UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended September 30, 2005 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Washington 91-1863696
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
624 Simpson Avenue, Hoquiam, Washington 98550
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01
per share
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2): YES X NO
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Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act): Yes NO X
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The aggregate market value of the Common Stock outstanding held by
nonaffiliates of the Registrant based on the closing sales price of the
Registrant's Common Stock as quoted on the Nasdaq Stock Market on March 31,
2005 was $83,114,121 (3,759,119 shares at $22.11 per share). For purposes of
this calculation, Common Stock held by officers and directors of the
Registrant and the Timberland Bank Employee Stock Ownership Plan and Trust are
considered nonaffiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Definitive Proxy Statement for the 2006 Annual Meeting
of Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I. Page
----
Item 1. Business
General......................................... 1
Branch Purchase................................. 1
Market Area..................................... 1
Lending Activities.............................. 3
Investment Activities........................... 20
Deposit Activities and Other Sources of Funds... 21
Bank Owned Life Insurance....................... 25
Regulation of the Bank.......................... 25
Regulation of the Company....................... 31
Taxation........................................ 33
Competition..................................... 34
Subsidiary Activities........................... 35
Personnel....................................... 35
Executive Officers of the Registrant............ 35
Item 2. Properties........................................ 36
Item 3. Legal Proceedings................................. 38
Item 4. Submission of Matters to a Vote of Security
Holders........................................... 38
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities................................. 38
Item 6. Selected Financial Data........................... 40
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations..... 42
General......................................... 42
Special Note Regarding Forward-Looking
Statements..................................... 42
Critical Accounting Policies.................... 42
New Accounting Pronouncements................... 43
Operating Strategy.............................. 43
Market Risk and Asset and Liability Management.. 44
Comparison of Financial Condition at
September 30, 2005 and 2004.................... 46
Comparison of Financial Condition at September
30, 2004 and 2003.............................. 47
Comparison of Operating Results for Years
Ended September 30, 2005 and 2004.............. 49
Comparison of Operating Results for Years
Ended September 30, 2004 and 2003.............. 51
Average Balances, Interest and Average
Yields/Cost.................................... 53
Rate/Volume Analysis............................ 55
Liquidity and Capital Resources................. 56
Effect of Inflation and Changing Prices......... 57
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk....................................... 57
Item 8. Financial Statements and Supplementary Data....... 58
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure............ 101
Item 9A. Controls and Procedures........................... 101
Item 9B. Other Information................................. 101
PART III.
Item 10. Directors and Executive Officers of the
Registrant........................................ 101
Item 11. Executive Compensation............................ 102
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder
Matters........................................... 102
Item 13. Certain Relationships and Related
Transactions...................................... 103
Item 14. Principal Accounting Fees and Services............ 103
PART IV.
Item 15. Exhibits and Financial Statement Schedules........ 103
PART I
Item 1. Business
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General
Timberland Bancorp, Inc. ("Company"), a Washington corporation, was
organized on September 8, 1997 for the purpose of becoming the holding company
for Timberland Savings Bank, SSB ("Bank") upon the Bank's conversion from a
Washington-chartered mutual savings bank to a Washington-chartered stock
savings bank ("Conversion"). The Conversion was completed on January 12, 1998
through the sale and issuance of 6,612,500 shares of common stock by the
Company. At September 30, 2005, the Company had total assets of $552.8
million, total deposits of $411.7 million and total shareholders' equity of
$74.6 million. The Company's business activities generally are limited to
passive investment activities and oversight of its investment in the Bank.
Accordingly, the information set forth in this report, including consolidated
financial statements and related data, relates primarily to the Bank and its
subsidiary.
The Bank was established in 1915 as "Southwest Washington Savings and
Loan Association." In 1935, the Bank converted from a state-chartered mutual
savings and loan association to a federally chartered mutual savings and loan
association, and in 1972, changed its name to "Timberland Federal Savings and
Loan Association." In 1990, the Bank converted to a federally chartered
mutual savings bank under the name "Timberland Savings Bank, FSB." In 1991,
the Bank converted to a Washington-chartered mutual savings bank and changed
its name to "Timberland Savings Bank, SSB." On December 29, 2000, the Bank
changed its name to "Timberland Bank." The Bank's deposits are insured by the
Federal Deposit Insurance Corporation ("FDIC") up to applicable legal limits
under the Savings Association Insurance Fund ("SAIF"). The Bank has been a
member of the Federal Home Loan Bank ("FHLB") System since 1937. The Bank is
regulated by the Washington Department of Financial Institutions, Division of
Banks ("Division") and the FDIC.
The Bank is a community-oriented bank which has traditionally offered a
variety of savings products to its retail customers while concentrating its
lending activities on real estate mortgage loans. Lending activities have
been focused primarily on the origination of loans secured by one- to
four-family residential dwellings, including an emphasis on construction and
land development loans, as well as the origination of multi-family and
commercial real estate loans. The Bank originates adjustable-rate residential
mortgage loans that do not qualify for sale in the secondary market under
Federal Home Loan Mortgage Corporation ("FHLMC") guidelines. The Bank also
originates commercial business loans and in 1998 established a business
banking division to increase the origination of these loans.
Branch Purchase
On June 22, 2004, the Bank entered into a branch purchase and assumption
agreement to purchase seven branches from Venture Bank, a subsidiary of
Venture Financial Group. The branches are located in Grays Harbor County
(Hoquiam, Aberdeen, Montesano, and Elma), Lewis County (Toledo and Winlock)
and Thurston County (Lacey), Washington. On October 9, 2004, the Bank
completed the acquisition of these branches. The transaction included $86.5
million in deposits. In addition, the Bank acquired real estate, branch
infrastructure, and employees for the seven offices. The Bank paid $1.8
million in cash for the branch buildings and fixed assets. The offices
acquired in Hoquiam and Montesano were consolidated with existing Bank
locations on November 15, 2004.
For additional information on the acquired branches, see "-Market Area"
and "Item 2. Properties."
Market Area
The Bank considered Grays Harbor, Thurston, Pierce, King, Kitsap and
Lewis Counties as its primary market areas as of September 30, 2005. The Bank
conducts operations from:
* its main office in Hoquiam (Grays Harbor County);
1
* five branch offices in Grays Harbor County (Ocean Shores,
Montesano, Elma, and two branches in Aberdeen);
* a branch office in King County (Auburn);
* five branch offices in Pierce County (Edgewood, Puyallup,
Spanaway, Tacoma, and Gig Harbor);
* five branch offices in Thurston County (Olympia, Yelm, Tumwater,
and two branches in Lacey);
* two branch offices in Kitsap County (Poulsbo and Silverdale);
* and two branch offices in Lewis County (Winlock and Toledo).
See "Item 2. Properties."
Hoquiam, with a population of approximately 9,000, is located in Grays
Harbor County which is situated along Washington State's central Pacific
coast. Hoquiam is located approximately 110 miles southwest of Seattle and
145 miles northwest of Portland, Oregon.
The Bank considers its primary market area to include six submarkets:
primarily rural Grays Harbor County with its historical dependence on the
timber and fishing industries; Pierce, Thurston and Kitsap Counties with their
dependence on state and federal government; King County with its broadly
diversified economic base; and Lewis County with its dependence on retail
trade, manufacturing, industrial services and local government. Each of these
markets presents operating risks to the Bank. The Bank's expansion into
Pierce, Thurston, King, Kitsap and Lewis Counties represents the Bank's
strategy to diversify its primary market area to become less reliant on the
economy of Grays Harbor County.
Grays Harbor County has a population of 67,000 according to the U.S.
Census Bureau 2000 census. The economic base in Grays Harbor has been
historically dependent on the timber and fishing industries. Other industries
that support the economic base are tourism, agriculture, shipping and
transportation and technology. According to the Washington State Employment
Security Department, the unemployment rate in Grays Harbor County decreased to
6.6% at September 30, 2005 from 6.9% at September 30, 2004. The Bank has six
branches (including its home office) located throughout the county. Slowdowns
in the Grays Harbor County economy could negatively impact the Bank's
profitability in this market area.
Pierce County is the second most populous county in the state and has a
population of 701,000 according to the U.S. Census Bureau 2000 census. The
economy in Pierce County is diversified with the presence of military related
government employment (Fort Lewis Army Base and McChord Air Force Base),
transportation and shipping employment (Port of Tacoma), and aerospace related
employment (Boeing). According to the Washington State Employment Security
Department, the unemployment rate for the Pierce County area decreased to 5.5%
at September 30, 2005 from 5.7% at September 30, 2004. The Bank has five
branches in Pierce County. These branches have been responsible for a
substantial portion of the Bank's construction lending activities. Slowdowns
in the Pierce County economy could negatively impact the demand for loans to
facilitate the construction of single family homes.
Thurston County has a population of 207,000 according to the U.S. Census
Bureau 2000 census. 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 had increased to 4.6% at
September 30, 2005 from 4.5% at September 30, 2004. The Bank currently has
five branches in Thurston County. This county has a stable economic base
primarily attributable to the state government presence. Slowdowns in the
Thurston County economy could negatively impact the Bank's lending
opportunities in this market.
2
Kitsap County has a population of 232,000 according to the U.S. Census
Bureau 2000 census. Timberland has two branches in Kitsap County. The
economic base of Kitsap County is largely supported by military related
government employment through the United States Navy. According to the
Washington State Employment Security Department, the unemployment rate for the
Kitsap County area was 4.8% at September 30, 2005 and September 30, 2004.
Reductions in the naval personnel stationed in Kitsap County could have a
negative impact on the county's economy and could negatively impact the Bank's
lending opportunities in this market.
King County is the most populous county in the state and has a population
of 1.7 million according to the U.S. Census Bureau 2000 census. Timberland
has one branch in King County in the city of Auburn. King County's economic
base is diversified with many industries including shipping and
transportation, aerospace (Boeing), and computer technology and biotech
industries. According to the Washington State Employment Security Department,
the unemployment rate for the King County area decreased to 4.8% at September
30, 2005 from 4.9% at September 30, 2004. The County's overall economic
condition has been weakened over the past couple of years due in large part to
slowing in the aerospace and computer technology industries. The slowdown in
the economy has negatively impacted commercial loan demand and has decreased
the Bank's origination of commercial real estate and commercial business loans
in the Southern King County market.
Lewis County has a population of 69,000 according to the U.S. Census
Bureau 2000 census. The economic base in Lewis County is supported by
manufacturing, retail trade, local government and industrial services.
According to the Washington State Employment Security Department, the
unemployment rate in Lewis County decreased to 6.5% at September 30, 2005 from
6.9% at September 30, 2004. The Bank has two branches located in Lewis
County, which it acquired in October 2004. A slowdown in the Lewis County
economy could negatively impact the Bank's lending opportunities in this
market.
Lending Activities
General. Historically, the principal lending activity of the Bank has
consisted of the origination of loans secured by first mortgages on
owner-occupied, one- to- four family residences and loans for the construction
of one- to- four family residences. Since 1998, the Bank has emphasized its
origination of construction and land development loans and commercial real
estate loans. The Bank's net loans receivable, including loans held for sale,
totaled approximately $388.1 million at September 30, 2005, representing
approximately 70.2% of consolidated total assets, and at that date
construction and land development loans, and loans secured by commercial
properties were $237.3 million, or 54.2%, of total loans. Construction and
land development loans and commercial real estate loans typically have higher
rates of return than one-to four- family loans; however, they also present a
higher degree of risk. See "- Lending Activities - Construction and Land
Development Lending" and "- Lending Activities - Commercial Real Estate
Lending."
The Bank's internal loan policy limits the maximum amount of loans to one
borrower to 25% of its capital. At September 30, 2005, the maximum amount
which the Bank could have lent to any one borrower and the borrower's related
entities was approximately $16.4 million under this policy. At September 30,
2005, the Bank had no loans to one borrower with an aggregate outstanding
balance in excess of this amount. At that date, the Bank had 52 borrowers or
related borrowers with total loans outstanding in excess of $1.0 million. The
largest amount outstanding to any one borrower and the borrower's related
entities was approximately $9.6 million (including $5.7 million of
undisbursed loans in process balance), which represents a commercial real
estate construction loan in Thurston County. This loan was performing
according to its terms at September 30, 2005.
3
Loan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio
by type of loan as of the dates indicated.
At September 30,
--------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Mortgage Loans:
One- to- four
family(1)(2)..$101,763 23.24% $ 99,835 25.25% $ 95,371 26.21% $113,144 31.28% $130,082 35.14%
Multi-family... 20,170 4.61 17,160 4.34 18,241 5.01 24,135 6.67 29,412 7.95
Commercial..... 124,849 28.51 108,276 27.39 102,972 28.30 97,644 27.00 65,731 17.76
Construction
and land
development... 112,470 25.68 106,241 26.88 94,117 25.87 80,144 22.16 106,244 28.71
Land(2)........ 24,981 5.71 19,895 5.03 15,628 4.30 15,453 4.27 13,632 3.68
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans......... 384,233 87.75 351,407 88.89 326,329 89.69 330,520 91.38 345,101 93.24
Consumer Loans:
Home equity
and second
mortgage...... 32,298 7.38 23,549 5.96 19,233 5.29 13,718 3.79 11,039 2.98
Other.......... 9,330 2.13 9,270 2.34 8,799 2.42 8,097 2.24 6,825 1.85
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
41,628 9.51 32,819 8.30 28,032 7.71 21,815 6.03 17,864 4.83
Commercial
business
loans......... 12,013 2.74 11,098 2.81 9,475 2.60 9,365 2.59 7,150 1.93
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans... 437,874 100.00% 395,324 100.00% 363,836 100.00% 361,700 100.00% 370,115 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
construction
loans in
process....... (42,771) (43,563) (34,785) (32,324) (39,803)
Deferred loan
origination
fees.......... (2,895) (3,176) (2,924) (3,218) (3,494)
Allowance for
loan losses... (4,099) (3,991) (3,891) (3,630) (3,050)
-------- -------- -------- -------- --------
Total loans
receivable,
net............$388,109 $344,594 $322,236 $322,528 $323,768
======== ======== ======== ======== ========
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(1) Includes loans held-for-sale
(2) Includes real estate contracts. See " - Lending Activities - Real Estate Contracts."
Residential One- to Four-Family Lending. At September 30, 2005, $101.8
million, or 23.2%, 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, fixed-rate loans, including 15, 20, 30, and five and seven
year balloon reset loans are originated to meet the requirements for sale in
the secondary market to the FHLMC. From time to time, however, a portion of
these fixed-rate loans may be retained in the loan portfolio to meet the
Bank's asset/liability management objectives. The Bank periodically retains
fixed-rate five and seven year balloon reset loans in its loan portfolio and
classifies them as held to maturity. The Bank uses an automated underwriting
program, which preliminarily qualifies a loan as conforming to FHLMC
underwriting standards when the loan is originated. At September 30, 2005,
$50.6 million, or 49.7%, 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 at rates and
terms competitive with market conditions. All of the Bank's ARM loans are
retained in its loan portfolio rather than intended for sale. The Bank offers
several ARM products which adjust annually after an initial period ranging
from one to five years subject to a limitation on the annual increase of 2%
and an overall limitation of 6%. These ARM products are priced utilizing the
weekly average yield on one year U.S. Treasury securities adjusted to a
constant maturity of one year plus a margin of 3.00% to 4.00%. Loans tied to
the prime rate or to LIBOR indices typically do not have periodic, or lifetime
adjustment limits. Loans tied to these indices normally have margins ranging
from 0.0% to 3.0%. ARM loans held in the Bank's portfolio do not permit
negative amortization of principal and carry no prepayment restrictions.
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
4
demand for each in a competitive environment. At September 30, 2005, $51.1
million, or 50.2%, of the Bank's one-to four- family loan portfolio consisted
of ARM loans.
A portion of the Bank's ARM loans are "non-conforming" because they do
not satisfy acreage limits, or various other requirements imposed by the
FHLMC. Some of these loans are also originated to meet the needs of borrowers
who cannot otherwise satisfy the FHLMC credit requirements because of personal
and financial reasons (i.e., divorce, bankruptcy, length of time employed,
etc.), and other aspects, which do not conform to the FHLMC's guidelines.
Many of these borrowers have higher debt-to-income ratios, or the loans are
secured by unique properties in rural markets for which there are no
comparable sales of comparable properties to support value according to
secondary market requirements. These loans are known as non-conforming loans
and the Bank may require additional collateral or lower loan-to-value ratios
to reduce the risk of these loans. The Bank believes that these loans satisfy
a need in its local market area. As a result, subject to market conditions,
the Bank intends to continue to originate these types of loans.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased interest
to be paid by the customer as a result of increases in interest rates. It is
possible that during periods of rising interest rates the risk of default on
ARM loans may increase as a result of repricing and the increased costs to the
borrower. Furthermore, because the ARM loans originated by the Bank generally
provide, as a marketing incentive, for initial rates of interest below the
rates which would apply were the adjustment index used for pricing initially,
these loans are subject to increased risks of default or delinquency. The
Bank attempts to reduce the potential for delinquencies and defaults on ARM
loans by qualifying the borrower based on the borrower's ability to repay the
ARM loan assuming that the maximum interest rate that could be charged at the
first adjustment period remains constant during the loan term. Another
consideration is that although ARM loans allow the Bank to increase the
sensitivity of its asset base due to changes in the interest rates, the extent
of this interest sensitivity is limited by the periodic and lifetime interest
rate adjustment limits. Because of these considerations, the Bank has no
assurance that yield increases on ARM loans will be sufficient to offset
increases in the Bank's cost of funds.
While fixed-rate, single-family residential mortgage loans are normally
originated with 15 to 30 year terms, these loans typically remain outstanding
for substantially shorter periods because borrowers often prepay their loans
in full upon sale of the property pledged as security or upon refinancing the
original loan. In addition, substantially all mortgage loans in the Bank's
loan portfolio contain due-on-sale clauses providing that the Bank may declare
the unpaid amount due and payable upon the sale of the property securing the
loan. Typically, the Bank enforces these due-on-sale clauses to the extent
permitted by law and as business judgment dictates. Thus, average loan
maturity is a function of, among other factors, the level of purchase and sale
activity in the real estate market, prevailing interest rates and the interest
rates received on outstanding loans.
The Bank requires that fire and extended coverage casualty insurance be
maintained on all of its real estate secured loans. Loans originated since
1994 also require flood insurance, if appropriate.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 95% of the
lesser of the appraised value or the purchase price. However, the Bank
usually obtains private mortgage insurance ("PMI") on the portion of the
principal amount that exceeds 80% of the appraised value of the security
property. The maximum loan-to-value ratio on mortgage loans secured by
non-owner-occupied properties is generally 80% (90% for loans originated for
sale in the secondary market to the FHLMC).
Construction and Land Development Lending. Prompted by unfavorable
economic conditions in its primary market area in the 1980s, the Bank sought
to establish a market niche and, as a result, began originating construction
loans outside of Grays Harbor County. In recent periods, construction lending
activities have been primarily in the Pierce County, King County, Thurston
County, and Kitsap County markets. Competition from other financial
institutions has increased in recent periods and it is possible that margins
on construction loans may be reduced in the future.
The Bank currently originates three types of residential construction
loans: (i) speculative construction loans, (ii) custom construction loans and
(iii) owner/builder loans. The Bank initiated its construction lending with
the
5
origination of speculative construction loans. As a result, the Bank began to
establish contacts with the building community and increased the origination
of custom construction and land development loans in rural and suburban market
areas. The Bank believes that its computer tracking system has enabled it to
establish processing and disbursement procedures to meet the needs of these
borrowers. To a lesser extent, the Bank also originates construction loans
for the development of multi-family and commercial properties. Subject to
market conditions, the Bank intends to continue to emphasize its construction
lending activities.
At September 30, 2005, the composition of the Bank's construction and
land development loan portfolio was as follows:
Outstanding Percent of
Balance Total
----------- ----------
(In thousands)
Speculative construction............... $ 29,635 26.35%
Custom and owner/builder construction.. 41,810 37.17
Multi-family........................... 10,754 9.56
Land development....................... 6,207 5.52
Commercial real estate................. 24,064 21.40
-------- ------
Total................................ $112,470 100.00%
======== ======
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Bank or another lender for the finished
home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to debt service
the speculative construction loan and finance real estate taxes and other
carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified and a sale is
consummated. The Bank lends to approximately 50 builders located in the
Bank's primary market area, each of which generally have two to six
speculative loans outstanding from the Bank during a 12 month period. Rather
than originating lines of credit to home builders to construct several homes
at once, the Bank originates and underwrites a separate loan for each home.
Speculative construction loans are generally originated for a term of 12
months, with current rates ranging from prime rate plus 1.0% to 1.5%, and with
a loan-to-value ratio of no more than 80% of the appraised estimated value of
the completed property. During this 12 month period, the borrower is required
to make monthly payments of accrued interest on the outstanding loan balance.
At September 30, 2005, speculative construction loans totaled $29.6 million,
or 26.4%, of the total construction loan portfolio. At September 30, 2005,
the Bank had 14 borrowers each with aggregate outstanding speculative loan
balances of more than $500,000. The largest aggregate outstanding balance to
one borrower amounted to $6.8 million, and the largest outstanding balance for
a single speculative loan was $956,000. At September 30, 2005, all
speculative construction loans were performing according to terms.
Unlike speculative construction loans, custom construction loans are made
to home builders who, at the time of construction, have a signed contract with
a home buyer who has a commitment for permanent financing for the finished
home with the Bank or another lender. Custom construction loans are generally
originated for a term of six to 12 months, with fixed interest rates currently
ranging from 7.0% to 7.5% and with loan-to-value ratios of 80% of the
appraised estimated value of the completed property or sales price, whichever
is less. During the construction period, the borrower is required to make
monthly payments of accrued interest on the outstanding loan balance.
Owner/builder construction loans are originated to the home owner rather
than the home builder as a single loan that automatically converts to a
permanent loan at the completion of construction. The construction phase of a
owner/builder construction loan generally lasts up to 12 months with fixed
interest rates currently ranging from 7.0% to 7.5%, and with loan-to-value
ratios of 80% (or up to 95% with PMI) of the appraised estimated value of the
completed property or cost, whichever is less. During the construction
period, the borrower is required to make monthly payments of accrued interest
on the outstanding loan balance. At the completion of construction, the loan
converts automatically
6
to either a fixed-rate mortgage loan, which conforms to secondary market
standards, or an ARM loan for retention in the Bank's portfolio. At September
30, 2005, custom and owner/builder construction loans totaled $41.8 million,
or 37.2%, of the total construction loan portfolio. At September 30, 2005,
the largest outstanding custom and owner/builder construction loan had an
outstanding balance of $653,000 and was performing according to its terms.
The Bank originates loans to local real estate developers with whom it
has established relationships for the purpose of developing residential
subdivisions (i.e., installing roads, sewers, water and other utilities)
(generally with ten to 50 lots). At September 30, 2005, subdivision
development loans totaled $6.2 million, or 5.5% of construction and land
development loans receivable. Land development loans are secured by a lien on
the property and made for a period of two to five years with fixed or variable
interest rates, and are made with loan-to-value ratios generally not exceeding
75%. Monthly interest payments are required during the term of the loan.
Land development loans are structured so that the Bank is repaid in full upon
the sale by the borrower of approximately 80% of the subdivision lots.
Substantially all of the Bank's land development loans are secured by property
located in its primary market area. In addition, in the case of a corporate
borrower, the Bank also generally obtains personal guarantees from corporate
principals and reviews their personal financial statements. At September 30,
2005, the largest land development loan had an outstanding loan balance of
$1.4 million (including $435,000 of undisbursed loans in process balance), and
was performing according to its terms.
Land development loans secured by land under development involve greater
risks than one- to- four family residential mortgage loans because these loans
are advanced upon the predicted future value of the developed property. If
the estimate of the future value proves to be inaccurate, in the event of
default and foreclosure the Bank may be confronted with a property the value
of which is insufficient to assure full repayment. The Bank attempts to
minimize this risk by generally limiting the maximum loan-to-value ratio on
land loans to 75% of the estimated developed value of the secured property.
The Bank also provides construction financing for multi-family and
commercial properties. At September 30, 2005, these loans amounted to $34.8
million, or 31.0% of construction loans. These loans are secured by motels,
apartment buildings, condominiums, office buildings and retail rental space
located in the Bank's primary market area and currently range in amount from
$25,000 to $8.5 million. At September 30, 2005, the largest outstanding
multi-family construction loan had a balance of $7.2 million (including
$258,000 of undisbursed loans in process balance). This loan was secured by a
condominium project in Grays Harbor County and was performing according to its
terms. At September 30, 2005, the largest outstanding commercial real estate
construction loan had a balance of $8.5 million (including $5.7 million of
undisbursed loans in process balance). This loan was secured by a mixed use
commercial/residential condominium project in Thurston County and was
performing according to its terms.
All construction loans must be approved by one of the Bank's Loan
Committees or the Bank's Board of Directors. See "- Lending Activities - Loan
Solicitation and Processing." Prior to preliminary approval of any
construction loan application, an independent fee appraiser inspects the site
and the Bank reviews the existing or proposed improvements, identifies the
market for the proposed project and analyzes the pro forma data and
assumptions on the project. In the case of a speculative or custom
construction loan, the Bank reviews the experience and expertise of the
builder. After preliminary approval has been given, the application is
processed, which includes obtaining credit reports, financial statements and
tax returns on the borrowers and guarantors, an independent appraisal of the
project, and any other expert reports necessary to evaluate the proposed
project. In the event of cost overruns, the Bank generally requires that the
borrower increase the funds available for construction by depositing its own
funds into a secured savings account, the proceeds of which are used to pay
construction costs.
Loan disbursements during the construction period are made to the
builder, materials' supplier or subcontractor, based on a line item budget.
Periodic on-site inspections are made by qualified inspectors to document the
reasonableness of the draw request. For most builders, the Bank disburses
loan funds by providing vouchers to suppliers, which when used by the builder
to purchase supplies are submitted by the supplier to the Bank for payment.
The Bank regularly monitors the construction loan disbursements using an
internal computer program. The Bank believes that its internal monitoring
system helps reduce many of the risks inherent in its construction lending.
7
The Bank originates construction loan applications through customer
referrals, contacts in the business community and occasionally real estate
brokers seeking financing for their clients.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost of
the project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the
estimate of value upon completion proves to be inaccurate, the Bank may be
confronted with a project whose value is insufficient to assure full
repayment. Projects may also be jeopardized by disagreements between
borrowers and builders and by the failure of builders to pay subcontractors.
Loans to builders to construct homes for which no purchaser has been
identified carry more risk because the payoff for the loan depends on the
builder's ability to sell the property prior to the time that the construction
loan is due. The Bank has sought to address these risks by adhering to strict
underwriting policies, disbursement procedures, and monitoring practices. In
addition, because the Bank's construction lending is primarily secured by
properties in its primary market area, changes in the local and state
economies and real estate markets could adversely affect the Bank's
construction loan portfolio.
Real Estate Contracts. The Bank purchases real estate contracts and
deeds of trust from individuals who have privately sold their homes or
property. These contracts are generally secured by one- to four- family
properties, building lots and undeveloped land and range in principal amount
from $10,000 to $200,000, but typically are in amounts between $20,000 and
$40,000. Properties securing real estate contracts purchased by the Bank are
generally located within its primary market area. Prior to purchasing the
real estate contract, the Bank reviews the contract and analyzes and assesses
the collateral for the loan, the down payment made by the borrower and the
credit history on the loan. As of September 30, 2005, the Bank had
outstanding $838,000 of real estate contracts.
Multi-Family Lending. At September 30, 2005, the Bank had $20.2 million,
or 4.6% of the Bank's total loan portfolio, secured by multi-family dwelling
units (more than four units) located primarily in the Bank's primary market
area. At September 30, 2005, approximately 10.0% of the Bank's multi-family
loans represent participation interests in loans, secured by properties
generally located in the Bank's primary market area, purchased from other
lenders. Participation interests are purchased without recourse to the seller
other than for fraud. The Bank underwrites participation interests according
to its own standards.
Multi-family loans are generally originated with variable rates of
interest ranging from 2.00% to 3.50% over the one-year constant maturity U.S.
Treasury Bill Index or a matched term FHLB advance, with principal and
interest payments fully amortizing over terms of up to 30 years. Multi-family
loans currently range in principal balance from $40,000 to $5.9 million. At
September 30, 2005, the largest multi-family loan had an outstanding principal
balance of $5.9 million and was secured by an apartment building located in
the Bank's primary market area. At September 30, 2005, this loan was
performing according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally 75%.
The Bank generally requests its multi-family loan borrowers to submit
financial statements and rent rolls on the subject property annually. The
Bank also inspects the subject property annually. The Bank generally imposes
a minimum debt coverage ratio of approximately 1.10 times for loans secured by
multi-family properties.
Multi-family mortgage lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to four-
family residential lending. However, loans secured by multi-family properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family
properties are often dependent on the successful operation and management of
the properties, repayment of such loans may be affected by adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these
risks by strictly scrutinizing the financial condition of the borrower, the
quality of the collateral and the management of the property
8
securing the loan. If the borrower is other than an individual, the Bank also
generally obtains personal guarantees from the principals based on a review of
personal financial statements.
Commercial Real Estate Lending. Commercial real estate loans totaled
$124.8 million, or 28.5% of total loans receivable at September 30, 2005, and
consisted of 294 loans. The Bank originated $32.3 million of commercial
mortgage loans during the year ended September 30, 2005 compared to $29.1
million originated during the year ended September 30, 2004. The Bank
originates commercial real estate loans generally at variable interest rates
and these loans are secured by properties, such as restaurants, motels, office
buildings and retail/wholesale facilities, located in the Bank's primary
market area. The principal balances of commercial real estate loans currently
ranges between $10,000 and $4.8 million. At September 30, 2005, the largest
commercial real estate loan was secured by a commercial property located in
Olympia, Washington, had a balance of $4.8 million and was performing
according to its terms. At September 30, 2005, two commercial real estate
loans totaling $261,000 were not performing according to their terms. See "-
Lending Activities - Nonperforming Assets and Delinquencies."
The Bank requires appraisals of all properties securing commercial real
estate loans. Appraisals are performed by independent appraisers designated
by the Bank, all of which are reviewed by management. The Bank considers the
quality and location of the real estate, the credit history of the borrower,
the cash flow of the project and the quality of management involved with the
property. The Bank generally imposes a minimum debt coverage ratio of
approximately 1.10 for originated loans secured by income producing commercial
properties. Loan-to-value ratios on commercial real estate loans are
generally limited to not more than 80%. The Bank generally obtains loan
guarantees from financially capable parties 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 strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank
also requests annual financial information and rent rolls on the subject
property from the borrowers.
Land Lending. The Bank originates loans for the acquisition of land upon
which the purchaser can then build or make improvements necessary to build or
to sell as improved lots. At September 30, 2005, land loans totaled $25.0
million, or 5.7% of the Bank's total loan portfolio. Land loans originated by
the Bank are generally fixed-rate loans and have maturities of five to ten
years. Land loans generally range in principal amount from $5,000 to $1.5
million. The largest land loan had an outstanding balance of $1.1 million at
September 30, 2005 and was performing according to its terms. At September
30, 2005, one land loan with a balance of $23,000 was not performing according
to terms. See "- Lending Activities - Nonperforming Assets and
Delinquencies."
Loans secured by undeveloped land or improved lots involve greater risks
than one- to four-family residential mortgage loans because these loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
in the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer lending has traditionally been a small part
of the Bank's business. Consumer loans generally have shorter terms to
maturity and higher interest rates than mortgage loans. Consumer loans
include home equity lines of credit, second mortgage loans, savings account
loans, automobile loans, boat loans, motorcycle loans, recreational vehicle
loans and unsecured loans. Consumer loans are made with both fixed and
variable interest rates and with varying terms. At September 30, 2005,
consumer loans amounted to $41.6 million, or 9.5%, of the total loan
portfolio.
