume making full payments on their loans once the COVID-19
pandemic is resolved. Any increases in the allowance for credit losses will result in a decrease in net income and, most likely,
capital, and may have a material negative effect on our financial condition and results of operations.
As of September 30, 2020, we hold and service SBA PPP loans with an aggregate balance of $126.82 million. These
SBA PPP loans are subject to the provisions of the CARES Act and to complex and evolving rules and guidance issued by the
SBA and other government agencies. We expect that the great majority of our SBA PPP borrowers will seek full or partial
forgiveness of their loan obligations. We have credit risk on SBA PPP loans if the SBA determines that there is a deficiency in
the manner in which we originated, funded or serviced loans, including any issue with the eligibility of a borrower to receive a
SBA PPP loan. We could face additional risks in our administrative capabilities to service our SBA PPP loans, and risk with
respect to the determination of loan forgiveness, depending on the final procedures for determining loan forgiveness. In the
event of a loss resulting from a default on a SBA PPP loan and a determination by the SBA that there was a deficiency in the
manner in which we originated, funded or serviced a SBA PPP loan, the SBA may deny its liability under the guaranty, reduce
the amount of the guaranty or, if the SBA has already paid under the guaranty, seek recovery of any loss related to the
deficiency from us.
In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the
purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or
the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather
than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment
charge could have a material adverse effect on our results of operations and financial condition.
We are an entity separate and distinct from our principal subsidiary, Timberland Bank, and derive substantially all of
our revenue at the holding company level in the form of dividends from that subsidiary. If the COVID-19 pandemic were to
materially adversely affect Timberland Bank’s regulatory capital levels or liquidity, it may result in Timberland Bank being
unable to pay dividends to us, which may result in our not being able to pay dividends on our common stock at the same rate or
at all.
Even after the COVID-19 pandemic subsides, the U.S. economy will likely require some time to recover from its
effects, the length of which is unknown. and during which we may experience a recession. As a result, we anticipate our
business may be materially and adversely affected during this recovery. To the extent the effects of the COVID-19 pandemic
adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening
many of the other risks described in this section.
Risks Related to Economic Conditions
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 changes in tariffs being imposed on international
trade 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;
we may increase our allowance for loan losses;
38
•
•
•
•
•
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 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. Many of the loans in our portfolio are
secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively
affect the borrower's ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by
various other factors, including changes in general or regional economic conditions, government rules or policies and natural
disasters such as fires and earthquakes. 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.
Risks Related to our Lending Activities
Our real estate construction and land 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, 2020, construction loans totaled $219.50 million, or 19.4% of our total loan portfolio, of which $178.64 million
were for residential real estate projects, $33.14 million for commercial real estate projects and $7.71 million for land
development projects. This compares to total construction loans of $223.53 million, or 22.5% of our total loan portfolio at
September 30, 2019, or a decrease of 1.8% during the past year. Approximately $129.57 million of our residential construction
loans at September 30, 2020 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 advanced 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 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, 2020, $14.59 million of our construction portfolio was comprised of speculative one- to four-family construction
loans. We also make land loans for the acquisition of land upon which the purchaser can then build or make improvements
necessary to build or to use for recreational purposes. At September 30, 2020, land loans totaled $25.71 million, or 2.3% of our
total loan portfolio. Loans on land under development or held for future construction as well as land loans made to individuals
for the future construction of a residence also pose additional risk because the length of time from financing to completion of a
39
development project is significantly longer than for a traditional construction loan, which makes them more susceptible to
declines in real estate values, declines in overall economic conditions which may delay the development of the land and
changes in the political landscape that could affect the permitted and intended use of the land being financed, and the potential
illiquid nature of the collateral. In addition, during this long period of time from financing to completion, the collateral often
does not generate any cash flow to support the debt service. At September 30, 2020, all construction loans were performing in
accordance to their terms and $394,000 of land loans were non-performing. A material increase in our non-performing
construction or land 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, 2020, we had $453.57 million of commercial real estate mortgage loans, representing 40.0% 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 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 because our
balance in commercial real estate loans (including owner-occupied loans) at September 30, 2020 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.
40
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, 2020, we had $69.54 million, or 6.1%, of total loans in commercial business loans (excluding SBA
PPP 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, 2020, $150.66 million, or 13.3%, 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.
Recessionary conditions or declines in the volume of single-family real estate and/or the sales prices as well as elevated
unemployment rates may result in higher than expected loan delinquencies or problem assets, and a decline in demand for our
products and services. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity
and damage our financial condition and business operations. Further, 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:
•
•
•
•
•
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.
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;
41
•
•
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. Management also recognizes that significant new growth in loan portfolios,
new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not
perform in a historical or projected manner and will increase the risk that our allowance may be insufficient to absorb losses
without significant additional provisions. Further, the Financial Accounting Standards Board has adopted a new accounting
standard that will be effective for our fiscal year beginning October 1, 2023. 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. We anticipate that our allowance for loan losses will increase as a
result of the implementation of CECL, however, until our evaluation is complete, the magnitude of the increase will be
unknown.
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, 2020 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 $4.16 million, or 0.27% 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 $2.87 million in loans
classified as performing troubled debt restructurings at September 30, 2020.
Risk Related to our Business Strategy
We may be adversely affected by risks associated with completed and potential acquisitions.
As part of our general growth strategy, on October 1, 2018 we completed the acquisition of South Sound Bank, a Washington-
state chartered bank, headquartered in Olympia, Washington. Although our business strategy emphasizes organic expansion,
we continue, from time to time in the ordinary course of business, to engage in preliminary discussions with potential
acquisition targets. There can be no assurance that, in the future, we will successfully identify suitable acquisition candidates,
42
complete acquisitions and successfully integrate acquired operations into our existing operations or expand into new markets.
The consummation of any future acquisitions may dilute shareholder value or may have an adverse effect upon our operating
results while the operations of the acquired business are being integrated into our operations. In addition, once integrated,
acquired operations may not achieve levels of profitability comparable to those achieved by our existing operations, or
otherwise perform as expected. Further, transaction-related expenses may adversely affect our earnings. These adverse effects
on our earnings and results of operations may have a negative impact on the value of our common stock. Acquiring banks,
bank branches or businesses involves risks commonly associated with acquisitions, including:
•
•
• We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses,
assets, and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and
financial condition may be materially negatively affected;
Higher than expected deposit attrition;
The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired
entity into our company to make the transaction economically successful. This integration process is complicated and
time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not
conducted successfully and with minimal adverse effect on the acquired business and its customers, we may not be
able to realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may
lose customers or employees of the acquired business. We may also experience greater than anticipated customer
losses even if the integration process is successful;
To the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate
goodwill. As discussed below, we are required to assess our goodwill for impairment at least annually, and any
goodwill impairment charge could have a material adverse effect on our results of operation and financial condition;
• We expect our net income will increase following an acquisition; however, we also expect our general and
administrative expenses to increase, which could result to an increase in our efficiency ratio. Ultimately, we would
expect our efficiency ratio to improve; however, if we are not successful in our integration process, this may not occur,
and our acquisition or branching activities may not be accretive to earnings in the short or long-term.
•
Risk Related to Market Interest Rates
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. After steadily increasing the target federal funds rate in 2018
and 2017, the Federal Reserve Board in 2019 decreased the target federal funds rate by 75 basis points, and in response to the
COVID-19 pandemic in March 2020, an additional 150 basis point decrease to a range of 0.00% to 0.25% as of March 31,
2020. The Federal Reserve Board could make additional changes during 2020 subject to economic conditions. If 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. economy. In addition, deflationary pressures,
while possibly lowering our operational costs, could have a significant negative effect on our borrowers, especially our business
borrowers, and the values of collateral securing loans which could negatively affect our financial performance.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities.
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. Earnings could also be adversely affected if the
interest rates received on loans and other investments decline more rapidly than the interest rates paid on deposits and other
borrowings. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to
manage interest rate risk effectively, our business, financial condition and results of operations could be materially 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
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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 or decrease in market interest rates could adversely affect our earnings. As is the case with many
financial institutions, our emphasis on increasing the development of core deposits, those deposits bearing no or a relatively low
rate of interest with no stated maturity, has resulted in our having a significant amount of these deposits bearing a relatively low
rate of interest and having a shorter duration than our assets. At September 30, 2020, we had $102.86 million in certificates of
deposit that mature within one year and $1.20 billion 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 affect 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 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. In
this regard, because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to
address its economic consequences are unknown, including the recent 150 basis point reductions in the targeted federal funds
rate, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely
affected. 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.
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 held to maturity and available for sale
investment securities are 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. There can be no assurance that the declines in market value, including as a result of the
COVID-19 pandemic, will not result in OTTI of these assets, which would lead to accounting charges that could have a
material adverse effect on our net income and capital levels.
During the year ended September 30, 2020, we recognized a $120,000 recovery of OTTI charges on private label
mortgage backed securities we hold for investment. During the year ended September 30, 2019, we recognized a $59,000
recovery of OTTI charges on private label mortgage backed securities we hold for investment. During the year ended
September 30, 2018, we recognized a $68,000 recovery of OTTI charges on private label mortgage backed securities we hold
for investment. At September 30, 2020, our remaining private label mortgage backed securities portfolio totaled $229,000 of
which $209,000 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
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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.
Risks Related to Laws and Regulations
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. Certain 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 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 marijuana businesses that are legal under state law. 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. In addition, legislation is currently pending
in Congress that would allow banks and financial institutions to serve marijuana businesses in states where it is legal without
any risk of federal prosecution. At September 30, 2020, approximately 2.6% 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.
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Risks Related to Cybersecurity, Third Parties and Technology
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.
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, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware 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. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries,
vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a
compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect
data about us, our clients and underlying transactions. Any compromise of our security 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. Although we have developed
and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber attacks and
periodically test our security, these precautions may not protect our systems from compromises or breaches of our security
measures, and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation, the
incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses,
additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could
have a material adverse effect on our business, financial condition and results of operation.
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. While the Company selects third-party vendors
carefully, it does not control their actions. If our third-party providers encounter difficulties, including those resulting from
breakdowns, or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or
higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them,
our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services
to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors
could also entail significant delay and expense. Threats to information security also exist in the processing of customer
information through various other vendors and their personnel.
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be
adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses as a result
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of third-party failures and insurance coverage may be inadequate to cover all losses, resulting from breaches, systems failures or
other disruptions. If any of our third party service providers experience financial, operational or technological difficulties, or if
there is any other disruption in our relationships with them, we may be required to 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.
The board of directors oversees the risk management process, including the risk of cybersecurity, and engages with
management on cybersecurity issues.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which may
result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customers'
information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation. Such
fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and
other dishonest acts. 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.
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.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day
operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the
contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the
contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial
condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our
operations, which in turn could have a material negative impact on our financial condition and results of operations. We also
could be adversely affected to the extent such an agreement is not renewed by a third party vendor or is renewed on terms less
favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our
vendors' performance, including aspects which they delegate to third parties. Disruptions or failures in the physical
infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the
networks, systems or devices that our customers use to access our products and services could result in client attrition,
regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional
compliance costs, any of which could materially adversely affect our results of operations or financial condition.
Risks Related to Accounting Matters
We may experience future goodwill impairment, which could reduce our earnings.
We performed our test for goodwill impairment for fiscal year 2020, 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. The acquisition of
South Sound Bank on October 1, 2018 substantially increased our goodwill.
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We may experience decreases in the fair value of our servicing rights, which could reduce our earnings.
Servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are
subsequently sold with servicing rights retained. At September 30, 2020, our servicing rights totaled $3.10 million (including a
valuation allowance of $229,000). Servicing rights are amortized to servicing income on loans sold over the period of
estimated net servicing income. The estimated fair value of servicing rights at the date of the sale of loans is determined based
on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and
prepayment rates on the underlying loans. On a quarterly basis, we evaluate the fair value of servicing rights 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 servicing rights 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 servicing rights portfolio. For example, a decrease in interest rates
typically increases the prepayment speeds of servicing rights and therefore decreases the fair value of the servicing
rights. Future decreases in interest rates could decrease the fair value of our servicing rights below their recorded amount,
which would decrease our earnings.
The required accounting treatment of loans we acquire through acquisitions including purchase credit impaired loans could
result in higher net interest margins and interest income in current periods and lower net interest margins and interest
income in future periods.
Under GAAP, we are required to record loans acquired through acquisitions, including purchase credit impaired loans,
at fair value. Estimating the fair value of such loans requires management to make estimates based on available information and
facts and circumstances on the acquisition date. Actual performance could differ from management’s initial estimates. If these
loans outperform our original fair value estimates, the difference between our original estimate and the actual performance of
the loan (the “discount”) is accreted into net interest income. Thus, our net interest margins may initially increase due to the
discount accretion. We expect the yields on our loans to decline as our acquired loan portfolio pays down or matures and the
discount decreases, and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan
portfolio is not replaced with comparable high-yielding loans. This could result in higher net interest margins and interest
income in current periods and lower net interest margins and lower interest income in future periods.
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.
Other Risks Related to Our Business
Ineffective liquidity management could adversely affect our financial results and condition.
Effective liquidity management is essential to our business. We require sufficient liquidity to meet customer loan
requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash
commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry
or general financial market stress. 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 at times, borrowings from the
FHLB, borrowings from the FRB and other borrowings to fund our operations. At September 30, 2020, we had $10.00 million
in outstanding FHLB borrowings and an additional $435.99 million of available borrowing capacity through the FHLB and the
FRB. Deposit flows 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
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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.
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. 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 needed on terms
that are acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our
operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In
addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock.
Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse
regulatory action.
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 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.
Uncertainty relating to the London Interbank Offered Rate ("LIBOR") calculation process and potential phasing out of
LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR,
announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the
administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot
and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide
49
LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United
Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR
and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans,
or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. The Federal
Reserve Board, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S.
financial institutions, is considering replacing the U.S. dollar LIBOR with a new index calculated by short-term repurchase
agreements, backed by Treasury securities ("SOFR"). SOFR is observed and backward looking, which stands in contrast with
LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert
judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate
that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR
and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains traction as a LIBOR
replacement tool remains in question, although transactions using SOFR have been completed including by Fannie Mae. Both
Fannie Mae and Freddie Mac have recently announced that they will cease accepting adjustable rate mortgages tied to LIBOR
by the end of 2020 and will soon begin accepting mortgages based on SOFR. Continued uncertainty as to the nature of
alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the
value of LIBOR-based loans, and securities in our portfolio. If LIBOR rates are no longer available, and we are required to
implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may
experience significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and
creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on
our results of operations.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
At September 30, 2020, the Bank operated 24 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, the Lacey office at 1751 Circle Lane SE and
the Lacey office at 4530 Lacey Blvd SE, which are leased.
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
(table continued on the following page)
50
Year Opened
Deposits at
September 30, 2020
(In thousands)
1966
$
79,164
1974
2004
1977
1980
1994
1996
41,102
46,457
41,481
63,003
42,401
51,780
Location
Year Opened
Deposits at
September 30, 2020
(In thousands)
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
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
2850 Harrison Ave NW
Olympia, Washington 98502
4530 Lacey Blvd SE
Lacey, Washington 98503
Loan Servicing Center/Call Center:
120 Lincoln Street
Hoquiam, Washington 98550
Data Center:
106 South 3rd Street
Elma, Washington 98541
Administrative Offices:
305 8th Street
Hoquiam, Washington 98550
1997
1999
1999
1999
2001
2001
2003
2003
2004
2004
2004
2004
2004
2004
2009
2018
2018
2003
2020
2004
34,674
44,090
28,193
56,294
51,052
119,664
51,946
70,826
55,254
60,701
59,166
18,257
50,321
28,082
49,693
85,931
128,874
N/A
N/A
N/A
Management believes that all facilities are appropriately insured and are adequately equipped for carrying on the
business of the Bank.
51
At September 30, 2020, the Bank operated 25 proprietary automated teller machines ("ATMs") that are part of a
nationwide cash exchange network.
Leases
The Company adopted Accounting Standards Codification ("ASC") 842 ("ASC 842") on October 1, 2019 and began
recording operating lease liabilities and operating lease right-of-use ("ROU") assets on the consolidated balance sheets. The
Company has operating leases for three retail bank branch offices. The ROU assets totaled $2.89 million at October 1, 2019.
The Company's leases have remaining lease terms of 22 months to eleven years, some of which include options to extend the
leases for up to five years. For additional information regarding operating lease liabilities and operating lease ROU assets see
Note 10 of the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
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.
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,
2020, there were 8,315,993 shares of common stock issued and approximately 451 shareholders of record. Our cash dividend
payout policy is reviewed regularly by management and the Board of Directors. Our Board of directors has declared quarterly
cash dividends on our common stock for 32 consecutive quarters. Any dividends declared and paid in the future would depend
upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations,
statutory and regulatory limitations, and general economic conditions. No assurances can be given that any dividends will be
paid or that, if paid, will not be reduced or eliminated in future periods. Our future payment of dividends may depend, in part,
upon receipt of dividends from the Bank, which are restricted by banking regulations.
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. On March 16, 2020, the Company temporarily suspended stock repurchases and then on October 29, 2020
announced plans to resume purchases under the existing stock repurchase program. As of September 30, 2020, the Company
had repurchased 207,829 shares under this plan at an average price of $15.71 per share. Cumulatively, since January 1998 the
Company has repurchased 7,991,763 shares at an average price of $9.15 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, 2020:
52
Period
July 1, 2020 - July 31, 2020
August 1, 2020 - August 31, 2020
September 1, 2020 - September 30, 2020
Total
Five-Year Stock Performance Graph
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
— $
—
—
— $
—
—
—
—
—
—
—
—
144,852
144,852
144,852
144,852
The following graph compares the cumulative total shareholder return on our common stock with the cumulative total
return on the Nasdaq Composite Index and with the SNL Thrift $500 Million to $1 Billion 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, 2015.
Index
Timberland Bancorp, Inc.
NASDAQ Composite Index
SNL Thrift $500M-$1B Index *
$
9/30/2015
9/30/2016
9/30/2017
9/30/2018
9/30/2019
100.00 $
100.00
100.00
148.61 $
116.42
113.81
302.35 $
144.00
163.99
307.23 $
180.24
189.97
278.16 $
181.19
172.63
9/30/2020
189.51
255.40
145.82
Year Ended
* Source: S&P Global Market Intelligence
53
For additional information, see Part III, Item 12 of this Form 10-K for information regarding the Company's Equity
Compensation Plans, which is incorporated into this Item 5 by reference.
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.
2020
2019
At September 30,
2018
(Dollars in thousands)
2017
2016
SELECTED FINANCIAL CONDITION DATA:
Total assets
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
Provision for (recapture of) loan losses
Net interest income after provision for (recapture
of) loan losses
Non-interest income
Non-interest expense
Income before income taxes
Provision for income taxes
Net income
Net income per common share:
Basic
Diluted
Dividends per common share
Dividend payout ratio (1)
$ 1,565,978
1,013,875
27,890
57,907
1,922
3,000
314,452
65,545
1,050
1,358,406
10,000
187,630
2020
$ 55,583
4,701
50,882
3,700
47,182
17,188
34,063
30,307
6,038
$ 24,269
$ 1,247,132
886,662
31,102
22,532
1,437
3,000
143,015
78,346
1,683
1,068,227
—
171,067
$ 1,018,290
725,391
12,810
1,154
1,190
3,000
148,864
63,290
1,913
889,506
—
124,657
$ 952,024
690,364
7,139
1,241
1,107
3,000
148,188
43,034
3,301
837,898
—
111,000
Year Ended September 30,
2019
2018
2017
(Dollars in thousands, except per share data)
$ 891,388
663,146
7,511
1,342
2,204
—
108,941
53,000
4,117
761,534
30,000
96,834
2016
$ 55,725
4,565
51,160
—
$ 41,833
2,778
39,055
—
$ 38,338
3,197
35,141
(1,250)
$ 34,875
4,072
30,803
—
51,160
14,341
35,580
29,921
5,901
39,055
12,544
29,177
22,422
5,701
36,391
12,368
27,516
21,243
7,076
30,803
10,889
26,637
15,055
4,901
$ 24,020
$ 16,721
$ 14,167
$ 10,154
$
$
$
2.91
2.88
0.85
$
$
$
2.89
2.84
0.78
$
$
$
2.28
2.22
0.60
$
$
$
1.99
1.92
0.50
$
$
$
1.48
1.43
0.37
29.19%
27.04%
26.50%
25.70%
25.39%
_______________
(1)
Cash dividends to common shareholders divided by net income to common shareholders.
54
OTHER DATA:
2020
2019
At September 30,
2018
2017
2016
Number of real estate loans outstanding
Deposit accounts
Full-service offices
2,508
58,566
24
2,766
59,547
24
2,550
55,441
22
2,593
54,707
22
2,615
53,611
22
At or For the Year Ended September 30,
2018
2017
2019
2020
2016
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
1.75%
13.59
3.70
3.90
1.96%
14.91
4.31
4.50
1.70%
14.27
4.10
4.23
1.53%
13.65
3.93
4.07
1.19%
11.00
3.72
3.88
155.98
148.15
144.17
137.75
131.69
2.45
2.91
2.96
2.98
3.13
Efficiency ratio (5)
50.04
54.32
56.55
57.92
63.89
Asset Quality Ratios:
Non-accrual and 90 days or more past due loans as a
percent of total loans receivable, net
Non-performing assets as a percent of total assets (6)
Allowance for loan losses as a percent of total loans
receivable, net (7)
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
0.28%
0.27
0.34%
0.40
0.18%
0.36
0.28%
0.60
0.45%
0.88
1.31
1.08
1.30
1.36
1.46
461.76
319.49
723.61
499.90
326.66
—
(0.02)
—
(0.14)
0.02
11.98%
12.85
13.71%
13.17
12.24%
11.90
11.66%
11.25
10.86%
10.84
__________________
(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. TDRs that are
on accrual status are not included.
(4)
(5)
(6)
(7)
(8)
55
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in
understanding the consolidated financial condition and results of operations of the Company. The information contained in this
section should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto included in
Item 8 of this Annual Report on Form 10-K.
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 24 branches (including its main office in
Hoquiam). At September 30, 2020, the Company had total assets of $1.57 billion, net loans receivable of $1.01 billion, total
deposits of $1.36 billion and total shareholders’ equity of $187.63 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.
On October 1, 2018, the Company completed the South Sound Acquisition. The operating results for the years ended
September 30, 2019 and 2020 include the operating results produced by the net assets acquired in the South Sound Acquisition.
For additional information on the South Sound Acquisition, see Note 2 to the Consolidated Financial Statements contained in
"Item 8. Financial Statements and Supplementary Data."
The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail and
business customers while concentrating its lending activities on real estate secured 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, some of which 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, the interest earned on those assets, the volume and mix of interest-
bearing liabilities and the interest paid on those interest-bearing liabilities. Management attempts to maintain a net interest
margin placing it within the top quartile of its Washington State peers. Because of the length of the COVID-19 pandemic and
the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the
150 basis point reductions in the targeted federal funds rate (in March 2020), until the pandemic subsides, the Company expects
its net interest income and net interest margin will be adversely affected.
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. The Company recorded provisions for loan losses of $3.70 million for the year ended September 30, 2020 compared
to none for the year ended September 30, 2019 due primarily to forecasted probable loan losses reflecting the potential future
impact of the COVID-19 pandemic on the economy.
On March 24, 2020, Washington State Governor Jay Inslee signed a statewide order due to the COVID-19 pandemic
requiring residents to stay-at-home unless involved in an essential activity. All business, except those that are considered
essential, were also ordered to close. Although the stay-at-home order has been lifted and certain businesses were allowed to
re-open, many restrictions remain in place. As an essential business, the Company took various steps to ensure the safety of
customers and personnel including branch lobby closures. To ensure the safety of the Company's customers and employees,
services are offered through drive up facilities and/or by appointment at some locations and other branch offices are now open
56
on a modified basis. Some of the Company's employees are working remotely or have flexible work schedules, and protective
measures within the Company's offices have been established to help ensure the safety of those that employees who must work
on-site.
The Company has worked with loan customers on loan deferral and forbearance plans. In response to requests from
borrowers, the Company made payment deferral modifications (typically 90-day payment deferrals with interest continuing to
accrue or scheduled to be paid monthly) on a number of loans. The majority of these borrowers had resumed making payments
as of September 30, 2020 and only five loans totaling $5.87 million remained on deferral status as of that date. These
modifications were not classified as TDRs at September 30, 2020 in accordance with guidance of the CARES Act and related
regulatory guidance. The CARES Act also authorized the SBA to temporarily guarantee loans under a new loan program called
the Paycheck Protection Program. As a qualified SBA lender, the Company was automatically authorized to originate PPP
loans upon commencement of the program in April 2020 through its conclusion in August 2020. As of September 30, 2020, the
Company had $126.82 million in PPP loans to new and existing customers who are small to midsize businesses as well as non-
profit organizations, independent contractors, and partnerships as allowed under PPP guidance issued in April 2020.
Net income is also affected by non-interest income and non-interest expense. For the year ended September 30, 2020,
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, escrow fee 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 income is also decreased by by valuation allowances on servicing
rights and increased by recoveries of valuation allowances on servicing rights, if any. Non-interest expense consisted primarily
of salaries and employee benefits, premises and equipment, advertising, ATM and debit card interchange transaction fees,
postage and courier expenses, amortization of CDI, 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 expense in certain periods are reduced by gains on the sale of premises and
equipment and by gains on the sale of OREO. Non-interest income and non-interest expense are affected by the growth of the
Company's operations and growth in the number and balances 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.
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 products and superior service to small businesses and individuals located in its primary market
area.
The Company's goal is to deliver returns to shareholders by focusing on the origination of higher-yielding assets (in
particular commercial real estate, construction, and commercial business loans), increasing core deposit balances, managing
problem assets, efficiently managing expenses, and seeking 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 the 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
development 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 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.
57
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 enable us to compete effectively with banks of all
sizes.
Managing exposure to fluctuating 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, although from time to time the Bank may
retain a portion of its fixed-rate mortgage loan originations and extend the initial fixed rate period of its hybrid ARM
commercial real estate loans for asset/liability purposes.
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 construction 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 receivable, net was 0.28% and 0.34% at September 30, 2020 and 2019,
respectively. The Company's percentage of non-performing assets to total assets at September 30, 2020 was 0.27% compared
to 0.40% at September 30, 2019. Non-performing assets have decreased to $4.16 million at September 30, 2020 from $14.98
million at September 30, 2015. 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.
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 six 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 determination
of any OTTI in the fair value of investment securities, the valuation of servicing rights, the valuation of OREO, the valuation of
assets acquired and liabilities assumed in acquisitions and the valuation of goodwill for potential impairment. 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.
58
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 servicing rights.
Sharp increases or decreases in interest rates may adversely affect the Bank's earnings. Management of the Bank
monitors the Bank's interest rate sensitivity through the use of a model provided by NXTsoft Data Analytics, LLC (“NXTsoft”),
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 NXTsoft based on data at September 30, 2020, an immediate increase in
interest rates of 100 basis points would increase the Bank’s projected net interest income by approximately 7.7%, primarily
because a larger portion of the Bank's interest rate sensitive assets than interest rate sensitive liabilities would reprice within a
one year period. Conversely, an immediate decrease in interest rates of 100 basis points would decrease the Bank's projected
net interest income by approximately 2.4%.
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, 2020,
the consumer, commercial business and construction loan portfolios amounted to $35.65 million, $196.36 million and $219.50
million, or 3.1%, 17.3% and 19.4% of total loans receivable, respectively.
Quantitative Aspects of Market Risk. The model provided for the Bank by NXTsoft 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 NXTsoft based on data at September 30, 2020:
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
$
58,220 $
54,406
50,681
47,067
43,722
42,653
42,370
14,498
10,684
6,959
3,345
—
(1,069)
(1,352)
33.16 % $
24.44
15.92
7.65
—
(2.44)
(3.09)
336,755 $
316,761
296,000
274,741
253,583
230,772
253,236
83,172
63,178
42,417
21,158
—
(22,811)
(347)
32.80 %
24.91
16.73
8.34
—
(9.00)
(0.14)
___________
(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.
59
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 9.0% decrease
in NPV and a 2.4% decrease in net interest income. In the event of a 100 basis point increase in interest rates, an 8.3% increase
in NPV and a 7.7% increase in net interest income would be expected. Based upon the modeling described above, the Bank's
asset and liability structure generally results in 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, 2020 and September 30, 2019
The Company's total assets increased by $318.85 million, or 25.6%, to $1.57 billion at September 30, 2020 from $1.25
billion at September 30, 2019. The increase in assets was primarily due to increase in total cash and cash equivalents, net loans
receivable, and investment securities. The increase in total assets was funded primarily by increases in total deposits and FHLB
borrowings.
Net loans receivable increased by $127.21 million, or 14.3%, to $1.01 billion at September 30, 2020 from $886.66
million at September 30, 2019, primarily due to increases in commercial business (including $126.82 million of SBA PPP
loans), commercial real estate, and multi-family loans. These increases were partially offset by decreases in one- to four-family
mortgage and consumer loans.
Total deposits increased by $290.18 million, or 27.2%, to $1.36 billion at September 30, 2020 from $1.07 billion at
September 30, 2019, primarily due to increases in non-interest bearing demand account balances, NOW checking account
balances, savings account balances, and money market account balances.
Shareholders' equity increased by $16.56 million, or 9.7%, to $187.63 million at September 30, 2020 from $171.07
million at September 30, 2019. The increase was primarily due to net income for the year ended September 30, 2020 of $24.27
million which was partially offset by $7.08 million in dividends paid to shareholders and $1.24 million in common stock
repurchases.
A more detailed explanation of the changes in significant balance sheet categories follows:
Cash and Cash Equivalents: Cash and cash equivalents increased by $171.44 million, or 119.9%, to $314.45 million
at September 30, 2020 from $143.02 million at September 30, 2019. The increase was primarily a result of increases in total
deposits, which exceeded the funds required for loan originations and purchases of investment securities.
CDs Held for Investment: CDs held for investment decreased by $12.80 million, or 16.3%, to $65.55 million at
September 30, 2020 from $78.35 million at September 30, 2019. Funds received as CDs matured were invested into other
interest-earning assets as interest rates on CDs decreased during the year.
Investment Securities and Investments in Equity Securities: Investment securities and investments in equity
securities increased by $32.18 million, or 59.0%, to $86.77 million at September 30, 2020 from $54.59 million at
September 30, 2019. The increase was primarily due to the purchase of additional agency mortgage-backed investment
securities as the Company put a portion of its excess overnight liquidity into higher-earning investment securities during the
year ended September 30, 2020. These increases were partially offset by maturities, prepayments and scheduled amortization
of other investment securities. For additional details on investment securities, see "Item 1. Business - Investment Activities"
and Note 4 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
60
FHLB Stock: FHLB stock increased by $485,000, or 33.8%, to $1.92 million at September 30, 2020 from $1.44
million at September 30, 2019, due to purchases required by the FHLB as a result of the increase in total assets and FHLB
borrowings.
Other Investments: Other investments consist solely of the Company's investment in the Solomon Hess SBA Loan
Fund LLC, which was unchanged at both September 30, 2020 and 2019. 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 decreased to $4.51 million, or 25.7%, at September 30, 2020 from $6.07
million at September 30, 2019, primarily due to the timing and volume of mortgage banking loan sales. 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 $167.24 million in loans during the year ended
September 30, 2020 compared to $73.03 million for the year ended September 30, 2019. Sales of loans increased primarily due
to increased refinance activity for one- to four-family loans due to the decrease in mortgage interest rates.
Loans Receivable, Net of Allowance for Loan Losses: Net loans receivable increased by $127.21 million, or 14.3%,
to $1.01 billion at September 30, 2020 from $886.66 million at September 30, 2019. The increase consisted of a $131.60
million increase in commercial business loans (including a $126.82 million increase in SBA PPP loans), a $34.46 million
increase in commercial real estate loans, a $9.02 million increase in multi-family loans and smaller increases in several other
categories. These increases were partially offset by a $14.08 million decrease in one- to four-family loans, an $8.85 million
decrease in consumer loans and smaller decreases in several other categories.
Loan originations increased by $241.15 million, or 67.7%, to $597.19 million for the year ended September 30, 2020
from $356.04 million for the year ended September 30, 2019. The increase in loan originations was primarily due to the
funding of SBA PPP loans, increased loan demand for one- to four-family mortgage loan refinances, and the funding of several
larger commercial business and commercial real estate loans. For additional information on loans, see "Item 1. Business -
Lending Activities" and Note 5 to the Consolidated Financial Statements contained in "Item 8, Financial Statements and
Supplementary Data."
Premises and Equipment, Net: Premises and equipment increased by $205,000, or 0.9%, to $23.04 million at
September 30, 2020 from $22.83 million at September 30, 2019. The increase was primarily due to capitalized remodeling
costs associated with the Company's new data center facility. This increase was partially offset by normal depreciation and the
sale of land acquired in the South Sound Acquisition that had been held for future expansion. For additional information on
premises and equipment, see "Item 2. Properties" and Note 6 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 $633,000, or 37.6%, to
$1.05 million at September 30, 2020 from $1.68 million at September 30, 2019. The decrease was primarily due to the sales of
$460,000 in OREO properties and OREO valuation write-downs of $173,000. At September 30, 2020, total OREO and other
repossessed assets consisted of six land parcels totaling $1.05 million. The largest OREO property at September 30, 2020 was
an undeveloped land parcel located in Lewis County with a balance of $702,000. 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 7 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
Bank Owned Life Insurance ("BOLI"): BOLI increased by $591,000, or 2.8%, to $21.60 million at September 30,
2020 from $21.01 million at September 30, 2019. The increase was due to net BOLI earnings, representing the increase in cash
surrender value of the BOLI policies.
Goodwill: The recorded amount of goodwill remained unchanged at $15.13 million at September 30, 2020 from
September 30, 2019. The Company performed its annual review of goodwill during the quarter ended June 30, 2020 and
determined that there was no impairment. As of September 30, 2020, management believes that there had been no subsequent
events or changes in circumstances that would indicate a potential impairment of goodwill. For additional information on
goodwill, see Note 8 to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary
Data."
CDI: CDI decreased by $406,000, or 20.0% to $1.63 million at September 30, 2020 from $2.03 million at September
30, 2019 due to scheduled amortization. For additional information on CDI, see Note 8 to the Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
61
Servicing Rights, Net: Servicing rights increased by $687,000, or 28.5%, to $3.10 million at September 30, 2020
from $2.41 million at September 30, 2019, primarily due to additional capitalized Freddie Mac servicing rights for loans being
sold with servicing retained, which was partially offset by amortization and valuation allowances. The principal amount of
loans serviced for Freddie Mac and the SBA increased by $27.46 million, or 6.9%, to $426.58 million at September 30, 2020
from $399.12 million at September 30, 2019. For additional information on servicing rights, see Note 9 to the Consolidated
Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
Operating Lease Right-of-Use Assets: Operating lease right-of-use-assets increased to $2.59 million at September
30, 2020 as the Company adopted ASC 842 on October 1, 2019 and began recording operating lease right-of-use assets and
operating lease liabilities on the balance sheet. The operating lease right-of-use assets at September 30, 2020 represented the
present value of three operating leases on branch facilities. The Company adopted the provisions of ASC 842 utilizing the
optional transition method and therefore prior periods have not been restated. For additional information on leases, see Note 10
to the Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data."
Other Assets: Other assets decreased by $2.02 million, or 38.0%, to $3.30 million at September 30, 2020 from $5.32
million at September 30, 2019. The decrease was primarily due to decreases in miscellaneous receivables (including income tax
receivables) and prepaid expenses.