9
At September 30, 2005, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $32.3 million, or 7.4%, of the total loan portfolio. Home
equity lines of credit and second mortgage loans are made for purposes such as
the improvement of residential properties, debt consolidation and education
expenses, among others. The majority of these loans are made to existing
customers and are secured by a first or second mortgage on residential
property. The Bank occasionally solicits these loans. The loan-to-value
ratio is typically 80% or less, when taking into account both the first and
second mortgage loans. Second mortgage loans typically carry fixed interest
rates with a fixed payment over a term between five and 15 years. Home equity
lines of credit are generally made at interest rates tied to the 26 week
Treasury Bill or the prime rate. Second mortgage loans and home equity lines
of credit have greater credit risk than one- to- four family residential
mortgage loans because they are secured by mortgages subordinated to the
existing first mortgage on the property, which may or may not be held by the
Bank.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining
deficiency often does not warrant further substantial collection efforts
against the borrower beyond obtaining a deficiency judgment. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and are more likely to be adversely affected by job loss, divorce,
illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount that can be recovered on such loans. The Bank
believes that these risks are not as prevalent in the case of the Bank's
consumer loan portfolio because a large percentage of the portfolio consists
of second mortgage loans and home equity lines of credit that are underwritten
in a manner such that they result in credit risk that is substantially similar
to one- to- four family residential mortgage loans. At September 30, 2005,
the Bank had $133,000 of consumer loans delinquent in excess of 90 days. See
"Lending Activities - Non performing Assets and Delinquencies."
Commercial Business Lending. Commercial business loans totaled $12.0
million, or 2.7% of total loans receivable at September 30, 2005, and
consisted of 114 loans. In July 1998, the Bank established a business banking
division staffed by three experienced commercial lenders to increase the
Bank's origination of commercial business loans and commercial real estate
loans. Currently, the division is staffed by a Division Manager and eight
commercial lenders. Commercial business loans are generally secured by
business equipment, accounts receivable, inventory or other property and are
made at variable rates of interest equal to a negotiated margin above the
prime rate. The Bank also generally obtains personal guarantees from
financially capable applicants based on a review of personal financial
statements. At September 30, 2005, the Bank had $300,000 of commercial
business loans not performing according to terms. See "Lending
Activities-Nonperforming Assets and Delinquencies."
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral based lending with loan
amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business
loans are often collateralized by equipment, inventory, accounts receivable or
other business assets, the liquidation of collateral in the event of a
borrower default is often an insufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete
or of limited use, among other things. Accordingly, the repayment of a
commercial business loan depends primarily on the creditworthiness of the
borrower (and any guarantors), while liquidation of collateral is a secondary
and often insufficient source of repayment.
10
Loan Maturity. The following table sets forth certain information at
September 30, 2005 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Demand loans, loans having no
stated schedule of repayments and no stated maturity, and overdrafts are
reported as due in one year or less.
After After After
One Year 3 Years 5 Years
Within Through Through Through After
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- -------- ------- -------- -------- -------
(In thousands)
Mortgage loans:
One- to four-
family (1)......$ 1,721 $ 1,734 $ 6,672 $ 5,451 $ 86,185 $101,763
Multi-family..... 1,718 1,311 773 15,223 1,145 20,170
Commercial....... 4,508 4,145 13,524 85,480 17,192 124,849
Construction
and land
development(2).. 51,768 2,632 -- 14,184 43,886 112,470
Land............. 4,925 5,444 13,026 257 1,329 24,981
Consumer loans:
Home equity
and second
mortgage........ 6,447 1,731 1,083 2,198 20,839 32,298
Other............ 1,793 863 1,293 911 4,470 9,330
Commercial business
loans............ 7,359 1,171 692 1,491 1,300 12,013
------- ------- ------- -------- -------- --------
Total............. 80,239 19,031 37,063 125,195 176,346 437,874
------- ------- ------- -------- -------- --------
Less:
Undisbursed
portion of
construction
loans in
process......... 42,771
Deferred loan
origination
fees............ 2,895
Allowance for
loan losses..... 4,099
--------
Loans receivable,
net............. $388,109
========
- --------------
(1) Includes loans held-for-sale.
(2) Includes construction/permanent that convert to a permanent mortgage loan
once construction is completed.
The following table sets forth the dollar amount of all loans due after
one year from September 30, 2005, which have fixed interest rates and have
floating or adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates Total
------- ---------------- -------
(In thousands)
Mortgage loans:
One- to four-family(1)............. $ 50,515 $ 49,527 $100,042
Multi-family....................... 7,976 10,476 18,452
Commercial......................... 10,378 109,963 120,341
Construction and land development.. 38,168 22,534 60,702
Land............................... 17,228 2,828 20,056
Consumer loans:
Home equity and second mortgage.... 19,523 6,328 25,851
Other.............................. 4,570 2,967 7,537
Commercial business loans........... 1,469 3,185 4,654
-------- -------- --------
Total............................ $149,827 $207,808 $357,635
======== ======== ========
- -------------
(1) Includes loans held-for-sale.
11
Scheduled contractual principal repayments of loans do not reflect the
actual life of these assets. The average life of loans is substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare loans
immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase, however, when
current mortgage loan interest rates are substantially higher than interest
rates on existing mortgage loans and, conversely, decrease when interest rates
on existing mortgage loans are substantially higher than current mortgage loan
interest rates.
Loan Solicitation and Processing. Loan originations are obtained from a
variety of sources, including walk-in customers, and referrals from builders
and realtors. Upon receipt of a loan application from a prospective borrower,
a credit report and other data are obtained to verify specific information
relating to the loan applicant's employment, income and credit standing. An
appraisal of the real estate offered as collateral generally is undertaken by
an appraiser retained by the Bank and certified by the State of Washington.
Loan applications are initiated by loan officers and are required to be
approved by one of the Bank's Loan Committees or the Bank's Board of
Directors. The Bank's Consumer Loan Committee, which consists of two
officers, can approve one-to-four family mortgage loans and other consumer
loans up to and including $360,000. Certain consumer loans up to and
including $25,000 may be approved by individual loan officers and the Bank's
Consumer Lending Department Manager may approve consumer loans up to and
including $75,000. The Bank's Commercial Loan Committee, which consists of
the Bank's President, Chief Credit Administrator, and Business Banking
Division Manager, may approve commercial real estate loans and commercial
business loans up to and including $1.5 million. The Bank's President, Chief
Credit Administrator, and Business Banking Division Manager also have
individual lending authority for loans up to and including $500,000. The
Bank's Board Loan Committee, which consists of two rotating outside Directors,
may approve loans up to and including $3.0 million. Loans in excess of $3.0
million, as well as loans of any size granted to a single borrower whose
aggregate loans exceed $3.0 million, must be approved by the Bank's Board of
Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 2005 and 2004, the Bank's total gross loan originations were $230.0
million and $201.1 million, respectively. Periodically, the Bank purchases
participation interests in construction and land development loans and
multi-family loans, secured by properties located in the Bank's primary market
area, from other lenders. These purchases are underwritten to the Bank's
underwriting guidelines and are without recourse to the seller other than for
fraud. See "- Lending Activities - Construction and Land Development Lending"
and "- Lending Activities - Multi-Family Lending."
Consistent with its asset/liability management strategy, the Bank's
policy generally is to retain in its portfolio all of the ARM loans originated
and to sell fixed rate one-to-four family mortgage loans in the secondary
market to the FHLMC; however, from time to time, a portion of fixed-rate loans
may be retained in the Bank's portfolio to meet its asset-liability
objectives. Loans sold in the secondary market are generally sold on a
servicing retained basis. At September 30, 2005, the Bank's loan servicing
portfolio totaled $155.9 million.
12
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
----------------------------
2005 2004 2003
------ ------ ------
Loans originated: (In thousands)
Mortgage loans:
One- to four-family................ $ 33,290 $ 36,824 $ 115,046
Multi-family....................... 4,685 1,150 718
Commercial......................... 32,266 29,056 21,012
Construction and land development.. 104,714 94,373 90,480
Land............................... 15,330 11,033 7,680
Consumer............................ 29,287 18,952 18,530
Commercial business loans........... 10,233 9,754 2,060
-------- -------- ---------
Total loans originated............ 229,805 201,142 255,526
Loans purchased:
Mortgage loans:
One- to four-family................ 209 30 338
Commercial......................... -- -- 800
-------- -------- ---------
Total loans purchased.............. 209 30 1,138
-------- -------- ---------
Total loans originated and
purchased........................ 230,014 201,172 256,664
Loans sold:
Whole loans sold................... (25,358) (35,741) (108,812)
Credit card loans sold............. (1,523) -- --
-------- -------- ---------
Total loans sold................... (26,881) (35,741) (108,812)
Loan principal repayments............ (160,583) (133,943) (145,716)
Decrease (increase) in other
items, net.......................... 965 (9,130) (2,428)
-------- -------- ---------
Net increase (decrease) in loans
receivable.......................... $ 43,515 $ 22,358 $ (292)
======== ======== =========
Construction and land development loan originations totaled $104.7
million, $94.4 million and $90.5 million for the years ended September 30,
2005, 2004 and 2003, respectively. One- to four-family mortgage loan
originations totaled $33.3 million, $36.8 million, and $115.0 million for the
years ended September 30, 2005, 2004, and 2003, respectively. The increased
origination of one-to four-family mortgage loans in fiscal 2003 was primarily
the result of refinancing activity prompted by a decline in interest rates to
historically low levels. Increased fixed rate loan originations resulted in
increased loans sold. It is anticipated that increasing interest rates will
diminish the refinancing activity of one- to four-family loans and,
correspondingly, the volume of loans sold.
Loan Origination Fees. The Bank generally receives loan origination
fees. Loan fees are a percentage of the principal amount of the loan which
are charged to the borrower for funding the loan. The amount of fees charged
by the Bank is generally 0.5% to 2.0% of the loan amount. Current accounting
standards require fees received and certain loan origination costs for
originating loans to be deferred and amortized into interest income over the
contractual life of the loan. Net deferred fees or costs associated with
loans that are prepaid are recognized as income at the time of prepayment.
Deferred loan origination fees totaled $2.9 million at September 30, 2005.
Nonperforming Assets and Delinquencies. The Bank assesses late fees or
penalty charges on delinquent loans of approximately 5% of the monthly loan
payment amount. Substantially all fixed-rate and ARM loan payments are due on
the first day of the month; however, the borrower is given a 15 day grace
period to make the loan payment. When a mortgage loan borrower fails to make
a required payment when due, the Bank institutes collection procedures. A
notice is mailed to the borrower 16 days after the date the payment is due.
Attempts to contact the borrower by telephone generally begin on or before the
30th day of delinquency. If a satisfactory response is not obtained,
continuous follow-up
13
contacts are attempted until the loan has been brought current. Before the
90th day of delinquency, attempts to interview the borrower, preferably in
person, are made to establish (i) the cause of the delinquency, (ii) whether
the cause is temporary, (iii) the attitude of the borrower toward the debt,
and (iv) a mutually satisfactory arrangement for curing the default.
If the borrower is chronically delinquent and all reasonable means of
obtaining payment on time have been exhausted, foreclosure is initiated
according to the terms of the security instrument and applicable law.
Interest income on loans in foreclosure is reduced by the full amount of
accrued and uncollected interest.
When a consumer loan borrower or commercial business borrower fails to
make a required payment on a loan by the payment due date, the Bank institutes
similar collection procedures as for its mortgage loan borrowers. Loans
becoming 90 days or more past due are placed on non-accrual status, with any
accrued interest reversed against interest income, unless they are well
secured and in the process of collection.
The Bank's Board of Directors is informed monthly as to the status of
loans that are delinquent by more than 30 days, the status of all loans
currently in foreclosure, and the status of all foreclosed and repossessed
property owned by the Bank.
The following table sets forth information with respect to the Company's
nonperforming assets at the dates indicated.
At September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
Loans accounted for on a (Dollars in thousands)
non-accrual basis:
Mortgage loans:
One- to four-family........ $ 2,208 $ 430 $ 1,409 $ 1,138 $ 863
Commercial................. 261 640 538 688 2,091
Construction and land
development............... -- -- 1,185 1,571 491
Land....................... 23 322 521 251 610
Consumer loans.............. 133 23 212 49 26
Commercial business loans... 301 27 30 44 10
-------- -------- -------- -------- --------
Total................... 2,926 1,442 3,895 3,741 4,091
Accruing loans which are
contractually past due
90 days or more............ -- -- -- -- --
Total of non-accrual and 90
days past due loans........ 2,926 1,442 3,895 3,741 4,091
Real estate owned and other
repossessed assets......... 509 421 1,258 680 1,006
-------- -------- -------- -------- --------
Total nonperforming
assets................. $ 3,435 $ 1,863 $ 5,153 $ 4,421 $ 5,097
======== ======== ======== ======== ========
Restructured loans.......... -- -- -- -- --
Non-accrual and 90 days or
more past due loans as a
percentage of loans
receivable, net............ 0.75% 0.41% 1.19% 1.15% 1.25%
Non-accrual and 90 days or
more past due loans as a
percentage of total
assets..................... 0.53% 0.31% 0.87% 0.87% 1.06%
Nonperforming assets as a
percentage of total
assets..................... 0.62% 0.40% 1.15% 1.03% 1.32%
Loans receivable, net(1).... $392,208 $348,585 $326,127 $326,158 $326,818
======== ======== ======== ======== ========
Total assets................ $552,765 $460,419 $449,633 $431,054 $386,305
======== ======== ======== ======== ========
- ---------------
(1) Includes loans held-for-sale and is before the allowance for loan losses.
14
The Bank's non-accrual loans increased by $1.5 million to $2.9 million at
September 30, 2005 from $1.4 million at September 30, 2004, primarily as a
result of a $1.8 million increase in one- to four-family mortgage loans on
non-accrual status, a $274,000 increase in commercial business loans on
non-accrual status, and a $110,000 increase in consumer loans on non-accrual
status. Partially offsetting these increases was a $379,000 decrease in
commercial mortgage loans on non-accrual status and a $299,000 decrease in
land loans on non-accrual status. The increase in one- to four-family
non-accrual loans was primarily attributable to a single $1.6 million loan
that was deemed to be well collateralized and listed for sale at September 30,
2005.
Additional interest income which would have been recorded for the year
ended September 30, 2005 had non-accruing loans been current in accordance
with their original terms totaled approximately $169,000.
Real Estate Owned and Other Repossessed Items. Real estate acquired by
the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as real estate owned until sold. When property is acquired, it is
recorded at the lower of its cost, which is the unpaid principal balance of
the related loan plus foreclosure costs, or fair market value. Subsequent to
foreclosure, the property is recorded at the lower of the foreclosed amount or
fair value, less estimated selling costs. At September 30, 2005, the Bank had
$509,000 in real estate owned and other repossessed items consisting primarily
of one commercial real estate property with a book value of $344,000 and five
land parcels totaling $165,000. Subsequent to September 30, 2005, the
$344,000 commercial real estate property was sold for a price in excess of the
property's book value.
Restructured Loans. Under accounting principles generally accepted in
the United States of America, the Bank is required to account for certain loan
modifications or restructuring as a "troubled debt restructuring." In
general, the modification or restructuring of a debt constitutes a troubled
debt restructuring if the Bank for economic or legal reasons related to the
borrower's financial difficulties grants a concession to the borrowers that
the Bank would not otherwise consider. Debt restructuring or loan
modifications for a borrower does not necessarily always constitute troubled
debt restructuring, however, and troubled debt restructurings do not
necessarily result in non-accrual loans. The Bank had no restructured loans
at September 30, 2005.
Other Loans of Concern. Loans not reflected in the table above, but
where known information about possible credit problems of borrowers causes
management to have doubts as to the ability of the borrower to comply with
present repayment terms and that may result in disclosure of such loans and
leases as underperforming assets in the future are commonly referred to as
"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 was $11.3
million at September 30, 2005 and $14.1 million at September 30, 2004. The
vast majority of these loans, as well as our nonperforming assets, are
collateralized.
Asset Classification. Applicable regulations require that each insured
institution review and classify its assets on a regular basis. In addition,
in connection with examinations of insured institutions, regulatory examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
substandard, doubtful and loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of substandard assets with the additional
characteristic that the weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions and values questionable, and
there is a high possibility of loss. An asset classified as loss is
considered uncollectible and of such little value that continuance as an asset
of the institution is not warranted. When an insured institution classifies
problem assets as either substandard or doubtful, it is required to establish
general allowances for loan losses in an amount deemed prudent by management.
These allowances represent loss allowances which have been established to
recognize the inherent risk associated with lending activities and the risks
associated with particular problem assets. When an insured institution
classifies problem assets as loss, it charges off the balance of the asset
against the allowance for loan losses. Assets which do not currently expose
the insured institution to sufficient risk to warrant classification in one of
the aforementioned categories but possess weaknesses are required to be
designated as special mention. The Bank's
15
determination of the classification of its assets and the amount of its
valuation allowances is subject to review by the FDIC and the Division which
can order the establishment of additional loss allowances.
The aggregate amounts of the Bank's classified assets (as determined by
the Bank), and of the Bank's allowances for loan losses at the dates
indicated, were as follows:
At September 30,
----------------------------
2005 2004 2003
------ ------ ------
(In thousands)
Loss......................... $ -- $ -- $ --
Doubtful..................... -- -- --
Substandard(1)............... 9,876 11,847 9,112
Special mention(1)........... 4,320 3,676 6,607
------- ------- -------
Total classified assets...... $14,196 $15,523 $15,719
======= ======= =======
Allowance for loan losses.... $ 4,099 $ 3,991 $ 3,891
- ------------
(1) For further information concerning the change in classified assets, see
"- Lending Activities - Nonperforming Assets and Delinquencies."
The Bank's classified assets decreased by $1.3 million from September 30,
2004 to September 30, 2005, primarily as a result of a $2.0 million decrease
in loans classified as substandard. This decrease was partially offset by a
$644,000 increase in loans classified as special mention.
Special mention loan are defined as those credits deemed by management to
have some potential weakness that deserve management's close attention. If
left uncorrected these potential weaknesses may result in the deterioration of
the payment prospects of the loan. Assets in this category are not adversely
classified and currently do not expose the Bank to sufficient risk to warrant
a substandard classification. Two loans comprise a majority of the amount
classified as special mention. They include a $1.9 million loan secured by a
multi-family property in Kitsap County, and a $1.1 million land development
loan in Grays Harbor County. At September 30, 2005 both of these loans were
current and paying in accordance with the required loan terms.
Substandard loans are classified as those loans that are inadequately
protected by the current net worth, and paying capacity of the obligor, or of
the collateral pledged. Assets classified as substandard have a well-defined
weakness, or weaknesses that jeopardize the repayment of the debt. If the
weakness, or weaknesses are not corrected there is the distinct possibility
that some loss will be sustained. The aggregate amount of loans classified as
substandard at September 30, 2005 decreased by $2.0 million to $9.9 million
from $11.9 million at September 30, 2004. At September 30, 2005, 37 loans
were classified as substandard compared to 36 at September 30, 2004. The
largest loan currently classified substandard is a $3.3 million loan secured
by a motel in Pierce County. This loan is current and paying in accordance
with the terms of the loan. The next largest loans classified as substandard
include a $1.6 million loan secured by a single family home in Pierce County,
a $1.2 million loan secured by a hotel in Grays Harbor County, and a $675,000
loan secured by a single family home in King County. At September 30, 2005,
the $1.6 million single family home loan was more than 90 days delinquent and
on non-accrual status. However, subsequent to September 30, 2005, this loan
was paid in full. At September 30, 2005, the $1.2 million hotel loan was
current and the $675,000 single- family home loan was 30 days delinquent.
Allowance for Loan Losses. The allowance for loan losses is maintained
to cover estimated losses in the loan portfolio. The Bank has established a
comprehensive methodology for the determination of provisions for loan losses
that takes into consideration the need for an overall general valuation
allowance. The Bank's methodology for assessing the adequacy of its allowance
for loan losses is based on its historic loss experience for various loan
segments; adjusted for changes in economic conditions, delinquency rates, and
other factors. Using these loss estimate factors, management develops a range
of probable loss for each loan category. Certain individual loans for which
full collectibility may not
16
be assured are evaluated individually with loss exposure based on estimated
discounted cash flows or collateral values. The total estimated range of loss
based on these two components of the analysis is compared to the loan loss
allowance balance. Based on this review, management will adjust the allowance
as necessary to maintain directional consistency with trends in the loan
portfolio.
In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. The Bank increases its allowance for loan losses
by charging provisions for loan losses against the Bank's income.
The Board of Directors reviews the adequacy of the allowance for loan
losses at least quarterly based on management's assessment of current economic
conditions, past loss and collection experience, and risk characteristics of
the loan portfolio.
At September 30, 2005, the Bank had an allowance for loan losses of $4.1
million. Management believes that the amount maintained in the allowance is
adequate to absorb probable losses in the portfolio. Although management
believes that it uses the best information available to make its
determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.
While the Bank believes it has established its existing allowance for
loan losses in accordance with accounting principles generally accepted in the
United States of America, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future
events affecting borrowers and collateral cannot be predicted with certainty,
there can be no assurance that the existing allowance for loan losses is
adequate or that substantial increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
Any material increase in the allowance for loan losses may adversely affect
the Bank's financial condition and results of operations.
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended September 30,
------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(Dollars in thousands)
Allowance at beginning of year.. $3,991 $3,891 $3,630 $3,050 $2,640
Provision for loan losses....... 141 167 347 992 1,400
Recoveries:
Mortgage loans:
One to four family............. -- 6 -- -- 21
Consumer loans:
Home Equity and Second
Mortgage...................... 5 -- -- -- --
Other.......................... 3 16 12 13 1
Commercial business loans....... 9 3 70 96 --
------ ------ ------ ------ ------
Total recoveries............. 17 25 82 109 22
(table continued of the following page)
17
Year Ended September 30,
------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(Dollars in thousands)
Charge-offs:
Mortgage loans:
One to four family............. -- 6 30 16 41
Multi Family................... 1 -- -- -- --
Consumer....................... -- -- -- 32 30
Commercial business loans...... -- 3 -- -- --
Land........................... 1 -- 10 -- 30
Consumer Loans:
Home Equity and Second
Mortgage...................... -- 9 40 -- --
Other.......................... 12 68 88 143 242
Commercial Business Loans....... 36 6 -- 330 669
Total charge-offs............ 50 92 168 521 1,012
------ ------ ------ ------ ------
Net charge-offs.............. 33 67 86 412 990
------ ------ ------ ------ ------
Balance at end of year....... $4,099 $3,991 $3,891 $3,630 $3,050
====== ====== ====== ====== ======
Allowance for loan losses
as a percentage of total
loans receivable (net)(1)
outstanding at the end of
the year....................... 1.05% 1.14% 1.19% 1.11% 0.93%
Net charge-offs as a
percentage of average
loans outstanding during
the year....................... 0.01% 0.02% 0.03% 0.13% 0.31%
Allowance for loan losses
as a percentage of
nonperforming loans at
end of year.................... 140.09% 276.77% 99.90% 97.03% 74.55%
- -------------
(1) Total loans receivable (net) includes loans held for sale and is before
the allowance for loan losses.
18
The following table sets forth the allocation of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
----------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------------- ------------------ ---------------- ----------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- -------- -------- -------- ------ -------- ------- -------- ------- ---------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Mortgage loans:
One- to four-
family....... $ 494 23.24% $ 386 25.25% $ 317 26.21% $ 322 31.28% $ 271 35.14%
Multi-family.. 194 4.61 242 4.34 374 5.01 214 6.67 195 7.95
Commercial.... 1,544 28.51 1,443 27.39 1,041 28.30 1,072 27.00 793 17.76
Construction.. 652 25.68 538 26.88 583 25.87 536 22.16 845 28.71
Land.......... 255 5.71 226 5.03 169 4.30 152 4.27 96 3.68
Non-mortgage
loans:
Consumer
loans........ 255 9.51 427 8.30 458 7.71 512 6.03 217 4.83
Commercial
business
loans........ 705 2.74 729 2.81 949 2.60 822 2.59 633 1.93
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total
allowance
for loan
losses..... $4,099 100.00% $3,991 100.00% $3,891 100.00% $3,630 100.00% $3,050 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
19
Investment Activities
At September 30, 2005, the Company's investment portfolio totaled $89.7
million, primarily consisting of $32.2 million of mutual funds available for
sale, $23.7 million of mortgage-backed securities available for sale, $33.7
million of U.S. agency securities available for sale, and $104,000 of
securities held to maturity. This compares with a total portfolio of $60.1
million at September 30, 2004, comprised of $32.6 million of mutual funds
available for sale, $18.3 million of mortgage-backed securities available for
sale, $9.0 million of U.S. agency securities available for sale and $174,000
of securities held to maturity. The mutual funds invest primarily in
mortgage-backed products and U.S. agency securities. The composition of the
portfolios by type of security, at each respective date is presented in the
table, which follows.
The investment policies of the Company are established and monitored by
the Board of Directors. The policies are designed primarily to provide and
maintain liquidity, to generate a favorable return on investments without
incurring undue interest rate and credit risk, and to compliment the Bank's
lending activities. These policies dictate the criteria for classifying
securities as either available for sale or held to maturity. The policies
permit investment in various types of liquid assets permissible under
applicable regulations, which includes U.S. Treasury obligations, securities
of various federal agencies, certain certificates of deposit of insured banks,
banker's acceptances, federal funds, mortgage-backed securities, and mutual
funds. The Company's investment policy also permits investment in equity
securities in certain financial service companies.
The following table sets forth the investment securities portfolio and
recorded values at the dates indicated.
At September 30,
--------------------------------------------------------
2005 2004 2003
----------------- ----------------- ------------------
Percent Percent Percent
Recorded of Recorded of Recorded of
Value Total Value Total Value Total
-------- ------- -------- ------- -------- --------
(Dollars in thousands)
Held-to-Maturity:
Mortgage-backed
securities......... $ 104 0.12% $ 174 0.29% $ 279 0.52%
Available-for-Sale
(at fair value):
U.S. agency
securities......... 33,695 37.56 8,983 14.96 2,511 4.62
Mortgage-backed
securities......... 23,735 26.46 18,329 30.52 17,098 31.48
Municipal bonds -- -- -- -- 12 0.02
Mutual funds........ 32,165 35.86 32,577 54.23 34,410 63.36
------- ------ ------- ------ ------- ------
Total portfolio...... $89,699 100.00% $60,063 100.00% $54,310 100.00%
======= ====== ======= ====== ======= ======
20
The following table sets forth the maturities and weighted average yields
of the investment and mortgage-backed securities in the Company's investment
securities portfolio at September 30, 2005. Mutual funds, which by their
nature do not have maturities, are classified in the less than one year
category.
After One to After Five to After Ten
One Year or Less Five Years Ten Years Years
---------------- ---------------- ---------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Held-to-Maturity:
Mortgage-backed
securities............. $ -- --% $ -- --% $ -- --% $ 104 4.17%
Available-for-Sale:
U.S. agency securities.. -- -- 31,717 3.34 1,978 4.09 -- --
Mortgage-backed
securities............. -- -- 813 4.93 187 5.27 22,735 3.94
Mutual funds............ 32,165 3.95 -- -- -- -- -- --
------- ---- ------- ---- ------ ---- ------- ----
Total portfolio......... $32,165 3.95% $32,530 3.38% $2,165 4.19% $22,839 3.94%
======= ==== ======= ==== ====== ==== ======= ====
The following table sets forth certain information with respect to each
security which had an aggregate book value in excess of 10% of the Company's
total equity at the date indicated.
At September 30, 2005
---------------------
Amortized Fair
Cost Value
--------- -------
(In thousands)
Asset Management Fund-Ultra Short Mortgage
Fund (ASARX).............................. $18,730 $18,312
Asset Management Fund-Ultra Short
Fund (AULTX).............................. 10,000 9,789
------- -------
Allowance for loan losses.................. $28,730 $28,101
======= =======
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the
Bank's funds for lending and other investment purposes. Scheduled loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are influenced significantly by general interest
rates and money market conditions. Borrowings through the FHLB-Seattle 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. In recent periods, the Bank has used deposit
interest rate promotions in connection with the opening of new branch offices.
The Bank actively seeks consumer and commercial checking accounts through a
checking account acquisition marketing program that was implemented in 2000.
At September 30, 2005, the Bank had 35.3% of total deposits in non-interest
bearing accounts and NOW checking accounts.
21
At September 30, 2005 the Bank had $35.2 million of jumbo certificates of
deposit of $100,000 or more. The Bank does not solicit brokered deposits and
believes that its jumbo certificates of deposit, which represented 8.6% of
total deposits at September 30, 2005, present similar interest rate risk
compared to its other deposit products.
The following table sets forth information concerning the Bank's deposits
at September 30, 2005.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
- ---------------------------------------- ------------- --------- ----------
(In thousands)
Non-Interest Bearing.................... --% $ 51,791 12.58%
Negotiable order of withdrawal ("NOW")
Checking............................... 0.64 93,478 22.71
Savings................................. 0.71 64,274 15.61
Money Market Accounts................... 1.45 49,295 11.98
-------- ------
Subtotal............................... 0.68 258,838 62.88
-------- ------
Certificates of Deposit(1)
- ----------------------------------------
Maturing within 1 year.................. 2.72 104,163 25.30
Maturing after 1 year but within
2 years................................ 3.46 30,769 7.47
Maturing after 2 years but within
5 years................................ 3.76 17,745 4.31
Maturing after 5 years.................. 4.92 150 0.04
-------- ------
Total certificates of deposit.......... 3.00 152,827 37.12
-------- ------
Total deposits........................ 1.54 $411,665 100.00%
======== ======
- ------------
(1) Based on remaining maturity of certificates.
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of September 30, 2005. Jumbo
certificates of deposit have principal balances of $100,000 or more and the
rates paid on these accounts are generally negotiable.
Maturity Period Amount
---------------------------------- ------------
(In thousands)
Three months or less.............. $ 7,466
Over three through six months..... 4,683
Over six through twelve months.... 9,780
Over twelve months................ 13,280
-------
Total........................... $35,209
=======
22
Deposit Flow. The following table sets forth the balances of deposits in the various types of accounts
offered by the Bank at the dates indicated.
At September 30,
------------------------------------------------------------------------------------
2005 2004 2003
------------------------------ ----------------------------- -------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- ---------- -------- -------- ---------- ------- --------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Non-interest-bearing....$ 51,791 12.58% $14,641 $ 37,150 11.63% $ 8,017 $ 29,133 9.47%
NOW checking............ 93,478 22.71 16,236 77,242 24.17 19,628 57,614 18.73
Savings accounts........ 64,274 15.61 16,074 48,200 15.08 (1,372) 49,572 16.11
Money market deposit.... 49,295 11.98 7,643 41,652 13.03 2,208 39,444 12.82
Certificates of deposit
which mature in the
year ending:
Within 1 year........ 104,163 25.30 17,736 86,427 27.05 (12,814) 99,241 32.26
After 1 year, but
within 2 years...... 30,769 7.47 12,711 18,058 5.65 (5,582) 23,640 7.68
After 2 years, but
within 5 years...... 17,745 4.31 7,582 10,163 3.18 3,149 7,014 2.28
Certificates maturing
thereafter.......... 150 0.04 (528) 678 0.21 (1,336) 2,014 0.65
-------- ------ ------- -------- ------ ------- -------- ------
Total...................$411,665 100.00% $92,095 $319,570 100.00% $11,898 $307,672 100.00%
======== ====== ======= ======== ====== ======= ======== ======
23
Certificates of Deposit by Rates. The following table sets forth the
certificates of deposit in the Bank classified by rates as of the dates
indicated.
At September 30,
-------------------------------
2005 2004 2003
-------- -------- --------
(In thousands)
0.00 - 1.99%..................... $ 24,765 $ 60,258 $ 50,569
2.00 - 3.99%..................... 125,541 46,482 68,274
4.00 - 5.99%..................... 2,034 7,890 11,757
6.00% - and over................. 487 696 1,309
-------- -------- --------
Total............................ $152,827 $115,326 $131,909
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth
the amount and maturities of certificates of deposit at September 30, 2005.
Amount Due
-------------------------------------------------
After
One to Two to
Less Than Two Five After
One Year Years Years Five Years Total
--------- ------- ------- ---------- -------
(In thousands)
0.00 - 1.99%.............. $ 24,098 $ 475 $ 127 $ -- $ 24,700
2.00 - 3.99%.............. 78,227 25,016 16,799 107 120,149
4.00 - 5.99%.............. 1,816 5,221 454 -- 7,491
6.00% and over............ 22 57 365 43 487
-------- ------- ------- ----- --------
Total..................... $104,163 $30,769 $17,745 $ 150 $152,827
======== ======== ======= ===== ========
Deposit Activities. The following table sets forth the savings
activities of the Bank for the periods indicated.
Year Ended September 30,
-------------------------------
2005 2004 2003
-------- -------- --------
(In thousands)
Beginning balance...................... $319,570 $307,672 $292,316
Net deposits before interest credited.. 86,673 7,730 9,786
Interest credited...................... 5,422 4,168 5,570
-------- -------- --------
Net increase in deposits............... 92,095 11,898 15,356
-------- -------- --------
Ending balance......................... $411,665 $319,570 $307,672
======== ======== ========
Borrowings. Deposits are the primary source of funds for the Bank's
lending and investment activities and for general business purposes. The Bank
has the ability to use advances from the FHLB-Seattle to supplement its supply
of lendable funds and to meet deposit withdrawal requirements. The
FHLB-Seattle functions as a central reserve bank providing credit for member
financial institutions. As a member of the FHLB-Seattle, the Bank is required
to own capital stock in the FHLB-Seattle and is authorized to apply for
advances on the security of such stock and certain mortgage loans and other
assets (principally securities which are obligations of, or guaranteed by, the
United States government) provided certain creditworthiness standards have
been met. Advances are made pursuant to several different credit programs.
Each credit program has its own interest rate and range of maturities.
Depending on the program, limitations on the amount of advances are based on
the financial condition of the member institution and the adequacy of
collateral pledged to secure the credit. At September 30, 2005, the Bank
maintained an uncommitted credit facility with the FHLB-
24
Seattle that provided for immediately available advances up to an aggregate
amount of 30% of the Bank's total assets, limited by available collateral,
under which $62.4 million was outstanding. The Bank also utilizes overnight
repurchase agreements with customers. These overnight repurchase agreements
are classified as other borrowings and totaled $781,000 at September 30, 2005.
There were no repurchase agreements in effect at September 30, 2004 and
September 30, 2003. At September 30, 2005, the Bank also maintained a $10.0
million overnight borrowing line with Pacific Coast Bankers Bank under which
there was no outstanding balance.
The following table sets forth certain information regarding borrowings
by the Bank at the end of and during the periods indicated:
At or For the
Year Ended September 30,
------------------------------
2005 2004 2003
-------- -------- --------
(Dollars in thousands)
Average total borrowings................ $60,537 $57,778 $61,715
Weighted average rate paid on total
borrowings............................. 5.26% 5.46% 5.47%
Total borrowings outstanding
at end of period....................... 63,134 65,421 61,605
Bank Owned Life Insurance
The Bank has purchased life insurance policies covering certain officers.
These policies are recorded at their cash surrender value, net of any policy
premium charged. Increases in cash surrender value, net of policy premiums,
and proceeds from death benefits are recorded in non-interest income. At
September 30, 2005, the Bank had $11.5 million in bank owned life insurance.
REGULATION OF THE BANK
General
The Bank, as a state-chartered savings bank, is subject to regulation and
oversight by the Division and the applicable provisions of Washington law and
regulations of the Division adopted thereunder. The Bank also is subject to
regulation and examination by the FDIC, which insures the deposits of the Bank
to the maximum extent permitted by law, and requirements established by the
Federal Reserve. State law and regulations govern the Bank's ability to take
deposits and pay interest thereon, to make loans on or invest in residential
and other real estate, to make consumer loans, to invest in securities, to
offer various banking services to its customers, and to establish branch
offices. Under state law, savings banks in Washington also generally have all
of the powers that federal savings banks have under federal laws and
regulations. The Bank is subject to periodic examination and reporting
requirements by and of the Division.
Deposit Insurance
The FDIC is an independent federal agency established originally to
insure the deposits, up to prescribed statutory limits, of federally-insured
depository institutions. The FDIC maintains two separate insurance funds: the
Bank Insurance Fund ("BIF") and the SAIF. The Bank is a member of the SAIF.
Deposits are insured up to the applicable limits by the FDIC and this
insurance is backed by the full faith and credit of the United States
government.
As insurer, the FDIC imposes deposit insurance premiums and is authorized
to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging
in
25
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate
enforcement actions against savings institutions and may terminate the deposit
insurance if it determines that the institution has engaged in unsafe or
unsound practices or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, an institution is
classified as well capitalized if it has a total risk-based capital ratio of
at least 10%, a core capital ratio of at least 5% and Tier 1 capital ratio of
at least 6%. An institution is less than adequately capitalized if it has a
risk-based capital ratio of less than 8% or a core capital ratio of less than
4%. The risk classification of all insured institutions is completed by the
FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than
the designated reserve ratio of 1.25% of SAIF insured deposits. In setting
these increased assessments, the FDIC must seek to restore the reserve ratio
to that designated reserve level, or such higher reserve ratio as established
by the FDIC. The FDIC may also impose special assessments on SAIF members to
repay amounts borrowed from the United States Treasury or for any other reason
deemed necessary by the FDIC.
Since January 1, 1997, the premium schedule for BIF and SAIF insured
institutions has ranged from 0 to 27 basis points. However, SAIF and BIF
insured institutions are required to pay a Financing Corporation assessment in
order to fund the interest on bonds issued to resolve thrift failures in the
1980s equal to approximately 1.50 points for each $100 in domestic deposits
annually. These assessments, which may be revised based upon the level of BIF
and SAIF deposits, will continue until the bonds mature.
Under the Federal Deposit Insurance Act ("FDIA"), the FDIC may terminate
deposit insurance upon a finding that the institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, rule, order or condition
imposed by the FDIC. Management of the Bank does not know of any practice,
condition or violation that might lead to termination of deposit insurance.
Prompt Corrective Action
The FDIC is required to take certain supervisory actions against
undercapitalized savings institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, an institution that
has a ratio of total capital to risk-weighted assets of less than 8%, a ratio
of Tier I (core) capital to risk-weighted assets of less than 4%, or a ratio
of core capital to total assets of less than 4% (3% or less for institutions
with the highest examination rating) is considered to be undercapitalized. An
institution that has a total risk-based capital ratio less than 6%, a Tier I
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be significantly undercapitalized and an institution that has a
tangible capital to assets ratio equal to or less than 2% is deemed to be
critically undercapitalized. Subject to a narrow exception, the FDIC is
required to appoint a receiver or conservator for a savings institution that
is critically undercapitalized. FDIC regulations also require that a capital
restoration plan be filed with the FDIC within 45 days of the date a savings
institution receives notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. Compliance with the plan
must be guaranteed by any parent holding company in an amount of up to the
lesser of 5% of the institution's assets or the amount which would bring the
institution into compliance with all capital standards. In addition, numerous
mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The FDIC also could take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
At September 30, 2005, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC.
26
Standards for Safety and Soundness
The federal banking regulatory agencies have prescribed, by regulation,
guidelines for all insured depository institutions relating to: internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate risk exposure, asset growth, asset quality,
earnings, and compensation, fees and benefits. The guidelines set forth the
safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before
capital becomes impaired. If the FDIC determines that the Bank fails to meet
any standard prescribed by the guidelines, the agency may require the Bank to
submit to the agency an acceptable plan to achieve compliance with the
standard. FDIC regulations establish deadlines for the submission and review
of such safety and soundness compliance plans. Management of the Bank is not
aware of any conditions relating to these safety and soundness standards which
would require submission of a plan of compliance.
Capital Requirements
FDIC regulations recognize two types or tiers of capital: core ("Tier 1")
capital and supplementary ("Tier 2") capital. Tier 1 capital generally
includes common shareholders' equity and noncumulative perpetual preferred
stock, less most intangible assets. Tier 2 capital, which is limited to 100%
of Tier 1 capital, includes such items as qualifying general loan loss
reserves, cumulative perpetual preferred stock, mandatory convertible debt,
term subordinated debt and limited life preferred stock; however, the amount
of term subordinated debt and intermediate term preferred stock (original
maturity of at least five years but less than 20 years) that may be included
in Tier 2 capital is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage
limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average
total assets. Most banks are required to maintain a minimum leverage ratio of
at least 4% to 5% of total assets. At September 30, 2005, the Bank had a Tier
1 leverage capital ratio of 10.7%. The FDIC retains the right to require an
institution to maintain a higher capital level based on the institution's
particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in
one of four categories and given a percentage weight - 0%, 20%, 50% or 100% -
based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance-sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories.
Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2
capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1
capital to risk-weighted assets must be at least 4%. At September 30, 2005,
the Bank's ratio of total capital to risk-weighted assets was 17.9% and the
ratio of Tier 1 capital to risk-weighted assets was 14.7%. In evaluating the
adequacy of a bank's capital, the FDIC may also consider other factors that
may affect a bank's financial condition. Such factors may include interest
rate risk exposure, liquidity, funding and market risks, the quality and level
of earnings, concentration of credit risk, risks arising from nontraditional
activities, loan and investment quality, the effectiveness of loan and
investment policies, and management's ability to monitor and control financial
operating risks.
The Division requires that net worth equal at least 5% of total assets.
Intangible assets must be deducted from net worth and assets when computing
compliance with this requirement. At September 30, 2005, the Bank had a net
worth of 12.0% of total assets.
FDIC capital requirements are designated as the minimum acceptable
standards for banks whose overall financial condition is fundamentally sound,
which are well-managed and have no material or significant financial
weaknesses. The FDIC capital regulations state that, where the FDIC
determines that the financial history or condition, including off-balance
sheet risk, managerial resources and/or the future earnings prospects of a
bank are not adequate and/or a bank has a significant volume of assets
classified substandard, doubtful or loss or otherwise criticized, the FDIC may
determine that the minimum adequate amount of capital for that bank is greater
than the minimum standards established in the regulation.
27
The Bank's management believes that, under the current regulations, the
Bank will continue to meet its minimum capital requirements in the foreseeable
future. However, events beyond the control of the Bank, such as a downturn in
the economy in areas where the Bank has most of its loans, could adversely
affect future earnings and, consequently, the ability of the Bank to meet its
capital requirements.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2005. The definitions of the terms
used in the table are those provided in the capital regulations issued by the
FDIC.
At September 30, 2005
--------------------------------
Percent of Adjusted
Amount Total Assets (1)
-------- -------------------
(Dollars in thousands)
Tier 1 (leverage) capital (2).............. $58,224 10.7%
Tier 1 (leverage) capital requirement...... 21,783 4.0
------- ----
Excess..................................... $36,441 6.7%
======= ====
Tier 1 risk adjusted capital............... $58,224 14.7%
Tier 1 risk adjusted capital requirement... 15,838 4.0
------- ----
Excess..................................... $42,386 10.7%
======= ====
Total risk-based capital................... $62,323 17.9%
Total risk-based capital requirement....... 31,677 8.0
------- ----
Excess..................................... $30,646 9.9%
======= ====
- ------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $544.6 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $396.0 million.
(2) As a Washington-chartered savings bank, the Bank is subject to the
capital requirements of the FDIC and the Division. The FDIC requires
state-chartered savings banks, including the Bank, to have a minimum
leverage ratio of Tier 1 capital to total assets of at least 3%,
provided, however, that all institutions, other than those (i) receiving
the highest rating during the examination process and (ii) not
anticipating any significant growth, are required to maintain a ratio of
1% to 2% above the stated minimum, with an absolute total capital to
risk-weighted assets of at least 8%. The Bank has not been notified by
the FDIC of any leverage capital requirement specifically applicable to
it.
Activities and Investments of Insured State-Financial Institutions
Federal law generally limits the activities and equity investments of
FDIC-insured, state-chartered banks to those that are permissible for national
banks. Under regulations dealing with equity investments, an insured state
bank generally may not directly or indirectly acquire or retain any equity
investment of a type, or in an amount, that is not permissible for a national
bank. An insured state bank is not prohibited from, among other things, (i)
acquiring or retaining a majority interest in a subsidiary, (ii) investing as
a limited partner in a partnership the sole purpose of which is direct or
indirect investment in the acquisition, rehabilitation or new construction of
a qualified housing project, provided that such limited partnership
investments may not exceed 2% of the bank's total assets, (iii) acquiring up
to 10% of the voting stock of a company that solely provides or reinsures
directors', trustees' and officers' liability insurance coverage or bankers'
blanket bond group insurance coverage for insured depository institutions, and
(iv) acquiring or retaining the voting shares of a depository institution if
certain requirements are met.
Washington law provides financial institution parity between commercial
banks and savings banks. Primarily, the law affords Washington-chartered
commercial banks the same powers as Washington-chartered savings banks. In
28
order for a bank to exercise these powers, it must provide 30 days notice to
the Director of Washington Division of Financial Institutions and the Director
must authorize the requested activity. In addition, the law provides that
Washington-chartered commercial banks may exercise any of the powers that the
Federal Reserve has determined to be closely related to the business of
banking and the powers of national banks, subject to the approval of the
Director in certain situations. The law also provides that
Washington-chartered savings banks may exercise any of the powers of
Washington-chartered commercial banks, national banks and federally-chartered
savings banks, subject to the approval of the Director in certain situations.
Finally, the law provides additional flexibility for Washington-chartered
commercial and savings banks with respect to interest rates on loans and other
extensions of credit. Specifically, they may charge the maximum interest rate
allowable for loans and other extensions of credit by federally-chartered
financial institutions to Washington residents.
Environmental Issues Associated With Real Estate Lending
The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), a federal statute, generally imposes strict liability on, among
other things, all prior and present "owners and operators" of hazardous waste
sites. However, the U.S. Congress created a safe harbor provision for secured
creditors by providing that the term "owner and operator" excludes a person
who, without participating in the management of the site, holds indicia of
ownership primarily to protect 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.
In response to the uncertainty created by judicial interpretations, in
April 1992, the United States Environmental Protection Agency ("EPA"), an
agency within the Executive Branch of the government, promulgated a regulation
clarifying when and how secured creditors could be liable for cleanup costs
under the CERCLA. Generally, the regulation protected a secured creditor that
acquired full title to collateral property through foreclosure as long as the
creditor did not participate in the property's management before foreclosure
and undertook certain due diligence efforts to divest itself of the property.
However, in February 1994, the U.S. Court of Appeals for the District of
Columbia Circuit held that the EPA lacked authority to promulgate such
regulation on the grounds that Congress meant for decisions on liability under
the CERCLA to be made by the courts and not the Executive Branch. In January
1995, the U.S. Supreme Court denied to review the U.S. Court of Appeal's
decision. In light of this adverse court ruling, in October 1995 the EPA
issued a statement entitled "Policy on CERCLA Enforcement Against Lenders and
Government Entities that Acquire Property Involuntarily" explaining that as an
enforcement policy, the EPA intended to apply as guidance the provisions of
the EPA lender liability rule promulgated in 1992.
To the extent that legal uncertainty exists in this area, all creditors,
including the Bank, that have made loans secured by properties with potential
hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
Federal Reserve System
The Federal Reserve Board requires under Regulation D that all depository
institutions, including savings banks, maintain reserves on transaction
accounts or non-personal time deposits. These reserves may be in the form of
cash or non-interest-bearing deposits with the regional Federal Reserve Bank.
Negotiable order of withdrawal accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any non-personal time deposits at a savings bank. Under Regulation D, a
bank must maintain reserves against net transaction accounts in the amount of
3% on amounts of $37.3 million or less, plus 10% on amounts in excess of $37.3
million. In addition, a bank may designate and exempt $5.0 million of certain
reservable liabilities from these reserve requirements. These amounts and
percentages are subject to adjustment by the Federal Reserve. The reserve
requirement on non-personal time deposits with original maturities of less
than 1.5 years is 0%. As of September 30, 2005, the Bank had a Regulation D
reserve requirement of $10.2 million.
29
Affiliate Transactions
The Company and the Bank are separate and distinct legal entities.
Various legal limitations restrict the Bank from lending or otherwise
supplying funds to the Company (an "affiliate"), generally limiting such
transactions with the affiliate to 10% of the bank's capital and surplus and
limiting all such transactions to 20% of the bank's capital and surplus.
These transactions, including extensions of credit, sales of securities or
assets and provision of services, also must be on terms and conditions
consistent with safe and sound banking practices, including credit standards,
that are substantially the same or at least as favorable to the bank as those
prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or
other affiliates, on investments in the stock or other securities of
affiliates and on the taking of such stock or securities as collateral from
any borrower. In addition, such banks are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit or the
providing of any property or service.
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, in connection with its regular examination of a bank, to assess the
bank's record 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, such assessment is required of any bank which has applied, among
other things, to 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
CRA examination.
Dividends
Dividends from the Bank constitute the major source of funds for
dividends which may be paid by the Company. The amount of dividends payable
by the Bank to the Company depends upon the Bank's earnings and capital
position, and is limited by federal and state laws, regulations and policies.
According to Washington law, the Bank may not declare or pay a cash dividend
on its capital stock if it would cause its net worth to be reduced below (i)
the amount required for liquidation accounts or (ii) the net worth
requirements, if any, imposed by the Director of the Division. Dividends on
the Bank's capital stock may not be paid in an aggregate amount greater than
the aggregate retained earnings of the Bank, without the approval of the
Director of the Division.
The amount of dividends actually paid during any one period will be
strongly affected by the Bank's management policy of maintaining a strong
capital position. Federal law further provides that no insured depository
institution may make any capital distribution (which would include a cash
dividend) if, after making the distribution, the institution would be
"undercapitalized," as defined in the prompt corrective action regulations.
Moreover, the federal bank regulatory agencies also have the general authority
to limit the dividends paid by insured banks if such payments should be deemed
to constitute an unsafe and unsound practice.
Privacy Standards
On November 12, 1999, the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA") was signed into law. The purpose of this
legislation is to modernize the financial services industry by establishing a
comprehensive framework to permit affiliations among commercial banks,
insurance companies, securities firms and other financial service providers.
The Bank is subject to FDIC regulations implementing the privacy
protection provisions of the GLBA. These regulations require the Bank to
disclose its privacy policy, including identifying with whom it shares
"non-public personal information," to customers at the time of establishing
the customer relationship and annually thereafter.
30
The regulations also require the Bank to provide its customers with
initial and annual notices that accurately reflect its privacy policies and
practices. In addition, the Bank is required to provide its customers with the
ability to "opt-out" of having the Bank share their non-public personal
information with unaffiliated third parties before they can disclose such
information, subject to certain exceptions.
The Bank is subject to regulatory guidelines establishing standards for
safeguarding customer information. These regulations implement certain
provisions of the GLBA. The guidelines describe the agencies' expectations for
the creation, implementation and maintenance of an information security
program, which would include administrative, technical and physical safeguards
appropriate to the size and complexity of the institution and the nature and
scope of its activities. The standards set forth in the guidelines are
intended to insure the security and confidentiality of customer records and
information, protect against any anticipated threats or hazards to the
security or integrity of such records and protect against unauthorized access
to or use of such records or information that could result in substantial harm
or inconvenience to any customer.
Anti-Money Laundering and Customer Identification
In response to the terrorist events of September 11, 2001, the Uniting
and Strengthening America by Providing Appropriate Tools Required to Intercept
and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") was signed into law
on October 26, 2001. The USA Patriot Act gives the federal government new
powers to address terrorist threats through enhanced domestic security
measures, expanded surveillance powers, increased information sharing, and
broadened anti-money laundering requirements. The Bank Secrecy Act, Title III
of the USA Patriot Act takes measures intended to encourage information
sharing among bank regulatory agencies and law enforcement bodies. Further,
certain provisions of Title III impose affirmative obligations on a broad
range of financial institutions. Title III of the USA Patriot Act and the
related FDIC regulations impose the following requirements with respect to
financial institutions:
* establishment of anti-money laundering programs;
* establishment of a program specifying procedures for obtaining
identifying information from customers seeking to open new
accounts, including verifying the identity of customers within a
reasonable period of time;
* establishment of enhanced due diligence policies, procedures and
controls designed to detect and report money laundering;
* prohibitions on correspondent accounts for foreign shelled banks
and compliance with record keeping obligations with respect to
correspondent accounts of foreign banks.
Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal Reserve Act
and Bank Merger Act applications. The Bank's policies and procedures have been
updated to reflect the requirements of the USA Patriot Act, which had a
minimal impact on business and customers.
REGULATION OF THE COMPANY
General
The Company, as the sole shareholder of the Bank is a bank holding
company and is registered as such with the Federal Reserve. Bank holding
companies are subject to comprehensive regulation by the Federal Reserve under
the Bank Holding Company Act of 1956, as amended ("BHCA"), and the regulations
of the Federal Reserve. As a bank holding company, the Company is required to
file with the Federal Reserve annual reports and such additional information
as the Federal Reserve may require and will be subject to regular examinations
by the Federal Reserve. The Federal Reserve also has extensive enforcement
authority over bank holding companies, including, among other things, the
ability to assess civil money penalties, to issue cease and desist or removal
orders and to require that a holding company divest subsidiaries (including
its bank subsidiaries). In general, enforcement actions may be initiated for
violations of law and regulations and unsafe or unsound practices.
31
Acquisitions
The BHCA prohibits a bank holding company, with certain exceptions, from
acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and
from engaging directly or indirectly in activities other than those of
banking, managing or controlling banks, or providing services for its
subsidiaries. Under the BHCA, the Federal Reserve is authorized to approve
the ownership of shares by a bank holding company in any company, the
activities of which the Federal Reserve has determined to be so closely
related to the business of banking or managing or controlling banks as to be a
proper incident thereto. The list of activities determined by regulation to
be closely related to banking within the meaning of the BHCA includes, among
other things: operating a savings institution, mortgage company, finance
company, credit card company or factoring company; performing certain data
processing operations; providing certain investment and financial advice;
underwriting and acting as an insurance agent for certain types of
credit-related insurance; leasing property on a full-payout, non-operating
basis; selling money orders, travelers' checks and U.S. Savings Bonds; real
estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing
securities brokerage services for customers.
Interstate Banking
The Federal Reserve must approve an application of an adequately
capitalized and adequately managed bank holding company to acquire control of,
or acquire all or substantially all of the assets of, a bank located in a
state other than such holding company's home state, without regard to whether
the transaction is prohibited by the laws of any state. The Federal Reserve
may not approve the acquisition of a bank that has not been in existence for
the minimum time period, not exceeding five years, specified by the statutory
law of the host state. Nor may the Federal Reserve approve an application if
the applicant, and its depository institution affiliates, controls or would
control more than 10% of the insured deposits in the United States or 30% or
more of the deposits in the target bank's home state or in any state in which
the target bank maintains a branch. Federal law does not affect the authority
of states to limit the percentage of total insured deposits in the state which
may be held or controlled by a bank holding company to the extent such
limitation does not discriminate against out-of-state banks or bank holding
companies. Individual states may also waive the 30% state-wide concentration
limit contained in the federal law.
The Federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the
law of any state, unless the home state of one of the banks adopted a law
prior to June 1, 1997 which applies equally to all out-of-state banks and
expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches will be permitted only if the law of the
state in which the branch is located permits such acquisitions. Interstate
mergers and branch acquisitions will also be subject to the nationwide and
statewide insured deposit concentration amounts described above.
Dividends
The Federal Reserve has issued a policy statement on the payment of cash
dividends by bank holding companies, which expresses the Federal Reserve's
view that a bank holding company should pay cash dividends only to the extent
that the company's net income for the past year is sufficient to cover both
the cash dividends and a rate of earning retention that is consistent with the
company's capital needs, asset quality and overall financial condition. The
Federal Reserve also indicated that it would be inappropriate for a company
experiencing serious financial problems to borrow funds to pay dividends.
Stock Repurchases
Bank holding companies, except for certain "well-capitalized" and highly
rated bank holding companies, are required to give the Federal Reserve prior
written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of their consolidated
net worth. The Federal Reserve may disapprove such a purchase or redemption
if it determines that the proposal would
32
constitute an unsafe or unsound practice or would violate any law, regulation,
Federal Reserve order, or any condition imposed by, or written agreement with,
the Federal Reserve.
Capital Requirements
The Federal Reserve has established capital adequacy guidelines for bank
holding companies that generally parallel the capital requirements of the FDIC
for the Bank. The Federal Reserve regulations provide that capital standards
will be applied on a consolidated basis in the case of a bank holding company
with $150 million or more in total consolidated assets.
The Company's total risk based capital must equal 8% of risk-weighted
assets and one half of the 8%, or 4%, must consist of Tier 1 (core) capital.
As of September 30, 2005, the Company's total risk based capital was 17.9% of
risk-weighted assets and its risk based capital of Tier 1 (core) capital was
16.8% of risk-weighted assets.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law
on July 30, 2002 in response to public concerns regarding corporate
accountability in connection with certain accounting scandals. The stated
goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to
provide for enhanced penalties for accounting and auditing improprieties at
publicly traded companies and to protect investors by improving the accuracy
and reliability of corporate disclosures pursuant to the securities laws. The
Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S.,
that file or are required to file periodic reports with the Securities and
Exchange Commission ("SEC"), under the Securities Exchange Act of 1934
("Exchange Act"), including the Company.
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules and mandates. The Sarbanes-Oxley Act
represents significant federal involvement in matters traditionally left to
state regulatory systems, such as the regulation of the accounting profession,
and to state corporate law, such as the relationship between a board of
directors and management and between a board of directors and its committees.
TAXATION
Federal Taxation
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income. The Bank's deductions with
respect to "qualifying real property loans," which are generally loans secured
by certain interest in real property, were computed using an amount based on
the Bank's actual loss experience, or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted additions to the non-qualifying reserve. Due to the Bank's
loss experience, the Bank generally recognized a bad debt deduction equal to
8% of taxable income.
The provisions repealing the current thrift bad debt rules were passed by
Congress as part of "The Small Business Job Protection Act of 1996." These
rules eliminated the 8% of taxable income method for deducting additions to
the tax bad debt reserves for all thrifts for tax years beginning after
December 31, 1995. These rules also required
33
that all institutions recapture all or a portion of their bad debt reserves
added since the base year (last taxable year beginning before January 1,
1988). The Bank had previously recorded deferred taxes equal to the bad debt
recapture and as such the new rules had no effect on the net income or federal
income tax expense. For taxable years beginning after December 31, 1995, the
Bank's bad debt deduction is determined under the experience method using a
formula based on actual bad debt experience over a period of years or, if the
Bank is a "large" association (assets in excess of $500 million) on the basis
of net charge-offs during the taxable year. The unrecaptured base year
reserves will not be subject to recapture as long as the institution continues
to carry on the business of banking. In addition, the balance of the pre-1988
bad debt reserves continue to be subject to provisions of present law referred
to below that require recapture in the case of certain excess distributions to
shareholders. As of September 30, 2005, the Bank has recaptured all federal
tax bad debt reserves that had been accumulated since October 1, 1988.
Distributions. To the extent that the Bank makes "nondividend
distributions" to the Company, such distributions will be considered to result
in distributions from the balance of its bad debt reserve as of December 31,
1987 (or a lesser amount if the Bank's loan portfolio decreased since December
31, 1987) and then from the supplemental reserve for losses on loans ("Excess
Distributions"), and an amount based on the Excess Distributions will be
included in the Bank's taxable income. Nondividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation. However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax
purposes, will not be considered to result in a distribution from the Bank's
bad debt reserve. The amount of additional taxable income created from an
Excess Distribution is an amount that, when reduced by the tax attributable to
the income, is equal to the amount of the distribution. Thus, if the Bank
makes a "nondividend distribution," then approximately one and one-half times
the Excess Distribution would be includable in gross income for federal income
tax purposes, assuming a 35% corporate income tax rate (exclusive of state and
local taxes). See "Regulation of the Bank - Dividends" for limits on the
payment of dividends by the Bank. The Bank does not intend to pay dividends
that would result in a recapture of any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. In addition, only 90% of
AMTI can be offset by net operating loss carryovers. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses).
Dividends-Received Deduction. The Company may exclude from its income
100% of dividends received from the Bank as a member of the same affiliated
group of corporations. The corporate dividends-received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
Audits. The Bank's federal income tax returns have been audited through
September 30, 1997.
Washington Taxation
The Bank is subject to a business and occupation tax imposed under
Washington law at the rate of 1.50% of gross receipts. Interest received on
loans secured by mortgages or deeds of trust on residential properties is
exempt from such tax.
Competition
The Bank operates in an intensely competitive market for the attraction
of deposits (its primary source of lendable funds) and in the origination of
loans. Historically, its most direct competition for deposits has come from
large commercial banks, thrift institutions and credit unions in its primary
market area. In times of high interest rates, the Bank experiences additional
significant competition for investors' funds from short-term money market
securities and other corporate and government securities. The Bank's
competition for loans comes principally from mortgage bankers,
34
commercial banks and other thrift institutions. Such competition for deposits
and the origination of loans may limit the Bank's future growth and earnings
prospects.
Subsidiary Activities
The Bank has one wholly-owned subsidiary, Timberland Service Corporation
("Timberland Service"), whose primary function is to act as the Bank's escrow
department and offer non-deposit investment services.
Personnel
As of September 30, 2005, the Bank had 221 full-time employees and 13
part-time employees. The employees are not represented by a collective
bargaining unit and the Bank believes its relationship with its employees is
good.
Executive Officers of the Registrant
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank. Each of the executive
officers holds the same position with the Company and the Bank.
Executive Officers of the Company and Bank
Age at Position
September ----------------------------------------------
Name 30, 2005 Company Bank
- ---------------- --------- --------------------- ---------------------
Clarence E. Hamre 71 Chairman of the Board Chairman of the Board
Michael R. Sand 51 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 38 Chief Financial Officer Chief Financial
and Secretary Officer and Secretary
Marci A. Basich 37 Treasurer Treasurer
Biographical Information.
Clarence E. Hamre is Chairman of the Board of the Company and the Bank.
He has been affiliated with the Bank since 1969 and served as President and
Chief Executive Officer of the Bank since 1969 and as President and Chief
Executive Officer of the Company since 1997. On January 23, 2003, Mr. Hamre
retired as President of the Bank and the Company and on September 30, 2003, he
retired as Chief Executive Officer of the Bank and the Company.
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.
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.
35
Item 2. Properties
- -------------------
At September 30, 2005 the Bank operated 21 full service facilities. On
October 9, 2004, the Bank completed the purchase of seven branch offices from
Venture Bank and, as a result of the acquisition, consolidated two locations.
The newly acquired office in Hoquiam at 305 8th Street was consolidated into
the Bank's existing Hoquiam office at 624 Simpson Avenue and the Bank's
Montesano office at 314 Main Street South was consolidated into the newly
acquired Montesano office at 201 Main Street South. The following table sets
forth certain information regarding the Bank's offices, all of which are
owned, except for the Tacoma office, the Gig Harbor office, the Lacey office
at 1751 Circle Lane SE, and the Data Center office at 504 8th Street, which
are leased.
Approximate Deposits at
Location Year Opened Square Footage September 30, 2005
- ------------------------------ ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $81,194
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 29,046
Aberdeen, Washington 98520
201Main Street South(1)(2) 2004 3,200 32,895
Montesano, Washington 98563
361 Damon Road 1977 2,100 24,548
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 42,333
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 17,625
Auburn, Washington 98002
12814 Meridian East (South Hill) 1996 4,200 19,832
Puyallup, Washington 98373
1201 Marvin Road, N.E. 1997 4,400 11,455
Lacey, Washington 98516
101 Yelm Avenue W. 1999 1,800 12,171
Yelm, Washington 98597
20464 Viking Way NW 1999 3,400 6,825
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,900 15,886
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 15,500
Tumwater, Washington 98512
(table continued on following page)
36
Approximate Deposits at
Location Year Opened Square Footage September 30, 2005
- ------------------------------ ----------- -------------- ------------------
(In thousands)
7805 South Hosmer Street 2001 5,000 $ 9,320
Tacoma, Washington 98408
423 Washington Street SE 2003 3,000 13,503
Olympia, Washington 98501
3105 Judson St 2004 2,700 4,060
Gig Harbor, Washington 98335
117 N. Broadway(1) 2004 3,700 7,933
Aberdeen, Washington 98520
313 West Waldrip(1) 2004 5,900 23,054
Elma, Washington 98541
1751 Circle Lane SE(1) 2004 900 9,346
Lacey, Washington 98503
101 2nd Street 2004 1,800 16,103
Toledo, Washington 98591
209 NE 1st Street(1) 2004 3,400 11,577
Winlock, Washington 98586
Data Centers:
422 6th Street 1990 2,700 --
Hoquiam, Washington 98550
504 8th Street 2003 5,400 --
Hoquiam, Washington 98550
Loan Center:
120 Lincoln Street 2003 5,000 --
Hoquiam, Washington 98550
Other Properties:
305 8th Street(1)(3)
Hoquiam, Washington 98550 2004 4,100 --
314 Main Street South(2)
Montesano, Washington 98563 1975 2,800 --
(footnotes on following page)
37
- -------------
(1) Acquired from Venture Bank on October 9, 2004
(2) Office at 314 Main Street South, Montesano, Washington was consolidated
into the office at 201 Main Street South, Montesano, Washington on
November 15, 2004.