Deposits: Deposits increased by $290.18 million, or 27.2%, to $1.36 billion at September 30, 2020 from $1.07 billion
at September 30, 2019. The increase consisted of a $145.42 million increase in non-interest bearing demand account balances,
a $79.84 million increase in NOW checking account balances, a $55.36 million increase in savings account balances, and a
$16.69 million increase in money market account balances. These increases were partially offset by a $7.13 million decrease in
certificates of deposit account balances. The increase in deposits was primarily driven by proceeds from SBA PPP loans and
government stimulus checks deposited directly into customer accounts, organic growth in customer relationships and reduced
withdrawals from deposit accounts due to a change in spending habits as a result of COVID-19. For additional information on
deposits, see "Item 1. Business - Deposit Activities and Other Sources of Funds" and Note 11 to the Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
FHLB Borrowings: The Company has short- and long-term borrowing lines with the FHLB with total credit
available on the lines equal to 45% of the Bank's total assets, limited by available collateral. FHLB borrowings increased to
$10.00 million at September 30, 2020, as the Company borrowed funds consistent with its asset-liability objectives in March
2020 as long-term rates dropped to historic lows in response to the COVID-19 pandemic. At September 30, 2020, FHLB
borrowings consisted of two $5.00 million borrowings, with scheduled maturities at March 2025 and March 2027, which bear
interest at 1.19% and 1.11%, respectively. The Company did not have any FHLB borrowings at September 30, 2019. For
additional information on FHLB borrowings, see Note 12 to the Consolidated Financial Statements contained in "Item 8.
Financial Statements and Supplementary Data".
Operating Lease Liabilities: Operating lease liabilities increased to $2.63 million at September 30, 2020 as the
Company adopted ASC 842 on October 1, 2019 and began recording operating lease liabilities and operating lease right-of-use
assets on the balance sheet. The operating lease liability at September 30, 2020 represented the present value of three operating
leases on branch facilities. The Company adopted the provisions of ASC 842 utilizing the optional transition method and
therefore prior periods have not been restated. For additional information on leases, see Note 10 to the Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
Other Liabilities and Accrued Expenses: Other liabilities and accrued expenses decreased by $526,000, or 6.7%, to
$7.31 million at September 30, 2020 from $7.84 million at September 30, 2019. The decrease was primarily due to timing
differences in the normal course of business and a reduction in deferred compensation payable.
Shareholders' Equity: Total shareholders' equity increased by $16.56 million, or 9.7%, to $187.63 million at
September 30, 2020 from $171.07 million at September 30, 2019. The increase was primarily due to net income of $24.27
million for the year ended September 30, 2020, which was partially offset by the payment of $7.08 million in dividends to
common shareholders and the repurchase of 56,601 shares of the Company's common stock for $1.24 million during the year
ended September 30, 2020. 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, 2020 and 2019
Net income for the year ended September 30, 2020 increased by $249,000, or 1.0%, to $24.27 million from $24.02
million for the year ended September 30, 2019. Net income per diluted common share increased by $0.04, or 1.4%, to $2.88
62
for the year ended September 30, 2020 from $2.84 for the year ended September 30, 2019. The increase in net income was
primarily due to an increase in non-interest income and a decrease in non-interest expense. These increases to net income were
partially offset by an increase in the provision for loan losses and a decrease in net interest income. The increase in non-
interest income was primarily due to an increase in gain on sales of loans. The decrease in non-interest expense was primarily
due to a decrease in data processing and telecommunication expenses. The increase in the provision for loan losses was
primarily due to economic uncertainties associated with the COVID-19 pandemic.
A more detailed explanation of the income statement categories is presented below.
Net Interest Income: Net interest income decreased by $278,000, or 0.5%, to $50.88 million for the year ended
September 30, 2020 from $51.16 million for the year ended September 30, 2019. The decrease in net interest income was
primarily due to a decrease in the average yield on interest-earning assets, which was partially offset by an increase in the
average balance of interest-earning assets.
Total interest and dividend income decreased by $142,000, or 0.3%, to $55.58 million for the year ended
September 30, 2020 from $55.73 million for the year ended September 30, 2019, primarily due to a decrease in the average
yield on interest-earning assets, which was partially offset by an increase in the average balance of interest-earning assets. The
average yield on interest-earnings assets decreased to 4.26% for the year ended September 30, 2020 from 4.90% for the year
ended September 30, 2019 as market rates decreased. Beginning in August 2019, the Federal Reserve reduced the targeted
federal funds rate by 25 basis points three times in 2019 and during the quarter ended March 31, 2020 by 150 basis points in
response to the COVID-19 pandemic, to a range of 0.00% to 0.25% at September 30, 2020. Partially offsetting the decrease in
the average yield on interest-earning assets was an increase in the average balance of interest-earning assets. Average total
interest-earning assets increased by $166.51 million, or 14.6%, to $1.30 billion for the year ended September 30, 2020 from
$1.14 billion for the year ended September 30, 2019. Interest income on loans receivable and loans held for sale increased by
$2.21 million, or 4.5%, to $51.34 million for the year ended September 30, 2020 from $49.13 million for the year ended
September 30, 2019, primarily due to a $91.42 million increase in the average balance of loans receivable during the current
year. This increase was partially offset by a decrease in the average yield on loans receivable to 5.29% for the year ended
September 30, 2020 from 5.59% for the year ended September 30, 2019.
During the year ended September 30, 2020, the accretion of the purchase accounting fair value discount on loans
acquired in the South Sound Acquisition increased interest income on loans by $597,000 compared to $645,000 for the year
ended September 30, 2019. The accretion of the net fair value discount on acquired loans increased the average yield on loans
by six basis points for the year ended September 30, 2020 and seven basis points for the year ended September 30, 2019. The
incremental accretion and the impact on loan yield will change during any period based on the volume of prepayments, but it is
expected to decrease over time as the balance of the net discount declines. The remaining net discount on these acquired loans
was $790,000 at September 30, 2020. During the year ended September 30, 2020 a total of $911,000 in non-accrual interest,
pre-payment penalties and late fees was collected compared to $372,000 for the year ended September 30, 2019.
Also impacting the average yield and average interest-earning asset balances during the year ended September 30,
2020 were SBA PPP loans originated. These PPP loans have a prescribed interest rate of 1.00% and are also subject to loan
origination fees which are accreted into interest income over the life of each loan. For the year ended September 30, 2020,
average PPP loans were $55.40 million and the Company recorded $556,000 in interest income and accreted $1.04 million in
PPP loan origination fees into income. Interest income on investment securities increased by $315,000, or 24.9%, to $1.58
million for the year ended September 30, 2020 from $1.26 million for the year ended September 30, 2019 primarily due to an
increase in the average balance of investment securities, which was partially offset by a decrease in the average yield on
investment securities. Interest income on interest-bearing deposits in banks and CDs decreased by $2.64 million, or 51.0%, to
$2.54 million for the year ended September 30, 2020 from $5.17 million for the year ended September 30, 2019, primarily due
to an decrease in the average yield to 1.00% from 2.41% as market rates decreased. The decrease in the average yield was
partially offset by an increase in the average balance of interest-bearing deposits in banks and CDs.
Total interest expense increased by $136,000, or 3.0%, to $4.70 million for the year ended September 30, 2020 from
$4.57 million for the year ended September 30, 2019. The increase in interest expense was primarily due to a increases in the
average balances of interest-bearing deposits and FHLB borrowings, which were partially offset by a decrease in the average
cost of interest-bearing liabilities. Average interest-bearing deposits increased by $62.52 million, or 8.1%, to $829.91 million
for the year ended September 30, 2020 from $767.39 million for the year ended September 30, 2019 and average FHLB
borrowings increased to $5.69 million for the year ended September 30, 2020 from $0 for the year ended September 30, 2019.
The average cost of interest-bearing liabilities decreased to 0.56% for the year ended September 30, 2020 from 0.59% for the
year ended September 30, 2019 as market interest rates for deposits decreased.
63
As a result of these changes, the net interest margin decreased 60 basis points to 3.90% for the year ended
September 30, 2020 from 4.50% for the year ended September 30, 2019.
Provision for Loan Losses: Provisions for loan losses totaled $3.70 million for the year ended September 30, 2020
compared to no provision for loan losses for the year ended September 30, 2019. The provision for loan for the current fiscal
year was primarily due to the deteriorating economic conditions and probable loan losses driven by the impact of the
COVID-19 pandemic on the U.S. and global economies. The Company had net recoveries of $24,000 for the year ended
September 30, 2020 and net recoveries of $160,000 for the year ended September 30, 2019. The net charge-offs (recoveries) to
average outstanding loans ratio was 0.00% for the year ended September 30, 2020 and (0.02)% for the year ended
September 30, 2019. The level of delinquent loans (loans 30 or more days past due) decreased by $177,000, or 4.5%, to $3.75
million at September 30, 2020 from $3.93 million at September 30, 2019 and the level of loans graded substandard decreased
by $1.67 million, or 31.4%, to $3.65 million at September 30, 2020 from $5.32 million at September 30, 2019. Special mention
loans increased by $3.32 million or 130.2%, to $5.86 million at September 30, 2020 from $2.55 million at September 30, 2019.
Non-accrual loans decreased by $128,000, or 4.2%, to $2.91 million at September 30, 2020 from $3.03 million at
September 30, 2019.
The Company has worked with loan customers impacted by the COVID-19 pandemic on loan deferral and forbearance
plans. In response to requests from borrowers, the Company made payment deferral modifications (typically 90-day payment
deferrals with interest continuing to accrue or scheduled to be paid monthly) on a number of loans during the year ended
September 30, 2020. Most of these borrowers had resumed making payments during the year and only five loans totaling $5.87
million remained on deferral status as of September 30, 2020. These modifications were not classified as TDRs at September
30, 2020 in accordance with guidance of the CARES Act and related regulatory guidance.
The $126.82 million balance of SBA PPP loans was omitted from the Company's normal allowance for loan losses
calculation at September 30, 2020 as these loans are fully guaranteed by the SBA and management expects that most PPP
borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which will in
turn reimburse the Bank for the amount forgiven.
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 amount to be allocated to each loan. The aggregate principal impairment amount determined
at September 30, 2020 was $41,000 compared to $172,000 at September 30, 2019.
In accordance with GAAP, loans acquired in the South Sound Acquisition were recorded at their estimated fair value,
which resulted in a net discount to the loans' contractual amounts, of which a portion reflects a discount for possible credit
losses. Credit discounts are included in the determination of fair value and as a result no allowance for loan losses is recorded
for acquired loans at the acquisition date. The discount recorded on the acquired loans is not reflected in the allowance for loan
losses or related allowance coverage ratios. The remaining fair value discount on loans acquired in the South Sound
Acquisition was $790,000 at September 30, 2020. The Company believes this should be considered by investors when
comparing the Company's allowance for loan losses to total loans in periods prior to the South Sound Acquisition.
Based on the comprehensive methodology, management believes the allowance for loan losses of $13.41 million at
September 30, 2020 (1.31% of loans receivable and 461.8% 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 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 $2.85 million, or 19.9%, to $17.19 million for the year
ended September 30, 2020 from $14.34 million for the year ended September 30, 2019. The increase was primarily due to a
$4.23 million increase in gain on sales of loans, recoveries of $483,000 of previously charged off receivables acquired in the
South Sound Acquisition (which are recorded in the "Other, net" non-interest category), and smaller increases in several other
categories. These increases were partially offset by a $1.05 million decrease in BOLI net earnings, a $757,000 decrease in
64
service charges on deposits and smaller decreases in several other categories. The increase in gain on sales of loans was
primarily due to an increase in the dollar amount of fixed rate one- to four-family loans originated and sold during the current
year and an increase in the average pricing margin. The increase in mortgage banking volumes were largely due to increased
refinance activity for single family homes due to lower mortgage interest rates. Net BOLI earnings were higher for the
comparable period one year ago primarily due to a BOLI death benefit claim. The decrease in service charges on deposits was
primarily due to a decrease in overdraft fee income.
Non-interest Expense: Total non-interest expense decreased by $1.52 million, or 4.3%, to $34.06 million for the year
ended September 30, 2020 from $35.58 million for the year ended September 30, 2019. The decrease was primarily due to a
$1.42 million decrease in data processing and telecommunications expense and smaller decreases in several other categories.
Data processing related expenses were elevated for the year ended September 30, 2019 due to the Company's core operating
system and ancillary technology systems conversions. The efficiency ratio for the year ended September 30, 2020 improved to
50.04% from 54.32% for the year ended September 30, 2019.
Provision for Income Taxes: The provision for income taxes increased by $137,000, or 2.3% to $6.04 million for the
year ended September 30, 2020 from $5.90 million for the year ended September 30, 2019. The increase in the provision for
income taxes was primarily due to higher income before income taxes. The Company's effective income tax rate was 19.9% for
the year ended September 30, 2020 compared to 19.7% for the year ended September 30, 2019. Contributing to the lower
effective income tax rate for the year ended September 30, 2019 was a higher percentage of tax-exempt income, primarily due
to a BOLI death benefit claim. For additional information on income taxes, see Note 14 of the Consolidated Financial
Statements contained in "Item 8. Financial Statements and Supplementary Data."
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.
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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,
2020 Compared to Year
Ended September 30, 2019
Increase (Decrease)
Due to
Year Ended September 30,
2019 Compared to Year
Ended September 30, 2018
Increase (Decrease)
Due to
Rate
Volume
Net
Change
(Dollars in thousands)
Rate
Volume
Net
Change
$
(2,714) $
(546)
4,928 $
861
2,214 $
315
2,112 $
99
8,717 $
948
10,829
1,047
(46)
(3,468)
12
831
(34)
36
(2,637)
1,478
6
496
42
1,974
(6,774)
6,632
(142)
3,725
10,167
13,892
60
(342)
(47)
215
33
22
(42)
89
115
33
82
(384)
42
330
66
11
311
201
754
—
10
86
188
226
—
21
397
389
980
—
(81)
(6,693) $
217
6,415 $
$
136
(278) $
1,277
2,448 $
510
9,657 $
1,787
12,105
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 checking accounts
Certificates of deposit accounts
FHLB borrowings
Total net change in expense on
interest-bearing liabilities
Net change in net interest income
______________
(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, maturing CDs held for investment and FHLB borrowings (if
needed). 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, 2020, 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 29.1%. At September 30, 2020, the Bank maintained an uncommitted credit facility
with the FHLB that provided for immediately available borrowings up to an aggregate amount equal to 45% of total assets,
limited by available collateral, under which $10.0 million was outstanding. The Bank had $364.09 million available for
additional borrowings with the FHLB at September 30, 2020. The Bank maintains a short-term borrowing line with the FRB
with total credit based on eligible collateral. At September 30, 2020, the Bank had no outstanding balance on this borrowing
line, under which $71.90 million was available for future borrowings. The Bank also maintains a $50.00 million overnight
borrowing line with PCBB. At September 30, 2020, the Bank did not have an outstanding balance on this borrowing line.
67
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, 2020, 2019
and 2018, the Bank originated $597.19 million, $356.04 million and $329.59 million of loans, respectively. At September 30,
2020, the Bank had loan commitments totaling $141.61 million and undisbursed construction loans in process totaling $100.56
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, 2020 totaled $102.86 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, 2020, 2019 and 2018, the Bank sold $167.24 million, $73.03 million and $66.40 million in loans and loan
participation interests, respectively. During the years ended September 30, 2020, 2019 and 2018, the Bank received $287.04
million, $241.66 million and $235.61 million in principal repayments, respectively.
The Bank’s liquidity has been impacted by increases in deposit levels. During the years ended September 30, 2020,
2019 and 2018, deposits increased by $290.18 million, $178.72 million and $51.61 million, respectively.
Cash and cash equivalents, CDs held for investment and investment securities increased to $465.79 million at
September 30, 2020 from $275.00 million at September 30, 2019.
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 distributions from the Bank and the
issuance of debt or equity securities. At September 30, 2020, Timberland Bancorp (on an unconsolidated basis) had liquid
assets of $2.63 million.
Bank holding companies and federally-insured state-chartered banks are required to maintain minimum levels of
regulatory capital. At September 30, 2020, Timberland Bancorp and the Bank were in compliance with all applicable capital
requirements. For additional details see Note 18 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, 2020, 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, 2020.
Contractual obligations
Long-term debt obligations
Operating lease obligations
Total contractual obligations
Less than
1 year
1 year
through
3 years
Payments due by period
After
3 years
through
5 years
(Dollars in thousands)
After
5 years
Total
$
$
— $
— $
5,000 $
5,000 $
10,000
327
652
630
1,322
2,931
327 $
652 $
5,630 $
6,322 $
12,931
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 17 of the Notes to Consolidated Financial Statements included in Item 8.
"Financial Statements and Supplementary Data" of this Form 10-K.
68
A summary of the Company's commitments at September 30, 2020 and 2019 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
2020
100,558 $
103,030
38,581
242,169 $
2019
92,226
80,184
16,578
188,988
$
$
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, 2020 and 2019
Consolidated Statements of Income for the Years Ended
September 30, 2020, 2019 and 2018
Consolidated Statements of Comprehensive Income for the
Years Ended September 30, 2020, 2019 and 2018
Consolidated Statements of Shareholders' Equity for the
Years Ended September 30, 2020, 2019 and 2018
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2020, 2019 and 2018
Notes to Consolidated Financial Statements
69
Page
70
71
73
75
76
78
80
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Timberland Bancorp, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Timberland Bancorp, Inc. and Subsidiary
(collectively, "the Company") as of September 30, 2020 and 2019, and the related consolidated statements of
income, comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year
period ended September 30, 2020, and the related notes (collectively referred to as "the financial statements"). In
our opinion, the financial statements present fairly, in all material respects, the financial position of the Company
as of September 30, 2020 and 2019, and the results of its operations and its cash flows for each of the years in
the three-year period ended September 30, 2020, in conformity with accounting principles generally accepted in
the United States of America (U.S.).
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express
an opinion on the Company's financial statements based on our audits. We are a public accounting firm
registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be
independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an
understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial
statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial statements. We believe that our
audits provide a reasonable basis for our opinion.
We have served as the Company's auditor since 2010.