(3) Office at 305 8th Street, Hoquiam, Washington was consolidated into the
office at 624 Simpson Avenue, Hoquiam, Washington on November 15, 2004.
Management believes that all facilities, except for the Data Center
building located at 422 6th Street in Hoquiam are appropriately insured and
are adequately equipped for carrying on the business of the Bank. The Data
Center building at 422 6th Street in Hoquiam has sustained structural damage
and is not currently occupied. A pending claim has been filed with the Bank's
previous insurance company.
At September 30, 2005 the Bank operated 22 proprietary ATMs that are part
of a nationwide cash exchange network.
Item 3. Legal Proceedings
- --------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties
in which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Bank is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Bank.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended
September 30, 2005.
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 National Market under
the symbol "TSBK". As of November 30, 2005, there were 3,765,237 shares of
common stock issued and approximately 660 shareholders of record, excluding
persons or entities who hold stock in nominee or "street name" accounts with
brokers. The following table sets forth the market price range of the
Company's common stock for the years ended September 30, 2005 and 2004. This
information was provided by the Nasdaq Stock Market.
High Low Dividends
------ ----- ---------
Fiscal 2005
-----------
First Quarter........ $25.00 $22.85 $0.15
Second Quarter....... 24.00 21.85 0.15
Third Quarter........ 23.47 22.02 0.15
Fourth Quarter....... 23.80 22.30 0.16
Fiscal 2004
-----------
First Quarter........ $24.95 $22.07 $0.14
Second Quarter....... 23.84 22.01 0.14
Third Quarter........ 23.50 21.00 0.14
Fourth Quarter....... 23.94 22.05 0.15
38
Dividends
Dividend payments by the Company are dependent primarily on dividends
received by the Company from the Bank. Under federal regulations, the dollar
amount of dividends the Bank may pay is dependent upon its capital position
and recent net income. Generally, if the Bank satisfies its regulatory
capital requirements, it may make dividend payments up to the limits
prescribed in the FDIC regulations. However, institutions that have converted
to a stock form of ownership may not declare or pay a dividend on, or
repurchase any of, its common stock if the effect thereof would cause the
regulatory capital of the institution to be reduced below the amount required
for the liquidation account which was established in connection with the
mutual to stock conversion.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d)
in Part III, Item 12. of this Form 10-K is incorporated herein by reference.
Stock Repurchases
The Company has had various buy-back programs since January 1998. On
April 7, 2005, the Company announced a plan to repurchase 187,955 shares of
the Company's common stock. This marked the Company's 13th stock repurchase
plan. As of September 30, 2005, the Company has repurchased 27,850 of these
shares at an average price of $23.16 per share. Cumulatively, the Company has
repurchased 3,367,121 shares at an average price of $15.39 per share. This
represents 50.9% of the 6,612,500 shares that were issued when the Company
went public in January 1998.
The following table sets forth the Company's repurchases of its
outstanding Common Stock during the fourth quarter of the year ended September
30, 2005.
Maximum
Total Number Number (or
of Shares Approximate
Purchased as Dollar Value)
Total Part of of Shares that
Number of Average Publicly May Yet Be
Shares Price Paid Announced Purchased
Period Purchased per Share Plans Under the Plans
- ----------------------- --------- ---------- ----------- ---------------
July 1, 2005 -
July 31, 2005.......... -- $ -- -- 160,105
August 1, 2005 -
August 31, 2005........ -- -- -- 160,105
September 1, 2005 -
September 30, 2005..... -- -- -- 160,105
----- ----- -----
Total................... -- $ -- --
===== ===== =====
39
Item 6. Selected Financial Data
- --------------------------------
The following table sets forth certain information concerning the
consolidated financial position and results of operations of the Company and
subsidiaries at and for the dates indicated. The consolidated data is derived
in part from, and should be read in conjunction with, the Consolidated
Financial Statements of the Company and its subsidiary presented herein.
At September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets . . . . . . . . $552,765 $460,419 $449,633 $431,054 $386,305
Loans receivable and
loans held for sale, net. . 388,109 344,594 322,236 322,528 323,768
Investment securities
available-for-sale . . . . . 65,860 41,560 36,933 23,694 10,210
Mortgage-backed securities
held to maturity. . . . . . . 104 174 279 -- --
Mortgage-backed securities
available-for-sale. . . . . . 23,735 18,329 17,098 17,888 19,159
FHLB Stock . . . . . . . . . . 5,705 5,682 5,454 5,139 4,830
Cash and due from financial
institutions, interest-
bearing deposits in banks
and fed funds sold. . . . . . 28,718 19,833 38,098 36,073 13,439
Deposits . . . . . . . . . . . 411,665 319,570 307,672 292,316 242,372
FHLB advances. . . . . . . . . 62,353 65,421 61,605 61,759 68,978
Shareholders' equity . . . . . 74,642 72,817 77,611 74,396 71,809
At September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income . . . . . . . . . . . $30,936 $ 26,571 $27,345 $ 29,975 $ 31,493
Interest expense . . . . . . 8,609 7,325 8,946 10,890 13,924
------ ------- ------- -------- -------
Net interest income. . . . . 22,327 19,246 18,399 19,085 17,569
Provision for loan losses. . 141 167 347 992 1,400
------ ------- ------- -------- -------
Net interest income after
provision for loan losses . 22,186 19,079 18,052 18,093 16,169
Noninterest income . . . . . 6,073 4,576 6,385 4,946 3,126
Noninterest expense. . . . . 18,536 15,575 14,832 12,716 11,092
Income before income taxes . 9,723 8,080 9,605 10,323 8,203
Federal income taxes . . . . 3,105 2,492 2,966 3,432 2,741
------ ------- ------- -------- -------
Net income . . . . . . . . . $6,618 $ 5,588 $ 6,639 $ 6,891 $ 5,462
====== ======= ======= ======== =======
Earnings per common share:
Basic . . . . . . . . . . . $ 1.90 $ 1.54 $ 1.74 $ 1.76 $ 1.30
Diluted . . . . . . . . . . $ 1.82 $ 1.46 $ 1.66 $ 1.71 $ 1.28
Dividends per share. . . . . $ 0.61 $ 0.57 $ 0.50 $ 0.45 $ 0.41
Dividend payout ratio. . . . 32.11% 37.01% 28.74% 25.57% 31.54%
40
Item 6. Selected Financial Data
- --------------------------------
The following table sets forth certain information concerning the
consolidated financial position and results of operations of the Company and
subsidiaries at and for the dates indicated. The consolidated data is derived
in part from, and should be read in conjunction with, the Consolidated
Financial Statements of the Company and its subsidiary presented herein.
At September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets................. $552,765 $460,419 $449,633 $431,054 $386,305
Loans receivable and
loans held for sale, net.... 388,109 344,594 322,236 322,528 323,768
Investment securities
available-for-sale.......... 65,860 41,560 36,933 23,694 10,210
Mortgage-backed securities
held to maturity............ 104 174 279 -- --
Mortgage-backed securities
available-for-sale.......... 23,735 18,329 17,098 17,888 19,159
FHLB Stock................... 5,705 5,682 5,454 5,139 4,830
Cash and due from financial
institutions, interest-
bearing deposits in banks
and fed funds sold.......... 28,718 19,833 38,098 36,073 13,439
Deposits..................... 411,665 319,570 307,672 292,316 242,372
FHLB advances................ 62,353 65,421 61,605 61,759 68,978
Shareholders' equity......... 74,642 72,817 77,611 74,396 71,809
At September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend
income..................... $30,936 $ 26,571 $27,345 $ 29,975 $ 31,493
Interest expense............ 8,609 7,325 8,946 10,890 13,924
------ ------- ------- -------- -------
Net interest income......... 22,327 19,246 18,399 19,085 17,569
Provision for loan losses... 141 167 347 992 1,400
------ ------- ------- -------- -------
Net interest income after
provision for loan losses.. 22,186 19,079 18,052 18,093 16,169
Noninterest income.......... 6,073 4,576 6,385 4,946 3,126
Noninterest expense......... 18,536 15,575 14,832 12,716 11,092
Income before income taxes.. 9,723 8,080 9,605 10,323 8,203
Federal income taxes........ 3,105 2,492 2,966 3,432 2,741
------ ------- ------- -------- -------
Net income.................. $6,618 $ 5,588 $ 6,639 $ 6,891 $ 5,462
====== ======= ======= ======== =======
Earnings per common share:
Basic...................... $ 1.90 $ 1.54 $ 1.74 $ 1.76 $ 1.30
Diluted ................... $ 1.82 $ 1.46 $ 1.66 $ 1.71 $ 1.28
Dividends per share......... $ 0.61 $ 0.57 $ 0.50 $ 0.45 $ 0.41
Dividend payout ratio....... 32.11% 37.01% 28.74% 25.57% 31.54%
40
At September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
OTHER DATA:
Number of real estate
loans outstanding............. 4,380 4,101 3,522 2,911 3,041
Deposit accounts............... 51,496 40,348 39,313 36,896 30,893
Full-service offices........... 21 16 15 13 13
At or For the Year Ended September 30,
---------------------------------------------
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average assets (1).. 1.23% 1.24% 1.52% 1.73% 1.47%
Return on average equity (2).. 9.08 7.52 8.67 9.42 7.53
Interest rate spread (3)...... 4.30 4.30 4.02 4.27 3.89
Net interest margin (4)....... 4.60 4.67 4.52 4.96 4.93
Average interest-earning
assets to average
interest-bearing liabilities. 116.56 120.68 122.74 125.73 126.58
Noninterest expense as a
percent of average total
assets....................... 3.44 3.46 3.39 3.19 2.99
Efficiency ratio (5).......... 65.27 65.38 59.85 52.91 53.60
Book value per share (6)...... $19.85 $18.76 $18.25 $17.14 $15.71
Book value per share (7)...... 21.30 20.28 19.77 18.69 17.20
Tangible book value per
share (6)(8)................. 17.86 18.76 18.25 17.14 15.71
Tangible book value per
share (7)(8)................. 19.16 20.28 19.77 18.69 17.20
Asset Quality Ratios:
Nonaccrual and 90 days or
more past due loans
as a percent of total loans
receivable, net............. 0.75% 0.41% 1.19% 1.15% 1.25%
Nonperforming assets as a
percent of total assets..... 0.62 0.40 1.15 1.03 1.32
Allowance for loan losses
as a percent of total
loans receivable, net (9)... 1.05 1.14 1.19 1.11 0.93
Allowance for losses as
a percent of nonperforming
loans ...................... 140.09 276.77 99.90 97.03 74.55
Net charge-offs to average
outstanding loans........... 0.01 0.02 0.03 0.13 0.31
Capital Ratios:
Total equity-to-assets ratio.. 13.50 15.82 17.26 17.26 18.59
Tangible equity-to-
assets ratio................ 12.15 15.82 17.26 17.26 18.59
Average equity to average
assets (10)................. 13.53 16.52 17.49 18.37 19.52
- -------------__________________
(1) Net income divided by average total assets.
(2) Net income divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(4) Net interest income (before provision for loan losses) as a percentage of
average interest-earning assets.
(5) Other expenses (excluding federal income tax expense) divided by the sum
of net interest income and noninterest income.
(6) Calculation includes Employee Stock Ownership Plan ("ESOP") shares not
committed to be released.
(7) Calculation excludes ESOP shares not committed to be released.
(8) Calculation subtracts goodwill and core deposit intangible from the
equity component.
(9) Loans receivable includes loans held for sale and is before the allowance
for loan losses.
(10) Average total equity divided by average total assets.
41
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- ------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results
of Operations is intended to assist in understanding the consolidated
financial condition and results of operations of the Company. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying notes thereto included in Item 8 of this
Annual Report on Form 10-K.
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis and Results of Operations and other
portions of this Form 10-K contain certain "forward-looking statements"
concerning future operations of the Company. Management desires to take
advantage of the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995 and is including this statement for the express purpose of
availing the Company of the protections of such safe harbor with respect to
all "forward-looking statements" contained in this Annual Report. The Company
has used "forward-looking statements" to describe future plans and strategies,
including its expectations of the Company's future financial results.
Management's ability to predict results or the effect of future plans or
strategies is inherently uncertain. Factors which could affect actual results
include interest rate trends, the general economic climate in the Company's
market area and the country as a whole, the ability of the Company to control
expenses, deposit flows, demand for mortgages and other loans, real estate
values, vacancy rates, competition, loan delinquency rates, and changes in
federal and state regulation. These factors should be considered in
evaluating the "forward-looking statements," and undue reliance should not be
placed on such statements. The Company does not undertake to update any
"forward-looking statement" that may be made on behalf of the Company.
Critical Accounting Policies
The Company has established various accounting policies that govern the
application of accounting principles generally accepted in the United States
of America ("GAAP") in the preparation of the Company's Consolidated Financial
Statements. The Company has identified two policies, that as a result of
judgments, estimates and assumptions inherent in those policies, are critical
to an understanding of the Company's Consolidated Financial Statements. These
policies relate to the methodology for the determination of the allowance for
loan losses and the valuation of mortgage servicing rights ("MSRs"). These
policies and the judgments, estimates and assumptions are described in greater
detail in subsequent sections of Management's Discussion and Analysis
contained herein and in the notes to the Consolidated Financial Statements
contained in Item 8 of this Form 10-K. In particular, Note 1 of the Notes to
Consolidated Financial Statement, "Summary of Significant Accounting
Policies," describes generally the Company's accounting policies. Management
believes that the judgments, estimates and assumptions used in the preparation
of the Company's Consolidated Financial Statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of the
Company's Consolidated Financial Statements to these critical policies, the
use of other judgments, estimates and assumptions could result in material
differences in the Company's results of operations or financial condition.
Allowance for Loan Losses. The allowance for loan losses is maintained
at a level sufficient to provide for probable loan losses based on evaluating
known and inherent risks in the portfolio. The allowance is based upon
management's comprehensive analysis of the pertinent factors underlying the
quality of the loan portfolio. These factors include changes in the size and
composition of the loan portfolio, actual loan loss experience, current
economic conditions, and detailed analysis of individual loans for which full
collectibility may not be assured. The detailed analysis includes methods to
estimate the fair value of loan collateral and the existence of potential
alternative sources of repayment. The appropriate allowance for loan loss
level is estimated based upon factors and trends identified by management at
the time the consolidated financial statements are prepared.
42
Mortgage Servicing Rights. Mortgage servicing rights are capitalized
when acquired through the origination of loans that are subsequently sold with
servicing rights retained and are amortized as an offset to servicing income
on loans sold in proportion to and over the period of estimated net servicing
income. The value of MSRs at the date of the sale of loans is determined
based on the discounted present value of expected future cash flows using key
assumptions for servicing income and costs and prepayment rates on the
underlying loans.
The estimated fair value is periodically evaluated for impairment by
comparing actual cash flows and estimated cash flows from the servicing assets
to those estimated at the time servicing assets were originated. The effect
of changes in market interest rates on estimated rates of loan prepayments
represents the predominant risk characteristic underlying the MSRs' portfolio.
The Company's methodology for estimating the fair value of MSRs is highly
sensitive to changes in assumptions. For example, the determination of fair
value uses anticipated prepayment speeds. Actual prepayment experience may
differ and any difference may have a material effect on the fair value. Thus,
any measurement of MSRs' fair value is limited by the conditions existing and
assumptions as of the date made. Those assumptions may not be appropriate if
they are applied at different times.
New Accounting Pronouncements
For a discussion of new accounting pronouncements and their impact on
the Company, see Note 1 of the Notes to the Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplemental Data."
Operating Strategy
The Company is a holding company which operates primarily through its
subsidiary, the Bank. The Bank is a community-oriented bank which has
traditionally offered a wide variety of savings products to its retail
customers while concentrating its lending activities on real estate loans.
The primary elements of the Bank's operating strategy include:
Emphasize Residential Mortgage Lending and Residential Construction
Lending. The Bank has historically attempted to establish itself as a niche
lender in its primary market areas by focusing a part of its lending
activities on the origination of loans secured by one- to- four family
residential dwellings, including an emphasis on loans for the construction of
residential dwellings. In an effort to meet the credit needs of borrowers in
its primary area, the Bank actively originates one- to- four family mortgage
loans that do not qualify for sale in the secondary market under FHLMC
guidelines. The Bank has also been an active participant in the secondary
market, originating residential loans for sale to the FHLMC on a servicing
retained basis. The Bank occasionally retains fixed-rate one-to-four family
mortgage loans in its portfolio for yield and asset-liability management
purposes.
Diversify Primary Market Area by Expanding Branch Office Network. In an
effort to lessen its dependence on the Grays Harbor County market whose
economy has historically been tied to the timber and fishing industries, the
Bank has opened branch offices in Pierce, King, Thurston and Kitsap Counties.
Pierce, King, Thurston and Kitsap Counties contain the Olympia, Bremerton, and
Seattle-Tacoma metropolitan areas and their economies are more diversified
with the presence of government, aerospace and computer technology industries.
In October 2004, the Bank continued its geographic diversification by
acquiring two branches in Lewis County as part of a seven-branch acquisition.
For additional information see "Item 1, Business - Branch Purchase" and
"Market Area."
Limit Exposure to Interest Rate Risk. In recent years, a majority of
the loans that the Bank has retained in its portfolio generally have periodic
interest rate adjustment features or have been relatively short-term in
nature. Loans originated for portfolio retention primarily have included ARM
loans and short-term construction loans. Longer term fixed-rate mortgage
loans have generally been originated for sale in the secondary market.
Management believes that the interest rate sensitivity of these adjustable
rate and short-term loans more closely match the interest rate sensitivity of
the Bank's funding sources than do other longer duration assets with fixed
interest rates.
43
Emphasize the Origination of Commercial Real Estate and Commercial
Business Loans. The Bank established a business banking division in 1998 for
the purpose of increasing the Bank's origination of commercial real estate and
commercial business loans. Originally, three lenders were hired to staff the
division. Currently, a Division Manager and eight lenders are active in the
origination of commercial real estate and commercial business loans.
Increase the Consumer Loan Portfolio. In 2001 the Bank hired a consumer
loan specialist to increase the origination of consumer loans. The consumer
loans generated since that time have been secured primarily by real estate.
The Bank expects to continue expanding its portfolio of consumer loans.
Pursue Low Cost Core Deposits and Deposit Related Fee Income. The Bank
has placed an emphasis on attracting commercial and personal checking
accounts. These transactional accounts typically provide a lower cost of
funding than certificates of deposit accounts and generate non-interest fee
income. The Bank implemented a checking account acquisition program in 2000
to increase these transactional accounts. On October 9, 2004, the Bank
increased its transaction account base by acquiring seven branches and the
related deposits. For additional information, see "Item 1, Business - Branch
Purchase."
Market Risk and Asset and Liability Management
General. Market risk is the risk of loss from adverse changes in market
prices and rates. The Company's market risk arises primarily from interest
rate risk inherent in its lending, investment, deposit and borrowing
activities. The Bank, like other financial institutions, is subject to
interest rate risk to the extent that its interest-earning assets reprice
differently than its interest-bearing liabilities. Management actively
monitors and manages its interest rate risk exposure. Although the Bank
manages other risks, such as credit quality and liquidity risk, in the normal
course of business management considers interest rate risk to be its most
significant market risk that could potentially have the largest material
effect on the Bank's financial condition and results of operations. The Bank
does not maintain a trading account for any class of financial instruments nor
does it engage in hedging activities or derivative instruments. Furthermore,
the Bank is not subject to foreign currency exchange rate risk or commodity
price risk.
Qualitative Aspects of Market Risk. The Bank's principal financial
objective is to achieve long-term profitability while reducing its exposure to
fluctuating market interest rates. The Bank has sought to reduce the exposure
of its earnings to changes in market interest rates by attempting to manage
the difference between asset and liability maturities and interest rates. The
principal element in achieving this objective is to increase the interest-rate
sensitivity of the Bank's interest-earning assets by retaining in its
portfolio, short-term loans and loans with interest rates subject to periodic
adjustments. The Bank relies on retail deposits as its primary source of
funds. Management believes retail deposits, compared to brokered deposits,
reduce the effects of interest rate fluctuations because they generally
represent a more stable source of funds. As part of its interest rate risk
management strategy, the Bank promotes transaction accounts and certificates
of deposit with terms of up to six years.
The Bank has adopted a strategy that is designed to substantially match
the interest rate sensitivity of assets relative to its liabilities. The
primary elements of this strategy involve originating ARM loans for its
portfolio, maintaining residential construction loans as a portion of total
net loans receivable because of their generally shorter terms and higher
yields than other one- to- four family residential mortgage loans, matching
asset and liability maturities, investing in short-term securities,
originating fixed-rate loans for retention or sale in the secondary market,
and retaining the related mortgage servicing rights.
Sharp increases or decreases in interest rates may adversely affect the
Bank's earnings. Based on a rate shock analysis prepared by the FHLB-Seattle,
an immediate increase in interest rates of 200 basis points would increase the
Bank's projected net interest income by approximately 4.6%, primarily because
a larger portion of the Bank's interest rate sensitive assets than interest
rate sensitive liabilities would reprice within a one year period. Similarly,
an immediate 200 basis point decrease in interest rates would negatively
affect net interest income by approximately 12.4%, as repricing would have the
opposite effect. See "Quantitative Aspects of Market Risk" below for
additional information. Management has sought to sustain the match between
asset and liability maturities and rates, while maintaining an acceptable
interest rate spread. Pursuant to this strategy, the Bank actively originates
adjustable-rate loans for retention
44
in its loan portfolio. Fixed-rate mortgage loans with maturities greater than
seven years generally are originated for the immediate or future resale in
the secondary mortgage market. At September 30, 2005, adjustable rate
mortgage loans and adjustable-rate mortgage-backed securities constituted
$254.0 million or 62.2%, of the Bank's total combined mortgage loan and
mortgage-backed securities portfolio. Although the Bank has sought to
originate ARM loans, the ability to originate such loans depends to a great
extent on market interest rates and borrowers' preferences. Particularly in
lower interest rate environments, borrowers often prefer fixed-rate loans.
Consumer loans and construction and land development loans typically have
shorter terms and higher yields than permanent residential mortgage loans, and
accordingly reduce the Bank's exposure to fluctuations in interest rates. At
September 30, 2005, the construction and land development, and consumer loan
portfolios amounted to $112.5 million and $41.6 million, or 25.7% and 9.5% of
total loans receivable (including loans held for sale), respectively.
Quantitative Aspects of Market Risk. Management of the Bank monitors the
Bank's interest rate sensitivity through the use of a model provided for the
Bank by the FHLB-Seattle. The model 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 the FHLB-Seattle based on data at September 30,
2005.
Net Interest Income Current Market Value
Projected ------------------------------ ------------------------------
Interest Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario Value from Base from Base Value from Base from Base
- ------------- --------- --------- --------- -------- --------- ---------
(Dollars in thousands)
+300 $ 24,530 $ 1,281 5.51% $ 64,273 $ (389) (0.60)%
+200 24,321 1,072 4.61 65,119 457 0.71
+100 24,037 788 3.39 65,541 879 1.36
BASE 23,249 -- -- 64,662 -- --
-100 22,534 (715) (3.07) 63,949 (711) (1.10)
-200 20,374 (2,875) (12.36) 62,660 (2,002) (3.10)
-300 17,472 (5,777) (24.85) 56,881 (7,781) (12.03)
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan repayments and deposit decay, and should not be relied
upon as indicative of actual results. Furthermore, the computations do not
reflect any actions management may undertake in response to changes in
interest rates.
In the event of a 200 basis point decrease in interest rates, the Bank
would be expected to experience a 3.1% decrease in NPV and a 12.4% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 0.7% increase in NPV and a 4.6% increase in net interest income would
be expected. Based upon the modeling described above, the Bank's asset and
liability structure generally results in decreases in NPV and decreases in net
interest income in a declining interest rate scenario. This structure also
generally results in increases in net interest income in a rising interest
rate environment.
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
45
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 could possibly deviate
significantly from those assumed in calculating the table.
Comparison of Financial Condition at September 30, 2005 and September 30, 2004
The Company's total assets increased 20.1% to $552.8 million at September
30, 2005 from $460.4 million at September 30, 2004 primarily attributable to a
$43.5 million increase in net loans receivable, a $29.7 million increase in
investment securities (including FHLB stock), and a $9.2 million increase in
cash and due from financial institutions and federal funds sold. This asset
growth was primarily funded by the net cash received in connection with the
acquisition of seven branch offices and related deposits in October 2004. The
branch acquisition furthered the Bank's geographic diversification efforts and
increased the Bank's deposit market share in existing markets. A majority of
the acquired deposit base consisted of checking, savings, and money market
accounts which will provide a valuable core deposit base to fund loan growth.
During the year, the Bank was successful in deploying a substantial portion of
the net cash received in connection with the acquisition into loans and
investment securities.
The Company's tangible capital was reduced by $7.5 million during the year
as intangible assets consisting of goodwill and core deposit intangible were
recorded in connection with the branch acquisition. The Company also
continued to manage its capital level through stock repurchases and dividends
to shareholders. During the year the Company repurchased 174,434 shares of
its stock for $4.1 million and paid out $2.3 million in dividends to its
shareholders.
A more detailed explanation of the changes in significant balance sheet
categories follows.
Cash and Due from Financial Institutions, Interest Bearing Deposits in
Banks, and Federal Funds Sold: Cash and due from financial institutions,
interest bearing deposits in banks and federal funds sold increased to $28.7
million from $19.8 million at September 30, 2004 as a portion of the funds
from increased deposits were held in these liquid accounts.
Investments and Mortgage-backed Securities and FHLB Stock: Investments and
mortgage-backed securities (including FHLB stock) increased by $29.7 million
to $95.4 million at September 30, 2005 from $65.7 million at September 30,
2004, as a portion of the deposits received in connection with the branch
acquisition was placed into investment securities. For additional details on
investments and mortgage-backed securities see, "Item 1, Business - Investment
Activities" and Note 3 of the Notes to the Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplemental Data."
Loans Receivable and Loans Held for Sale, Net of Allowance for Loan
Losses: Net loans receivable, including loans held for sale, increased by
$43.5 million to $388.1 million at September 30, 2005 from $344.6 million at
September 30, 2004. The increase in the portfolio was primarily a result of a
$16.6 million increase in commercial real estate loans, an $8.8 million
increase in consumer loans, a $7.0 million increase in construction loans (net
of undisbursed portion), a $5.1 million increase in land loans, a $3.0 million
increase in multi-family loans, a $1.9 million increase in one-to-four family
mortgage loans, and a $915,000 increase in commercial business loans.
Loan originations totaled $230.0 million for the year ended September 30,
2005 compared to $201.1 million for the year ended September 30, 2004. The
Bank sold loans totaling $26.9 million ($25.4 million in fixed rate
one-to-four family mortgage loans and $1.5 million in credit card loans)
during the year ended September 30, 2005, compared to $35.7 million in fixed
rate one-to-four family mortgage loans sold for the year ended September 30,
2004. For additional information on loan, see "Item 1, Business - Lending
Activities" and Note 4 of the Notes to Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplemental Data."
Premises and equipment: Premises and equipment increased $2.0 million to
$15.9 million at September 30, 2005 from $13.9 million at September 30, 2004.
This increase was primarily attributable to the branch acquisition in October
2004. The acquired offices are located in Toledo, Winlock, Elma, Montesano,
Hoquiam, Aberdeen, and Lacey,
46
Washington. The Bank acquired the real estate for all of these offices with
the exception of the facility in Lacey, which is leased. Subsequent to the
acquisition, two of the offices were consolidated with existing Bank branch
offices. For additional information on premises and equipment, see "Item 2,
Properties" and Note 6 of the Notes to Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplemental Data."
Real Estate Owned: Real estate owned ("REO") and other repossessed items
increased $88,000 to $509,000 at September 30, 2005 from $421,000 at September
30, 2004. The balance increased as three properties were added and five
properties were sold during the year. The REO balance of $509,000 at
September 30, 2005 consisted of one commercial real estate property with a
book value of $344,000 and five land parcels totaling $165,000. For
additional information on REOs, see "Item 1, Business Lending Activities -
Nonperforming Assets" and Note 7 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplemental Data."
Goodwill and Core Deposit Intangible ("CDI"): The amortized value of
goodwill and CDI was $7.5 million at September 30, 2005. The Bank recorded
goodwill and CDI in connection with the October 2004 acquisition of seven
branches and related deposits. For additional information on Goodwill and
CDI, see Note 1 and Note 8 of the Notes to Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplemental Data."
Deposits: Deposits increased by $92.1 million to $411.7 million at
September 30, 2005 from $319.6 million at September 30, 2004, primarily
attributable to the acquisition of $86.5 million in deposits in October 2004.
The $92.1 million deposit increase is comprised of a $37.5 million increase in
certificate of deposit accounts, a $16.2 million increase in NOW checking
accounts, a $16.1 million increase in savings accounts, a $14.6 million
increase in non-interest bearing accounts, and a $7.6 million increase in
money market accounts. For additional information on deposits, see "Item 1,
Business - Deposit Activities and Other Sources of Funds" and Note 9 of the
Notes to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Federal Home Loan Bank Advances: FHLB advances decreased $3.1 million to
$62.4 million at September 30, 2005 from $65.4 million at September 30, 2004,
primarily as a result of scheduled amortization payments on existing advances.
For additional information on borrowings, see "Item 1, Business - Deposit
Activities and Other Sources of Funds - Borrowings" and Note 11 of the Notes
to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Shareholders' Equity: Total shareholders' equity increased by $1.8 million
to $74.6 million at September 30, 2005 from $72.8 million at September 30,
2004, primarily as a result of net income of $6.6 million and a $1.2 million
increase to additional paid in capital from the exercise of stock options and
the vesting associated with the Bank's benefit plans. Also increasing
shareholders' equity were decreases of $537,000 and $529,000 in the equity
components related to unearned shares issued to the Management Recognition and
Development Plan and the Employee Stock Ownership Plan, respectively.
Partially offsetting these increases to shareholders' equity were the
repurchase of 174,434 shares of the Company's stock for $4.1 million, the
payment of $2.3 million in dividends to shareholders, and a $714,000 increase
in accumulated other comprehensive loss.
On April 7, 2005, the Company announced a plan to repurchase up to 5% of
the Company's outstanding shares, or 187,955 shares. This represents the
Company's 13th stock repurchase plan. As of September 30, 2005, the Company
had repurchased 27,850 of these shares at an average price of $23.16.
Cumulatively, the Company has repurchased 3,367,121 (50.9%) of the 6,612,500
shares that were issued when the Company went public in January 1998. These
3,367,121 shares have been repurchased at an average price of $15.39 per
share.
Comparison of Financial Condition at September 30, 2004 and 2003
The Company's total assets increased 2.4% to $460.4 million at September
30, 2004 from $449.6 million at September 30, 2003 primarily due to a $22.4
million increase in net loans receivable and a $5.9 million in investment
securities (including FHLB Stock). Partially offsetting these increases was
an $18.2 million net decrease in cash and due from financial institutions,
interest-bearing deposits in banks, and federal funds sold. The net asset
growth was
47
primarily funded by an $11.9 million increase in deposits and a $3.8 million
increase in Federal Home Loan Bank borrowings.
The Bank continued its geographic expansion during the year by opening a
new branch in Gig Harbor (Pierce County) and announcing in June 2004 an
agreement to purchase seven branch offices and related deposits. The branch
acquisition subsequently closed in October 2004 and provided the Bank with
additional offices in Grays Harbor County and Thurston County as well as the
Bank's first locations in Lewis County.
The Company continued to manage its capital levels through stock
repurchases and dividends to shareholders during the year. The Company's
capital was reduced by $4.8 million during the year as 482,016 shares were
repurchased for $11.1 million and dividends of $2.3 million were paid to
shareholders.