Lake Oswego, Oregon
December 9, 2020
70
Consolidated Balance Sheets
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Assets
Cash and cash equivalents:
Cash and due from financial institutions
Interest-bearing deposits in banks
Total cash and cash equivalents
2020
2019
$
21,877 $
292,575
314,452
25,179
117,836
143,015
Certificates of deposit (“CDs”) held for investment (at cost, which
approximates fair value)
Investment securities held to maturity, at amortized cost (estimated fair value $29,827 and
$32,580)
Investment securities available for sale, at fair value
Investments in equity securities, 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 $13,414 and $9,690
Premises and equipment, net
Other real estate owned (“OREO”) and other repossessed assets, net
Accrued interest receivable
Bank owned life insurance (“BOLI”)
Goodwill
Core deposit intangible (“CDI”), net
Servicing rights, net
Operating lease right-of-use ("ROU") assets
Other assets
Total assets
$
65,545
78,346
27,890
57,907
977
1,922
3,000
4,509
1,013,875
23,035
1,050
4,484
21,596
15,131
1,625
3,095
2,587
3,298
1,565,978 $
31,102
22,532
958
1,437
3,000
6,071
886,662
22,830
1,683
3,598
21,005
15,131
2,031
2,408
—
5,323
1,247,132
Liabilities and shareholders’ equity
Liabilities
Deposits:
Non-interest-bearing demand
Interest-bearing
Total deposits
Operating lease liabilities
FHLB borrowings
Other liabilities and accrued expenses
Total liabilities
Commitments and contingencies (See Note 17)
$
441,889 $
916,517
296,472
771,755
1,358,406
1,068,227
2,630
10,000
7,312
—
—
7,838
1,378,348
1,076,065
See notes to consolidated financial statements
71
Consolidated Balance Sheets (continued)
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Shareholders’ equity
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued
Common stock, $0.01 par value; 50,000,000 shares authorized;
8,310,793 shares issued and outstanding - September 30, 2020
8,329,419 shares issued and outstanding - September 30, 2019
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
Total liabilities and shareholders’ equity
2020
— $
2019
—
42,396
145,173
61
187,630
1,565,978 $
43,030
127,987
50
171,067
1,247,132
$
$
See notes to consolidated financial statements
72
Consolidated Statements of Income
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2020, 2019 and 2018
2020
2019
2018
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
$
51,341 $
1,579
128
2,535
55,583
49,127 $
1,264
162
5,172
55,725
38,298
217
120
3,198
41,833
2,778
—
2,778
4,635
66
4,701
4,565
—
4,565
50,882
51,160
39,055
3,700
—
—
Interest expense
Deposits
FHLB borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision of loan losses
47,182
51,160
39,055
Non-interest income
Recoveries on investment securities
Adjustment for portion of other than temporary impairment ("OTTI")
transferred from other comprehensive income (loss) (before income
taxes)
Net recoveries on investment securities
Gain on sales of investment securities, net
Service charges on deposits
ATM and debit card interchange transaction fees
BOLI net earnings
Gain on sales of loans, net
Escrow fees
Servicing income on loans sold
Valuation allowance on servicing rights, net
Fee income from non-deposit investment sales
Other, net
Total non-interest income, net
120
—
120
—
4,147
4,378
591
5,979
273
193
(221)
22
1,706
17,188
71
(12)
59
47
4,904
4,036
1,641
1,754
197
466
(4)
46
1,195
14,341
73
(5)
68
—
4,581
3,570
547
1,893
211
480
—
109
1,085
12,544
See notes to consolidated financial statements
73
Consolidated Statements of Income (continued)
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2020, 2019 and 2018
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
Amortization of CDI
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
2020
2019
2018
$
18,351 $
3,962
(98)
631
276
1,628
568
406
998
1,107
204
448
2,285
1,114
2,183
34,063
18,545 $
3,831
7
696
221
1,583
514
452
873
1,019
187
382
3,707
1,358
2,205
35,580
15,740
3,231
(102)
782
140
1,296
456
—
687
1,390
294
336
1,938
1,192
1,797
29,177
30,307
29,921
22,422
6,038
$
24,269 $
5,901
24,020 $
5,701
16,721
$
$
2.91 $
2.88 $
2.89 $
2.84 $
2.28
2.22
See notes to consolidated financial statements
74
Consolidated Statements of Comprehensive Income
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2020, 2019 and 2018
Comprehensive income
Net income
Other comprehensive income (loss)
Unrealized holding gain (loss) on investment securities available for
sale, net of income taxes of $(1), $23, and $8, 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 $(1), $(1), and
$(2), respectively
Amount reclassified to credit loss for previously recorded
market loss, net of income taxes of $0, $3, and $1, respectively
Accretion of OTTI on investment securities held to maturity, net
of income taxes of $4, $6, and $10, respectively
Total other comprehensive income (loss), net of income taxes
2020
2019
2018
$
24,269 $
24,020 $
16,721
(3)
85
(39)
(3)
—
17
11
(3)
9
25
116
(7)
4
37
(5)
Total comprehensive income
$
24,280 $
24,136 $
16,716
See notes to consolidated financial statements
75
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Consolidated Statements of Cash Flows
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2020, 2019 and 2018
Cash flows from operating activities
2020
2019
2018
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
$
24,269 $
24,020 $
16,721
Depreciation
Deferred income taxes
Amortization of CDI
Earned ESOP shares
Accretion of discount on purchased loans
Stock option compensation expense
Gain on sales of investment securities
Net recoveries on investment securities
Change in fair value of investments in equity securities
Gain on sales of OREO and other repossessed assets, net
(Accretion) amortization of discounts and premiums on securities
Provision for OREO losses
Gain on sales of loans, net
(Gain) loss on sales/dispositions of premises and equipment, net
Provision for loan losses
Loans originated for sale
Proceeds from sales of loans
Amortization of servicing rights
Valuation adjustment on servicing rights, net
BOLI net earnings
BOLI death benefit in excess of cash surrender value
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
Purchase of investment securities available for sale
Proceeds from maturities and prepayments of investment securities
held to maturity
Proceeds from maturities and prepayments of investment securities
available for sale
Proceeds from sale of investment securities held to maturity
Proceeds from sales of investment securities available for sale
Purchase of FHLB stock
Increase in loans receivable, net
Additions to premises and equipment
Proceeds from sales of OREO and other repossessed assets
Proceeds from sales/dispositions of premises and equipment
Proceeds from death benefit on BOLI
Cash acquired, net of cash consideration paid in business combination
Escrow deposit for business combination
Net cash used in investing activities
1,572
76
406
31
(597)
182
—
(120)
(19)
(35)
(183)
173
(5,979)
(98)
3,700
(153,446)
160,987
838
221
(591)
—
3,637
1,604
703
452
441
(645)
159
(47)
(59)
(41)
(89)
167
24
(1,754)
7
—
(70,132)
67,600
646
8
(613)
(1,028)
161
1,290
797
—
882
—
172
—
(68)
—
(229)
(17)
248
(1,893)
(102)
—
(62,424)
66,131
491
—
(547)
—
171
(1,168)
33,856
(3,476)
18,108
(173)
21,450
12,801
(10,255)
(41,212)
(12,083)
(13,166)
(20,909)
(20,256)
(6,073)
—
13,818
11,784
554
5,802
—
—
(485)
(133,953)
(1,986)
495
307
—
—
—
(154,668)
1,412
2,937
2,332
(42)
(39,536)
(2,151)
613
—
3,078
14,284
6,900
(44,547)
41
—
—
(83)
(35,522)
(2,186)
1,693
463
—
—
(6,900)
(68,269)
See notes to consolidated financial statements
78
Consolidated Statements of Cash Flows (continued)
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2020, 2019 and 2018
Cash flows from financing activities
Net increase in deposits
Proceeds from FHLB borrowings
Proceeds from exercise of stock options
Repurchase of common stock
Payment of dividends
Net cash provided by financing activities
2020
2019
2018
$ 290,179 $
10,000
391
(1,238)
(7,083)
292,249
27,183 $
—
401
(499)
(6,495)
20,590
51,608
—
318
—
(4,431)
47,495
Net increase (decrease) in cash and cash equivalents
171,437
(5,849)
676
Cash and cash equivalents
Beginning of year
End of year
143,015
148,188
$ 314,452 $ 143,015 $ 148,864
148,864
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 (loss) related to investment securities
Operating lease liabilities arising from recording of ROU assets
$
$
5,522 $
4,760
6,593 $
4,457
4,462
2,714
— $
11
2,889
293 $
116
—
324
(5)
—
See notes to consolidated financial statements
79
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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.
On October 1, 2018, the Company completed the acquisition of South Sound Bank, a Washington-state chartered bank,
headquartered in Olympia, Washington ("South Sound Acquisition"). The Company acquired 100% of the outstanding
common stock of South Sound Bank, and South Sound Bank was merged into the Bank. The results of operations of the
acquired assets and assumed liabilities have been included in the Company's consolidated financial statements as of and for the
period since the acquisition date. See Note 2 for additional information on the South Sound Acquisition.
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 24 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 any OTTI in the fair value of investment securities, the valuation of servicing
rights, the valuation of OREO, the valuation of assets acquired and liabilities assumed in acquisitions and the valuation of
goodwill for potential impairment.
Certain prior year amounts have been reclassified to conform to the 2020 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, 2020 and 2019 included deposits with the Federal Reserve Bank of San
Francisco ("FRB") of $266,171,000 and $102,189,000, 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.
80
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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 60 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.
Investment Securities
Investments in debt securities are classified upon acquisition as held to maturity or available for sale. Investments in debt
securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported
at amortized cost. Investments in debt securities classified as available for sale are reported 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 interest income 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 debt securities available for sale that are deemed to be other than temporary are
recognized in earnings when identified. The fair value of the debt security then becomes the new cost basis. For individual
debt 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 debt 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 debt 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 debt security’s cost basis and
its fair value at the consolidated balance sheet date. For individual debt 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.
Investments in Equity Securities
Investments in equity securities are stated at fair value. Prior to October 1, 2018, changes in the fair value of investments in
equity securities were excluded from earnings and reported in other comprehensive income (loss), net of income tax effects.
On October 1, 2018, the Company adopted ASU 2016-01 and reclassified its mutual funds as investments in equity securities.
Beginning October 1, 2018, changes in the fair value of investments in equity securities are recorded in other non-interest
income.
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 any 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, 2020 and 2019.
81
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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 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
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.
Acquired Loans
Purchased loans, including loans acquired in business combinations, are recorded at their estimated fair value at the acquisition
date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at
the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit-impaired ("PCI") or
purchased non-credit-impaired. PCI loans reflect credit deterioration since origination such that it is probable at acquisition that
the Company will be unable to collect all contractually required payments. The excess of the cash flows expected to be
collected over a PCI loan's carrying value is considered to be the accretable yield and is recognized as interest income over the
estimated life of the PCI loan using the effective yield method. The excess of the undiscounted contractual balances due over
the cash flows expected to be collected is considered to be the nonaccretable difference. The nonaccretable difference
represents the Company's estimate of the credit losses expected to occur and would be considered in determining the estimated
fair value of the loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over
those expected at the purchase date in excess of fair value are adjusted through a change to the accretable yield on a prospective
basis. Any subsequent decreases in expected cash flows attributable to credit deterioration are recognized by recording an
allowance for loan losses. PCI loans were insignificant as of September 30, 2020 and 2019.
For purchased non-credit-impaired loans, the difference between the fair value and unpaid principal balance of the loan at the
acquisition date is amortized or accreted to interest income over the life of the loans. Any subsequent deterioration in credit
quality is recognized by recording an allowance for loan losses.
82
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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. In March 2020, the Company announced loan modification programs to support and
provide relief for its borrowers during the novel coronavirus of 2019 ("COVID-19") pandemic. The Company has followed the
loan modification criteria within the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"), which was
signed into law on March 27, 2020 and interagency guidance from the federal banking agencies when determining if a
borrower's modification is subject to a TDR classification. If it is determined that the modification does not meet the criteria
under the CARES Act or interagency guidance to be excluded from TDR classification, the Company evaluates the loan
modifications under its existing TDR framework. Loans subject to forbearance under the COVID-19 loan modification
program are not reported as past due or placed on non-accrual status during the forbearance time period, and interest income
continues to be recognized over the contractual life of the loans.
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 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. When determining the appropriate historical loss and qualitative factors, management took into consideration the
impact of the COVID-19 pandemic on such factors as the national and state unemployment rates and related trends, the amount
of and timing of financial assistance provided by the government, consumer spending levels and trends, industries significantly
impacted by the COVID-19 pandemic, and the Company's COVID-19 loan modification program. 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.
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
estimated net realizable value of the impaired loan is less than the recorded investment in the loan (including accrued interest
83
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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, 2020 or 2019 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 values 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. 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.
84
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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 the share price of the Company's common stock. The Company performed
its fiscal year 2020 goodwill impairment test during the quarter ended June 30, 2020 with the assistance of an independent
third-party firm specializing in goodwill impairment valuations for financial institutions. The third-party analysis was
conducted as of May 31, 2020 and the step one test concluded that the reporting unit's fair value was more than its recorded
value and, therefore, step two of the analysis was not necessary. Accordingly, the recorded value of goodwill as of May 31,
2020 was not impaired.
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, 2020, management believes that there were no events or changes in the circumstances since May 31, 2020
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. If adverse economic conditions or the recent decrease in the Company's
stock price and market capitalization as a result of the COVID-19 pandemic were deemed to be other than temporary, it may
significantly affect the fair value of the Company's goodwill and may trigger impairment charges. Any impairment charge
could have a material adverse effect on the Company's results of operation and financial condition.
CDI
CDI represents the future economic benefit of the potential cost savings from acquiring core deposits as part of a business
combination compared to the cost of alternative funding sources. CDI is amortized to non-interest expense using an accelerated
method based on an estimated runoff of related deposits over a period of ten years. CDI is evaluated for impairment whenever
events or changes in circumstances indicate that its carrying amount may not be recoverable, with any changes in estimated
useful life accounted for prospectively over the revised remaining life.
85
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Servicing Rights
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. Servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are
subsequently sold with the servicing rights retained. Servicing rights are amortized to servicing income on loans sold
approximately in proportion to and over the period of estimated net servicing income. The value of servicing rights 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 servicing rights must be stratified
by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized servicing rights
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 servicing rights 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, 2016.
ESOP
The Bank sponsors a leveraged ESOP; however, all ESOP debt was fully repaid during the year ended September 30, 2019.
The debt of the ESOP was payable to Timberland Bancorp, was recorded as other borrowed funds of the Bank, and was
eliminated in the consolidated financial statements. The shares of the Company's common stock pledged as collateral for the
ESOP's debt were reported as unearned shares issued to the ESOP in the consolidated financial statements. As shares were
released from collateral, compensation expense was recorded equal to the average market price of the shares for the period, and
the shares became available for net income per common share calculations. Dividends paid on unallocated shares reduced the
Company’s cash contributions to the ESOP.
86
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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.
Net Income Per Common Share
Basic net income per common share is computed by dividing net income to common shareholders by the weighted average
number of common shares outstanding during the period, without considering any dilutive items. Diluted net income per
common share is computed by dividing net income to common shareholders by the weighted average number of common
shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury
stock method at the average share price for the Company's common stock during the period. Common stock equivalents arise
from the assumed conversion of outstanding stock options. Shares owned by the Bank’s ESOP that have not been allocated are
not considered to be outstanding for the purpose of computing basic and diluted net income per common share.
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, 2020, 2019 and 2018 totaled
$78,000, $69,000 and $94,000, respectively.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, Revenue from Contracts with
Customers, which created FASB Accounting Standards Codification ("ASC") Topic 606 ("ASC 606"). The core principle of
ASC 606 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. To achieve that
core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the
performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance
obligations in the contract and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASC 606 was
effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company
adopted ASC 606 on October 1, 2018 using the modified retrospective approach. Therefore, the comparative information has
not been adjusted and continues to be reported under the superseded ASC 605. There was no cumulative effect adjustment as
of October 1, 2018, and there were no material changes to the timing or amount of revenue recognized for the year ended
September 30, 2019; however, additional disclosures were incorporated in the footnotes upon adoption. The majority of the
Company's revenue is comprised of interest income from financial assets, which is explicitly excluded from the scope of ASC
606. The Company elected to apply the practical expedient pursuant to ASC 606 and therefore does not disclose information
about remaining performance obligations that have an original expected term of one year or less and allows the Company to
expense costs related to obtaining a contract as incurred when the amortization period would have been one year or less. See
Note 24 for additional information.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and
Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 generally requires equity investments - except those
accounted for under the equity method of accounting or those that result in consolidation of the investee - to be measured at fair
value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that
do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable
price changes in orderly transactions for the identical or a similar investment of the same issuer. ASU 2016-01 is intended to
simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative
assessment to identify impairment. ASU 2016-01 also eliminates certain disclosures related to the fair value of financial
instruments and requires entities to use the exit price notion when measuring the fair value of financial instruments for
disclosure purposes. ASU 2016-01 was effective for fiscal years beginning after December 15, 2017, including interim periods
87
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
within those fiscal years. The Company adopted ASU 2016-01 on October 1, 2018. As required by ASU 2016-01, on October
1, 2018 the Company recorded a one-time cumulative effect adjustment of $63,000 representing net unrealized losses on equity
securities (mutual funds) between accumulated other comprehensive loss and retained earnings on the accompanying
consolidated balance sheet. Additionally, the fair values of financial instruments for disclosure purposes were computed using
an exit price notion and deposits with no stated maturity are no longer included in the fair value disclosures in Note 22.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which created FASB ASC Topic 842 ("ASC 842") and
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 ASC 842 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 generally on a
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. ASC 842 also changes disclosure requirements related to leasing activities
and requires certain qualitative disclosures along with specific quantitative disclosures. ASC 842 also provides an optional
transition method for adoption, under which an entity initially applies ASC 842 at the adoption date and recognizes a
cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity's
reporting for the comparative periods presented in the financial statements in which it adopts ASC 842 will continue to be in
accordance with current GAAP. ASC 842 is effective for annual periods, and interim periods within those annual periods,
beginning after December 15, 2018. Early application of ASC 842 is permitted. The Company adopted the provisions of ASC
842 effective October 1, 2019 utilizing the optional transition method and will not restate comparative periods. The Company
also elected the package of practical expedients permitted under ASC 842's transition guidance, which allows the Company to
carryforward its historical lease classifications and its assessment as to whether a contract is or contains a lease. The Company
also elected to not recognize lease assets and lease liabilities for leases with an initial term of 12 months or less. As a result of
adopting ASC 842, ROU assets and operating lease liabilities increased by $2.89 million on October 1, 2019.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, as amended by ASU 2018-19, ASU
2019-04 and ASU 2019-05. 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 2016-13 also changes the accounting for purchased credit-impaired debt
securities and loans. ASU 2016-13 retains many of the current disclosure requirements in GAAP and expands certain
disclosure requirements. ASU 2016-13 is effective for fiscal years beginning after December 15, 2022, 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 2016-13 and has begun 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 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 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 2017-04 is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2022.