A more detailed explanation of the changes in significant balance sheet
categories follows.
Cash and Due from Financial Institutions, Interest Bearing Deposits in
Banks, and Federal Funds Sold: Cash and due from financial institutions,
interest bearing deposits in banks, and federal funds sold decreased by $18.3
million to $19.8 million at September 30, 2004 from $38.1 million at September
30, 2003. The decrease was a result of using a portion of these short-term
deposits to fund loan growth, to fund the Company's stock repurchase program,
and to fund the purchase of additional investment securities.
Investments, Mortgage-backed Securities and FHLB Stock: Investments,
mortgage-backed securities and FHLB stock increased by $5.9 million to $65.7
million at September 30, 2004 from $59.8 million at September 30, 2003, as
additional U.S. agency securities and mortgage-backed securities were
purchased. For additional details on investments and mortgage-backed
securities, see "Item 1, Business - Investment Activities" and Note 3 of the
Notes to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Loans Receivable and Loans Held for Sale, net of allowance for loan
losses: Net loans receivable, including loans held-for-sale, increased by
$22.4 million to $344.6 million at September 30, 2004 from $322.2 million at
September 30, 2003. The increase in the portfolio was primarily a result of
increases of $5.3 million in commercial real estate loans, $4.8 million in
consumer loans, $4.5 million in one-to four-family mortgage loans, $4.3
million in land loans, $3.3 million in construction loans (net of undisbursed
portion), and $1.6 million in commercial business loans. These increases were
partially offset by a $1.1 million decrease in multi-family loans.
Loan originations totaled $201.1 million for the year ended September 30,
2004, compared to $255.5 million for the year ended September 30, 2003. The
Bank sold $35.7 million in fixed rate one-to-four family mortgage loans for
the year ended September 30, 2004, compared to $108.8 million for the year
ended September 30, 2003. Loan originations and loan sales were higher in 2003
primarily due to the robust refinance activity of single family mortgage loans
attributed to the low interest rate environment. For additional information
on loans, see "Item 1, Business Lending Activities" and Note 4 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
Premises and Equipment: Premises and equipment increased $484,000 to
$13.9 million at September 30, 2004 from $13.4 million at September 30, 2003
primarily attributable to the opening of a new branch in Gig Harbor during the
year. For additional information on premises and equipment, see Note 6 of the
Notes to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Real Estate Owned: REO and other repossessed items decreased $837,000 to
$421,000 at September 30, 2004 from $1.3 million at September 30, 2003. The
balance decreased as ten properties were sold and four properties were added
to REO status during the year. For additional information on REOs, see "Item
1, Business Lending Activities Nonperforming Assets" and Note 7 of the
Notes to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
48
Deposits: Deposits increased by $11.9 million to $319.6 million at
September 30, 2004 from $307.7 million at September 30, 2003, primarily
attributable to increases of $19.6 million in NOW checking accounts, $8.0
million in non-interest bearing accounts, and $2.2 million in money market
accounts. These increases were partially offset by decreases of $16.6 million
in certificate of deposit accounts and $1.4 million in savings accounts. The
Bank continued to focus on attracting transaction accounts rather than
higher-rate certificate of deposit accounts. Transaction accounts represent a
stronger core deposit relationship than other types of deposit accounts. For
additional information of deposits, see "Item 1, Business Deposit Activities
and Other Sources of Funds" and Note 9 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplemental Data."
Federal Home Loan Bank Advances: FHLB advances increased by $3.8 million
to $65.4 million at September 30, 2004 from $61.6 million at September 30,
2003. The increased borrowings were used to fund a portion of the Bank's loan
portfolio growth. For additional information on borrowings, see "Item 1,
Business Deposit Activities and Other Sources of Funds Borrowings" and
Note 10 of the Notes to Consolidated Financial Statements contained in "Item
8, Financial Statements and Supplemental Data."
Shareholders' Equity: Total shareholders' equity decreased by $4.8 million
to $72.8 million at September 30, 2004 from $77.6 million at September 30,
2003, primarily as a result of the repurchase of 482,016 shares of the
Company's stock for $11.1 million, the payment of $2.3 million in dividends to
shareholders and a $324,000 decrease in accumulated other comprehensive
income. Partially offsetting these decreases to equity, were net income of
$5.6 million and a $2.2 million increase to additional paid in capital from
the exercise of stock options and the vesting of shares associated with the
Bank's benefit plans. Also increasing shareholders' equity were decreases of
$645,000 and $529,000 in the equity components related to unearned shares
issued to the Management Recognition and Development Plan ("MRDP") and the
ESOP, respectively, as more shares vested under the MRDP and were released
under the ESOP.
Comparison of Operating Results for the Years Ended September 30, 2005 and
2004
The Company's net income increased by 18.4% to $6.62 million for the year
ended September 30, 2005 from $5.59 million for the year ended September 30,
2004. Diluted earnings per share increased by 24.7% to $1.82 for the year
ended September 30, 2005 from $1.46 for the year ended September 30, 2004.
The improved results were primarily a result of increased net interest income
and increased non-interest income, which were partially offset by higher
non-interest expenses.
The increased net interest income was largely a result of an increased
loan portfolio and an increased investment securities portfolio. These
portfolio increases were primarily funded by the net cash received in
connection with the acquisition of seven branch offices and related deposits
in October 2004. The acquired deposit base represents a valuable low cost
funding source for the Bank as a majority of the deposits consist of checking,
savings, and money market accounts. Net interest income was increased as the
Bank was successful in deploying a substantial portion of the net cash
received from the deposit acquisition into loans and investment securities.
The increase in non-interest income was primarily a result of increased
service charges from deposits and increased ATM transaction fees. These
increases were largely a result of an increased transaction account base
attributable to the branch acquisition. Non-interest income was also
increased during the year as a result of a $264,000 gain from the sale of the
Bank's credit card portfolio.
Partially offsetting the increased net interest income and non-interest
income was and increase in non-interest expenses as the Bank operated with a
larger branch network and employee base as a result of the branch acquisition.
The Company also incurred approximately $253,000 in compliance costs
attributable to Section 404 of the Sarbanes-Oxley Act of 2002 during the year
ended September 30, 2005.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2005 increased
$1.03 million to $6.62 million, or $1.82 per diluted share ($1.90 per basic
share) from $5.59 million, or $1.46 per diluted share ($1.54 per basic share)
for
49
the year ended September 30, 2004. The $0.36 increase in diluted earnings per
share for the year ended September 30, 2005 was primarily the result of a
$3.11 million ($2.05 million net of income tax - $0.53 per diluted share)
increase in net interest income after provision for loan losses, a $1.50
million ($988,000 net of income tax - $0.26 per diluted share) increase in
non-interest income, and a lower number of weighted average shares outstanding
which increased diluted earnings per share by approximately $0.08. These items
were partially offset by a $2.96 million ($1.95 million net of income tax -
$0.51 per diluted share) increase in non-interest expense.
Net Interest Income: Net interest income increased $3.08 million to $22.33
million for the year ended September 30, 2005 from $19.25 million for the year
ended September 30, 2004, primarily as a result of increased interest income
from a larger interest earning asset base. Total interest income increased
$4.37 million to $30.94 million for the year ended September 30, 2005 from
$26.57 million for the year ended September 30, 2004 as average total interest
earning assets increased by $73.76 million. The increased interest earning
asset balances were primarily a result of investing the funds received in
connection with the October 2004 acquisition of deposits into loans and
investment securities. The increased interest earning balances were partially
offset by a reduction in the yield on assets. The yield on earning assets
decreased to 6.37% for the year ended September 30, 2005 from 6.45% for the
year ended September 30, 2004. The decrease in yield was partially
attributable to a change in the composition of interest earning assets as
investment securities comprised a higher percentage of the total interest
earning asset base during 2005. Also partially offsetting the increased
interest income was an increase in interest expense as average interest
bearing deposits and borrowings increased. Total interest expense increased
by $1.28 million to $8.61 million for the year ended September 30, 2005 from
$7.33 million for the year ended September 30, 2004 as average interest
bearing liabilities increased $75.33 million. As a result of these changes
the net interest margin decreased to 4.60% for the year ended September 30,
2005 from 4.67% for the year ended September 30, 2004.
Provision for Loan Losses: The provision for loan losses decreased to
$141,000 for the year ended September 30, 2005 from $167,000 for the year
ended September 30, 2004. The provision for loan losses was lower primarily as
a result of changes in the composition of the portfolio, a decrease in the
level of loans classified as substandard, and a decrease in the level of
actual charge-offs. For the years ended September 30, 2005 and 2004, net
charge-offs were $33,000 and $67,000. The net charge-offs to average
outstanding loans ratio was 0.01% for the year ended September 30, 2005 and
0.02% for the year ended September 30, 2004.
The Bank has established a comprehensive methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration pertinent factors underlying the quality of the loan
portfolio. These factors include changes in the size and composition of the
loan portfolio, historical loss experience for various loan segments, changes
in economic conditions, delinquency rates, a detailed analysis of individual
loans on non-accrual status, and other factors to determine the level of
allowance for loan losses needed. The allowance for loan losses increased by
of $108,000 to $4.10 million at September 30, 2005 from $3.99 million at
September 30, 2004. The increased level of the allowance for loan losses was
primarily attributable to a larger loan portfolio (loans receivable and loans
held for sale), which increased by $43.5 million to $388.1 million at
September 30, 2005 from $344.6 million at September 30, 2004. Partially
offsetting the increased allowance due to loan portfolio growth, were
decreases in the level of loans classified as substandard and changes in the
category composition of the loan portfolio. The Bank's $1.5 million credit
card portfolio, which historically had the highest charge-off rate, was sold
in December 2004.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $4.10 million at September 30, 2005 (1.05% of loans
receivable and 140.09% of non-performing loans) adequate to provide for
probable losses based on an evaluation of known and inherent risks in the loan
portfolio at that date. While the Bank believes it has established its
existing allowance for loan losses in accordance with GAAP, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be necessary should the quality of any loans deteriorate. Any material
increase in the allowance for loan losses would adversely affect the Bank's
financial condition and results of operations. For additional information,
see "Item 1, Business - Lending Activities Allowance for Loan Losses."
50
Non-interest Income: Total non-interest income increased by $1.49 million
to $6.07 million for the year ended September 30, 2005 from $4.58 million for
the year ended September 30, 2004, primarily as a result of an $895,000
increase in service charges on deposits, a $235,000 increase in ATM
transaction fees, a $155,000 increase in income from loan sales (gain on sale
of loans and servicing income on loans sold) and an $81,000 distribution from
one of the Bank's ATM network associations. The increased service charges on
deposits and the increased ATM transaction fees were primarily a result of the
increased transaction account base acquired through the branch acquisition in
October 2004. The increased income from loan sales was primarily attributable
to $264,000 gain from the sale of the Bank's credit card portfolio. The
increased income from the credit card portfolio is partially offset by a
$109,000 decrease in income from the sale and servicing income on fixed rate
one-to four-family mortgages. The ATM network association distribution was
cash consideration paid to network association members in connection with the
association's merger.
Non-interest Expense: Total non-interest expense increased by $2.96
million to $18.54 million for the year ended September 30, 2005 from $15.58
million for the year ended September 30, 2004, as the Company operated with a
larger branch network as a result of the acquisition of seven branch offices
and the associated employees in October 2004. The increase was primarily a
result of a $1.40 million increase in salaries and employee benefits, a
$367,000 core deposit intangible amortization expense, a $350,000 increase in
premises and equipment expenses, a $186,000 increase in postage and courier
expense, a $69,000 increase in ATM operating fees and $142,000 in expenses
associated with the branch acquisition in October 2004. The increased
employee expenses were primarily attributable to the larger employee base
resulting from the branch acquisition, annual salary adjustments, and
increased medical insurance costs. The Company also incurred approximately
$253,000 in compliance related costs attributable to Section 404 of the
Sarbanes-Oxley Act of 2002 during the year ended September 30, 2005. The
Company's efficiency ratio decreased slightly to 65.27% for the year ended
September 30, 2005 from 65.38% for the year ended September 30, 2004.
Provision for Income Taxes: The provision for income taxes increased
$613,000 to $3.11 million for the year ended September 30, 2005 from $2.49
million for the year ended September 30, 2004 primarily as a result of
increased income before taxes. The Company's effective tax rate was 31.9% for
the year ended September 30, 2005 and 30.8% for the year ended September 30,
2005. The increase in the effective tax rate was primarily a result of a
decrease in the percentage of tax exempt income during the current year and
tax adjustments relating to the Company's branch acquisition.
Comparison of Operating Results for Years Ended September 30, 2004 and 2003
The Company's net income decreased by 15.8% to $5.59 million for the year
ended September 30, 2004 from $6.64 million for the year ended September 30,
2003. Diluted earnings per share decreased by 12.0% to $1.46 for the year
ended September 30, 2004 from $1.66 for the year ended September 30, 2003.
The lower earnings were primarily attributable to decreased income from loan
sales and increased non-interest expense, which were partially offset by
increased net interest income. Specifically, the $0.20 per diluted share
decrease in earnings for the year ended September 30, 2004 was a result of the
$1.81 million ($1.19 million net of income tax - $0.32 per diluted share)
decrease in non-interest expense, and the $743,000 ($490,000 net of income tax
- - $0.13 per diluted share increase in non-interest expense. These items were
partially offset by a $1.03 million ($678,000 net of income tax - $0.18 per
diluted share) increase in net interest income after provision for loan losses
and a lower number of weighted average shares outstanding (due to share
repurchases), which increased diluted earnings per share by approximately
$0.07.
The $1.81 million decrease in non-interest income was largely attributable
to decreased income from loan sales as mortgage banking activity slowed and
the Bank began holding some shorter term fixed-rate one-to four-family
mortgage loans in its portfolio. Income from loan sales (gain on sale of
loans and servicing income on loans sold) decreased by $1.06 million during
the year as the Bank's sale of fixed-rate mortgage loans decreased to $35.7
million for the year ended September 30, 2004 from $108.8 million for the year
ended September 30, 2003.
The $743,000 increase in non-interest expense was primarily attributable
to increased employee expenses, increased audit and consulting expenses, and
increased premises and equipment expenses. Employee expenses increased by
$493,000 primarily as a result of a larger employee base, annual salary
adjustments, and increased medical insurance costs.
51
The $1.03 million increase in net interest income after provision for loan
losses was primarily attributable to decreased funding costs and a decreased
provision for loan losses.
A more detailed explanation of the income statement categories is
presented below.
Net Interest Income: Net interest income increased $847,000 to $19.25
million for the year ended September 30, 2004 from $18.40 million for the year
ended September 30, 2003, primarily due to a decrease in the Company's funding
costs. Total interest expense decreased by $1.62 million to $7.33 million
for the year ended September 30, 2004 from $8.95 million for the year ended
September 30, 2003 as the Company's total cost of funds decreased to 2.14%
from 2.69%.
Interest expense on deposits decreased $1.40 million to $4.17 million for
the year ended September 30, 2004 from $5.57 million for the year ended
September 30, 2003 primarily due to lower average rates paid on interest
bearing accounts and a change in the composition of average interest bearing
deposits. In 2003, certificates of deposits, the Company's highest cost of
deposits, comprised 49.3% of average interest bearing deposits. In 2004,
certificates of deposit comprised 44.6% of average interest bearing deposits.
The change in the composition of the deposit base was a result of the
continued focus on attracting transaction accounts rather than higher-rate
certificates of deposit. Interest expense on FHLB advances decreased $219,000
to $3.16 million for the year ended September 30, 2004 from $3.38 million for
the year ended September 30, 2003, primarily due to a reduction in the average
outstanding FHLB advances to $57.78 million for the year ended September 30,
2004 from $61.72 million for the year ended September 30, 2003.
Partially offsetting the decreased interest expense was a decrease in
interest income. Total interest income decreased $774,000 to $26.57 million
for the year ended September 30, 2004 from $27.35 million for the year ended
September 30, 2003, primarily due to a reduction in average yields on earning
assets. The yield on earning assets was 6.45% for the year ended September
30, 2004 compared to 6.71% for the year ended September 30, 2003. As a result
of these changes, the net interest margin increased to 4.67% for the year
ended September 30, 2004 from 4.52% for the year ended September 30, 2003.
Provision for Loan Losses: The provision for loan losses for the year
ended September 30, 2004 decreased by $180,000 to $167,000 from $347,000 for
the year ended September 30, 2003. The provision for loan losses was lower
primarily due to changes in the loss factors used in the allowance for loan
loss analysis and a lower level of net charge-offs experienced. For the years
ended September 30, 2004 and 2003, net charge-offs were $67,000 and $86,000,
respectively.
The Bank has established a comprehensive methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration historic loss experience for various loan segments,
changes in economic conditions, delinquency rates, and other factors to
determine the level of allowance for loan losses needed. The allowance for
loan losses had a net increase of $100,000 to $3.99 million at September 30,
2004 from $3.89 million at September 30, 2003. The increased level of the
allowance for loan losses was primarily due to a larger loan portfolio (loans
receivable and loans held for sale), which increased $22.5 million to $348.6
million at September 30, 2004 from $326.1 million at September 30, 2003.
Partially offsetting the increased allowance tied to loan portfolio growth,
were changes in the loss factors used in the allowance for loan loss analysis
for certain categories. Based on the trends in the historical charge-off and
improved economic conditions, the loss factors used in the allowance for loan
loss analysis for one-to four-family loans, multi-family loans, commercial
real estate loans, land loans, and commercial business loans were decreased
during the year.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $3.99 million at September 30, 2004 (1.14% of loans
receivable and 276.8% of non-performing loans) adequate to provide for
probable losses based on an evaluation of known and inherent risks in the loan
portfolio at that date. While the Bank believes it has established its
existing allowance for loan losses in accordance with GAAP, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that substantial increases will not
be
52
necessary should the quality of any loans deteriorate. Any material increase
in the allowance for loan losses would adversely affect the Bank's financial
condition and results of operations. For additional information, see "Item 1,
Business Lending Activities Allowance for Loan Losses."
Non-interest Income: Total non-interest income decreased $1.81 million to
$4.58 million for the year ended September 30, 2004 from $6.39 million for the
year ended September 30, 2003, primarily due to a $1.06 million decrease in
income from loan sales (gain on sale of loans and servicing income on loans
sold), a $141,000 decrease in gain on sale of securities, a $127,000 decrease
in escrow fees, a $104,000 decrease in loan application fees, an $87,000
decrease in ATM transaction fees, an $82,000 decrease in services charges on
deposits, and a $68,000 decrease in BOLI income. Income from loan sales
decreased as mortgage banking activity slowed and the Bank began holding some
fixed rate one-to-four family mortgage loans in its portfolio. The Bank sold
$35.7 million in fixed-rate one- to four-mortgages during the year ended
September 30, 2004 compared to $108.8 million for the same period a year ago.
Non-interest Expense: Total non-interest expense increased by $743,000 to
$15.58 million for the year ended September 30, 2004 from $14.83 million for
the year ended September 30, 2003. The increase is primarily a result of a
$493,000 increase in employee expenses, a $91,000 increase in audit and
Sarbanes-Oxley related expenses, an $80,000 increase in premises and equipment
expenses, and $70,000 in expenses related to the Bank's acquisition of seven
branches which closed In October 2004. The increased employee expenses are
primarily due to a larger employee base, annual salary adjustments, and
increased medical insurance costs. The number of full-time equivalent
employees increased during the year to 195 at September 30, 2004 from 186 at
September 30, 2003 as the Bank opened a new branch in Gig Harbor and increased
staffing levels in several other departments.
As a result of the increased non-interest expenses, the Company's
efficiency ratio increased to 65.38% for the year ended September 30, 2004
from 59.85% for the year ended September 30, 2003.
Provision for Income Taxes: The provision for income taxes decreased
$474,000 to $2.49 million for the year ended September 30, 2004 from $2.97
million for the year ended September 30, 2003 primarily as a result of lower
income before taxes. The effective tax was 30.8% for the year ended September
30, 2004 and 30.9% for the year ended September 30, 2003.
Average Balances, Interest and Average Yields/Cost
The earnings of the Company depend largely on the spread between the
yield on interest-earning assets and the cost of interest-bearing liabilities,
as well as the relative amount of the Company's interest-earning assets and
interest- bearing liability portfolios.
The following table sets forth, for the periods indicated, information
regarding average balances of assets and liabilities as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and average yields
and costs. Such yields and costs for the periods indicated are derived by
dividing income or expense by the average daily balance of assets or
liabilities, respectively, for the periods presented.
53
Year Ended September 30,
---------------------------------------------------------------------------------------
2005 2004 2003
--------------------------- --------------------------- ---------------------------
Interest Interest Interest
Average and Yield/ Average and Yield/ Average and Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- --------- ------ ------- --------- ------ ------- --------- ------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Interest-earning
assets:
Loans receivable
(1)(2)............ $378,113 $ 27,514 7.28% $338,752 $24,501 7.23% $319,583 $25,013 7.83%
Mortgage-backed and
investment
securities (3).... 54,541 1,962 3.60 22,376 934 4.17 16,282 873 5.36
FHLB stock and equity
securities (3).... 37,904 1,093 2.88 39,183 1,021 2.61 36,489 1,064 2.92
Federal funds sold. 11,653 282 2.42 577 8 1.39 -- -- --
Interest-bearing
deposits.......... 3,405 85 2.50 10,970 107 0.98 35,102 395 1.13
-------- -------- -------- -------- -------- --------
Total interest-
earning assets... 485,616 30,936 6.37 411,858 26,571 6.45 407,456 27,345 6.71
Non-interest-
earning assets.... 52,786 37,845 30,353
-------- -------- --------
Total assets...... $538,402 $449,703 $437,809
======== ======== ========
Interest-bearing liabilities:
Savings accounts.. $ 61,798 438 0.71% $ 48,243 342 0.71% $ 47,411 570 1.20
Money market
accounts......... 50,337 626 1.24 38,558 439 1.14 43,637 704 1.61
NOW accounts...... 95,471 657 0.69 70,195 544 0.77 45,999 335 0.73
Certificates
of deposit....... 148,483 3,701 2.53 126,521 2,843 2.25 133,218 3,961 2.97
Short-term
borrowings(4).... 5,875 236 4.02 633 12 1.90 -- -- --
Long-term
borrowings (5)... 54,662 2,951 5.40 57,145 3,145 5.50 61,715 3,376 5.47
-------- -------- -------- -------- -------- --------
Total interest
bearing
liabilities..... 416,626 8,609 2.07 341,295 7,325 2.15 331,980 8,946 2.69
Non-interest
bearing
liabilities....... 48,916 34,115 29,272
-------- --------
Total
liabilities..... 465,542 375,410 361,252
Shareholders'
equity............ 72,860 74,293 76,557
-------- --------
Total liabilities
and shareholders'
equity........... $538,402 $449,703 $437,809
======== ======== ========
Net interest income. $ 22,327 $ 19,246 $ 18,399
======== ======== ========
Interest rate
spread............. 4.30% 4.30% 4.02%
====== ====== ======
Net interest
margin (6)......... 4.60% 4.67% 4.52%
====== ====== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities........ 116.56% 120.68% 122.74%
====== ====== ======
- -----------------
(1) Does not include interest on loans 90 days or more past due. Includes loans originated for sale.
Amortized net deferred loan fees, late fees, extension fees and prepayment penalties (2005, $2,146;
2004, $1,718; and 2003, $2,140) included with interest and dividends.
(2) Average balance includes nonaccrual loans.
(footnotes continued on following page)
54
(3) For purposes of the computation of average yield on investments available
for sale, historical cost balances were utilized, therefore the yield
information does not give effect to changes in fair value that are
reflected as a component of shareholders' equity.
(4) Includes FHLB advances with original maturities of less than one year and
other short-term borrowings-repurchase agreements.
(5) Includes FHLB advances with original maturities of one year or greater.
(6) Net interest income divided by total average interest earning assets.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes
on net interest income on the Company. Information is provided with respect
to the (i) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate), and (ii) effects on interest
income attributable to changes in rate (changes in rate multiplied by prior
volume), and (iii) the net change (sum of the prior columns). Changes in
rate/volume have been allocated to rate and volume variances based on the
absolute values of each.
Year Ended September 30, Year Ended September 30,
2005 Compared to Year 2005 Compared to Year
Ended September 30, 2004 Ended September 30, 2003
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------- --------------------------
Net Net
Rate Volume Change Rate Volume Change
------ ------ ------ ------ ------ ------
(In thousands)
Interest-earning assets:
Loans receivable (1)... $ 150 $2,863 $3,013 $(2,441) $1,929 $ (512)
Investments and
mortgage-backed
securities............ (145) 1,173 1,028 (220) 281 61
FHLB stock and
equity securities..... 106 (34) 72 (118) 75 (43)
Federal funds sold..... 1 273 274 -- 8 8
Interest-bearing
deposits.............. 87 (109) (22) (61) (227) (288)
Total net change in
income on interest-
earning assets........ 199 4,166 4,365 (2,840) 2,066 (774)
Interest-bearing liabilities:
Savings accounts....... -- 96 96 (238) 10 (228)
NOW accounts........... (66) 179 113 20 189 209
Money market accounts.. 35 152 187 (167) (98) (265)
Certificate accounts... 219 639 858 (907) (211) (1,118)
Short-term borrowings
(2)................... 27 197 224 -- 12 12
Long-term borrowings
(3)................... (59) (135) (194) 21 (252) (231)
----- ------ ------ ------- ------ -------
Total net change in
expense on interest-
bearing liabilities... 156 1,128 1,284 (1,271) (350) (1,621)
----- ------ ------ ------- ------ -------
Net change in net
interest income....... $ 43 $3,038 $3,081 $(1,569) $2,416 $ 847
===== ====== ====== ======= ====== =======
- -------------_
(1) Excludes interest on loans 90 days or more past due. Includes loans
originated for sale.
55
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds
from principal and interest payments on loans and the sale of loans, maturing
securities and FHLB advances. While the maturity and scheduled amortization
of loans are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and competition.
The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to fund loan originations and deposit
withdrawals, to satisfy other financial commitments and to take advantage of
investment opportunities. The Bank generally maintains sufficient cash and
short-term investments to meet short-term liquidity needs. At September 30,
2005, 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 12.24%. At September 30, 2005, the Bank also maintained an uncommitted
credit facility with the FHLB-Seattle that provided for immediately available
advances up to an aggregate amount equal to 30% of total assets, limited by
available collateral, under which $62.4 million was outstanding.
Liquidity management is both a short and long-term responsibility of the
Bank's management. The Bank adjusts its investments in liquid assets based
upon management's assessment of (i) expected loan demand, (ii) projected loan
sales, (iii) expected deposit flows, and (iv) yields available on interest-
bearing deposits. Excess liquidity is invested generally in interest-bearing
overnight deposits and other short-term government and agency obligations. If
the Bank requires funds beyond its ability to generate them internally, it has
additional borrowing capacity with the FHLB and collateral for repurchase
agreements.
The Bank's primary investing activity is the origination of mortgage
loans, which includes construction and land development loans. During the
years ended September 30, 2005, 2004, and 2003 the Bank originated $190.3
million, $172.4 million and $234.9 million of mortgage loans, respectively.
At September 30, 2005, the Bank had mortgage loan commitments totaling $33.3
million and undisbursed loans in process totaling $42.8 million. The Bank
anticipates that it will have sufficient funds available to meet current loan
commitments. Certificates of deposit that are scheduled to mature in less
than one year from September 30, 2005 totaled $104.2 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, 2005, 2004 and 2003,
the Bank sold $25.4 million, $35.7 million and $108.8 million in fixed rate,
one- to four-family mortgage loans. The Bank also sold $1.5 million in credit
card loans during the year ended September 30, 2005. The higher loan sales in
2003 were partially attributable to the refinancing cycle as a result of
decreasing interest rates. During the years ended September 30, 2005, 2004
and 2003, the Bank received $160.8 million, $133.9 million and $145.7 million
in principal repayments.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2005, 2004 and 2003, deposits increased
by $92.1 million, $11.9 million and $15.4 million. On October 9, 2004, the
Bank acquired $86.3 million in deposits by acquiring seven branches. For
additional information, See "Item 1, Business - Branch Purchase" and "Item 2,
Properties."
Investment and mortgage-backed securities and interest bearing deposits
increased to $98.4 million at September 30, 2005 from $64.6 million at
September 30, 2004.
Federally-insured state-chartered banks are required to maintain minimum
levels of regulatory capital. Under current FDIC regulations, insured
state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage
capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most
highly rated banks), (ii) a ratio of Tier 1 capital to risk weighted assets of
at least 4.0% and (iii) a ratio of total capital to risk weighted assets of at
least 8.0%. At September 30, 2005, the Bank was in compliance with all
applicable capital requirements. For additional details see the regulatory
capital table in Note 21 of the Notes to Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplementary Data" and "Item
1, Business - Regulation of the Bank - Capital Requirements."
56
Contractual obligations. The following table presents, as of September
30, 2005, the Company's significant fixed and determinable contractual
obligations, within the categories described below, by payment date or
contractual maturity. These contractual obligations, except for the operating
lease obligations are included in the Consolidated Balance Sheet. The payment
amounts represent those amounts contractually due at September 30, 2005.
Payments due by period
--------------------------------------------------
After After
1 year 3 years
Within through through After
Contractual obligations Total 1 year 3 years 5 years 5 years
------ --------- --------- --------- ---------
(In thousands)
Short-term debt
obligations.............. $ 8,781 $ 8,781 $ -- $ -- $ --
Long-term debt
obligations.............. 54,353 10,591 19,134 4,628 20,000
Operating lease
obligations.............. 802 184 493 125 --
------- ------- ------- ------- -------
Total contractual
obligations............ $63,936 $19,556 $19,627 $ 4,753 $20,000
======= ======= ======= ======= =======
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America which require the measurement of
financial position and operating results in terms of historical dollars,
without considering the change in the relative purchasing power of money over
time due to inflation. The primary impact of inflation on the operation of
the Company is reflected in increased operating costs. Unlike most industrial
companies, virtually all the assets and liabilities of a financial institution
are monetary in nature. As a result, interest rates generally have a more
significant impact on a financial institution's performance than do general
levels of inflation. Interest rates do not necessarily move in the same
direction or to the same extent as the prices of goods and services.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under "Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations - Market Risk and
Asset and Liability Management" of this Form 10-K is incorporated herein by
reference.
57
Item 8. Financial Statements and Supplementary Data
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting. Internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles. The Company's internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the Company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and
that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the Company's assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Management conducted an evaluation of the effectiveness of internal
control over financial reporting based on the framework in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission. Based on this evaluation, management concluded that
the Company's internal control over financial reporting was effective as of
September 30, 2005. Management's assessment of the effectiveness of the
Company's internal control over financial reporting has been audited by
McGladrey & Pullen , LLP, an independent registered public accounting firm, as
stated in their report which is included herein.
58
Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited management's assessment, included in the accompanying Internal
Control Assessment, that Timberland Bancorp, Inc. and Subsidiary maintained
effective internal control over financial reporting as of September 30, 2005,
based on criteria established in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Timberland Bancorp, Inc. and Subsidiary's management is responsible
for maintaining effective internal control over financial reporting and for
its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
59
In our opinion, management's assessment that Timberland Bancorp, Inc. and
Subsidiary maintained effective internal control over financial reporting as
of September 30, 2005, is fairly stated, in all material respects, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also
in our opinion, Timberland Bancorp, Inc. and Subsidiary maintained, in all
material respects, effective internal control over financial reporting as of
September 30, 2005, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of Timberland Bancorp, Inc. and Subsidiary and our report dated
December 7, 2005 expressed an unqualified opinion.
/s/McGladrey & Pullen, LLP
Tacoma, Washington
December 7, 2005
60
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm......... 62
Consolidated Balance Sheets as of September 30, 2005 and 2004... 63
Consolidated Statements of Income For the Years Ended
September 30, 2005, 2004, and 2003............................ 64
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2005, 2004 and 2003................. 65
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2005, 2004 and 2003............................. 66
Consolidated Statements of Comprehensive Income For the
Years Ended September 30, 2005, 2004 and 2003................. 68
Notes to Consolidated Financial Statements...................... 69
61
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited the consolidated balance sheets of Timberland Bancorp, Inc.
and Subsidiary as of September 30, 2005, 2004 and 2003, and the related
consolidated statements of income, shareholders' equity, cash flows and
comprehensive income for each of the three years in the period ended September
30, 2005. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provided a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Timberland
Bancorp, Inc. and Subsidiary as of September 30, 2005, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years
in the period ended September 30, 2005, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Timberland
Bancorp, Inc. and Subsidiary's internal control over financial reporting as of
September 30, 2005, based on criteria established in Internal Control
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) and our report dated December 7, 2005 expressed
an unqualified opinion on management's assessment of the effectiveness of
Timberland Bancorp's internal control over financial reporting and an
unqualified opinion on the effectiveness of Timberland Bancorp's internal
control over financial reporting.