88
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The adoption ASU 2017-04 is not expected to a have a material impact on the Company's future consolidated financial
statements.
In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20):
Premium Amortization on Purchased Callable Debt Securities. This ASU shortens the amortization period for certain callable
debt securities held at a premium to the earliest call date. This ASU was effective for fiscal years, including interim periods
within those fiscal years, beginning after December 15, 2018. The Company adopted ASU 2017-08 effective October 1, 2019
and it did not have a material impact on the Company's consolidated financial statements.
In May 2017, the FASB issued ASU 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 2017-09 was effective for fiscal years, including
interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The Company
adopted ASU 2017-09 effective October 1, 2018 and it did not have a material impact on the Company's consolidated financial
statements.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to
Nonemployee Share-Based Payment Accounting. This ASU was issued to expand the scope of Topic 718 to include share-
based payment transactions for acquiring goods and services from nonemployees. Previously, these awards were recorded at
the fair value of consideration received or the fair value of the equity instruments issued and were measured at the earlier of the
commitment date or the date performance was completed. The amendments in this ASU require nonemployee share-based
payment awards to be measured at the grant-date fair value of the equity instrument. ASU 2018-07 was effective for fiscal
years, including interim periods within those fiscal years, beginning after December 15, 2018. The Company adopted ASU
2018-07 effective October 1, 2019 and it did not have a material impact on the Company's consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to
the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements for fair value
measurements. The following disclosure requirements were removed from ASC Topic 820, Fair Value Measurement: (1) the
amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (2) the policy for timing of
transfers between levels; and (3) the valuation process for Level 3 fair value measurements. This ASU clarifies that the
measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting
date. This ASU adds the following disclosure requirements for Level 3 measurements: (1) changes in unrealized gains and
losses for the period included in other comprehensive income for the recurring Level 3 fair value measurements held at the end
of the reporting period, and (2) the range and weighted average of significant unobservable inputs used to develop Level 3 fair
value measurements. ASU 2018-13 was effective for fiscal years beginning after December 15, 2019, including interim periods
within those fiscal years. The Company adopted ASU 2018-13 effective October 1, 2020 and it is not expected to have a
material impact on the Company's future consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40),
Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The
amendments in this ASU broaden the scope of ASC Subtopic 350-40 to include costs incurred to implement a hosting
arrangement that is a service contract. The amendments align the requirements for capitalizing implementation costs incurred
in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to
develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The costs are
capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred, consistent
with the accounting for internal-use software costs. The amendments in this ASU result in consistent capitalization of
implementation costs of a hosting arrangement that is a service contract and implementation costs incurred to develop or obtain
internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service
element of a hosting arrangement that is a service contract is not affected by the amendments in this ASU. ASU 2018-15 was
effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company
adopted ASU 2018-15 effective October 1, 2020 and it is not expected to have a material impact on the Company's future
consolidated financial statements.
89
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), Simplifying the accounting for Income Taxes.
The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the general principles
in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by
clarifying and amending existing guidelines. ASU 2019-12 is effective for fiscal years beginning after December 15, 2021,
including interim periods within fiscal years. The adoption of ASU 2019-12 is not expected to have a material impact on the
Company's future consolidated financial statements.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of
Reference Rate Reform on Financial Reporting. This ASU applies to contracts, hedging relationships and other transactions
that reference the London Interbank Offered Rate ("LIBOR") or other rate references expected to be discontinued because of
reference rate reform. The ASU permits an entity to make necessary modifications to eligible contracts or transactions without
requiring contract remeasurement or reassessment of a previous accounting determination. This ASU is effective for all entities
as of March 12, 2020 through December 31, 2022. The Company has not adopted ASU 2020-04 as of September 30, 2020.
The adoption of ASU 2020-04 is not expected to have a material impact on the Company's future consolidated financial
statements.
On March 22, 2020, federal banking regulators issued an interagency statement that included guidance on their approach for the
accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current
accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-
term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms,
or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its
contractual payments at the time a modification is implemented. The agencies confirmed in working with the staff of the FASB
that short-term modification made on a good faith basis in response to COVID-19 to borrowers who were current prior to any
relief are not troubled debt restructurings.
Note 2 - Business Combination
On October 1, 2018, the Company completed the South Sound Acquisition. The primary reason for the acquisition was to
expand the Company's presence along Washington State's economically important I-5 corridor.
Pursuant to the terms of the merger agreement, South Sound Bank shareholders received 0.746 of a share of the Company's
common stock and $5.68825 in cash per share of South Sound Bank common stock. The Company issued 904,826 shares of its
common stock (valued at $28,267,000 based on the Company's closing stock price on September 30, 2018 of $31.24 per share)
and paid $6,903,000 in cash in the transaction for total consideration paid of $35,170,000.
The South Sound Acquisition constitutes a business combination as defined by GAAP, which establishes principles and
requirements for how the acquirer in a business combination recognizes and measures in its financial statements the identifiable
assets acquired and liabilities assumed. The Company was considered the acquirer in this transaction. Accordingly, the
estimated fair values of the acquired assets, including the identifiable intangible assets, and the assumed liabilities in the South
Sound Acquisition were measured and recorded as of October 1, 2018. The excess of the total consideration paid over the fair
value of the net assets acquired was allocated to goodwill. The South Sound Acquisition resulted in $9,481,000 of goodwill.
The goodwill arising from this transaction consists largely of the synergies and expected economies of scale from combining
the operations of the Company and South Sound Bank. This goodwill is not deductible for tax purposes.
In most instances, determining the estimated fair values of the acquired assets and assumed liabilities requires the Company to
estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at the appropriate rate of
interest. Differences may arise between contractually required payments and the expected cash flows at the acquisition date due
to items such as estimated credit losses, prepayments or early withdrawal, and other factors. One of the most significant of
those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition
over the estimated fair value is recognized as interest income over the remaining lives of the loans. In accordance with GAAP,
there was no carry-over of South Sound Bank's previously established allowance for loan losses.
90
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The following table summarizes the fair value of consideration paid, the estimated fair values of assets acquired and liabilities
assumed as of the acquisition date, and the resulting goodwill relating to the transaction:
Total acquisition consideration
Recognized amounts of identifiable assets acquired and liabilities assumed
Identifiable assets acquired:
Cash and cash equivalents
CDs held for investment
FHLB stock
Investment securities held to maturity
Investment securities available for sale
Loans receivable
Premises and equipment
OREO
Accrued interest receivable
BOLI
CDI
Servicing rights
Other assets
Total assets
Liabilities assumed:
Deposits
Other liabilities and accrued expenses
Total liabilities assumed
Total identifiable net assets acquired
Goodwill recognized
At October 1, 2018
Fair Value
Adjustment
Book Value
Estimated
Fair Value
(Dollars in thousands)
$
35,170
$
21,187 $
2,973
205
19,891
5,022
123,627
3,225
25
554
2,629
—
285
1,087
180,710
—
—
—
(189)
—
(2,083)
112
—
—
—
2,483
(4)
(511)
(192)
21,187
2,973
205
19,702
5,022
121,544
3,337
25
554
2,629
2,483
281
576
180,518
151,378
3,291
154,669
26,041 $
$
160
—
160
(352)
$
151,538
3,291
154,829
25,689
9,481
The acquired loan portfolio was valued using Level 3 inputs (see Note 22) and included the use of present value techniques,
including cash flow estimates and incorporated assumptions that the Company believes marketplace participants would use in
estimating fair values.
The operating results of the Company for the years ended September 30, 2020 and 2019 include the operating results produced
by the net assets acquired in the South Sound Acquisition since the October 1, 2018 acquisition date. The Company determined
that the disclosure requirements related to the amounts of revenues and earnings from the net assets acquired in the South
Sound Acquisition since the October 1, 2018 acquisition date is impracticable. The financial activity and operating results of
the net assets acquired in the South Sound Acquisition were commingled with the Company's financial activity and operating
results as of the acquisition date.
During the year ended September 30, 2020, the Company incurred acquisition-related expenses of $2,000 related to the South
Sound Acquisition. During the year ended September 30, 2019, the Company incurred acquisition-related expenses of
$462,000 related to the South Sound Acquisition, of which $317,000 is included in data processing and $145,000 is included in
91
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
professional fees in the accompanying consolidated statement of income. During the year ended September 30, 2018, the
Company incurred acquisition-related expenses of $616,000 related to the South Sound Acquisition, which are all included in
professional fees in the accompanying consolidated statement of income. South Sound Bank incurred acquisition-related
expenses of $1,598,000 for the fiscal year ended September 30, 2018 related to the South Sound Acquisition.
Note 3 - 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. In response to the COVID-19 pandemic the Federal Reserve
reduced the reserve requirement ratio to zero percent, effective March 26, 2020. The amounts of the reserve requirement
balances as of September 30, 2020 and 2019 were $0 and $1,898,000, respectively.
Note 4 - Investment Securities
Held to maturity and available for sale investment securities were as follows as of September 30, 2020 and 2019 (dollars in
thousands):
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
September 30, 2020
Held to Maturity
Mortgage-backed securities ("MBS"):
U.S. government agencies
Private label residential
Bank issued trust preferred securities
Total
Available for Sale
MBS: U.S. government agencies
Total
September 30, 2019
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
Total
27,161 $
229
500
27,890 $
1,635 $
307
—
1,942 $
(3) $
(1)
(1)
(5) $
28,793
535
499
29,827
57,797 $
57,797 $
178 $
178 $
(68) $
(68) $
57,907
57,907
27,786 $
317
2,999
31,102 $
999 $
490
—
1,489 $
(2) $
(1)
(8)
(11) $
28,783
806
2,991
32,580
22,418 $
22,418 $
114 $
114 $
— $
— $
22,532
22,532
$
$
$
$
$
$
$
$
92
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2020
(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
Qty
Estimated
Fair
Value
Gross
Unrealized
Losses
Held to Maturity
MBS:
U.S. government
agencies
Private label residential
Bank issued trust preferred
securities
Total
Available for Sale
MBS:
U.S. government
agencies
Total
$
$
$
$
5,130 $
7
499
5,636 $
(2) 4 $
1
—
(1) 1
(3) 6 $
39 $
11
—
50 $
(1) 4 $
(1) 2
5,169 $
18
—
—
(2) 6 $
499
5,686 $
21,464 $
(68) 11 $
— $
—
— $ 21,464 $
21,464 $
(68) 11 $
— $
—
— $ 21,464 $
(3)
(1)
(1)
(5)
(68)
(68)
Held to maturity investment securities with unrealized losses were as follows as of September 30, 2019 (dollars in thousands):
Less Than 12 Months
12 Months or Longer
Estimated
Fair
Value
Gross
Unrealized
Losses
Qty
Estimated
Fair
Value
Gross
Unrealized
Losses
Qty
Total
Estimated
Fair
Value
Gross
Unrealized
Losses
Held to Maturity
MBS:
U.S. government agencies $
Private label residential
291 $
—
(1) 2 $
—
—
76 $
23
(1)
(1)
6 $
5
367 $
23
U.S. Treasury and U.S.
government agency
securities
Total
—
291 $
$
—
—
(1) 2 $
2,991
3,090 $
(8)
(10)
1
12 $
2,991
3,381 $
(2)
(1)
(8)
(11)
The Company has evaluated the investment securities in the above tables and has determined that the decline in their fair 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 fair value of these securities recovers. Additional deterioration in market and economic conditions
related to the COVID-19 pandemic may, however, have an adverse impact on credit quality in the future and result in OTTI
charges.
The Company bifurcates OTTI into (1) amounts related to credit losses which are recognized through earnings and (2) amounts
related to all other factors which are recognized as a component of other comprehensive income (loss).
To determine the component of the gross OTTI related to credit losses, the Company compared the amortized cost basis of the
OTTI security to the present value of its revised expected cash flows, discounted using its pre-impairment yield. The revised
expected cash flow estimates for individual securities are based primarily on an analysis of default rates, prepayment speeds and
93
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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, 2020, 2019 and 2018:
September 30, 2020
Constant prepayment rate
Collateral default rate
Loss severity rate
September 30, 2019
Constant prepayment rate
Collateral default rate
Loss severity rate
September 30, 2018
Constant prepayment rate
Collateral default rate
Loss severity rate
Range
Minimum
Maximum
Weighted
Average
6.00%
2.17%
—%
6.00%
3.00%
—%
6.00%
—%
—%
15.00%
27.39%
11.27%
15.00%
19.70%
10.59%
15.00%
10.42%
75.00%
8.97%
14.37%
2.87%
10.67%
10.40%
4.07%
12.91%
5.03%
37.25%
The following table presents the OTTI recoveries for the years ended September 30, 2020, 2019 and 2018 (dollars in
thousands):
2020
Held To
Maturity
2019
Held To
Maturity
2018
Held To
Maturity
$
$
120
—
120
$
$
71
$
(12)
59
$
73
(5)
68
Total recoveries
Adjustment for portion of OTTI transferred from other
comprehensive income (loss) before income taxes (1)
Net recoveries recognized in earnings (2)
________________________
(1) Represents OTTI related to all other factors.
(2) Represents OTTI related to credit losses.
94
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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,
2020, 2019 and 2018 (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
2020
2019
2018
$
1,071 $
1,153 $
1,301
3
13
14
(66)
(123)
885 $
(23)
(72)
1,071 $
(80)
(82)
1,153
$
During the year ended September 30, 2020, the Company recorded a $66,000 net realized loss (as a result of investment
securities being deemed worthless) on nineteen held to maturity investment securities, all of which had been recognized
previously as a credit loss. During the year ended September 30, 2019, the Company recorded a $23,000 net realized loss (as a
result of investment securities being deemed worthless) on seventeen held to maturity investment securities, all of which had
been recognized previously as a credit loss. During the year ended September 30, 2018, the Company recorded an $80,000 net
realized loss (as a result of investment securities being deemed worthless) on sixteen 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 and FHLB collateral totaled $81,028,000 and $18,587,000 at September 30, 2020 and 2019, respectively.
The contractual maturities of debt securities at September 30, 2020 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
$
$
— $
126
7,157
20,607
27,890 $
— $
831 $
130
7,937
21,760
3,270
18,507
35,189
29,827 $
57,797 $
830
3,261
18,491
35,325
57,907
95
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 5 - Loans Receivable and Allowance for Loan Losses
Loans receivable by portfolio segment consisted of the following at September 30, 2020 and 2019 (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
Construction – land development
Land
Total mortgage loans
Consumer loans:
Home equity and second mortgage
Other
Total consumer loans
Commercial loans:
Commercial business
U.S. Small Business Administration ("SBA") Paycheck Protection Program ("PPP")
Total commercial business and SBA PPP loans
Total loans receivable
Less:
Undisbursed portion of construction loans in process
Deferred loan origination fees, net
Allowance for loan losses
Loans receivable, net
2020
2019
$ 118,580 $ 132,661
76,036
419,117
128,848
16,445
39,566
36,263
2,404
30,770
882,110
85,053
453,574
129,572
14,592
33,144
34,476
7,712
25,571
902,274
32,077
3,572
35,649
40,190
4,312
44,502
69,540
126,820
196,360
1,134,283
64,764
—
64,764
991,376
100,558
6,436
13,414
120,408
92,226
2,798
9,690
104,714
$ 1,013,875 $ 886,662
Loans receivable at September 30, 2020 and 2019 are reported net of unamortized discounts totaling $790,000 and $1,386,000,
respectively.
Significant Concentrations of Credit Risk
Most of the Company’s lending activity is with customers located in the state of Washington and involves real estate. At
September 30, 2020, the Company had $934,351,000 (including $100,558,000 of undisbursed construction loans in process) in
loans secured by real estate, which represented 82.4% 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, 2020, 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.
96
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Related Party Loans
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, 2020 and
2019. Activity in related party loans during the years ended September 30, 2020, 2019 and 2018 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
2020
94 $
178
(24)
248 $
2019
119 $
1
(26)
94 $
2018
741
368
(990)
119
$
$
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, multi-family
construction loans and land development 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
97
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
identified carry more risk because the payoff for the loan depends on the builder’s ability to sell the property prior to the time
that the construction loan is due. The 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 and owner/builder construction loans are
originated to home owners 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.
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.
Construction Lending - Land Development: Land development loans are originated to real estate developers for the purpose
of developing residential subdivisions. The Company is currently originating land development loans on a limited basis.
Land Lending: The Company originates loans for the acquisition of land upon which the purchaser can then build or make
improvements necessary to build or to sell as improved lots. 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, excluding SBA PPP loans, 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
98
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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.
SBA PPP: The CARES Act, which was signed into law on March 27, 2020, authorized the SBA to temporarily guarantee
loans under a new loan program called PPP. As a qualified SBA lender, the Company was automatically authorized to
originate PPP loans upon commencement of the program in April 2020 through the conclusion of the PPP on August 8, 2020.
The SBA guarantees 100% of PPP loans made to eligible borrowers and the entire amount of the borrower's PPP loan,
including any accrued interest, is eligible to be forgiven and repaid by the SBA. PPP loans have: (a) an interest rate of 1%, (b)
a two-year loan term to maturity for loans approved by the SBA prior to June 5, 2020 and a five-year maturity for loans
approved thereafter; and (c) principal and interest payments deferred for at least six months from the date of disbursement.