/s/McGladrey & Pullen, LLP
Tacoma, Washington
December 7, 2005
62
Consolidated Balance Sheets
- ------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
2005 2004
Assets
Cash and due from financial institutions $ 20,015 $ 15,268
Interest-bearing deposits in banks 3,068 3,385
Federal funds sold 5,635 1,180
Mortgage-backed securities - held to maturity
(market value $101 and $166) 104 174
Investments and mortgage-backed securities -
available for sale 89,595 59,889
Federal Home Loan Bank stock (at cost) 5,705 5,682
Loans receivable, net of allowance for loan
losses of $4,099 and $3,991 385,754 343,984
Loans held for sale 2,355 610
388,109 344,594
Premises and equipment, net 15,862 13,913
Real estate owned and other repossessed items 509 421
Accrued interest receivable 2,294 1,828
Bank owned life insurance (BOLI) 11,458 11,028
Goodwill 5,650 --
Core deposit intangible (CDI) 1,834 --
Mortgage servicing rights 928 930
Other assets 1,999 2,127
Total assets $552,765 $460,419
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand, non-interest-bearing $ 51,791 $ 37,150
Interest-bearing 359,874 282,420
Total deposits 411,665 319,570
Federal Home Loan Bank advances 62,353 65,421
Other borrowings: repurchase agreements 781 --
Other liabilities and accrued expenses 3,324 2,611
Total liabilities 478,123 387,602
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;
2005- 3,759,937 shares issued and outstanding
2004- 3,882,070 shares issued and outstanding 38 39
Additional paid-in capital 22,040 24,867
Unearned shares issued to employee stock
ownership trust (3,833) (4,362)
Unearned shares issued to management recognition
and development plan -- (537)
Retained earnings 57,268 52,967
Accumulated other comprehensive loss (871) (157)
Total shareholders' equity 74,642 72,817
Total liabilities and shareholders' equity $552,765 $460,419
See notes to consolidated financial statements.
63
Consolidated Statements of Income
- ------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2005, 2004 and 2003
2005 2004 2003
Interest and Dividend Income
Loans receivable $27,514 $24,501 $25,013
Investments and mortgage-backed securities 1,962 934 873
Dividends from investments 1,093 1,021 1,064
Interest-bearing deposits in banks 367 115 395
Total interest and dividend income 30,936 26,571 27,345
Interest Expense
Deposits 5,422 4,168 5,570
Federal Home Loan Bank advances 3,156 3,157 3,376
Other borrowings - repurchase agreements 31 -- --
Total interest expense 8,609 7,325 8,946
Net interest income 22,327 19,246 18,399
Provision for Loan Losses 141 167 347
Net interest income after provision for
loan losses 22,186 19,079 18,052
Non-Interest Income
Service charges on deposits 2,822 1,927 2,009
Gain on sale of loans, net 728 642 1,451
Gain (loss) on sale of securities available
for sale, net -- (6) 135
BOLI net earnings 430 462 530
Escrow fees 141 140 267
Servicing income on loans sold 379 310 561
ATM transaction fees 871 636 723
Other 702 465 709
Total non-interest income 6,073 4,576 6,385
Non-Interest Expense
Salaries and employee benefits 10,196 8,794 8,301
Premises and equipment 2,229 1,879 1,799
Advertising 797 729 730
Real estate owned expense (income) 4 (3) 164
ATM expenses 465 396 564
Postage and courier 529 343 354
Amortization of CDI 367 -- --
State and local taxes 436 343 302
Professional fees 656 467 270
Other 2,857 2,627 2,348
Total non-interest expense 18,536 15,575 14,832
Income before federal income taxes 9,723 8,080 9,605
Federal Income Taxes 3,105 2,492 2,966
Net income $ 6,618 $ 5,588 $ 6,639
Earnings Per Common Share
Basic $ 1.90 $ 1.54 $ 1.74
Diluted 1.82 1.46 1.66
See notes to consolidated financial statements.
64
Consolidated Statements of Shareholders' Equity
(Dollars in Thousands)
- -----------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2005, 2004 and 2003
Consolidated Statements of Shareholders' Equity
- -----------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2004, 2003 and 2002
Unearned
Unearned Shares
Shares Issued to Accumulated
Issued to Management Other
Employee Recognition Compre-
Common Stock Additional Stock and Develop- hensive
Paid-in Ownership ment Retained Income
Shares Amount Capital Trust Plan Earnings (Loss) Total
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Balance, September
30, 2002 4,340,976 $43 $35,857 ($5,419) ($1,826) $45,210 $531 $74,396
Net income -- -- -- -- -- 6,639 -- 6.639
Repurchase of common
stock (188,367) (1) (3,851) -- -- -- -- (3,852)
Exercise of stock
options 99,071 1 1,490 -- -- -- -- 1,491
Cash dividends ($.50
per share) -- -- -- -- -- (2,150) -- (2,150)
Earned ESOP shares -- 120 528 -- -- -- 648
Earned MRDP shares -- 159 -- 644 -- -- 803
Change in fair value of
securities available
for sale, net of tax -- -- -- -- -- -- (364) (364)
Balance,
September 30, 2003 4,251,680 43 33,775 (4,891) (1,182)
49,699 167 77,611
Net income -- -- -- -- --
5,588 -- 5,588
Repurchase of common
stock (482,016) (5) (11,074) -- --
-- -- (11,079)
Exercise of stock
options 112,406 1 1,747 -- -- -- -- 1,748
Cash dividends ($.57
per share) -- -- -- -- -- (2,320) -- (2,320)
Earned ESOP shares -- 283 529 -- -- -- 812
Earned MRDP shares -- 136 -- 645 -- -- 781
Change in fair value
of securities available
for sale, net of tax -- -- -- -- -- -- (324) (324)
Balance,
September 30, 2004 3,882,070 39 24,867 (4,362) (537) 52,967 (157) 72,817
Net income -- -- -- -- -- 6,618 -- 6,618
Repurchase of common
stock (174,434) (2) (4,062) -- -- -- -- (4,064)
Exercise of stock
options 52,301 1 813 -- -- -- -- 814
Cash dividends ($.61
er share) -- -- -- -- -- (2,317) -- (2,317)
Earned ESOP shares -- 293 529 -- -- -- 822
Earned MRDP shares -- 129 -- 537 -- -- 666
Change in fair value of
securities available
for sale, net of tax -- -- -- -- -- -- (714) (714)
Balance,
September 30, 2005 3,759,937 $38 $22,040 ($3,833) $ -- $57,268 ($871) $74,642
See notes to consolidated financial statements.
65
Consolidated Statements of Cash Flows
(Dollars in Thousands)
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2005, 2004 and 2003
2005 2004 2003
Cash Flows from Operating Activities
Net income $ 6,618 $5,588 $ 6,639
Noncash revenues, expenses, gains and losses
included in net income:
Depreciation 933 812 697
Deferred federal income taxes 64 69 42
Amortization of core deposit intangible 367 -- --
Earned ESOP shares 822 812 648
Earned MRDP shares 666 691 693
Federal Home Loan Bank (FHLB) stock
dividends (23) (228) (315)
Gain on sale of real estate owned, net (5) (81) (1)
(Gain) loss on sale of securities available
for sale -- 6 (135)
Gain on sale of loans (728) (642) (1,451)
Loss on sale of premises and equipment 13 -- --
Provision for loan and real estate owned
losses 161 206 431
Loans originated for sale (26,528) (35,350) (106,652)
Proceeds from loans held for sale 25,247 36,383 110,263
Proceeds from credit card portfolio sale 264 -- --
BOLI net earnings (430) (462) (530)
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses 397 (267) (583)
Net cash provided by operating activities 7,838 7,537 9,746
Cash Flows from Investing Activities
Net (increase) decrease in interest-bearing
deposits in banks 317 26,126 (4,018)
Net increase in federal funds sold (4,455) (1,180) --
Activity in securities held to maturity:
Maturities and prepayments 62 105 234
Purchases -- -- (519)
Activity in securities available for sale:
Sales -- 1,600 2,064
Maturities and prepayments 8,140 10,006 8,595
Purchases (38,977) (17,965) (23,560)
Increase in loans receivable, net (42,272) (23,453) (3,189)
Additions to premises and equipment (837) (1,296) (2,462)
Purchase of branches, net of cash and cash
equivalent 76,630 -- --
Proceeds from sale of real estate owned 549 1,138 425
Proceeds from the disposition of premises and
equipment 6 -- --
Net cash used in investing activities (837) (4,919) (22,430)
(continued)
See notes to consolidated financial statements.
66
Consolidated Statements of Cash Flows
(concluded) (Dollars in Thousands)
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2005, 2004 and 2003
2005 2004 2003
Cash Flows from Financing Activities
Increase in deposits $ 5,600 $ 11,898 $ 15,356
Net decrease in FHLB advances - long term (583) (6,669) (154)
Net increase (decrease) in FHLB advances -
short term (2,485) 10,485 --
Net increase in repurchase agreements 781 -- --
Proceeds from exercise of stock options 814 1,748 1,491
Repurchase of common stock (4,064) (11,079) (3,852)
Payment of dividends (2,317) (2,320) (2,150)
Net cash provided (used) by financing
activities (2,254) 4,063 10,691
Net increase (decrease) in cash 4,747 6,681 (1,993)
Cash and Due from Financial Institutions
Beginning of year 15,268 8,587 10,580
End of year $ 20,015 $ 15,268 $ 8,587
Supplemental Disclosures of Cash Flow Information
Income taxes paid $2,370 $2,095 $ 2,790
Interest paid 8,362 7,107 9,011
Supplemental Disclosures of Non-Cash Investing
and Financing Activities
Market value adjustment of securities
held for sale,net of tax ($ 714) ($ 324) ($ 364)
Loans transferred to real estate owned 625 344 1,157
Financed sale of real estate owned -- 169 --
Supplemental Disclosures of Branch Purchase
Premium paid for deposits ($7,848) $ -- $ --
Fair value of assets acquired (2,064) -- --
Deposits assumed 86,495 -- --
Other liabilities assumed 47 -- --
Net cash provided by branch purchase $76,630 $ -- $ --
See notes to consolidated financial statements.
67
Consolidated Statements of Comprehensive Income
(Dollars in Thousands)
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2005, 2004 and 2003
2005 2004 2003
Comprehensive Income
Net income $6,618 $5,588 $6,639
Change in fair value of
securities available for sale,
net of tax (714) (324) (364)
Total comprehensive income $5,904 $5,264 $6,275
See notes to consolidated financial statements.
68
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. (the Company); its wholly owned subsidiary, Timberland Bank (the
Bank); and the Bank's wholly owned subsidiary, Timberland Service Corp. All
significant intercompany transactions and balances have been eliminated.
Nature of Operations
The Company is a holding company which operates primarily through its
subsidiary, the Bank. The Bank was established in 1915 and, through its 21
branches located in Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis
Counties in Washington State, attracts deposits from the general public, and
uses those funds, along with other borrowings, to provide residential real
estate, retail and commercial loans to borrowers in western Washington, and to
invest in investment securities and mortgage-backed securities.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
practices within the banking industry. The preparation of consolidated
financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and the disclosure
of contingent assets and liabilities, as of the date of the balance sheet, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and the valuation of mortgage
servicing rights.
Certain prior year amounts have been reclassified to conform to the 2005
presentation with no change to net income or shareholders' equity previously
reported.
Investments and Mortgage-Backed Securities - Available for Sale
Debt and equity securities that will be held for indefinite periods of time,
including securities that may be sold in response to changes in market
interest rates, prepayment rates, need for liquidity, and changes in the
availability of and the yield of alternative investments, are considered
securities available for sale, and are reported at fair value. Fair value is
determined using published quotes as of the close of business on reporting
dates. Unrealized gains and losses are excluded from earnings, and are
reported as a separate component of shareholders' equity, net of the related
deferred tax effect, entitled "Accumulated other comprehensive income (loss)."
Realized gains and losses on securities available for sale, determined using
the specific identification method, are included in earnings. Amortization of
premiums and accretion of discounts are recognized in interest income over
period to maturity.
(continued)
69
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 1 - Summary of Significant Accounting Policies (continued)
Investments and Mortgage-Backed Securities - Held for Maturity
Debt securities for which the Bank has the positive intent and ability to hold
to maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts, which are recognized in interest income using the
interest method.
Declines in the fair value of individual securities held to maturity and
available for sale below their cost that are other than temporary would result
in write-downs of the individual securities to their fair value. Management
evaluates individual securities for other than temporary impairment on a
quarterly basis based on the securities' current credit quality, interest
rates, term to maturity and management's intent and ability to hold the
securities until the net book value is recovered. Any other than temporary
declines in fair value are recognized in the statement of income as loss on
sale of investments.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank (FHLB) system, is
required to maintain an investment in capital stock of the FHLB in an amount
equal to the greater of 1% of its outstanding home loans or 5% of advances
from the FHLB. The recorded amount of FHLB stock equals its fair value
because the shares can only be redeemed by the FHLB at the $100 per share par
value.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
stated in the aggregate at the lower of cost or estimated market value. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income. Gains or losses on sales of loans are recognized at the
time of sale. The gain or loss is the difference between the net sales
proceeds and the recorded value of the loans, including any remaining
unamortized deferred loan fees.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed
portion of construction loans in process, deferred loan origination fees and
an allowance for loan losses.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to provide
for estimated loan losses based on evaluating known and inherent risks in the
loan portfolio. The allowance is provided based upon management's
comprehensive analysis of the pertinent factors underlying the quality of the
loan portfolio. These factors include changes in the size and composition of
the loan portfolio, delinquency levels, actual loan loss experience, current
economic conditions, and detailed analysis of individual loans for which full
collectibility may not be assured. The detailed analysis includes methods to
estimate the fair value of loan collateral and the existence of potential
alternative sources of repayment. The allowance consists of specific, general
and unallocated components. The specific component relates to loans that are
classified as doubtful, substandard or special mention. For such loans that
are also classified as impaired, an allowance is established when the
discounted cash flows (or collateral value or observable market price) of the
impaired loan is lower than the recorded value of that loan. The general
component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. An unallocated component is
maintained to cover uncertainties that could affect management's estimate of
probable losses. The unallocated component of the allowance reflects the
margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the portfolio. The
appropriateness of the allowance for losses on loans is estimated based upon
these factors and trends identified by management at the time financial
statements are prepared.
(continued)
70
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (concluded)
When available information confirms that specific loans or portions thereof
are uncollectible, identified amounts are charged against the allowance for
loan losses. The existence of some or all of the following criteria will
generally confirm that a loss has been incurred: the loan is significantly
delinquent and the borrower has not demonstrated the ability or intent to
bring the loan current; the Bank has no recourse to the borrower, or if it
does, the borrower has insufficient assets to pay the debt; the estimated fair
value of the loan collateral is significantly below the current loan balance,
and there is little or no near-term prospect for improvement.
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a
Loan, and SFAS No. 118, an amendment of SFAS No. 114, a loan is considered
impaired when it is probable that a creditor will be unable to collect all
amounts (principal and interest) due according to the contractual terms of the
loan agreement. Smaller balance homogenous loans, such as residential mortgage
loans and consumer loans, are collectively evaluated for potential loss. When
a loan has been identified as being impaired, the amount of the impairment is
measured by using discounted cash flows, except when, as an alternative, the
current fair value of the collateral, reduced by costs to sell, is used. When
the measurement of the impaired loan is less than the recorded investment in
the loan (including accrued interest and net deferred loan fees or costs), an
impairment is recognized by creating or adjusting an allocation of the
allowance for loan losses. Uncollected accrued interest is reversed against
interest income. If ultimate collection of principal is in doubt, all cash
receipts on impaired loans are applied to reduce the principal balance.
A provision for loan losses is charged against income and is added to the
allowance for loan losses based on quarterly assessments of the loan
portfolio. The allowance for loan losses is allocated to certain loan
categories based on the relative risk characteristics, asset classifications
and actual loss experience of the loan portfolio. While management has
allocated the allowance for loan losses to various loan portfolio segments,
the allowance is general in nature and is available for the loan portfolio in
its entirety.
The ultimate recovery of all loans is susceptible to future market factors
beyond the Bank's control. These factors may result in losses or recoveries
differing significantly from those provided in the consolidated financial
statements. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses,
and may require the Bank to make additions to the allowance based on their
judgment about information available to them at the time of their
examinations.
Interest on Loans and Loan Fees
Interest on loans is accrued daily based on the principal amount outstanding.
Allowances are established for uncollected interest on loans for which the
interest is determined to be uncollectible. Generally, all loans past due 90
days or more are placed on nonaccrual status and internally classified as
substandard. Any interest income accrued at that time is fully reversed.
Subsequent collections are applied proportionately to past due principal and
interest, unless collectibility of principal is in doubt, in which case all
payments are applied to principal. Loans are removed from nonaccrual status
only when the loan is deemed current, and the collectibility of principal and
interest is no longer doubtful, or on 1-4 family loans, when the loan is less
than 90 days delinquent.
The Bank charges fees for originating loans. These fees, net of certain loan
origination costs, are deferred and amortized to income, on the level-yield
basis, over the loan term. If the loan is repaid prior to maturity, the
remaining unamortized deferred loan fee is recognized in income at the time of
repayment.
71
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 1 - Summary of Significant Accounting Policies (continued)
Mortgage Servicing Rights
Mortgage servicing rights are capitalized when acquired through the
origination of loans that are subsequently sold with the servicing rights
retained and are amortized as an offset to servicing income on loans sold in
proportion to and over the period of estimated net servicing income. The
value of mortgage servicing rights at the date of the sale of loans is
determined based on the discounted present value of expected future cash flows
using key assumptions for servicing income and costs and prepayment rates on
the underlying loans. The estimated fair value is periodically evaluated for
impairment by comparing actual cash flows and estimated future cash flows from
the servicing assets to those estimated at the time servicing assets were
originated. Fair values are estimated using discounted cash flows based on
current market rates of interest. For purposes of measuring impairment, the
rights must be stratified by one or more predominant risk characteristics of
the underlying loans. The Company stratifies its capitalized mortgage
servicing rights based on product type, interest rate and term of the
underlying loans. The amount of impairment recognized is the amount, if any,
by which the amortized cost of the rights for each stratum exceed their fair
value.
Goodwill
Goodwill is initially recorded when the purchase price paid for an acquisition
exceeds the estimated fair value of the net identified tangible and intangible
assets acquired. Goodwill is presumed to have an infinite useful life and is
tested, at least annually, for impairment. An annual review is performed at
the end of the third quarter of each year, or more frequently if indicators of
potential impairment exist, to determine if the recorded goodwill is impaired.
If the fair value exceeds the recorded value, goodwill is not considered
impaired and no additional analysis is necessary. As of September 30, 2005,
there have been no events or changes in the circumstances that would indicate
a potential impairment.
Core Deposit Intangible
The core deposit intangible (CDI) is amortized to non-interest expense using
an accelerated method over a ten year period.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed on the
straight-line method over the following estimated useful lives: buildings and
improvements - up to forty years; furniture and equipment - three to seven
years; and automobiles - five years. The cost of maintenance and repairs is
charged to expense as incurred. Gains and losses on dispositions are
reflected in earnings.
Real Estate Owned and Other Repossessed Items
Real estate owned consists of properties or assets acquired through or in lieu
of foreclosure, and are recorded initially at the lower of cost or fair value
of the properties less estimated costs of disposal. Costs relating to
development and improvement of the properties or assets are capitalized while
costs relating to holding the properties or assets are expensed.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to earnings if the recorded value of a
property exceeds its estimated net realizable value.
72
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 1 - Summary of Significant Accounting Policies (continued)
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 income tax return with its
subsidiaries. Prior to fiscal year 1997, the Bank qualified under provisions
of the Internal Revenue Code which permitted, as a deduction from taxable
income, an allowance for bad debts based on a percentage of taxable income.
In 1996, the percentage-of-income bad debt deduction for federal tax purposes
was eliminated. In addition, federal tax bad debt reserves which had been
accumulated since October 1, 1988, that exceeded the reserves which would have
been accumulated based on actual experience, are subject to recapture over a
six-year recapture period. As of September 30, 2005, all federal tax bad debt
reserves had been recaptured.
Deferred federal income taxes result from temporary differences between the
tax basis of assets and liabilities, and their reported amounts in the
consolidated financial statements. These will result in differences between
income for tax purposes and income for financial reporting purposes in future
years. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes.
Employee Stock Ownership Plan
The Bank sponsors a leveraged Employee Stock Ownership Plan (ESOP). The ESOP
is accounted for in accordance with the American Institute of Certified Public
Accountants Statement of Position 93-6, Employers' Accounting for Employee
Stock Ownership Plan. Accordingly, the debt of the ESOP is recorded as other
borrowed funds of the Bank, and the shares pledged as collateral are reported
as unearned shares issued to the employee stock ownership trust on the
consolidated balance sheets. The debt of the ESOP is with the Company and is
thereby eliminated in the consolidated financial statements. As shares are
released from collateral, compensation expense is recorded equal to the
average market price of the shares for the period, and the shares become
available for earnings per share calculations.
Cash Equivalents and Cash Flows
The Company considers all amounts included in the balance sheets caption "Cash
and due from financial institutions" to be cash equivalents. Cash flows from
interest-bearing deposits in banks, federal funds sold, loans, deposits,
Federal Home Loan Bank advances short-term, Federal Home Loan Bank advances
long-term and other borrowings - repurchase agreements are reported net.
73
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 1 - Summary of Significant Accounting Policies (concluded)
Advertising
Costs incurred for advertising and marketing are expensed as incurred.
Stock-Based Compensation
At September 30, 2005, the Company has a stock-based option plan, which is
described more fully in Note 16. The Company applies APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in
accounting for this plan. Accordingly, no compensation cost has been
recognized for the plan. Had compensation cost for the Company's stock option
plan been determined based on the fair value at the grant dates for awards
granted under this plan, consistent with the method prescribed in SFAS No.
123, the Company's reported and pro forma net income and earnings per share
for the years ended September 30 would be as follows (dollars in thousands,
except per share amounts):
2005 2004 2003
Net income, as reported $6,618 $5,588 $6,639
Less total stock-based compensation
expense determined under fair value
method for all qualifying awards,
net of tax 256 172 224
Pro forma net income $6,362 $5,416 $6,415
Earnings Per Share
Basic:
As reported $ 1.90 $ 1.54 $ 1.74
Pro forma 1.83 1.49 1.68
Diluted:
As reported 1.82 1.46 1.66
Pro forma 1.76 1.41 1.61
Earnings Per Share
Basic earnings per share exclude dilution and are computed by dividing net
income by the weighted average number of common shares outstanding. Diluted
earnings per share reflect the potential dilution that could occur if common
shares were issued under the Company's stock option and management recognition
and development plans.
74
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (Revised), Share-Based Payment (SFAS 123(R)). This Statement
establishes standards for accounting for transactions in which an entity
exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments,
or that may be settled by the issuance of those equity instruments. SFAS No.
123(R) covers a wide range of share-based compensation arrangements including
share options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. SFAS No. 123(R)
replaces existing requirements under SFAS No. 123, Accounting for Stock-Based
Compensation, and eliminates the ability to account for share-based
compensation transactions using APB Opinion No. 25, Accounting for Stock Issue
to Employees. For the Company, the Statement is effective for the interim
reporting period beginning October 1, 2005. Adoption of the Statement will
impact the consolidated financial statements by requiring compensation expense
to be recorded for the unvested portion of stock options, which have been
granted or which are subsequently granted.
In May 2005, FASB issued SFAS No. 154, Accounting Changes for Error
Corrections (SFAS No. 154). SFAS No. 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections. It
establishes, unless impracticable, retrospective application as the required
method for reporting a change in accounting principle in the absence of
explicit transaction requirements specific to the newly adopted accounting
principle. SFAS No. 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005. The
adoption of SFAS No. 154 is not expected to have a material impact on the
Company's consolidated financial statements.
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain
minimum reserve balances on hand or on deposit with the Federal Reserve Bank,
based on a percentage of deposits. The amount of such balances for the years
ended September 30, 2005 and 2004 was approximately $10.2 million and $7.0
million, respectively.
75
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 3 - Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities have been classified according to
management's intent (in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
September 30, 2005
Held to Maturity
Mortgage-backed securities $ 104 $ -- ($3) $ 101
Available for Sale
Mortgage-backed securities $23,990 $ 78 ($333) $23,735
Mutual funds 32,939 -- (774) 32,165
U.S. agency securities 33,986 -- (291) 33,695
Total $90,915 $ 78 ($1,398) $89,595
September 30, 2004
Held to Maturity
Mortgage-backed securities $ 174 $ - - ($8) $ 166
Available for Sale
Mortgage-backed securities $18,193 $236 ($100) $18,329
Mutual funds 32,939 - - (362) 32,577
U.S. agency securities 8,994 4 (15) 8,983
Total $60,126 $240 ($477) $59,889
(continued)
76
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 3 - Investments and Mortgage-Backed Securities (concluded)
The fair value of temporarily impaired securities, the amount of unrealized
losses and the length of time these unrealized losses existed as of September
30, 2005 are as follows (in thousands):
Less Than 12 Months 12 Months or Longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Value Losses Value Losses Value Losses
Securities
Mutual funds $ -- $ -- $32,165 ($774) $32,165 ($774)
Mortgage-backed
securities 13,660 (201) 7,250 (132) 20,910 (333)
U.S. agency
securities 31,732 (254) 1,963 (37) 33,695 (291)
Total $45,392 ($455) $41,378 ($943) $86,770 ($1,398)
The Company has evaluated these securities and has determined that the decline
in their value is temporary. The decline in the value is not related to any
company or industry specific event. The Company has the ability and intent to
hold the investments until the market value recovers.
Mortgage-backed and agency securities pledged as collateral for public fund
deposits, federal treasury tax and loan deposits, FHLB collateral, retail
repurchase agreements and other non-profit organization deposits totaled
$56,516,000 and $25,228,000 at September 30, 2005 and 2004, respectively.
The contractual maturities of debt securities at September 30, 2005 are as
follows (in thousands). Expected maturities may differ from scheduled
maturities due to the prepayment of principal or call
provisions.
Held to Maturity Available for Sale
Amortized Fair Amortized Fair
Cost Value Cost Value
Due within one year $ -- $ -- $ -- $ --
Due from one year to five years -- -- 32,782 32,530
Due from five to ten years -- -- 2,180 2,165
Due after ten years 104 101 23,014 22,735
Mutual funds -- -- 32,939 32,165
Total $ 104 $ 101 $ 90,915 $ 89,595
There were no gross realized gains or gross realized losses on sales of
securities available for sale for the year ended September 30, 2005. For the
year ended September 30, 2004 gross realized losses totaled $6,000 and there
were no gross realized gains on sales of securities available for sale. For
the year ended September 30, 2003 gross realized gains totaled $135,000 and
there were no gross realized losses on sales of securities available for sale.
77
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable and loans held for sale consisted of the following at
September 30 (in thousands):
2005 2004
Mortgage loans:
One- to four-family $ 99,408 $ 99,225
Multi-family 20,170 17,160
Commercial 124,849 108,276
Construction and land development 112,470 106,241
Land 24,981 19,895
Total mortgage loans 381,878 350,797
Consumer loans:
Home equity and second mortgage 32,298 23,549
Other 9,330 9,270
Total consumer loans 41,628 32,819
Commercial business loans 12,013 11,098
Total loans receivable 435,519 394,714
Less:
Undisbursed portion of construction
loans in process 42,771 43,563
Deferred loan origination fees 2,895 3,176
Allowance for loan losses 4,099 3,991
49,765 50,730
Loans receivable, net 385,754 343,984
Loans held for sale (one- to four-family) 2,355 610
Total loans receivable and loans held for
sale $388,109 $344,594
Certain related parties of the Bank, principally Bank directors and officers,
were loan customers of the Bank in the ordinary course of business during the
years ended September 30, 2005 and 2004. Activity in related party loans
during the years ended September 30 is as follows (in thousands):
2005 2004
Balance, beginning of year $1,467 $1,041
New loans 1 484
Repayments (73) (58)
Balance, end of year $1,395 $1,467
(continued)
78
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
At September 30, 2005 and 2004, the Bank had non-accruing loans totaling
approximately $2,926,000 and $1,442,000, respectively. At September 30, 2005
and 2004, no loans were 90 days or more past due and still accruing interest.
Interest income recognized on a cash basis on non-accrual loans for the years
ended September 30, 2005, 2004 and 2003 was $189,000, $43,000 and $50,000,
respectively. The average investment in non-accrual loans for the years ended
September 30, 2005 and 2004 was $2,681,000 and $3,432,000, respectively.
An analysis of the allowance for loan losses for the years ended September 30
follows (in thousands):
2005 2004 2003
Balance, beginning of year $3,991 $3,891 $3,630
Provision for loan losses 141 167 347
Loans charged off (50) (86) (168)
Recoveries 17 19 82
Net charge-offs (33) (67) (86)
Balance, end of year $4,099 $3,991 $3,891
Following is a summary of information related to impaired loans at September
30 (in thousands):
2005 2004
Impaired loans without a valuation allowance $2,601 $1,122
Impaired loans with a valuation allowance 325 320
$2,926 $1,442
Valuation allowance related to impaired loans $49 $93
Note 5 - Loan Servicing
Loans serviced for the Federal Home Loan Mortgage Corporation and others are
not included on the consolidated balance sheets. The principal amounts of
those loans at September 30, 2005 and 2004 were $155,864,000 and $165,206,000,
respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (in thousands):
2005 2004 2003
Balance, at beginning of year $930 $ 1,017 $834
Additions 200 273 837
Amortization (202) (360) (654)
Balance, end of year $928 $930 $1,017
(continued)
79
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 5 - Loan Servicing (concluded)
At September 30, 2005 and 2004, the fair value of mortgage servicing rights
totaled $1,433,000 and $1,718,000 which was estimated using a premium rate of
9.62% and 9.34% and a prepayment speed factor of 313 and 250. There was no
valuation allowance at September 30, 2005 or 2004.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (in
thousands):
2005 2004
Land $ 3,760 $ 3,239
Buildings and improvements 12,508 11,321
Furniture and equipment 5,175 4,653
Property held for future expansion 293 253
Construction and purchases in progress 426 213
22,162 19,679
Less accumulated depreciation 6,300 5,766
Total premises and equipment $15,862 $13,913
The Bank leases premises under operating leases. Rental expense of leased
premises was $199,000, $171,000, and $109,000 for September 30, 2005, 2004 and
2003, respectively, which is included in premises and equipment expense.
Minimum net rental commitments under noncancellable leases having an original
or remaining term of more than one year for future years ending September 30
are as follows (in thousands):
2006 $184
2007 184
2008 184
2009 125
2010 125
Total minimum payments required $802
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
80
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 7 - Real Estate Owned and Other Repossessed Items
Real estate owned and other repossessed items consisted of the following at
September 30 (in thousands):
2005 2004
Real estate acquired through foreclosure $509 $403
Items acquired through repossession -- 18
Total real estate owned and other repossessed items $509 $421
Note 8 - Core Deposit Intangibles (CDI)
During the year ended September 30, 2005, the Company recorded a core deposit
intangible of $2,201,000 in connection with the October 2004 acquisition of
seven branches and related deposits. Net unamortized core deposit intangible
totaled $1,834,000 at September 30, 2005. Amortization expense related to the
core deposit intangible during the year ended September 30, 2005 totaled
$367,000.