Allowance for Loan Losses
The following table sets forth information for the year ended September 30, 2020 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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
1,167 $
481
4,154
755
212
338
375
67
697
623
99
722
9,690 $
(6) $
237
2,984
72
(54)
82
(137)
66
(145)
(45)
(19)
665
3,700 $
— $
—
—
—
—
—
—
—
—
—
(12)
(15)
(27) $
2 $
—
6
5
—
—
—
—
20
15
3
—
51 $
1,163
718
7,144
832
158
420
238
133
572
593
71
1,372
13,414
99
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The following table sets forth information for the year ended September 30, 2019 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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
1,086 $
433
4,248
671
178
563
135
49
844
649
117
557
9,530 $
(23) $
48
(260)
82
34
(225)
240
18
(116)
— $
—
—
—
—
—
—
—
(49)
(21)
(19)
242
—
$
(5)
(5)
(102)
(161) $
104 $
—
166
2
—
—
—
—
18
—
6
25
321 $
1,167
481
4,154
755
212
338
375
67
697
623
99
722
9,690
The following table sets forth information for the year ended September 30, 2018 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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
$
1,082 $
447
4,184
699
128
303
173
—
918
983
121
515
9,553 $
4 $
(14)
92
(28)
37
260
(38)
49
(71)
(334)
1
42
— $
— $
—
(28)
—
—
—
—
—
(22)
—
(6)
—
(56) $
— $
—
—
—
13
—
—
—
19
—
1
—
33 $
1,086
433
4,248
671
178
563
135
49
844
649
117
557
9,530
100
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The following table presents information on loans evaluated individually and collectively for impairment in the allowance for
loan losses by portfolio segment at September 30, 2020 (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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
SBA PPP loans
Total
$
3 $
—
—
1,160 $ 1,163 $
718
7,144
718
7,144
1,143 $
—
3,242
117,437 $ 118,580
85,053
85,053
453,574
450,332
—
—
—
—
—
—
832
158
420
238
133
572
832
158
420
238
133
572
—
—
—
—
—
394
75,332
75,332
7,108
20,927
10,832
4,739
25,177
7,108
20,927
10,832
4,739
25,571
—
—
38
—
41 $
593
71
1,334
—
593
71
1,372
—
13,373 $ 13,414 $
555
9
430
—
32,077
31,522
3,572
3,563
69,540
69,110
126,820
126,820
5,773 $ 1,027,952 $ 1,033,725
The following table presents information on loans evaluated individually and collectively for impairment in the allowance for
loan losses by portfolio segment at September 30, 2019 (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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
— $
—
—
1,167 $ 1,167 $
481
4,154
481
4,154
1,192 $
—
3,190
131,469 $ 132,661
76,036
419,117
76,036
415,927
—
—
—
—
—
27
—
17
128
172 $
755
212
338
375
67
670
623
82
594
755
212
338
375
67
697
623
99
722
9,518 $ 9,690 $
101
—
—
—
—
—
204
75,411
75,411
10,779
24,051
19,256
1,803
30,566
10,779
24,051
19,256
1,803
30,770
603
23
725
5,937 $
39,587
4,289
64,039
40,190
4,312
64,764
893,213 $ 899,150
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2020 (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
$
— $
—
—
68 $
—
519
659 $
—
858
— $
—
—
727 $ 117,853 $ 118,580
85,053
—
453,574
1,377
85,053
452,197
—
—
—
—
—
—
—
—
—
—
38
144
—
—
—
—
—
394
—
—
—
—
—
—
—
75,332
75,332
—
—
—
38
538
7,108
20,927
10,832
4,701
25,033
7,108
20,927
10,832
4,739
25,571
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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
SBA PPP loans
Total
$
—
3
49
—
52 $
22
—
—
—
791 $
555
9
430
—
2,905 $
577
12
479
—
32,077
—
3,572
—
69,540
—
126,820
—
— $ 3,748 $ 1,029,977 $ 1,033,725
31,500
3,560
69,061
126,820
__________________
(1)
Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual.
102
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2019 (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
$
— $
—
94
286 $
—
218
699 $
—
779
— $
—
—
985 $ 131,676 $ 132,661
76,036
—
419,117
1,091
76,036
418,026
—
—
—
—
—
5
—
—
—
—
—
193
—
—
—
—
—
204
—
—
—
—
—
—
—
75,411
75,411
—
—
—
—
402
10,779
24,051
19,256
1,803
30,368
10,779
24,051
19,256
1,803
30,770
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
Construction – land development
Land
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
$
94
—
—
193 $
—
—
2
699 $
603
23
725
3,033 $
697
23
727
40,190
—
4,312
—
64,764
—
— $ 3,925 $ 895,225 $ 899,150
39,493
4,289
64,037
___________________
(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.
Doubtful: Loans in this classification have the weaknesses of substandard loans with the additional characteristic that the
weaknesses make the collection or liquidation in full on the basis of currently existing facts, conditions and values questionable,
and there is a high possibility of loss. At September 30, 2020 and 2019, there were no loans classified as doubtful.
103
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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,
2020 and 2019, there were no loans classified as loss.
The following table presents an analysis of loans by credit quality indicator and portfolio segment at September 30, 2020
(dollars in thousands):
Loan Grades
Pass
Watch
Special
Mention
Substandard
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
Construction – land development
Land
$ 115,992 $
85,053
441,037
74,529
7,108
19,525
10,832
4,701
23,290
1,369 $
—
7,712
803
—
—
—
—
1,518
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
SBA PPP loans
Total
31,344
3,531
68,904
126,820
$ 1,012,666 $
53
32
59
—
11,546 $
551 $
—
3,447
—
—
1,402
—
—
370
—
—
94
—
5,864 $
668 $ 118,580
85,053
—
453,574
1,378
75,332
—
7,108
—
20,927
—
10,832
—
4,739
38
25,571
393
680
9
483
—
32,077
3,572
69,540
126,820
3,649 $ 1,033,725
The following table presents an analysis of loans by credit quality indicator and portfolio segment at September 30, 2019
(dollars in thousands):
Loan Grades
Pass
Watch
Special
Mention
Substandard
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
Construction – land development
Land
$ 129,748 $
76,036
405,165
75,178
10,779
24,051
19,256
1,659
28,390
296 $
—
11,944
233
—
—
—
—
952
562 $
—
683
—
—
—
—
—
1,217
2,055 $ 132,661
76,036
419,117
75,411
10,779
24,051
19,256
1,803
30,770
—
1,325
—
—
—
—
144
211
Consumer loans:
Home equity and second mortgage
Other
Commercial business loans
Total
39,364
4,257
63,669
$ 877,552 $
41
33
232
13,731 $
—
—
85
2,547 $
785
22
778
40,190
4,312
64,764
5,320 $ 899,150
104
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107
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The CARES Act provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined,
among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under
the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment
deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are
considered current under the CARES Act and related regulatory guidance if they are less than 30 days past due on their
contractual payments at the time a modification program is implemented. In response to requests from borrowers, the Company
made payment deferral modifications (typically 90-day payment deferrals with interest continuing to accrue or scheduled to be
paid monthly) on a number of loans. The majority of these borrowers had resumed making payments as of September 30, 2020
and only five loans totaling $5,870,000 remained on deferral status under COVID-19 loan modification forbearance agreements
as of that date. Loan modifications in accordance with the CARES Act and related regulatory guidance are still subject to an
evaluation in regard to determining whether or not a loan is deemed to be impaired.
The following table details the COVID-19 loan modifications, still on deferral status, as of September 30, 2020 (dollars in
thousands):
COVID-19 Loan Modifications
Mortgage loans
One- to four-family
Commercial
Construction
Total mortgage loans
Consumer loans
Home equity and second mortgage
Total consumer loans
Total COVID-19 Modifications
Number
Balance
Percent
1
2
1
4
1
1
5
$
467
3,951
1,402
5,820
50
50
8.0%
67.2
23.9
99.1
0.9
0.9
$
5,870
100.0%
The Company had $3,071,000 in TDRs included in impaired loans at September 30, 2020 and had no commitments to lend
additional funds on these loans. The Company had $3,269,000 in TDRs included in impaired loans at September 30, 2019 and
had no commitments to lend additional funds on these loans. The allowance for loan losses allocated to TDRs at September 30,
2020 and 2019 was $3,000 and $56,000, respectively.
The following tables set forth information with respect to the Company’s TDRs by interest accrual status as of September 30,
2020 and 2019 (dollars in thousands):
2020
Non-
Accrual
Total
Accruing
$
$
483 $
—
2,385
—
—
2,868 $
— $
—
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130
73
203 $
483
—
2,385
130
73
3,071
Mortgage loans:
One- to four-family
Multi-family
Commercial
Land
Consumer loans:
Home equity and second mortgage
Total
108
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Mortgage loans:
One- to four-family
Commercial
Consumer loans:
Home equity and second mortgage
Commercial business loans
Total
2019
Non-
Accrual
Total
141 $
—
82
143
366 $
634
2,410
82
143
3,269
Accruing
$
493 $
2,410
—
—
2,903 $
$
There were no new TDRs recognized during the fiscal year ended September 30, 2020. There was one new TDR during the
year ended September 30, 2019. There were three new TDRs during the year ended September 30, 2018. The following tables
set forth information with respect to the Company's TDRs, by portfolio segment, during the years ended September 30, 2019
and 2018 (dollars in thousands):
2019
Home equity and second mortgage loans (1)
Total
2018
Land loans (2)
Commercial business loans (1)
Total
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment
End of
Period
Balance
Number of
Contracts
1 $
1 $
1 $
2
3 $
85 $
85 $
85 $
85 $
82
82
244 $
155 $
183
183
427 $
338 $
153
170
323
(1) Modifications were a result of a reduction in interest rates or monthly payment amounts.
(2) Modification was a result of a reduction in principal balance.
There were no TDRs for which there was a payment default within the first 12 months of modification during the years ended
September 30, 2020, 2019 or 2018.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30, 2020 and 2019 (dollars in thousands):
Land
Buildings and improvements
Furniture and equipment
Property held for future expansion
Construction and purchases in progress
Less accumulated depreciation
Premises and equipment, net
109
2020
5,404 $
24,636
9,978
129
138
40,285
17,250
23,035 $
$
$
2019
5,404
23,847
9,012
334
338
38,935
16,105
22,830
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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 $377,000, $332,000 and $206,000 for the years ended September 30,
2020, 2019 and 2018, respectively, which is included in premises and equipment expense in the accompanying consolidated
statements of income. See Note 10 for additional information on the Company's leases.
Note 7 – OREO and Other Repossessed Assets
The following table presents the activity related to OREO and other repossessed assets for the years ended September 30, 2020
and 2019 (dollars in thousands):
Balance, beginning of year
Addition due to South Sound Acquisition
Other additions
Writedowns
Sales
Balance, end of year
2020
2019
Amount
1,683
—
(173)
(460)
1,050
$
$
Number
12 $
—
—
(6)
6 $
Amount
1,913
25
293
(24)
(524)
1,683
Number
12
1
2
—
(3)
12
At September 30, 2020, OREO and other repossessed assets consisted of six OREO properties in Washington, with balances
ranging from $79,000 to $702,000. At September 30, 2019, OREO and other repossessed assets consisted of 12 OREO
properties in Washington, with balances ranging from $13,000 to $874,000. The Company recorded net gains on sales of
OREO and other repossessed assets of $35,000, $89,000, and $229,000 for the years ended September 30, 2020, 2019 and
2018, 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, 2020, there were no foreclosed residential real estate properties held in OREO as a result of obtaining
physical possession and there were no one- to four-family properties in the process of foreclosure. At September 30, 2019, there
were no foreclosed residential real estate properties held in OREO as a result of obtaining physical possession and the amount
of one- to four-family properties in the process of foreclosure totaled $150,000.
Note 8 - Goodwill and CDI
Goodwill
There were no changes to the recorded amount of goodwill for both years ended September 30, 2020 and 2018. The following
table presents the change in the recorded amount of goodwill for the year ended September 30, 2019 (dollars in thousands).
Balance, beginning of year
Addition as a result of the South Sound Acquisition (see Note 2)
Balance, end of year
$
$
5,650
9,481
15,131
CDI
During the year ended September 30, 2019, the Company recorded a CDI of $2,483,000 in connection with the South Sound
Acquisition. The CDI amortization expense totaled $406,000 and $452,000 for the years ended September 30, 2020 and 2019,
respectively.
110
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Amortization expense for the CDI for fiscal years ending subsequent to September 30, 2020 is estimated to be as follows
(dollars in thousands):
2021
2022
2023
2024
2025
Thereafter
Total
Note 9 - Servicing Rights
$
$
361
316
271
226
180
271
1,625
The Company services one- to four-family mortgage loans for Freddie Mac and also provides servicing 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, 2020, 2019 and 2018 was $418,559,000,
$386,357,000 and $370,928,000, respectively. The guaranteed principal amount of SBA loans serviced for others at
September 30, 2020, 2019 and 2018 was $8,022,000, $12,765,000 and $754,000, respectively.
The following is an analysis of the changes in Freddie Mac servicing rights for the years ended September 30, 2020, 2019 and
2018 (dollars in thousands):
Balance, beginning of year
Additions
Amortization
Valuation allowance
Balance, end of year
2020
2,206 $
1,733
(748)
(211)
2,980 $
2019
2,022 $
747
(563)
—
2,206 $
2018
1,823
687
(488)
—
2,022
$
$
At September 30, 2020, 2019 and 2018, the estimated fair value of Freddie Mac servicing rights totaled $3,120,000, $3,694,000
and $4,171,000, respectively. The Freddie Mac servicing rights' fair values at September 30, 2020, 2019 and 2018 were
estimated using discounted cash flow analyses with average discount rates of 9.00%, 9.00% and 8.99%, respectively, and
average conditional prepayment rates of 14.42%, 11.31% and 8.10%, respectively. At September 30, 2020 there was a
valuation allowance of $211,000. At both September 30, 2019 and 2018, there was no valuation allowance on the Freddie Mac
servicing rights.
The following is an analysis of the changes in SBA servicing rights for the years ended September 30, 2020, 2019 and 2018
(dollars in thousands):
Balance, beginning of year
Additions due to South Sound Acquisition
Other additions
Amortization
Valuation allowance - South Sound Acquisition
Valuation allowance
Balance, end of year
2020
2019
2018
$
202 $
6 $
—
13
(90)
—
(10)
115 $
285
2
(83)
(4)
(4)
202 $
$
2
—
7
(3)
—
—
6
At September 30, 2020 and 2019, the estimated fair value of SBA servicing rights totaled $115,000 and $202,000, respectively.
The SBA servicing rights' fair values at September 30, 2020 and 2019 were estimated using discounted cash flow analyses with
111
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
average discount rates of 15.00% for both years and average conditional prepayment rates of 16.29% and 16.13% respectively.
At September 30, 2020 and 2019, there were valuation allowances of $18,000 and $8,000, respectively, on SBA servicing
rights. At September 30, 2018, the SBA servicing rights were insignificant.
Note 10 - Leases
The Company adopted ASC 842 on October 1, 2019 and began recording operating lease liabilities and operating lease ROU
assets on the consolidated balance sheets. The Company has operating leases for three retail bank branch offices. The ROU
assets totaled $2.89 million at October 1, 2019. The Company's leases have remaining lease terms of 22 months to eleven
years, some of which include options to extend the leases for up to five years.
The components of lease cost (included in the premises and equipment expense category in the consolidated statements of
income) are as follows for the year ended September 30, 2020 (dollars in thousands):
Lease cost:
Operating lease cost
Total lease cost
$
$
377
377
The following table provides supplemental information to operating leases at or for the year ended September 30, 2020 (dollars
in thousands):
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
Weighted average remaining lease term-operating leases
Weighted average discount rate-operating leases
$
318
9.24 years
2.22%
The Company's leases typically do not contain a discount rate implicit in the lease contract. As an alternative, the weighted
average discount rate used to value the future value of lease payments due in calculating the value of the ROU asset and lease
liability was determined by utilizing the September 30, 2019 fixed-rate advances issued by the FHLB, for all leases entered into
prior to the October 1, 2019 adoption date.
Maturities of operating lease liabilities at September 30, 2020 for future years are as follows (dollars in thousands):
2021
2022
2023
2024
2025
Thereafter
Total lease payments
Less imputed interest
Total
$
$
327,000
342,000
310,000
313,000
317,000
1,322,000
2,931,000
301,000
2,630,000
112
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 11 - Deposits
Deposits consisted of the following at September 30, 2020 and 2019 (dollars in thousands):
Non-interest-bearing demand
NOW checking
Savings
Money market
Certificates of deposit
Total
2020
2019
$ 441,889 $ 296,472
297,055
164,506
144,539
165,655
$ 1,358,406 $ 1,068,227
376,899
219,869
161,225
158,524
Individual certificates of deposit in amounts of $250,000 or greater totaled $28,945,000 and $29,211,000 at September 30, 2020
and 2019, respectively. The Company had brokered deposits totaling $11,303,000 and $19,327,000 at September 30, 2020 and
2019, respectively.
Scheduled maturities of certificates of deposit for fiscal years ending subsequent to September 30, 2020 are as follows (dollars
in thousands):
2021
2022
2023
2024
2025
Total
$ 102,862
29,355
9,314
8,664
8,329
$ 158,524
Interest expense on deposits by account type was as follows for the years ended September 30, 2020, 2019 and 2018 (dollars in
thousands):
NOW checking
Savings
Money market
Certificates of deposit
Total
2020
882 $
188
735
2,830
4,635 $
2019
840 $
106
1,119
2,500
4,565 $
2018
451
85
722
1,520
2,778
$
$
Note 12 – 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 45% of the Bank’s
total assets, limited by available collateral. The Bank had $10,000,000 of long-term FHLB borrowings outstanding at
September 30, 2020. These borrowings consisted of two $5,000,000 borrowings, with scheduled maturities in March 2025 and
March 2027, and which bear interest at 1.19% and 1.11%, respectively. The Bank had no FHLB borrowings outstanding at
September 30, 2019. 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 maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. At
September 30, 2020, the Bank had a borrowing capacity on this line of $71,900,000. The Bank had no outstanding borrowings
on this line at both September 30, 2020 and 2019.