Amortization expense for the core deposit intangible for future years ending
September 30 is estimated to be as follows (in thousands):
2006 $ 328
2007 285
2008 249
2009 217
2010 190
After 2011 565
Total $1,834
81
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 9 - Deposits
Deposits consisted of the following at September 30 (in thousands):
2005 2004
Non-interest-bearing $ 51,791 $ 37,150
NOW checking 93,478 77,242
Savings 64,274 48,200
Money market accounts 49,295 41,652
Certificates of deposit 152,827 115,326
Total deposits $411,665 $319,570
Certificates of deposit of $100,000 or greater totaled $35,209,000 and
$22,041,000 at September 30, 2005 and 2004, respectively.
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (in thousands):
2006 $104,163
2007 30,769
2008 8,642
2009 5,293
2010 3,810
Thereafter 150
Total $152,827
Interest expense by account type is as follows for the years ended September
30 (in thousands):
2005 2004 2003
NOW checking $ 657 $ 544 $ 335
Savings 438 342 570
Money market accounts 625 439 704
Certificates of deposit 3,702 2,843 3,961
Total $5,422 $4,168 $5,570
82
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 10 - Other Borrowings - Repurchase Agreements
Other borrowings at September 30, 2005 consisted of overnight repurchase
agreements with customers totaling $781,000.
Information concerning repurchase agreements is summarized as follows at
September 30, 2005 (dollars in thousands):
Average daily balance during the period $ 1,345
Average daily interest rate during the period 2.30%
Maximum month-end balance during the period 2,102
Weighted average rate at end of period 3.14%
Securities underlying the agreements at the end of period:
Carrying value $ 1,803
Fair value 1,803
The securities underlying the agreements at September 30, 2005 were under the
Company's control in safekeeping at third-party financial institutions.
Note 11 - Federal Home Loan Bank (FHLB) Advances and Other Borrowing Lines
The Bank has long- and short-term borrowing lines with the Federal Home
Loan Bank of Seattle with total credit on the lines equal to 30% of the Bank's
total assets, limited by available collateral. Borrowings are considered
short-term when the original maturity is less than one year. FHLB advances
consisted of the following at September 30 (in thousands):
2005 2004
Short-term
$ 8,000 $ 10,485
Long-term
54,353 54,936
Total
$ 62,353 $ 65,421
(continued)
83
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 11 - Federal Home Loan Bank Advances and Other Borrowing Lines
(concluded)
The short-term borrowing as of September 30, 2005 matures in April 2006 and
bears interest at 3.79%. The long-term borrowings mature at various dates
through January 2011, bear interest at rates ranging from 4.16% to 6.55%, and
advances totaling $5,353,000 have monthly payments aggregating $5,000 plus
interest. Under the Advances, Security and Deposit Agreement, virtually all
of the Bank's assets, not otherwise encumbered, are pledged as collateral for
advances. Principal reductions due for future years ending September 30 are
as follows (in thousands):
2006 $ 10,591
2007 4,064
2008 15,070
2009 4,628
2010 --
Thereafter 20,000
$54,353
In addition, the Bank has a $10,000,000 overnight borrowing line with
Pacific Coast Banker's Bank. The borrowing line may be reduced or withdrawn
at any time. As of September 30, 2004 and 2005 the Bank did not have any
outstanding advances on this borrowing line.
Note 12 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses comprise the following at September 30
(in thousands):
2005 2004
Accrued deferred compensation and profit
sharing plans payable $ 1,077 $ 925
Accrued interest payable on deposits and FHLB advances 708 461
Accounts payable and accrued expenses - other 1,539 1,225
Total other liabilities and accrued expenses $3,324 $2,611
Note 13 - Federal Income Taxes
The Bank previously qualified under provisions of the Internal Revenue Code
that permitted federal income taxes to be computed after a deduction for
additions to bad debt reserves. Accordingly, retained earnings include
approximately $2,200,000 for which no provision for federal income taxes has
been made. If in the future this portion of retained earnings is used for any
purpose other than to absorb bad debt losses, federal income taxes at the
current applicable rates would be imposed.
(continued)
84
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 13 - Federal Income Taxes (continued)
The components of the provision for income taxes at September 30 are as
follows (in thousands):
2005 2004 2003
Current $3,041 $2,423 $2,924
Deferred 64 69 42
Total federal income taxes $3,105 $2,492 $2,966
The components of the Company's prepaid federal income taxes and net deferred
tax assets included in other assets as of September 30 are as follows (in
thousands):
2005 2004
Prepaid federal income taxes $ 259 $ 705
Net deferred tax assets 1,054 750
Total $ 1,313 $1,455
The components of the Company's deferred tax assets and liabilities at
September 30 are as follows (in thousands):
2005 2004
Deferred Tax Assets
Accrued interest on loans $ 53 $ 11
Accrued vacation 127 106
Deferred compensation 89 92
Unearned ESOP shares 420 404
Allowance for possible losses 1,466 1,394
CDI 77 --
Unearned MRDP shares -- 38
Net unrealized securities losses 449 81
Acquisition costs -- 8
Total deferred tax assets 2,681 2,134
Deferred Tax Liabilities
FHLB stock dividends 906 898
Depreciation 281 232
Goodwill 132 --
Certificate of deposit valuation 19 --
Mortgage servicing rights 289 254
Total deferred tax liabilities 1,627 1,384
Net deferred tax assets $1,054 $ 750
(continued)
85
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 13 - Federal Income Taxes (concluded)
The provision for federal income taxes differs from that computed at the
statutory corporate tax rate as
follows (dollars in thousands):
2005 2004 2003
Amount Percent Amount Percent Amount Percent
Taxes at statutory rate $3,403 35.0% $2,828 35.0% $3,362 35.0%
BOLI income (151) (1.6) (162) (2.0) (185) (1.9)
Other - net (147) (1.5) (174) (2.2) (211) (2.2)
Federal income taxes $3,105 31.9% $2,492 30.8% $2,966 30.9%
Note 14 - Profit Sharing Plans
The Bank has established a 401(k) profit sharing plan for employees who meet
the eligibility requirements set forth in the plan. Eligible employees may
contribute up to the IRS maximum. Contributions by the Bank are at the
discretion of the board of directors. Bank contributions totaled $641,000,
$524,000 and $497,000 for the years ended September 30, 2005, 2004 and 2003,
respectively.
In addition, the Bank has an employee bonus plan based on net income. Bonuses
accrued for the years ended September 30, 2005, 2004 and 2003 totaled
$215,000, $175,000 and $261,000, respectively.
Note 15 - Employee Stock Ownership Plan
In 1998, the Bank established an Employee Stock Ownership Plan (ESOP) that
benefits employees with at least one year of service who are 21 years of age
or older. The ESOP may be funded by Bank contributions in cash or stock.
Employee vesting occurs over six years. The amount of the annual contribution
is discretionary, except that it must be sufficient to enable the ESOP to
service its debt. All dividends received by the ESOP are used to pay debt
service. As of September 30, 2005, 32,482 ESOP shares had been distributed to
participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase
529,000 shares of common stock of the Company. The loan will be repaid
primarily from the Company's contributions to the ESOP over 15 years. The
interest rate on the loan is 8.5%. The balance of the loan at September 30,
2005 was $5,032,000.
Shares held by the ESOP as of September 30 were classified as follows:
2005 2004 2003
Unallocated shares 255,682 290,949 326,216
Shares released for allocation 240,836 217,159 185,826
Total ESOP shares 496,518 508,108 512,042
(continued)
86
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 15 - Employee Stock Ownership Plan (concluded)
The approximate fair market value of the Bank's unallocated shares at
September 30, 2005, 2004 and 2003, was $5,932,000, $6,829,000 and $7,797,000,
respectively. Compensation expense recognized under the ESOP was $516,000,
$524,000 and $454,000 for the years ended September 30, 2005, 2004 and 2003,
respectively.
Note 16 - Stock Options
Under the Company's stock option plans, the Company may grant options for up
to 811,250 shares of common stock to certain key employees and directors. The
exercise price of each option equals the fair market value of the Company's
stock on the date of grant. An option's maximum term is ten years. Options
vest in annual installments of 10% on each of the ten anniversaries from the
date of grant. If certain Company performance criteria are met vesting will
be accelerated to 20% per year. These criteria were not met in 2005, but were
met in 2004 and 2003. At September 30, 2005, options for 139,208 shares are
available for future grant under these plans.
The fair value of stock-based awards to employees and directors is calculated
through the use of option pricing models, even though such models were
developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which significantly differ from the
Company's stock option awards. The Company's calculations were made using the
Black-Scholes option pricing model with the following weighted average
assumptions.
Risk Free Expected Expected Expected
Interest Rate Life (Years) Dividends Volatility
Fiscal 2004 3.6% 8 2.4% 21.5%
Fiscal 2003 3.4 8 2.5 24.1
Their were no options granted in 2005. The average fair value of options
granted in 2004 and 2003 was $5.25 and $4.62, respectively.
(continued)
87
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 16 - Stock Options (concluded)
Stock option activity is summarized in the following table:
Weighted
Average
Number of Exercise
Shares Price
Outstanding September 30, 2002 568,350 $12.27
Grants 30,840 19.37
Options exercised (99,071) 12.02
Outstanding September 30, 2003 500,119 12.75
Grants 28,338 23.06
Options exercised (112,406) 12.11
Forfeited (1,339) 12.00
Outstanding September 30, 2004 414,712 13.63
Options exercised (52,301) 12.01
Outstanding September 30, 2005 362,411 13.86
Additional information regarding options outstanding at September 30, 2005 is
as follows:
Options Outstanding Options Exercisable
--------------------- ----------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Contractual Number Exercise Number Exercise
Prices Life (Years) Outstanding Price Exercisable Price
$12.00 - 12.38 3.4 257,894 $12.01 256,394 $12.01
13.59 - 14.90 5.7 33,339 14.70 23,337 14.70
15.20 - 15.96 6.5 12,000 15.56 4,500 15.45
19.05 7.4 28,340 19.05 8,502 19.05
22.92 - 23.25 8.3 30,838 23.06 30,838 23.06
4.4 362,411 $13.86 323,571 $13.49
88
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 17 - Deferred Compensation/Non-Competition Agreement and Employee
Severance Compensation Agreement
The Bank has a deferred compensation/noncompetition arrangement with its
former chief executive officer which will provide monthly payments of $2,000
per month upon retirement. Payments under this agreement began in March 2004
and will continue until his death, at which time payments will continue to his
surviving spouse until the earlier of her death or for 60 months. The present
value of the payments as of September 30, 2005 and 2004, $201,000 and
$225,000, respectively, has been accrued under the agreement and is included
in other liabilities on the consolidated balance sheets.
In connection with the January 1998 mutual to stock conversion, the Bank
adopted an Employee Severance Compensation Plan, which expires in ten years,
to provide benefits to eligible employees in the event of a change in control
of the Company or the Bank (as defined in the plan). In general, all
employees with two or more years of service will be eligible to participate in
the plan. Under the plan, in the event of a change in control of the Company
or the Bank, eligible employees who are terminated or who terminate employment
(but only upon the occurrence of events specified in the plan) within 12
months of the effective date of a change in control would be entitled to a
payment based on years of service with the Bank. The maximum payment for any
eligible employee would be equal to 24 months of their current compensation.
Note 18 - Management Recognition and Development Plan
On November 10, 1998, the Board of Directors adopted a Management Recognition
and Development Plan (MRDP). On January 25, 1999, shareholders approved the
adoption of the MRDP for the benefit of officers, employees and non-employee
directors of the Company. The objective of the MRDP is to retain personnel of
experience and ability in key positions by providing them with a proprietary
interest in the Company.
The MRDP allows for the issuance to participants of up to 264,500 shares of
the Company's common stock. Shares issued may be purchased in the open market
or may be issued from authorized and unissued shares. On July 26, 2001, the
Company awarded 204,927 shares under the MRDP to employees and directors. No
shares were awarded during the years ended September 30, 2005 and 2004.
Awards under the MRDP were made in the form of restricted shares of common
stock that are subject to restrictions on the transfer of ownership.
Compensation expense in the amount of the fair value of the common stock at
the date of the grant to the plan participants was recognized over a five-
year vesting period, with 20% vesting immediately upon grant. At September
30, 2005, participants were fully vested in all shares awarded. Compensation
expense related to the MRDP was $556,000, $691,000 and $693,000 for the years
ended September 30, 2005, 2004 and 2003, respectively.
Note 19 - Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. These instruments
involve, to varying degrees, elements of credit risk not recognized on the
consolidated balance sheets.
(continued)
89
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 19 - Commitments and Contingencies (concluded)
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments as it does for on-balance-sheet
instruments. A summary of the Bank's commitments at September 30 is as
follows (in thousands):
2005 2004
Commitments to extend credit $33,250 $31,333
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since
commitments may expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. The Bank evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of credit,
is based on management's credit evaluation of the party. Collateral held
varies, but may include accounts receivable, inventory, property and
equipment, residential real estate, and income-producing commercial
properties.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these
claims, if any, will not have a material effect on the financial position of
the Company.
Note 20 Significant Concentrations of Credit Risk
Most of the Bank's lending activity is with customers located in the state of
Washington and involves real estate. At September 30, 2005, the Bank had
$416,531,000 (including $42,771,000 of undisbursed construction loan proceeds)
in loans secured by real estate, which represents 95.1% of the total loan
portfolio. The real estate loan portfolio is primarily secured by one- to
four-family properties, multi-family properties, undeveloped land, and a
variety of commercial real estate property types. At September 30, 2005,
there were no concentrations of real estate loans to a specific industry or
secured by a specific collateral type that equaled or exceeded 20% of the
Bank's total loan portfolio, other than loans secured by one-to four-family
properties. The ultimate collectibility of a substantial portion of the loan
portfolio is susceptible to changes in economic and market conditions in the
region and the impact of those changes on the real estate market. The Bank
typically maintains loan-to-value ratios of no greater than 90% on real estate
loans.
The Bank believes its lending policies and procedures adequately minimize the
potential exposure to such risks and that adequate provisions for loan losses
are provided for all known and inherent risks. Collateral and / or guarantees
are required for all loans.
90
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 21 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Company's consolidated financial statements.
Under capital adequacy guidelines of the regulatory framework for prompt
corrective action, the Bank must meet specific capital adequacy guidelines
that involve quantitative measures of the Bank's assets, liabilities and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Bank's capital classification is also subject to qualitative
judgments by the regulators about components, risk weightings and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios as
defined in the regulations (set forth in the table below) of Tier 1 capital to
average assets, and minimum ratios of Tier 1 and total capital to risk-
weighted assets.
At September 30, 2005, the most recent notification from the Bank's regulator
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank
must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or events since
that notification that management believes have changed the Bank's category.
The Company's and the Bank's actual capital amounts (dollars in thousands) and
ratios are also presented in the table.
To be Well
Capitalized
Under Prompt
Capital Corrective
Adequacy Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
September 30, 2005
Tier 1 capital
(to average assets):
Consolidated $67,074 12.3% $21,833 4.0% N/A N/A
Timberland Bank 58,224 10.7 21,783 4.0 $27,229 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 67,074 16.8 15,936 4.0 N/A N/A
Timberland Bank 58,224 14.7 15,838 4.0 23,757 6.0
Total capital (to
risk-weighted
assets):
Consolidated 71,173 17.9 31,873 8.0 N/A N/A
Timberland Bank 62,323 15.7 31,677 8.0 39,596 10.0
September 30, 2004
Tier 1 capital
(to average
assets):
Consolidated $72,512 16.2% $17,883 4.0% N/A N/A
Timberland Bank 63,434 14.2 17,848 4.0 $22,310 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 72,512 21.0 13,813 4.0 N/A N/A
Timberland Bank 63,434 18.5 13,694 4.0 20,541 6.0
Total capital
(to risk-weighted
assets):
Consolidated 76,503 22.2 27,626 8.0 N/A N/A
Timberland Bank 67,425 19.7 27,388 8.0 34,235 10.0
(continued)
91
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 21 - Regulatory Matters (concluded)
Restrictions on Retained Earnings
The Bank is subject to certain restrictions on the amount of dividends that it
may declare without prior regulatory approval.
At the time of conversion of the Bank from a Washington-chartered mutual
savings bank to a Washington-chartered stock savings bank, the Bank
established a liquidation account in an amount equal to its retained earnings
of $23,866,000 as of June 30, 1997, the date of the latest statement of
financial condition used in the final conversion prospectus. The liquidation
account will be maintained for the benefit of eligible withdrawable account
holders who have maintained their deposit accounts in the Bank after
conversion. The liquidation account reduces annually to the extent that
eligible account holders have reduced their qualifying deposits as of each
anniversary date. Subsequent increases will not restore an eligible account
holder's interest in the liquidation account. In the event of a complete
liquidation of the Bank (and only in such an event), eligible depositors who
have continued to maintain accounts will be entitled to receive a distribution
from the liquidation account before any liquidation may be made with respect
to common stock. The Bank may not declare or pay cash dividends if the effect
thereof would reduce its regulatory capital below the amount required for the
liquidation account.
Note 22 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(In Thousands)
2005 2004
Assets
Cash and due from financial institutions $ 229 $ 137
Interest-bearing deposits in banks 414 670
Investments and mortgage-backed securities
(available for sale) 2,084 2,109
Loan receivable from Bank 5,032 5,515
Investment in Bank 65,777 63,628
Other assets 1,223 828
Total assets $74,759 $72,887
Liabilities and Shareholders' Equity
Accrued expenses $ 117 $ 70
Shareholders' equity 74,642 72,817
Total liabilities and shareholders' equity $74,759 $72,887
(continued)
92
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 22 - Condensed Financial Information - Parent Company Only (continued)
Condensed Statements of Income - Years Ended September 30
(In Thousands)
2005 2004 2003
Operating Income
Interest-bearing deposits in banks $ 11 $ 9 $ 12
Interest on loan receivable from Bank 454 494 528
Dividends on investments 66 63 88
Loss on sale of investment securities
available for sale -- (6) --
Dividends from Bank 5,029 9,169 6,650
Total operating income 5,560 9,729 7,278
Operating Expenses 460 507 329
Income before income taxes and equity
in undistributed income of Bank 5,100 9,222 6,949
Income Taxes (Benefit) (96) (77) 16
Income before equity in undistributed
income of Bank 5,196 9,299 6,933
Equity in Undistributed Income of Bank
(Dividends in Excess of Income of Bank) 1,422 (3,711) (294)
Net income $6,618 $5,588 $6,639
(continued)
93
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 22 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(In Thousands)
2005 2004 2003
Cash Flows from Operating Activities
Net income $ 6,618 $5,588 $ 6,639
Adjustments to reconcile net income
to net cash provided:
(Equity in undistributed income of
Bank) dividends in excess of income
of Bank (1,422) 3,711 294
ESOP shares earned 822 781 648
MRDP shares earned 666 812 803
Loss on sale of securities available
for sale -- 6 --
Other, net (340) (480) (291)
Net cash provided by operating activities 6,344 10,418 8,093
Cash Flows from Investing Activities
Net (increase) decrease in interest-bearing
deposits in banks 256 682 (1,093)
Investment in Bank (1,424) (1,499) (1,515)
Proceeds from sales of securities available
for sale -- 1,600 --
Principal repayments on loan receivable from
Bank 483 444 408
Net cash provided by (used in) investing
activities (685) 1,227 (2,200)
Cash Flows from Financing Activities
Decrease in note payable -- -- (1,290)
Proceeds from exercise of stock options 814 1,748 1,491
Repurchase of common stock (4,064) (11,079) (3,852)
Payment of dividends (2,317) (2,320) (2,150)
Net cash used in financing activities (5,567) (11,651) (5,801)
Net increase (decrease) in cash 92 (6) 92
Cash and Due from Financial Institutions
Beginning of year 137 143 51
End of year $ 229 $ 137 $ 143
94
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 23 - Earnings Per Share Disclosures
Basic earnings per share are computed by dividing net income applicable to
common stock by the weighted average number of common shares outstanding
during the period, without considering any dilutive items. Diluted earnings
per share are computed by dividing net income applicable to common stock by
the weighted average number of common shares and common stock equivalents for
items that are dilutive, net of shares assumed to be repurchased using the
treasury stock method at the average share price for the Company's common
stock during the period. Common stock equivalents arise from assumed
conversion of outstanding stock options and from assumed vesting of shares
awarded but not released under the Company's Management Recognition and
Development Plan. In accordance with Statement of Position 93-6, Employers'
Accounting for Employee Stock Ownership Plans, issued by the American
Institute of Certified Public Accountants, shares owned by the Bank's Employee
Stock Ownership Plan that have not been allocated are not considered to be
outstanding for the purpose of computing earnings per share. Information
regarding the calculation of basic and diluted earnings per share for the
years ended September 30 is as follows (dollars in thousands, except per share
amounts):
2005 2004 2003
Basic EPS Computation
Numerator - net income $6,618 $5,588 $6,639
Denominator - weighted average common
shares outstanding 3,475,400 3,637,510 3,814,344
Basic EPS $1.90 $1.54 $1.74
Diluted EPS Computation
Numerator - net income $6,618 $5,588 $6,639
Denominator - weighted average common
shares outstanding 3,475,400 3,637,510 3,814,344
Effect of dilutive stock options 132,732 161,808 158,238
Effect of dilutive MRDP shares 19,857 28,679 31,619
Weighted average common shares outstanding-
assuming dilution 3,627,989 3,827,997 4,004,201
Diluted EPS $1.82 $1.46 $1.66
95
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 24 - Comprehensive Income
Net unrealized gains and losses included in comprehensive income were computed
as follows for the years ended September 30 (in thousands):
Tax
Before-Tax (Benefit) Net-of-Tax
Amount Expense Amount
2005
Unrealized holding losses arising
during the year ($1,083) ($369) ($714)
Net unrealized losses ($1,083) ($369) ($714)
2004
Unrealized holding losses arising
during the year ($497) ($169) ($328)
Reclassification adjustment for
gains included in net income 6 2 4
Net unrealized losses ($491) ($167) ($324)
2003
Unrealized holding gains arising
during the year ($417) ($142) ($275)
Reclassification adjustment for
losses included in net income (135) (46) (89)
Net unrealized gains ($552) ($188) ($364)
96
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 25 - Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures About Fair
Value of Financial Instruments, requires disclosure of estimated fair values
for financial instruments. Such estimates are subjective in nature, and
significant judgment is required regarding the risk characteristics of various
financial instruments at a discrete point in time. Therefore, such estimates
could vary significantly if assumptions regarding uncertain factors were to
change. Major assumptions, methods and fair value estimates for the Company's
significant financial instruments are set forth below:
Cash and Due from Financial Institutions, Interest-Bearing Deposits in
Banks, and Federal Funds Sold
The recorded amount is a reasonable estimate of fair value.
Investments and Mortgage-Backed Securities
The fair value of investments and mortgage-backed securities has been based
on quoted market prices or dealer quotes.
Federal Home Loan Bank Stock
The recorded value of stock holdings approximates fair value.
Loans Receivable and Loans Held for Sale
Fair value of loans is estimated for portfolios of loans with similar
financial characteristics. Fair value is estimated by discounting the
future cash flows using the current rates at which similar loans would be
made to borrowers for the same remaining maturities. Prepayments are based
on the historical experience of the Bank. Loans held for sale has been
based on quoted market prices.
Deposits
The fair value of deposits with no stated maturity date is included at the
amount payable on demand. The fair value of fixed maturity certificates of
deposit is estimated by discounting future cash flows using the rates
currently offered by the Bank for deposits of similar remaining maturities.
Federal Home Loan Bank Advances
The fair value of borrowed funds is estimated by discounting the future
cash flows of the borrowings at a rate which approximates the current
offering rate of the borrowings with a comparable remaining life.
Other Borrowings: Repurchase Agreements
The recorded value of repurchase agreements approximates fair value.
Accrued Interest
The recorded amounts of accrued interest approximate fair value.
Off-Balance-Sheet Instruments
The fair value of commitments to extend credit was estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
customers. Since the majority of the Bank's off-balance-sheet instruments
consist of non-fee producing, variable-rate commitments, the Bank has
determined they do not have a distinguishable fair value.
(continued)
97
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 25 - Fair Value of Financial Instruments (concluded)
The estimated fair value of financial instruments at September 30 were as
follows (in thousands):
2005 2004
Recorded Fair Recorded Fair
Amount Value Amount Value
Financial Assets
Cash and due from financial
institutions and interest-
bearing deposits in banks $23,083 $23,083 $18,653 $18,653
Federal funds sold 5,635 5,635 1,180 1,180
Investments and mortgage-backed
securities 89,699 89,696 60,063 60,055
Federal Home Loan Bank stock 5,705 5,705 5,682 5,682
Loans receivable 388,109 387,086 344,594 342,700
Accrued interest receivable 2,294 2,294 1,828 1,828
Financial Liabilities
Deposits $411,665 $412,115 $319,570 $319,909
Federal Home Loan Bank advances -
short term 8,000 8,000 10,485 10,485
Federal Home Loan Bank advances -
long term 54,353 55,421 54,936 58,435
Other borrowings: repurchase
agreements 781 781 -- --
Accrued interest payable 708 708 461 461
The Bank assumes interest rate risk (the risk that general interest rate
levels will change) as a result of its normal operations. As a result, the
fair value of the Bank's financial instruments will change when interest rate
levels change and that change may either be favorable or unfavorable to the
Bank. Management attempts to match maturities of assets and liabilities to
the extent believed necessary to minimize interest rate risk. However,
borrowers with fixed interest rate obligations are less likely to prepay in a
rising interest rate environment and more likely to prepay in a falling
interest rate environment. Conversely, depositors who are receiving fixed
interest rates are more likely to withdraw funds before maturity in a rising
interest rate environment and less likely to do so in a falling interest rate
environment. Management monitors interest rates and maturities of assets and
liabilities, and attempts to minimize interest rate risk by adjusting terms of
new loans, and deposits and by investing in securities with terms that
mitigate the Bank's overall interest rate risk.
Note 26 - Stock Repurchase Plan
In April 2005, the Company initiated a stock repurchase plan for the purchase
of 187,955 shares of stock. As of September 30, 2005, 27,850 shares have been
repurchased. The remainder is anticipated to be purchased during the year
ending September 30, 2006.
98
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 27 - Subsequent Event
On October 25, 2005, the board of directors approved a dividend in the amount
of $0.16 per share to be paid on November 23, 2005 to shareholders of record
as of November 9, 2005.
Note 28 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data are presented for the quarters ended (in
thousands, except per share amounts):
September 30, June 30, March 31, December 31
2005 2005 2005 2004
Interest and dividend income $8,166 $8,037 $7,430 $7,303
Interest expense (2,443) (2,228) (2,004) (1,934)
Net interest income 5,723 5,809 5,426 5,369
Provision for loan losses (25) (96) (20) - -
Non-interest income 1,647 1,548 1,340 1,538
Non-interest expense (4,640) (4,465) (4,671) (4,760)
Income before income taxes 2,705 2,796 2,075 2,147
Federal income taxes 867 961 624 653
Net income $1,838 $1,835 $1,451 $1,494
Basic earnings per share $0.533 $0.537 $0.415 $0.420
Diluted earnings per share 0.513 0.513 0.398 0.401
(continued)
99
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2005 and 2004
Note 28 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30, June 30, March 31, December 31
2004 2004 2004 2003
Interest and dividend income $6,671 $6,592 $6,590 $6,718
Interest expense (1,743) (1,711) (1,892) (1,979)
Net interest income 4,928 4,881 4,698 4,739
Provision for loan losses (73) (14) (30) (50)
Non-interest income 1,078 1,118 1,245 1,135
Non-interest expense (4,012) (3,894) (3,843) (3,826)
Income before income taxes 1,921 2,091 2,070 1,998
Federal income taxes 588 645 647 611
Net income $1,332 $1,446 $1,423 $1,387
Basic earnings per share $.380 $.414 $.384 $.361
Diluted earnings per share .363 .394 .365 .341
100
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
- ------------------------------------------------------------------------
Not applicable.
Item 9A. Controls and Procedures
- ---------------------------------
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
the Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
of the Securities Exchange Act of 1934 (the "Exchange Act")) was carried out
under the supervision and with the participation of the Company's Chief
Executive Officer, Chief Financial Officer and several other members of the
Company's senior management as of the end of the period covered by this annual
report. The Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures as currently
in effect are effective in ensuring that the information required to be
disclosed by the Company in the reports it files or submits under the Act is
(i) accumulated and communicated to the Company's management (including the
Chief Executive Officer and Chief Financial Officer) in a timely manner, and
(ii) recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms.
(b) Changes in Internal Controls: There have been no changes in our
internal control over financial reporting (as defined in 13a-15(f) of the Act)
that occurred during the quarter ended September 30, 2005, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. The Company continued, however, to implement
suggestions from its internal auditor and independent auditors on ways to
strengthen existing controls. The Company does not expect that its disclosure
controls and procedures and internal controls over financial reporting will
prevent all error and fraud. A control procedure, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control procedure are met. Because of the inherent
limitations in all control procedures, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgements in decision-making can be faulty, and that
breakdowns in controls or procedures can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control. The design of any control procedure is based in part upon
certain assumptions about the likelihood of future events and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, controls become inadequate because of
changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control procedure, misstatements due to error or fraud may
occur and not de detected.
Management's Report on Internal Control Over Financial Reporting is
included in this Form 10-K under Part II, Item 8, "Financial Statements and
Supplementary Data."
Item 9B. Other Information
- ---------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information contained under the section captioned "Proposal I -
Election of Directors" is included in the Company's Definitive Proxy Statement
for the 2006 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."
101
Compliance with Section 16(a) of the Exchange Act
The information contained under the section captioned "Section 16(a)
Beneficial Ownership Reporting Compliance" is included in the Company's Proxy
Statement and is incorporated herein by reference.
Audit Committee Financial Expert
The Company has a separately designated standing Audit Committee, composed
of Directors Warren, Robbel and Smith. Each member of the Audit Committee is
"independent" as defined in the Nasdaq Stock Market listing standards. The
Company's Board of Directors has designated Directors Warren and Robbel as the
Audit Committee financial experts, as defined in the SEC's Regulation S-K.
Directors Warren, Robbel and Smith are independent as that term is used in
Item 7(d)(3)(iv) 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, 2005. 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.
Item 11. Executive Compensation
- --------------------------------
The information contained under the sections captioned "Executive
Compensation," "Directors' Compensation" and "Compensation Committee
Interlocks and Insider Participation" is included in the Company's Proxy
Statement and is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
- ------------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners.
The information contained under the section captioned "Security Ownership
of Certain Beneficial Owners and Management" is included in the Company's
Proxy Statement and is incorporated herein by reference.
(b) Security Ownership of Management.
The information contained under the sections captioned "Security Ownership
of Certain Beneficial Owners and Management" and "Proposal I - Election of
Directors" is included in the Company's Proxy Statement and are incorporated
herein by reference.
(c) Changes In Control.
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
102
(d) Equity Compensation Plan Information. The following table
summarizes share and exercise price information about the Company's equity
compensation plans as of September 30, 2005.
Number of securities
remaining available
for future
Number of securities Weighted-average issuance under
to be issued upon exercise price of equity compensation
exercise of outstanding plans (excluding
outstanding options, options, warrants, securities reflected
Plan category warrants and rights and rights in column (a))
- --------------- ------------------- ----------------- --------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders:
Management
Recognition and
Development Plan... -- -- 59,573
1999 Stock Option
Plan............... 350,280 $13.54 1,339
2003 Stock Option
Plan............... 12,131 23.25 137,869
Equity compensation
plans not approved
by security
holders............. -- -- --
-------- ------- -------
Total............. 362,411 $13.86 198,781
======== ======= =======
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information contained under the section captioned "Certain
Relationships and Related Transactions" is included in the Company's Proxy
Statement and is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
- ------------------------------------------------
The information contained under the section captioned "Independent
Auditors" is included in the Company's Proxy Statement and is incorporated
herein by reference.
PART IV
Item 15. Exhibits and Financial Statement Schedules
- ----------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (1)
3.2 Bylaws of the Registrant (1)
3.3 Amendment to Bylaws(2)
10.1 Employee Severance Compensation Plan (3)
10.2 Employee Stock Ownership Plan (3)
10.3 1999 Stock Option Plan (4)
10.4 2003 Stock Option Plan (5)
10.5 Form of Incentive Stock Option Agreement
10.6 Form of Non-qualified Stock Option Agreement
10.7 Management Recognition and Development Plan (4)
10.8 Form of Management Recognition and Development Award
Agreement
14 Code of Ethics (6)
21 Subsidiaries of the Registrant
23 Consent of Accountants
103
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act
- -------------
(1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1
(333-35817).