The Bank has a short-term $50,000,000 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 both September 30, 2020 and 2019.
113
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 13 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses were comprised of the following at September 30, 2020 and 2019 (dollars in thousands):
Accrued deferred compensation, profit sharing plans and bonuses payable
Accrued interest payable on deposits
Accounts payable and accrued expenses - other
Total other liabilities and accrued expenses
Note 14 - Income Taxes
2020
3,110 $
274
3,928
7,312 $
2019
3,131
333
4,374
7,838
$
$
On December 22, 2017, the federal government enacted the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act significantly
revised the future ongoing federal corporate income tax by, among other things, decreasing the federal corporate income tax
rate to 21.0% from 35.0% effective January 1, 2018. As the Company has a September 30 fiscal year-end, the lower corporate
income tax rate was phased in, resulting in a blended federal income tax rate of approximately 24.5% for the Company's fiscal
year ended September 30, 2018, and 21.0% for subsequent fiscal years. In addition, the reduction of the corporate federal
income tax rate required the Company to revalue its deferred tax assets and liabilities based on the lower federal income tax rate
of 21.0%.
As a result of the Tax Act, during the year ended September 30, 2018, the Company recorded a one-time income tax expense of
$548,000 in conjunction with remeasuring its net deferred tax assets. The impact of using the 24.5% blended federal income
tax rate for the year ended September 30, 2018 versus a 35.0% rate reduced the provision for income taxes by approximately
$2.21 million, which was partially offset by the $548,000 one-time net deferred tax asset remeasurement.
The components of the provision for income taxes for the years ended September 30, 2020, 2019 and 2018 were as follows
(dollars in thousands):
Current:
Federal
State
Deferred
Provision for income taxes
2020
2019
2018
$
$
5,962 $
—
76
6,038 $
5,198 $
—
703
5,901 $
4,900
4
797
5,701
At September 30, 2020, the Company had income taxes receivable of $781,000, which is included in other assets in the
accompanying 2020 consolidated balance sheet. At September 30, 2019, the Company had income taxes receivable of
$1,210,000, which is included in other assets in the accompanying 2019 consolidated balance sheet.
114
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The components of the Company’s deferred tax assets and liabilities at September 30, 2020 and 2019 were as follows (dollars
in thousands):
Deferred Tax Assets
Allowance for loan losses
Allowance for OREO losses
OTTI credit impairment on investment securities
Accrued interest on loans
Deferred compensation and bonuses
Reserve for loan commitments
Lease liability
Other
Total deferred tax assets
Deferred Tax Liabilities
Goodwill
Servicing rights
Depreciation
Loan fees/costs
FHLB stock dividends
Prepaid expenses
Purchase accounting adjustment
Net unrealized gains on investment securities and investments in equity securities
Right of use asset
Total deferred tax liabilities
2020
2019
$
2,440 $
171
64
8
372
81
552
69
3,757
1,187
650
778
428
81
98
207
23
543
3,995
1,550
218
97
76
520
51
—
82
2,594
1,187
506
494
267
82
70
110
15
—
2,731
Net deferred tax assets (liabilities)
$
(238) $
(137)
Deferred tax liabilities are included in other liabilities on the consolidated balance sheet.
The provision for income taxes for the years ended September 30, 2020, 2019 and 2018 differs from that computed at the
federal statutory corporate tax rate as follows (dollars in thousands):
Expected federal income tax provision at statutory rate
Net impact of the Tax Act
BOLI income
Dividends on ESOP
Stock options tax effect
Other, net
Provision for income taxes
2020
6,365 $
—
(124)
(75)
(33)
(95)
6,038 $
2019
6,283 $
—
(345)
(73)
(87)
123
5,901 $
2018
5,500
548
(134)
(71)
(157)
15
5,701
$
$
No valuation allowance for deferred tax assets was recorded as of September 30, 2020 and 2019, as management believes that it
is more likely than not that all of the deferred tax assets will be realized based on management's expectations of future taxable
income.
Note 15 - 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 18 years of age or older. The Bank
115
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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 was repaid primarily from the Bank’s contributions to the ESOP and was fully repaid by March 31, 2019.
The interest rate on the loan was 8.5%. Interest expense on the ESOP debt was $9,000 and $53,000 for the years ended
September 30, 2019 and 2018, respectively.
The amount of the Bank's annual contribution was discretionary, except that it must have been sufficient to enable the ESOP to
service its debt. All dividends received by the ESOP were used to pay debt service through March 31, 2019. The dividends
received after March 31, 2019 have been paid directly to participants. Dividends of $176,000 and $291,000 were used to
service the debt during the years ended September 30, 2019 and 2018, respectively. As the Plan made each payment of
principal and interest, an appropriate percentage of stock was released and allocated annually to eligible employee accounts, in
accordance with applicable regulations. As of September 30, 2020, an aggregate of 642,302 ESOP shares, which were
previously released for allocation to participants, had been distributed to participants.
Shares held by the ESOP as of September 30, 2020, 2019 and 2018 were classified as follows:
Unallocated shares
Shares released for allocation
Total ESOP shares
2020
—
415,698
415,698
2019
—
425,281
425,281
2018
17,639
451,644
469,283
The approximate fair market value of the ESOP’s unallocated shares at September 30, 2018 was $551,000. There was no
compensation expense recognized for the ESOP for the year ended September 30, 2020. Compensation expense recognized for
the ESOP for the years ended September 30, 2019 and 2018 was $318,000, and $823,000, 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 $908,000, $743,000
and $379,000 for the years ended September 30, 2020, 2019 and 2018, respectively.
Note 16 - 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. Under the Company's 2019 Equity Incentive Plan, which
was approved by shareholders on January 28, 2020, the Company is able to grant options and awards or restricted stock (with or
without performance measures) for up to 350,000 shares of common stock, of which 300,000 share are reserved to be awarded
to employees and officers and 50,000 shares are reserved to be awarded to directors and directors emeriti. Shares issued may be
purchased in the open market or may be issued from authorized and unissued shares. The exercise price of each option equals
the fair market value of the Company’s common stock on the date of grant. Generally, options and restricted stock vest in 20%
annual installments on each of the five anniversaries from the date of the grant, and options generally have a maximum
contractual term of ten years from the date of the grant. At September 30, 2020, there were 25,556 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 September 30, 2020 there were 299,500 shares of common stock available which may be awarded as options or restricted
stock pursuant to future grants under the 2019 Equity Incentive Plan.
At both September 30, 2020 and 2019, there were no unvested restricted stock awards. There were no restricted stock grants
awarded during the years ended September 30, 2020, 2019 and 2018.
116
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Stock option activity for the years ended September 30, 2020, 2019 and 2018 is summarized as follows:
Number of
Shares
Outstanding September 30, 2017
Options granted
Options exercised
Options forfeited
Outstanding September 30, 2018
Options granted
Options exercised
Options forfeited
Outstanding September 30, 2019
Options granted
Options exercised
Options forfeited
Outstanding September 30, 2020
Weighted
Average
Exercise
Price
13.23
31.80
7.92
13.39
16.03
27.14
9.14
19.89
18.15
17.01
10.31
25.36
18.45
380,120 $
45,950
(40,100)
(5,150)
380,820
46,840
(43,856)
(5,500)
378,304
69,150
(37,975)
(14,130)
395,349 $
The aggregate intrinsic value of options exercised during the years ended September 30, 2020 and 2019 was $640,000 and
$864,000, 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
45,950 options granted during the year ended September 30, 2018 with an aggregate grant date fair value of $206,000. There
were 46,840 options granted during the year ended September 30, 2019 with an aggregate grant date fair value of $240,000.
There were 69,150 options granted during the year ended September 30, 2020 with an aggregate grant date fair value of
$187,000.
The weighted average assumptions for options granted during the years ended September 30, 2020, 2019 and 2018 were as
follows:
Expected volatility
Expected life (in years)
Expected dividend yield
Risk free interest rate
Grant date fair value per share
2020
33%
5
5.36%
0.28%
2019
29%
5
3.28%
1.53%
2018
17%
5
2.61%
2.97%
$ 2.70
$ 5.12
$ 4.48
There were 58,548 options that vested during the year ended September 30, 2020 with a total fair value of $176,000. There
were 77,540 options that vested during the year ended September 30, 2019 with a total fair value of $203,000. There were
76,450 options that vested during the year ended September 30, 2018 with a total fair value of $181,000.
At September 30, 2020, there were 159,192 unvested options with an aggregate grant date fair value of $571,000, all of which
the Company assumes will vest. The unvested options had an aggregate intrinsic value of $99,000 at September 30, 2020. At
September 30, 2019, there were 160,750 unvested options with an aggregate grant date fair value of $605,000.
117
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Additional information regarding options outstanding at September 30, 2020 is as follows:
Range of
Exercise
Prices ($)
- 6.00
- 10.71
- 16.87
- 27.14
$ 4.01
5.86
9.00
10.26
15.67
26.50
29.69
31.80
Options Outstanding
Options Exercisable
Weighted
Average
Exercise
Price
4.01
5.97
9.00
10.59
16.41
27.13
29.69
31.80
18.45
Number
1,000 $
19,100
37,425
89,064
110,150
45,240
51,800
41,570
395,349 $
Weighted
Average
Remaining
Contractual
Life (Years)
1.2
2.1
3.1
4.6
8.5
9.0
7.0
8.0
6.6
Weighted
Average
Exercise
Price
4.01
5.97
9.00
10.59
15.67
27.14
29.69
31.80
15.31
Weighted
Average
Remaining
Contractual
Life (Years)
1.2
2.1
3.1
4.6
6.0
9.0
7.0
8.0
5.1
Number
1,000 $
19,100
37,425
89,064
32,500
8,848
31,400
16,820
236,157 $
The aggregate intrinsic value of options outstanding at September 30, 2020, 2019 and 2018 was $1,416,000, $3,854,000, and
$5,813,000, respectively.
As of September 30, 2020, unrecognized compensation cost related to non-vested stock options was $595,000, which is
expected to be recognized over a weighted average period of 2.36 years.
Note 17 - Commitments and Contingencies
In the normal course of business the Company is party to financial instruments with off-balance-sheet risk 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.
A summary of the Company’s commitments at September 30, 2020 and 2019 is as follows (dollars in thousands):
Undisbursed portion of construction loans in process (see Note 5)
Undisbursed lines of credit
Commitments to extend credit
2020
$ 100,558 $
103,030
38,581
2019
92,226
80,184
16,578
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 $384,000 and $241,000 at September 30,
2020 and 2019, respectively. These amounts are included in other liabilities and accrued expenses in the accompanying
118
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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 18 - 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 is required to
maintain a capital conservation buffer consisting 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, engaging in share repurchases, and paying
discretionary bonuses based on percentages of retained income that could be utilized for such actions. At September 30, 2020,
the Bank's CET1 capital exceeded the required capital conservation buffer.
At September 30, 2020 and 2019, the Bank exceeded all regulatory capital requirements. The Bank was categorized as "well
capitalized" at September 30, 2020 and 2019 under the regulations of the FDIC. The following tables compare the Bank’s
actual capital amounts at September 30, 2020 and 2019 to its minimum regulatory capital requirements and "Well Capitalized"
regulatory capital at those dates (dollars in thousands):
September 30, 2020
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
$ 168,937
11.1% $ 60,993
4.0% $
76,241
5.0%
168,937
168,937
179,671
19.7
19.7
21.0
38,504
51,339
68,452
4.5
6.0
8.0
55,618
68,452
85,566
6.5
8.0
10.0
119
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
September 30, 2019
Actual
Regulatory Minimum
To Be "Adequately
Capitalized"
Amount
Ratio
Amount
Ratio
Regulatory Minimum To
Be "Well Capitalized"
Under Prompt Corrective
Action Provisions
Ratio
Amount
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
Common equity Tier 1 capital
Tier 1 capital
Total capital
$ 152,926
12.5% $ 49,044
4.0% $
61,305
5.0%
152,926
152,926
162,857
18.1
18.1
19.3
38,019
50,692
67,589
4.5
6.0
8.0
54,916
67,589
84,487
6.5
8.0
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 $3.0 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 $3.0 billion or more in assets at September 30, 2020, Timberland Bancorp would have exceeded all regulatory
requirements.
The following table presents the regulatory capital ratios for Timberland Bancorp at September 30, 2020 and 2019 assuming
Timberland Bancorp was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets
(dollars in thousands):
Leverage Capital Ratio:
Tier 1 capital
Risk-based Capital Ratios:
Common equity Tier 1 capital
Tier 1 capital
Total capital
2020
2019
Amount
Ratio
Amount
Ratio
$ 172,000
11.3%
$ 155,468
12.7%
172,000
172,000
182,805
20.1
20.1
21.3
155,468
155,468
165,399
18.4
18.4
19.6
Note 19 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30, 2020 and 2019
(dollars in thousands)
Assets
Cash and cash equivalents:
Cash and due from financial institutions
Interest-bearing deposits in banks
Total cash and cash equivalents
Investment securities held to maturity, at amortized cost (estimated fair value $499)
Investment in Bank
Other assets
Total assets
Liabilities and shareholders’ equity
Accrued expenses
Shareholders’ equity
Total liabilities and shareholders’ equity
120
2020
2019
$
505 $
2,128
2,633
336
2,555
2,891
500
184,567
23
—
168,525
15
$ 187,723 $ 171,431
$
93 $
364
171,067
$ 187,723 $ 171,431
187,630
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Condensed Statements of Income - Years Ended September 30, 2020, 2019 and 2018
(dollars in thousands)
Operating income
Interest on deposits in banks
Interest on loan receivable from ESOP
Interest on investment securities
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
2020
2019
2018
$
26 $
—
5
8,762
8,793
67 $
9
—
6,607
6,683
554
525
8,239
(186)
6,158
(169)
8,425
6,327
37
53
—
4,429
4,519
591
3,928
(198)
4,126
15,844
24,269 $
17,693
24,020 $
12,595
16,721
$
Condensed Statements of Cash Flows - Years Ended September 30, 2020, 2019 and 2018
(dollars in thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
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
Purchase of investment securities held to maturity
Principal repayments on loan receivable from ESOP
Cash acquired, net of cash consideration paid in business combination
Net cash used in investing activities
Cash flows from financing activities
Proceeds from exercise of stock options
Repurchase of common stock
Payment of dividends
Net cash used in financing activities
2020
2019
2018
$
24,269 $
24,020 $
16,721
(15,844)
31
182
(279)
8,359
(17,693)
441
159
9
6,936
(12,595)
882
172
280
5,460
(187)
(500)
—
—
(687)
(14,915)
—
285
14,284
(346)
391
(1,238)
(7,083)
(7,930)
401
(499)
(6,495)
(6,593)
(1,271)
—
536
—
(735)
318
—
(4,431)
(4,113)
Net (decrease) increase in cash and cash equivalents
(258)
(3)
612
Cash and cash equivalents
Beginning of year
End of year
2,891
2,633 $
2,894
2,891 $
2,282
2,894
$
121
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 20 - Net Income Per Common Share
Information regarding the calculation of basic and diluted net income per common share for the years ended September 30,
2020, 2019 and 2018 is as follows (dollars in thousands, except per share amounts):
Basic net income per common share computation
Numerator - net income
2020
2019
2018
$
24,269 $
24,020 $
16,721
Denominator - weighted average common shares outstanding
8,326,600
8,318,928
7,334,577
Basic net income per common share
$
2.91 $
2.89 $
2.28
Diluted net income per common share computation
Numerator - net income
Denominator - weighted average common shares outstanding
Effect of dilutive stock options (1)
$
24,269 $
24,020 $
16,721
8,326,600
95,886
8,318,928
149,298
7,334,577
191,767
Weighted average common shares outstanding-assuming dilution
8,422,486
8,468,226
7,526,344
Diluted net income per common share
$
2.88 $
2.84 $
2.22
___________________
(1) For the years ended September 30, 2020, 2019 and 2018, average options to purchase 131,186, 102,920 and 29,581 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.
Note 21 - Accumulated Other Comprehensive Income (Loss)
The changes in accumulated other comprehensive income (loss) ("AOCI") by component during the years ended September 30,
2020, 2019 and 2018 are as follows (dollars in thousands):
Changes in fair
value of available for
sale securities [1]
Changes in OTTI on
held to maturity
securities [1]
Total [1]
2020
Balance of AOCI at the beginning of period
Other comprehensive income (loss)
Balance of AOCI at the end of period
2019
Balance of AOCI at the beginning of period
Other comprehensive income
Adoption of ASU 2016-01
Balance of AOCI at the end of period
2018
Balance of AOCI at the beginning of period
Other comprehensive income (loss)
Balance of AOCI at the end of period
___________________
[1] All amounts are net of income taxes.
$
$
$
$
$
$
$
122
90
(3)
87
$
$
(58) $
85
63
90
$
$
(19) $
(39)
(58) $
(40) $
14
(26) $
(71) $
31
— $
(40) $
(105) $
34
(71) $
50
11
61
(129)
116
63
50
(124)
(5)
(129)
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 22 - Fair Value Measurements
Fair value is defined under GAAP as the exchange price that would be received for an asset or paid to transfer a liability (exit
price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market
participants on the measurement date. GAAP requires that valuation techniques maximize the use of observable inputs and
minimize the use of unobservable inputs. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs
into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of three
levels. These levels are:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the
ability to access at the measurement date.
Level 2: Significant observable inputs other than quoted prices included within Level 1, such as quoted prices for
similar (as opposed to identical) assets or liabilities in active markets, quoted prices for identical or similar assets or
liabilities in markets that are not active, and inputs other than quoted prices that are observable or can be corroborated
by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions market
participants would use in pricing an asset or liability based on the best information available in the circumstances.
The Company's assets measured at fair value on a recurring basis consist of investment securities available for sale and
investments in equity securities. The estimated fair values of MBS are based upon market prices of similar securities or
observable inputs (Level 2). The estimated fair values of mutual funds are based upon quoted market prices (Level 1).