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2002.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997.
(4) Incorporated by reference to Exhibit 99 included in the Registrant's
Registration Statement on Form S-8 (333-32386)
(5) Incorporated by reference to Exhibit 99.2 included in the Registrant's
Registration Statement on Form S-8(333-1161163)
(6) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2003.
104
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
TIMBERLAND BANCORP, INC.
Date: December 6, 2005 By:/s/Michael R. Sand
-------------------------------------
Michael R. Sand
President and Chief Executive Officer
Pursuant to the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
SIGNATURES TITLE DATE
/s/Michael R. Sand President, Chief Executive Officer December 6, 2005
- ---------------------- and Director
Michael R. Sand (Principal Executive Officer)
/s/Clarence E. Hamre Chairman of the Board December 6, 2005
- ----------------------
Clarence E. Hamre
/s/Dean J. Brydon Chief Financial Officer December 6, 2005
- ---------------------- (Principal Financial and
Dean J. Brydon Accounting Officer)
/s/Andrea M. Clinton Director December 6, 2005
- ----------------------
Andrea M. Clinton
/s/David A. Smith Director December 6, 2005
- ----------------------
David A. Smith
/s/Harold L. Warren Director December 6, 2005
- ----------------------
Harold L. Warren
/s/Jon C. Parker Director December 6, 2005
- ----------------------
Jon C. Parker
/s/James C. Mason Director December 6, 2005
- ----------------------
James C. Mason
/s/Ronald A. Robbel Director December 6, 2005
- ----------------------
Ronald A. Robbel
105
EXHIBIT INDEX
Exhibit No. Description of Exhibit
---------- -------------------------------------------------------
10.5 Form of Incentive Stock Option Agreement
10.6 Form of Non-qualified Stock Option Agreement
10.8 Form of Management Recognition and Development Award
Agreement
21 Subsidiaries of the Registrant
23 Consent of Accountants
31.1 Certification of Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act
Exhibit 10.5
Form of Incentive Stock Option Agreement
TIMBERLAND BANCORP, INC.
2003 STOCK OPTION PLAN
INCENTIVE STOCK OPTION AGREEMENT
--------------------------------
ISO NO.
-----
This Option is granted on ______________ ____, ____ (the "Grant Date"),
by Timberland Bancorp, Inc., a Washington corporation ("Corporation"), to
_________________ (the "Optionee"), in accordance with the following terms and
conditions:
1. Option Grant and Exercise Period. The Corporation hereby grants to
the Optionee an Incentive Stock Option ("Option") to purchase, pursuant to the
Timberland Bancorp, Inc. 2003 Stock Option Plan, as the same may be amended
from time to time (the "Plan"), and upon the terms and conditions therein and
hereinafter set forth, an aggregate of _______ shares (the "Option Shares") of
the common stock of the Corporation ("Share" or "Shares") at the price of
$______ per Share (the "Exercise Price"). A copy of the Plan, as currently in
effect, is incorporated herein by reference and is attached to this Award
Agreement.
Except as provided in Sections 8 and 9 below, this Option shall be
exercisable only during the period (the "Exercise Period") commencing on the
dates set forth in Section 2 below, and ending at 5:00 p.m., Hoquiam,
Washington time, on the date ten years after the Grant Date, such later time
and date being hereinafter referred to as the "Expiration Date," subject to
earlier expiration in accordance with Section 5 in the event of a Termination
of Service. The aggregate Market Value (as determined on the Grant Date) of
the Option Shares with respect to which Incentive Stock Options are
exercisable for the first time by the Optionee in any calendar year shall not
exceed One Hundred Thousand Dollars ($100,000.00). To the extent that this
Option does not qualify as an Incentive Stock Option for any reason, it shall
be deemed ab initio to be a Non-Qualified Stock Option.
2. Method of Exercise of This Option. This Option may be exercised
during the Exercise Period, with respect to not more than the cumulative
number of the Option Shares set forth below on or after the dates indicated,
by giving written notice to the Corporation as hereinafter provided specifying
the number of the Option Shares to be purchased.
Cumulative Number of
Option Shares Exercisable Date
------------------------- ----
The notice of exercise of this Option shall be in the form prescribed by the
Committee referred to in Section 3 of the Plan and directed to the address set
forth in Section 12 below. The date of exercise is the date on which such
notice is received by the Corporation. Such notice shall be accompanied by
payment in full of the Exercise Price for the Option Shares to be purchased
upon such exercise. Payment shall be made (i) in cash, which may be in the
form of a check, money order, cashier's check or certified check, payable to
the Corporation, or (ii) by delivering Shares already owned by the Optionee
having a Market Value equal to the Exercise Price, or (iii) a combination of
cash and such Shares. Promptly after such payment, subject to Section 3
below, the Corporation shall issue and deliver to the Optionee or other person
exercising this Option a certificate or certificates representing the Option
Shares so purchased, registered in the name of the Optionee (or such other
person), or, upon request, in the name of the Optionee (or such other person)
and in the name of another in such form of joint ownership as requested by the
Optionee (or such other person) pursuant to applicable state law.
3. Delivery and Registration of the Option Shares. The Corporation's
obligation to deliver the Option Shares hereunder shall, if the Committee so
requests, be conditioned upon the Optionee's compliance with the terms and
provisions of Section 11 of the Plan.
4. Nontransferability of This Option. This Option may not be assigned,
encumbered, transferred, pledged or hypothecated except, in the event of the
death of the Optionee, by will or the applicable laws of descent and
distribution to the extent provided in Section 5 below. This Option is
exercisable during the Optionee's lifetime only by the Optionee or a person
acting with the legal authority of the Optionee. The provisions of this
Option shall be binding upon, inure to the benefit of and be enforceable by
the parties hereto, the successors and assigns of the Corporation and any
person acting with the legal authority of the Optionee to whom this Option is
transferred by will or by the laws of descent and distribution.
5. Termination of Service or Death or Disability of the Optionee.
Except as provided in this Section 5 and in Section 9 below, and
notwithstanding any other provision of this Option to the contrary, this
Option shall be exercisable only if the Optionee has not incurred a
Termination of Service at the time of such exercise.
If the Optionee incurs a Termination of Service for any reason excluding
death, Disability and Termination of Service for Cause, then the Optionee may,
but only within the period of three months immediately succeeding such
Termination of Service and in no event after the Expiration Date, exercise
this Option to the extent the Optionee was entitled to exercise this Option on
the date of Termination of Service. If the Optionee incurs a Termination of
Service for Cause, all rights under this Option shall expire immediately upon
the giving to the Optionee of notice of such termination, except as provided
in Section 9 below.
In the event of the death or Disability of the Optionee prior to the
Optionee's Termination of Service or within three months thereafter, the
Optionee or person or persons to whom the Option has been transferred by will
or by the laws of descent and distribution may, but only to the extent the
Optionee was entitled to exercise this Option on the date of the Optionee's
death or Disability, exercise this Option at any time within one year
following the death or Disability of the Optionee, but in no event after the
Expiration Date.
Following the death of the Optionee, the Committee may, in its sole
discretion, as an alternative means of settlement of this Option, elect to pay
to the person to whom this Option is transferred by will or by the laws of
descent and distribution, the amount by which the Market Value per Share on
the date of exercise of this Option shall exceed the Exercise Price for each
of the Option Shares, multiplied by the number of the Option Shares with
respect to which this Option is properly exercised. Any such settlement of
this Option shall be considered an exercise of this Option for all purposes of
this Option and of the Plan.
6. Notice of Sale. The Optionee or any person to whom the Option Shares
shall have been transferred shall promptly give notice to the Corporation in
the event of the sale or other disposition of the Option Shares within the
later of (i) two years from the Grant Date or (ii) one year from the date of
exercise of this Option. Such notice shall specify the number of the Option
Shares sold or otherwise disposed of and be directed to the address set forth
in Section 12 below.
7. Adjustments for Changes in Capitalization of the Corporation. In the
event of any change in the outstanding Shares by reason of any
recapitalization, stock split, reverse stock split, stock dividend,
reorganization, consolidation, combination or exchange of shares, merger, or
any other change in the corporate structure of the Corporation or in the
Shares, the number and class of the Option Shares covered by this Option and
the Exercise Price shall be appropriately adjusted by the Committee, whose
determination shall be conclusive.
8. Effect of Merger or Other Reorganization. In the event of any
merger, consolidation or combination of the Corporation with or into another
corporation (other than a merger, consolidation or combination in which the
Corporation is the continuing corporation and which does not result in the
outstanding Shares being converted into or exchanged for different securities,
cash or other property, or any combination thereof), the Optionee shall have
the right (subject to the provisions of the Plan and the limitations contained
herein), thereafter and during the Exercise Period, to receive upon exercise
of this Option an amount equal to the excess of the Market Value on the date
of such exercise of the securities, cash or other property, or combination
thereof, receivable upon such merger, consolidation or combination in respect
of a Share over the Exercise Price, multiplied by the number of the Option
Shares with respect to which this Option shall have been exercised. Such
amount may be payable fully in cash, fully in one or more of the kind or kinds
of property payable in such merger, consolidation or combination, or partly in
cash and partly in one or
ISO-2
more of such kind or kinds of property, all in the discretion of the
Committee. The exercise of the right provided herein shall result in that
portion of this Option so exercised being disqualified as an incentive stock
option for tax purposes and being deemed a non-qualified stock option for tax
purposes.
9. Effect of Change in Control. If a tender offer or exchange offer for
Shares (other than such an offer by the Corporation) is commenced, or if a
change in control as defined in the Plan shall occur, all Options theretofore
granted and not fully exercisable shall become exercisable in full upon the
happening of such event.
10. Stockholder Rights Not Granted by This Option. The Optionee is not
entitled by virtue hereof to any rights of a stockholder of the Corporation or
to notice of meetings of stockholders or to notice of any other proceedings
of the Corporation.
11. Withholding Tax. Where the Optionee or another person is entitled to
receive the Option Shares pursuant to the exercise of this Option, the
Corporation shall have the right to require the Optionee or such other person
to pay to the Corporation the amount of any taxes which the Corporation or any
of its Affiliates is required to withhold with respect to the Option Shares,
or in lieu thereof, to retain, or sell without notice, a sufficient number of
the Option Shares to cover the amount required to be withheld, or, in lieu of
any of the foregoing, to withhold a sufficient sum from the Optionee's
compensation payable by the Corporation to satisfy the Corporation's tax
withholding requirements.
12. Notices. All notices hereunder to the Corporation shall be delivered
or mailed to it addressed to the Corporate Secretary of Timberland Bancorp,
Inc., 624 Simpson Avenue, Hoquiam, Washington 98550. Any notices hereunder to
the Optionee shall be delivered personally or mailed to the Optionee's address
noted below. Such addresses for the service of notices may be changed at any
time provided written notice of the change is furnished in advance to the
Corporation or to the Optionee, as the case may be.
13. Plan and Plan Interpretations as Controlling. This Option and
the terms and con-ditions herein set forth are subject in all respects to the
terms and conditions of the Plan, which are controlling. Capitalized terms
used herein which are not defined in this Award Agreement shall have the
meaning ascribed to such terms in the Plan. All determinations and
interpretations made in the discretion of the Committee shall be final and
conclusive upon the Optionee or his legal representatives with regard to any
question arising hereunder or under the Plan.
14. Optionee Service. Nothing in this Option shall limit the right of
the Corporation or any of its Affiliates to terminate the Optionee's service
as an employee, or otherwise impose upon the Corporation or any of its
Affiliates any obligation to employ or accept the services of the Optionee.
15. Amendment. The Committee may waive any conditions of or rights of
the Corporation or modify or amend the terms of this Award Agreement;
provided, however, that the Committee may not amend, alter, suspend,
discontinue or terminate any provision hereof which may adversely affect the
Optionee without the Optionee's (or his legal representative's) written
consent.
16. Optionee Acceptance. The Optionee shall signify his acceptance of
the terms and conditions of this Option by signing in the space provided below
and returning a signed copy hereof to the Corporation at the address set forth
in Section 12 above.
ISO-3
IN WITNESS WHEREOF, the parties hereto have caused this Award Agreement
to be executed as of the date first above written.
TIMBERLAND BANCORP, INC.
By: ________________________________
Its: ________________________________
ACCEPTED:
______________________________________
(Signature)
______________________________________
(Street Address)
______________________________________
(City, State and Zip Code)
ISO-4
Exhibit 10.6
Form of Non-qualified Stock Option Agreement
TIMBERLAND BANCORP, INC.
2003 STOCK OPTION PLAN
NON-QUALIFIED STOCK OPTION AGREEMENT
------------------------------------
NQSO NO. _____
This Option is granted on ______________ ____, ____ (the "Grant Date"),
by Timberland Bancorp, Inc., a Washington corporation ("Corporation"), to
_________________ (the "Optionee"), in accordance with the following terms and
conditions:
1. Option Grant and Exercise Period. The Corporation hereby grants to
the Optionee a Non-Qualified Option ("Option") to purchase, pursuant to the
Timberland Bancorp, Inc. 2003 Stock Option Plan, as the same may be amended
from time to time (the "Plan"), and upon the terms and conditions therein and
hereinafter set forth, an aggregate of _______ shares (the "Option Shares") of
the common stock of the Corporation ("Share" or "Shares") at the price of
$______ per Share (the "Exercise Price"). A copy of the Plan, as currently in
effect, is incorporated herein by reference and is attached to this Award
Agreement.
Except as provided in Sections 7 and 8 below, this Option shall be
exercisable only during the period (the "Exercise Period") commencing on the
dates set forth in Section 2 below, and ending at 5:00 p.m., Hoquiam,
Washington time, on the date ten years after the Grant Date, such later time
and date being hereinafter referred to as the "Expiration Date," subject to
earlier expiration in accordance with Section 5 in the event of a Termination
of Service.
2. Method of Exercise of This Option. This Option may be exercised
during the Exercise Period, with respect to not more than the cumulative
number of the Option Shares set forth below on or after the dates indicated,
by giving written notice to the Corporation as hereinafter provided specifying
the number of the Option Shares to be purchased.
Cumulative Number of
Option Shares Exercisable Date
------------------------- ----
The notice of exercise of this Option shall be in the form prescribed by the
Committee referred to in Section 3 of the Plan and directed to the address set
forth in Section 11 below. The date of exercise is the date on which such
notice is received by the Corporation. Such notice shall be accompanied by
payment in full of the Exercise Price for the Option Shares to be purchased
upon such exercise. Payment shall be made (i) in cash, which may be in the
form of a check, money order, cashier's check or certified check, payable to
the Corporation, or (ii) by delivering Shares already owned by the Optionee
having a Market Value equal to the Exercise Price, or (iii) a combination of
cash and such Shares. Promptly after such payment, subject to Section 3
below, the Corporation shall issue and deliver to the Optionee or other person
exercising this Option a certificate or certificates representing the Option
Shares so purchased, registered in the name of the Optionee (or such other
person), or, upon request, in the name of the Optionee (or such other person)
and in the name of another in such form of joint ownership as requested by the
Optionee (or such other person) pursuant to applicable state law.
3. Delivery and Registration of the Option Shares. The Corporation's
obligation to deliver the Option Shares hereunder shall, if the Committee so
requests, be conditioned upon the Optionee's compliance with the terms and
provisions of Section 11 of the Plan.
4. Nontransferability of This Option. This Option may not be assigned,
encumbered, transferred, pledged or hypothecated except, (i) in the event of
the death of the Optionee, by will or the applicable laws of descent and
distribution, (ii) pursuant to a "domestic relations order," as defined in
Section 414(p)(1)(B) of the Code, (iii) by gift to any member of the
Optionee's immediate family or to a trust for the benefit of one or more of
such immediate family members. During the lifetime of the Optionee, this
Option shall be exercisable only by the Optionee or a person acting
with the legal authority of the Optionee unless it has been transferred as
permitted hereby, in which case it shall be exercisable only by such
transferee. The provisions of this Option shall be binding upon, inure to the
benefit of and be enforceable by the parties hereto, the successors and
assigns of the Corporation and any person acting with the legal authority of
the Optionee to whom this Option is transferred in accordance with this
Section 4.
5. Termination of Service or Death or Disability of the Optionee.
Except as provided in this Section 5 and in Section 8 below, and
notwithstanding any other provision of this Option to the contrary, this
Option shall be exercisable only if the Optionee has not incurred a
Termination of Service at the time of such exercise.
If the Optionee incurs a Termination of Service for any reason excluding
death, Disability and Termination of Service for Cause, then the Optionee may,
but only within the period of one year immediately succeeding such Termination
of Service and in no event after the Expiration Date, exercise this Option to
the extent the Optionee was entitled to exercise this Option on the date of
Termination of Service. If the Optionee incurs a Termination of Service for
Cause, all rights under this Option shall expire immediately upon the giving
to the Optionee of notice of such termination, except as provided in Section 8
below.
In the event of the death or Disability of the Optionee prior to the
Optionee's Termination of Service or within three months thereafter, the
Optionee or person or persons to whom the Option has been transferred pursuant
to Section 4 may, but only to the extent the Optionee was entitled to exercise
this Option on the date of the Optionee's death or Disability, exercise this
Option at any time within two years following the death or Disability of the
Optionee, but in no event after the Expiration Date.
Cause shall mean termination of the employment of the Optionee with
either the Corporation or any Affiliate, as the case may be, because of the
Optionee's dishonesty, incompetence, willful misconduct, breach of a fiduciary
duty involving personal profit, intentional failure to perform stated duties
or willful violation of any law, rule, or regulation (excluding violations
which do not have a material adverse affect on the Corporation or its
Affiliates) or final cease-and-desist order. No act or failure to act by the
Optionee shall be considered willful unless the Optionee acted or failed to
act with an absence of good faith and without a reasonable belief that his
action or failure to act was in the best interest of the Corporation.
Following the death of the Optionee, the Committee may, in its sole
discretion, as an alternative means of settlement of this Option, elect to pay
to the person to whom this Option is transferred pursuant to Section 4 the
amount by which the Market Value per Share on the date of exercise of this
Option shall exceed the Exercise Price for each of the Option Shares,
multiplied by the number of the Option Shares with respect to which this
Option is properly exercised. Any such settlement of this Option shall be
considered an exercise of this Option for all purposes of this Option and of
the Plan.
6. Adjustments for Changes in Capitalization of the Corporation. In
the event of any change in the outstanding Shares by reason of any
recapitalization, stock split, reverse stock split, stock dividend,
reorganization, consolidation, combination or exchange of shares, merger, or
any other change in the corporate structure of the Corporation or in the
Shares, the number and class of the Option Shares covered by this Option and
the Exercise Price shall be appropriately adjusted by the Committee, whose
determination shall be conclusive.
7. Effect of Merger or Other Reorganization. In the event of any
merger, consolidation or combination of the Corporation with or into another
corporation (other than a merger, consolidation or combination in which the
Corporation is the continuing corporation and which does not result in the
outstanding Shares being converted into or exchanged for different securities,
cash or other property, or any combination thereof), the Optionee shall have
the right (subject to the provisions of the Plan and the limitations contained
herein), thereafter and during the Exercise Period, to receive upon exercise
of this Option an amount equal to the excess of the Market Value on the date
of such exercise of the securities, cash or other property, or combination
thereof, receivable upon such merger, consolidation or combination in respect
of a Share over the Exercise Price, multiplied by the number of the Option
Shares with respect to which this Option shall have been exercised. Such
amount may be payable fully in cash, fully in one or more of the kind or kinds
of property payable in such merger, consolidation or combination, or partly in
cash and partly in one or more of such kind or kinds of property, all in the
discretion of the Committee.
NQSO-2
8. Effect of Change in Control. If a tender offer or exchange offer
for Shares (other than such an offer by the Corporation) is commenced, or if a
change in control as defined in the Plan shall occur, all Options theretofore
granted and not fully exercisable shall become exercisable in full upon the
happening of such event.
9. Stockholder Rights Not Granted by This Option. The Optionee is not
entitled by virtue hereof to any rights of a stockholder of the Corporation or
to notice of meetings of stockholders or to notice of any other proceedings of
the Corporation.
10. Withholding Tax. Where the Optionee or another person is entitled
to receive the Option Shares pursuant to the exercise of this Option, the
Corporation shall have the right to require the Optionee or such other person
to pay to the Corporation the amount of any taxes which the Corporation or any
of its Affiliates is required to withhold with respect to the Option Shares,
or in lieu thereof, to retain, or sell without notice, a sufficient number of
the Option Shares to cover the amount required to be withheld, or, in lieu of
any of the foregoing, to withhold a sufficient sum from the Optionee's
compensation payable by the Corporation to satisfy the Corporation's tax
withholding requirements.
11. Notices. All notices hereunder to the Corporation shall be
delivered or mailed to it addressed to the Corporate Secretary of Timberland
Bancorp, Inc., 624 Simpson Avenue, Hoquiam, Washington 98550. Any notices
hereunder to the Optionee shall be delivered personally or mailed to the
Optionee's address noted below. Such addresses for the service of notices may
be changed at any time provided written notice of the change is furnished in
advance to the Corporation or to the Optionee, as the case may be.
12. Plan and Plan Interpretations as Controlling. This Option and the
terms and con-ditions herein set forth are subject in all respects to the
terms and conditions of the Plan, which are controlling. Capitalized terms
used herein which are not defined in this Award Agreement shall have the
meaning ascribed to such terms in the Plan. All determinations and
interpretations made in the discretion of the Committee shall be final and
conclusive upon the Optionee or his legal representatives with regard to any
question arising hereunder or under the Plan.
13. Optionee Service. Nothing in this Option shall limit the right of
the Corporation or any of its Affiliates to terminate the Optionee's service
as a director, advisory director, director emeritus or employee, or otherwise
impose upon the Corporation or any of its Affiliates any obligation to employ
or accept the services of the Optionee.
14. Amendment. The Committee may waive any conditions of or rights of
the Corporation or modify or amend the terms of this Award Agreement;
provided, however, that the Committee may not amend, alter, suspend,
discontinue or terminate any provision hereof which may adversely affect the
Optionee without the Optionee's (or his legal representative's) written
consent.
15. Optionee Acceptance. The Optionee shall signify his acceptance of
the terms and conditions of this Option by signing in the space provided below
and returning a signed copy hereof to the Corporation at the address set forth
in Section 11 above.
NQSO-3
IN WITNESS WHEREOF, the parties hereto have caused this Award Agreement
to be executed as of the date first above written.
TIMBERLAND BANCORP, INC.
By: __________________________
Its: _______________________
ACCEPTED:
______________________________
(Signature)
______________________________
(Street Address)
______________________________
(City, State and Zip Code)
NQAO-4
Exhibit 10.8
Form of Management Recognition and Development Plan Award Agreement
TIMBERLAND BANCORP, INC.
MANAGEMENT RECOGNITION AND DEVELOPMENT PLAN
RESTRICTED STOCK AGREEMENT
--------------------------
RS No. __________
Shares of Restricted Stock are hereby awarded on ___________, 2001, by
Timberland Bancorp, Inc., a Washington corporation (the "Corporation"), to
______________ (the "Participant"), in accordance with the following terms and
conditions:
1. Share Award. The Corporation hereby awards to the Participant ______
shares ("Shares") of Common Stock of the Corporation ("Stock") pursuant to the
Timberland Bancorp, Inc. Management Recognition and Development Plan, as the
same may be amended from time to time (the "Plan"), and upon the terms and
conditions and subject to the restrictions therein and hereinafter set forth.
A copy of the Plan, as currently in effect, is incorporated herein by
reference and is attached hereto.
2. Restrictions on Transfer and Restricted Period. During the period
(the "Restricted Period") commencing on the date of this Award Agreement and
terminating on ____________, ____, Shares with respect to which the Restricted
Period has not lapsed may not be sold, assigned, transferred, pledged, or
otherwise encumbered by the Participant except, in the event of the death of
the Participant, by will or the laws of descent and distribution or pursuant
to a "domestic relations order," as defined in Section 414(p)(1)(B) the Code,
or as hereinafter provided. Shares with respect to which the Restricted
Period has lapsed shall sometimes be referred to herein as "Vested."
Subject to the provisions of Sections 3 and 8 below, Shares shall become
Vested in accordance with the following schedule.
Date of Vesting Number of Shares Vested
--------------- --------------------------
The Committee appointed by the Board of the Directors to administer the Plan
shall have the authority, in its discretion, to accelerate the time at which
any or all of the restrictions shall lapse with respect to any Shares or to
remove any or all of such restrictions, whenever the Committee may determine
that such action is appropriate by reason of changes in applicable tax or
other laws, changes in circumstances occurring after the commencement of the
Restricted Period, or any other reason.
3. Termination of Service. Except as provided in Section 8 below, if
the Participant incurs a termination of service for any reason (other than
death or Disability), all Shares which are not Vested at the time of such
termination of service shall upon such termination of service be forfeited to
the Corporation. To the extent that a Participant serves as both a director
and an employee of the Corporation, a termination of service shall have been
deemed to occur only if the Participant no longer serves as either a director
or employee of the Corporation. If the Participant incurs a termination of
service by reason of death or Disability, all Shares awarded pursuant to this
Award Agreement shall become Vested at the time of such termination, and the
Shares shall not thereafter be forfeited.
4. Certificates for the Shares. The Corporation shall issue _____
certificates in respect of the Shares in the name of the Participant, and
shall hold such certificates for the benefit of the Participant until the
Shares represented thereby become vested. Such certificates shall bear the
following legend:
"The transferability of this certificate and the shares
of stock represented hereby are subject to the terms
and conditions (including forfeiture) contained in the
Timberland Bancorp, Inc. Management Recognition and
Development Plan. Copies of such Plan are on file in the
office of the Secretary of Timberland Bancorp, Inc., 624
Simpson Avenue, Hoquiam, Washington 98550.
The Participant further agrees that simultaneously with the execution of
this Award Agreement, the Participant shall execute stock powers in favor of
the Corporation with respect to the Shares and that the Participant shall
promptly deliver such stock powers to the Corporation.
5. Participant's Rights. Subject to all limitations provided herein,
the Participant, as owner of the Shares, shall have all the rights of a
stockholder, including, but not limited to, the right to receive all dividends
paid on the Shares and the right to vote such Shares.
6. Expiration of Restricted Period. Upon the lapse or expiration of the
Restricted Period with respect to a portion of the Shares, the Corporation
shall deliver to the Participant (or in the case of a deceased Participant, to
his legal representative) the certificate in respect of such Shares and the
related stock power held by the Corporation pursuant to Section 4 above. The
Shares as to which the Restricted Period shall have lapsed or expired shall be
free of the restrictions referred to in Section 2 above, and such certificate
shall not bear the legend provided for in Section 4 above.
7. Adjustments for Changes in Capitalization of the Corporation. In the
event of any change in the outstanding shares of Stock by reason of any
reorganization, recapitalization, stock split, stock dividend, combination or
exchange of shares, merger, consolidation, or any change in the corporate
structure of the Corporation or in the shares of Stock, the number and class
of shares covered by this Award Agreement shall be appropriately adjusted by
the Committee, whose determination shall be conclusive. Any shares of Stock
or other securities received, as a result of the foregoing, by the Participant
with respect to Shares subject to the restrictions contained in Section 2
above shall also be subject to such restrictions, and the certificate or other
instruments representing or evidencing such shares or securities shall be
legended and deposited with the Corporation in the manner provided in Section
4 above. The Participant shall execute stock powers in favor of the
Corporation with respect to such shares received by the Participant.
8. Effect of Change in Control. In the event of a Change in Control,
the Participant shall be given the right to have the Shares Vest in full (to
the extent they are not then Vested) upon the happening of such event,
provided, however, that no Shares which have previously been forfeited shall
thereafter become Vested.
9. Delivery and Registration of Shares of Stock. The Corporation's
obligation to deliver shares of Stock hereunder shall, if the Committee so
requests, be conditioned upon the Participant's compliance with the terms and
provisions of Section 6(h) of the Plan.
10. Plan and Plan Interpretations as Controlling. The Shares hereby
awarded and the terms and conditions herein set forth are subject in all
respects to the terms and conditions of the Plan, which are controlling.
Capitalized terms used herein which are not defined in this Award Agreement
shall have the meaning ascribed to such terms in the Plan. All determinations
and interpretations made in the discretion of the Committee shall be binding
and conclusive upon the Participant or the Participant's legal representatives
with regard to any question arising hereunder or under the Plan.
11. Participant Service. Nothing in this Award Agreement shall limit the
right of the Corporation or any of its Affiliates to terminate the
Participant's service as a director or employee, or otherwise impose upon the
Corporation or any of its Affiliates any obligation to employ or accept the
services of the Participant.
12. Withholding Tax. Upon the termination of the Restricted Period with
respect to any Shares (or at any such earlier time, if any, that an election
is made by the Participant under Section 83(b) of the Code, or any successor
thereto), the Corporation may withhold from any payment or distribution made
under the Plan sufficient Shares to cover any applicable withholding and
employment taxes. The Corporation shall have the right to deduct from all
dividends paid with respect to Shares the amount of any taxes which the
Corporation is required to withhold with respect to such dividend payments.
13. Amendment. The Committee may waive any conditions of or rights of
the Corporation or modify or amend the terms of this Award Agreement;
provided, however, that the Committee may not amend, alter, suspend,
discontinue or terminate any provision hereof which may adversely affect the
Participant without the Participant's (or the Participant's legal
representative's) written consent.
RS-2
14. Participant Acceptance. The Participant shall signify his acceptance
of the terms and conditions of this Award Agreement by signing in the space
provided below, by signing the attached stock powers, and by returning a
signed copy hereof and of the attached stock powers to the Corporation.
IN WITNESS WHEREOF, the parties hereto have caused this Award Agreement
to be executed as of the date first above written.
TIMBERLAND BANCORP, INC.
By ___________________________________
Its ___________________________________
ACCEPTED:
___________________________
(Signature)
___________________________
(Street Address)
___________________________
(City, State & Zip Code)
RS-3
STOCK POWER
For value received, I hereby sell, assign, and transfer to Timberland
Bancorp, Inc. (the "Corporation") _____ shares of the common stock of the
Corporation, standing in my name on the books and records of the aforesaid
Corporation, represented by Certificate No. _________, and do hereby
irrevocably constitute and appoint the Secretary of the Corporation attorney,
with full power of substitution, to transfer this stock on the books and
records of the aforesaid Corporation.
_______________________________
Dated:
__________________________
In the presence of:
__________________________
RS-4
Exhibit 21
Subsidiaries of the Registrant
Parent
- -----------------------------
Timberland Bancorp, Inc.
Percentage Jurisdiction or
Subsidiaries of Ownership State of Incorporation
- ----------------------------- ----------------- ---------------------------
Timberland Bank 100% Washington
Timberland Service Corporation (1) 100% Washington
- --------------
(1) This corporation is a wholly owned subsidiary of Timberland Bank.
Exhibit 23
Consent of Accountants
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statements No.
333-32386 and No. 333-116163 on Form S-8 of Timberland Bancorp, Inc. of our
reports dated December 7, 2005, relating to the consolidated financial
statements and the effectiveness of internal control over financial reporting
of Timberland Bancorp, Inc. which appear in this Form 10-K for the year ended
September 30, 2005.
/s/McGladrey & Pullen, LLP
MCGLADREY & PULLEN, LLP
Tacoma, WA
December 7, 2005
Exhibit 31.1
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Michael R. Sand, certify that:
1. I have reviewed this Annual Report on Form 10-K of Timberland Bancorp,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: December 6, 2005
/s/Michael R. Sand
------------------------------
Michael R. Sand
Chief Executive Officer
Exhibit 31.2
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Dean J. Brydon, certify that:
1. I have reviewed this Annual Report on Form 10-K of Timberland Bancorp,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such
evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: December 6, 2005
/s/Dean J. Brydon
-----------------------------
Dean J. Brydon
Chief Financial Officer
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF TIMBERLAND BANCORP, INC.
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form
10-K, that:
1. the report fully complies with the requirements of Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, and
2. the information contained in the report fairly presents, in all
material respects, the Company's financial condition and results of
operations, as of the dates and for the periods presented in the
financial statements included in such report.
/s/Michael R. Sand /s/Dean J. Brydon
-------------------------- -------------------------
Michael R. Sand Dean J. Brydon
Chief Executive Officer Chief Financial Officer
Dated: December 6, 2005