The Company had no liabilities measured at fair value on a recurring basis at September 30, 2020 and 2019. The Company's
assets measured at estimated fair value on a recurring basis at September 30, 2020 and 2019 are as follows (dollars in
thousands):
September 30, 2020
Available for sale investment securities
MBS: U.S. government agencies
Investments in equity securities
Mutual funds
Total
September 30, 2019
Available for sale investment securities
MBS: U.S. government agencies
Investments in equity securities
Mutual funds
Total
Level 1
Estimated Fair Value
Level 3
Level 2
Total
— $
57,907 $
— $
57,907
977
977 $
—
57,907 $
—
— $
977
58,884
— $
22,532 $
— $
22,532
958
958 $
—
22,532 $
—
— $
958
23,490
$
$
$
$
There were no transfers among Level 1, Level 2 and Level 3 during the years ended September 30, 2020 and 2019.
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis
in accordance with GAAP. These include assets that are measured at the lower of cost or market value that were recognized at
fair value below cost at the end of the period.
The Company uses the following methods and significant assumptions to estimate fair value on a non-recurring basis:
Impaired Loans: The estimated fair value of impaired loans is calculated using the collateral value method or on a
discounted cash flow basis. The specific reserve for collateral dependent impaired loans is based on the estimated fair
value of the collateral less estimated costs to sell, if applicable. In some cases, adjustments are made to the appraised
values due to various factors including age of the appraisal, age of comparables included in the appraisal and known
123
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
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).
The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at September
30, 2020 (dollars in thousands):
Impaired loans:
Mortgage loans:
One- to four-family
Commercial business loans
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
$
$
—
—
—
—
—
—
$
$
—
—
—
8
—
8
$
$
481
210
691
—
1,050
1,741
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, 2020 (dollars in thousands):
Estimated
Fair Value
Valuation
Technique(s)
Unobservable Input(s)
Range
Impaired loans
$
691 Market approach
OREO and other repossessed
assets
1,050 Market approach
Appraised value less estimated
selling costs
Lower of appraised value or
listing price less estimated selling
costs
NA
NA
124
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at September
30, 2019 (dollars in thousands):
Impaired loans:
Mortgage loans:
Land
Consumer loans:
Other
Commercial business loans
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
$
—
$
—
$
—
—
—
—
—
—
$
—
—
—
2
—
2
$
$
114
6
408
528
—
1,683
2,211
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, 2019 (dollars in thousands):
Estimated
Fair Value
Valuation
Technique(s)
Unobservable Input(s)
Range
Impaired loans
$
528 Market approach
OREO and other repossessed
assets
1,683 Market approach
Appraised value less estimated
selling costs
Lower of appraised value or
listing price less estimated selling
costs
NA
NA
GAAP requires disclosure of estimated fair values for financial instruments. Such estimates are subjective in nature, and
significant judgment is required regarding the risk characteristics of various financial instruments at a discrete point in
time. Therefore, such estimates could vary significantly if assumptions regarding uncertain factors were to change. In addition,
as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize
many of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for certain items
which are not defined as financial instruments but which may have significant value. The Company does not believe that it
would be practicable to estimate a fair value for these types of items as of September 30, 2020 and 2019. 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. Additionally, in accordance with ASU 2016-01, which the Company adopted
on October 1, 2018 on a prospective basis, the Company uses the exit price notion in calculating the fair values of financial
instruments not measured at fair value on a recurring basis.
125
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
The recorded amounts and estimated fair values of financial instruments were as follows as of September 30, 2020 (dollars in
thousands):
Recorded
Amount
Estimated
Fair Value
Fair Value Measurements Using:
Level 1
Level 2
Level 3
Financial Assets
Cash and cash equivalents
CDs held for investment
Investment securities
Investments in equity securities
FHLB stock
Other investments
Loans held for sale
Loans receivable, net
Accrued interest receivable
Financial Liabilities
Certificates of deposit
Accrued interest payable
$ 314,452 $ 314,452 $ 314,452 $
65,545
87,734
977
1,922
3,000
4,664
1,034,876
4,484
65,545
85,797
977
1,922
3,000
4,509
1,013,875
4,484
65,545
—
977
1,922
3,000
4,664
—
4,484
— $
—
87,235
—
—
—
—
—
—
—
—
499
—
—
—
—
1,034,876
—
158,524
274
160,921
274
—
274
—
—
160,921
—
The recorded amounts and estimated fair values of financial instruments were as follows as of September 30, 2019 (dollars in
thousands):
Recorded
Amount
Estimated
Fair Value
Fair Value Measurements Using:
Level 1
Level 2
Level 3
Financial Assets
Cash and cash equivalents
CDs held for investment
Investment securities
Investment in equity securities
FHLB stock
Other investments
Loans held for sale
Loans receivable, net
Accrued interest receivable
Financial Liabilities
Certificates of deposit
Accrued interest payable
$ 143,015 $ 143,015 $ 143,015 $
78,346
55,112
958
1,437
3,000
6,260
892,495
3,598
78,346
53,634
958
1,437
3,000
6,071
886,662
3,598
78,346
3,949
958
1,437
3,000
6,260
—
3,598
— $
—
51,163
—
—
—
—
—
—
—
—
—
—
—
—
—
892,495
—
165,655
333
166,852
333
—
333
—
—
166,852
—
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal
operations. As a result, the estimated fair value of the Company’s financial instruments will change when interest rate levels
change, and that change may either be favorable or unfavorable to the Company. Management attempts to match maturities of
assets and liabilities to the extent believed necessary to appropriately manage interest rate risk. However, borrowers with fixed
interest rate obligations are less likely to prepay in a rising interest rate environment and more likely to prepay in a falling
interest rate environment. Conversely, depositors who are receiving fixed interest rates are more likely to withdraw funds
before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management
monitors interest rates and maturities of assets and liabilities, and attempts to manage interest rate risk by adjusting terms of
new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
126
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 23 - 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
Provision for loan losses
Non-interest income
Non-interest expense (1)
Income before income taxes
Provision for income taxes
Net income
Net income per common share
Basic (2)
Diluted
$
September 30,
2020
13,593 $
(1,073)
12,520
June 30,
2020
13,668 $
(1,188)
12,480
March 31,
2020
14,131 $
(1,251)
12,880
December 31,
2019
14,191
(1,189)
13,002
500
4,715
(8,743)
1,000
4,855
(8,661)
2,000
3,680
(8,286)
7,992
7,674
6,274
1,635
6,357 $
1,463
6,211 $
1,225
5,049 $
200
3,938
(8,373)
8,367
1,715
6,652
0.76 $
0.76 $
0.75 $
0.74 $
0.61 $
0.60 $
0.80
0.78
$
$
$
__________________________________________
(1) During the quarters ended December 31, 2019, March 31, 2020, June 30, 2020 and September 30, 2020, the Company
incurred expenses related to the acquisition of South Sound Bank of $0, $2, $0, and $0, respectively.
(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 (1)
Income before income taxes
Provision for income taxes
Net income
Net income per common share
Basic
Diluted (2)
$
September 30,
2019
14,384 $
(1,233)
13,151
June 30,
2019
14,185 $
(1,248)
12,937
March 31,
2019
13,841 $
(1,113)
12,728
December 31,
2018
13,315
(971)
12,344
3,597
(8,774)
3,538
(8,967)
3,940
(9,277)
7,974
7,508
7,391
1,639
6,335 $
1,552
5,956 $
1,277
6,114 $
3,266
(8,562)
7,048
1,433
5,615
0.76 $
0.75 $
0.71 $
0.70 $
0.74 $
0.72 $
0.68
0.66
$
$
$
__________________________________________
(1) During the quarters ended December 31, 2018, March 31, 2019, June 30, 2019, and September 30, 2019, the Company
incurred expenses related to the acquisition of South Sound Bank of $64, $55, $328, and $15, respectively.
(2) The net income per common share amounts for the quarters do not add to the total for the fiscal year due to rounding.
127
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2020 and 2019
Note 24 - Revenue from Contracts with Customers
In accordance with ASC 606, revenues are recognized when control of promised goods or services is transferred to customers in
an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To
determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, the Company
performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the
contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract;
and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-
step model to contracts when it is probable that the Company will collect the consideration it is entitled to in exchange for the
goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of
ASC 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain
performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as
revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the
performance obligation is satisfied.
ASC 606 applies to all contracts with customers to provide goods or services in the ordinary course of business, except for
contracts that are specifically excluded from its scope. The majority of the Company's revenues are composed of interest
income, deferred loan fee accretion, premium/discount accretion, gains on sales of loans and investments, BOLI net earnings,
servicing income on loans sold and other loan fee income, which are not in the scope of ASC 606. Revenue reported as service
charges on deposits, ATM and debit card interchange transaction fees, merchant services fees, non-deposit investment fees and
escrow fees are within the scope of ASC 606. All of the Company's revenue from contracts with customers in the scope of
ASC 606 is recognized in non-interest income with the exception of gains on sale of OREO and gains on sales/disposition of
premises and equipment, which are included in non-interest expense. For the year ended September 30, 2020, the Company
recognized $4,147,000 in services charges on deposits, $4,378,000 in ATM and debit card interchange fees, $273,000 in escrow
fees and $22,000 in fee income from non-deposit investment sales, all considered within the scope of ASC 606. For the year
ended September 30, 2019, the Company recognized $4,904,000 in service charges on deposits, $4,036,000 in ATM and debit
card interchange fees, $197,000 in escrow fees and $46,000 in fee income from non-deposit investment sales, all considered
within the scope of ASC 606.
Descriptions of the Company's revenue-generating activities that are within the scope of ASC 606 are as follows:
•
•
•
•
Service Charges on Deposits: The Company earns fees from its deposit customers from a variety of deposit products
and services. Non-transaction based fees such as account maintenance fees and monthly statement fees are considered
to be provided to the customer under a day-to-day contract with ongoing renewals. Revenue for these non-transaction
fees are earned over the course of a month, representing the period over which the Company satisfies the performance
obligation. Transaction-based fees such as non-sufficient fund charges, stop payment charges and wire fees are
recognized at the time the transaction is executed as the contract duration does not extend beyond the service
performed.
ATM and Debit Card Interchange Transaction Fees: The Company earns fees from cardholder transactions
conducted through third party payment network providers which consist of interchange fees earned from the payment
networks as a debit card issuer. These fees are recognized when the transaction occurs, but may settle on a daily or
monthly basis.
Escrow Fees: The Company earns fees from real estate escrow contracts with customers. The Company receives and
disburses money and/or property per the customer's contract. Fees are recognized when the escrow contract closes.
Fee income from Non-Deposit Investment Sales: The Company earns fees from contracts with customers for
investment activities. Revenues are generally recognized on a monthly basis and are generally based on a percentage
of the customer's assets under management or based on investment solutions that are implemented for the customer.
128
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, 2020 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, 2020, 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 is 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
129
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 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, 2020.
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, 2020. 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 9, 2020
/s/ Michael R. Sand
Michael R. Sand
President and Chief Executive Officer
/s/ Dean J. Brydon
Dean J. Brydon
Chief Financial Officer
130
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 2020 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, 2020 was composed
of Directors Stoney, Smith, and Davis. 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,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, 2020. 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.
131
(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.
Equity Compensation Plan Information
The following table summarizes share and exercise price information about the Company’s equity compensation plans
as of September 30, 2020:
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)
Plan category
Equity compensation plans
approved by security holders:
2003 Stock Option Plan
Timberland Bancorp, Inc. 2014
Equity Incentive Plan:
Timberland Bancorp, Inc. 2019
Equity Incentive Plan:
Equity compensation plans
not approved by security holders
69,525
$
275,324
50,500
—
8.33
21.29
16.87
—
18.45
—
25,556
299,500
—
325,056
Total
395,349
$
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.
132
Item 15. Exhibits and Financial Statement Schedules
(a)
Exhibits
PART IV
2.1
Agreement and Plan of Merger, dated as of May 22, 2018, by and between Timberland Bancorp, Timberland
Bank and South Sound Bank (1)
Articles of Incorporation of the Registrant (2)
Amended and Restated Bylaws of the Registrant (3)
Form of Certificate of Timberland Bancorp, Inc. Common Stock (4)
Description of Capital Stock of Timberland Bancorp, Inc. (5)
3.1
3.2
4.1
4.2
Employee Severance Compensation Plan, as revised (6)
10.1
Employee Stock Ownership Plan (6)
10.2
2003 Stock Option Plan (7)
10.3
Form of Incentive Stock Option Agreement (7)
10.4
Form of Non-qualified Stock Option Agreement (8)
10.5
Form of Management Recognition and Development Award Agreement (8)
10.6
Employment Agreement with Michael R. Sand (9)
10.7
Employment Agreement with Dean J. Brydon (9)
10.8
10.9
Timberland Bancorp, Inc. 2014 Equity Incentive Plan (10)
10.10 Timberland Bancorp, Inc. 2019 Equity Incentive Plan (11)
10.11
Form of Incentive Stock Option Agreement (12)
10.12
Form of Non-qualified Stock Option Agreement (12)
10.13
Form of Restricted Stock Grant Agreement (12)
14
Code of Ethics (13)
21
Subsidiaries of the Registrant*
23.1
31.1
31.2
32
101
Consent of Delap LLP*
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act*
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act*
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act*
The following materials from Timberland Bancorp, Inc.’s Annual Report on Form 10-K for the year ended
September 30, 2020, 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
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Incorporated by reference to the Registrant's Current Report on Form 8-K filed May 23, 2018.
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 October 1, 2018.
Filed as an exhibit to the Registrant's Statement on Form S-1 (333-35817) and incorporated by reference.
Incorporated by reference to the Registrant's Annual Report on Form 10-K for year ended September 30, 2019.
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(333-116163).
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.
Attached as Appendix A to the Registrant's Annual Meeting Proxy Statement filed on December 18, 2019.
Incorporated by reference and included in the Registrant's Registration Statement on Form S-8 (333-240040).
Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended September 30, 2003.
(9)
(10)
(11)
(12)
(13)
Item 16. Form 10-K Summary
None.
133
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
TIMBERLAND BANCORP, INC.
Date: December 9, 2020
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
/s/Kelly A. Suter
Kelly A. Suter
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
Director
DATE
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
December 9, 2020
134
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DIRECTORS AND OFFICERS
TIMBERLAND BANCORP, INC.
OFFICERS:
Michael R. Sand
President and Chief Executive Officer
Edward C. Foster
Executive Vice President
Marci A. Basich
Senior Vice President
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 Silverdale, Washington that provides security, consulting and investigation
consulting company based in Silverdale, Washington that provides security, consulting and investigation
and litigation support services to corporations, law-firms, small- and medium-sized businesses, and
and litigation support services to corporations, law-firms, small- and medium-sized businesses, and
individuals.
individuals.
David A. Smith is a pharmacist and the former owner of Harbor Drug, Inc., a retail pharmacy located in
David A. Smith is a pharmacist and the former 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.
Kelly A. Suter, is a former technology executive with over 25 years of experience in software, data
Kelly A. Suter, is a former technology executive with over 25 years of experience in software, data
management and digital transformation. Since late 2017, she has been an independent consultant and
management and digital transformation. Since late 2017, she has been an independent consultant and
prior to that she was the Chief Operating Officer at Calico Energy Services, which provided services to
prior to that she was the Chief Operating Officer at Calico Energy Services, which provided services to
large investor-owned utilities. She began her career as an auditor at Price Waterhouse and is a Certified
large investor-owned utilities. She began her career as an auditor at Price Waterhouse and is a Certified
Public Accountant (inactive status).
Public Accountant (inactive status).
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
6201 15th Avenue
Brooklyn, NY 11219
(800) 937-5449
ANNUAL MEETING
The Annual Meeting of Shareholders will be a virtual meeting on Tuesday, January 26, 2021 at 1:00 p.m.,
Pacific Time.
Hoquiam
624 Simpson Ave.
Hoquiam, WA 98550
(360) 533-4747
South Aberdeen
300 N. Boone St.
Aberdeen, WA 98520
(360) 533-6440
Ocean Shores
361 Damon Rd.
Ocean Shores, WA 98569
(360) 289-2476
Montesano
210 S. Main St.
Montesano, WA 98563
(360) 249-4021
Downtown Aberdeen
117 N. Broadway
Aberdeen, WA 98520
(360) 533-4500
Elma
313 W. Waldrip
Elma, WA 98541
(360) 482-3333
Toledo
101 Ramsey Way
Toledo, WA 98591
(360) 864-6102
Winlock
209 NE 1st St.
Winlock, WA 98596
(360) 785-3552
Chehalis
714 W. Main St.
Chehalis, WA 98532
(360) 740-0770
Tumwater
801 Trosper Rd. SW
Tumwater, WA 98512
(360) 705-2863
Olympia
423 Washington St. SE
Olympia, WA 98501
(360) 943-5496
West Olympia
2850 Harrison Ave. NW
Olympia, WA 98502
(360) 705-4200
PLANT
YOUR
FutureHERE
2020 Annual Report
Panorama
1751 Circle Lane SE
Lacey, WA 98503
(360) 413-3891
Lacey
1201 Marvin Rd. NE
Lacey, WA 98516
(360) 438-1400
Downtown Lacey
4530 Lacey Blvd SE
Lacey, WA 98503
(360) 528-4200
Yelm
101 Yelm Ave. W.
Yelm, WA 98597
(360) 458-2221
Bethel Station
2419 224th St. E.
Spanaway, WA 98387
(253) 875-4250
Puyallup (South Hill)
12814 Meridian E.
Puyallup, WA 98373
(253) 841-4980
Edgewood (North Hill)
2418 Meridian E.
Edgewood, WA 98371
(253) 845-0999
Auburn
202 Auburn Way S.
Auburn, WA 98002
(253) 804-6177
Tacoma
7805 S. Hosmer St.
Tacoma, WA 98408
(253) 472-4465
Gig Harbor
3105 Judson St.
Gig Harbor, WA 98335
(253) 851-1188
Silverdale
2401 NW Bucklin Hill Rd.
Silverdale, WA 98383
(360) 337-7727
Poulsbo
20464 Viking Way NW
Poulsbo, WA 98370
(360) 598-5801
www.timberlandbank.com