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, 2007
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 (I.R.S. Employer
incorporation or organization) Identification Number)
624 Simpson Avenue, Hoquiam, Washington 98550
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including (360) 533-4747
area code: -------------------------------
Securities registered pursuant to Section 12(b)of the Act:
Common Stock, par value $.01 per share The Nasdaq Stock Market LLC
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(Title of Each Class) (Name of Each Exchange on Which
Registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
YES NO X
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Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 of Section 15(d) of the Act. YES NO X
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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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act (Check one):
Large accelerated filer Accelerated filer X Non-accelerated filer
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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 LLC on March
31, 2007 was $128,633,948 (7,298,380 shares at $17.625 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 2008 Annual Meeting
of Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2007 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
------
PART I.
Item 1. Business
General.............................................. 1
Market Area.......................................... 1
Lending Activities................................... 3
Investment Activities................................ 20
Deposit Activities and Other Sources of Funds........ 21
Bank Owned Life Insurance............................ 26
Regulation of the Bank............................... 26
Regulation of the Company............................ 31
Taxation............................................. 33
Competition.......................................... 34
Subsidiary Activities................................ 34
Personnel............................................ 35
Executive Officers of the Registrant................. 35
Item 1A. Risk Factors........................................... 36
Item 1B. Unresolved Staff Comments.............................. 40
Item 2. Properties.............................................. 40
Item 3. Legal Proceedings....................................... 43
Item 4. Submission of Matters to a Vote of Security Holders..... 43
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities.............................................. 43
Item 6. Selected Financial Data................................. 46
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 48
General.............................................. 48
Special Note Regarding Forward-Looking Statements.... 48
Critical Accounting Policies and Estimates........... 48
New Accounting Pronouncements........................ 49
Operating Strategy................................... 49
Market Risk and Asset and Liability Management 50
Comparison of Financial Condition at September 30,
2007 and September 30, 2006.......................... 52
Comparison of Operating Results for Years Ended
September 30, 2007 and 2006.......................... 53
Comparison of Operating Results for Years Ended
September 30, 2006 and 2005.......................... 55
Average Balances, Interest and Average Yields/Cost... 57
Rate/Volume Analysis................................. 59
Liquidity and Capital Resources...................... 60
Effect of Inflation and Changing Prices.............. 61
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk................................................... 61
Item 8. Financial Statements and Supplementary Data............. 62
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure..................... 104
Item 9A. Controls and Procedures................................ 104
Item 9B. Other Information...................................... 104
i
PART III.
Item 10. Directors, Executive Officers and Corporate
Governance............................................. 104
Item 11. Executive Compensation................................. 105
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters............. 105
Item 13. Certain Relationships and Related Transactions, and
Director Independence.................................. 106
Item 14. Principal Accounting Fees and Services................. 106
PART IV.
Item 15. Exhibits, Financial Statement Schedules................ 106
ii
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 13,225,000 shares of common stock by the
Company. At September 30, 2007, the Company had total assets of $644.8
million, total deposits of $466.7 million and total shareholders' equity of
$74.5 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 up to
applicable legal limits by the Federal Deposit Insurance Corporation ("FDIC").
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 real estate,
including an emphasis on construction and land development loans, one- to
four-family residential loans, multi-family loans, commercial real estate
loans and land loans. The Bank originates adjustable-rate residential
mortgage loans that do not qualify for sale in the secondary market 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.
The Corporation maintains a website at www.timberlandbank.com. The
information contained on that website is not included as a part of, or
incorporated by reference into, this Annual Report on Form 10-K. Other than
an investor's own internet access charges, the Corporation makes available
free of charge through that website the Corporation's Annual Report on Form
10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
amendments to these reports, as soon as reasonably practicable after these
materials have been electronically filed with, or furnished to, the Securities
and Exchange Commission.
Market Area
The Bank considers Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis
Counties as its primary market areas. The Bank conducts operations from:
* its main office in Hoquiam (Grays Harbor County);
* five branch offices in Grays Harbor County (Ocean Shores,
Montesano, Elma, and two branches in Aberdeen);
* a branch office in King County (Auburn);
* five branch offices in Pierce County (Edgewood, Puyallup, Spanaway,
Tacoma, and Gig Harbor);
1
* 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 and a loan production office in Lewis County
(Winlock, Toledo and Centralia).
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 72,000 according to the U.S.
Census Bureau 2006 estimates and a median family income of $49,900 according
to 2007 HUD estimates. 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,
transportation and technology. According to the Washington State Employment
Security Department, the unemployment rate in Grays Harbor County decreased to
6.2% at September 30, 2007 from 6.8% at September 30, 2006. The Bank has six
branches (including its home office) located throughout the county. A slowdown
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 767,000 according to the U.S. Census Bureau 2006 estimates. The
county's median family income is $61,500 according to 2007 HUD estimates. 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 4.6%
at September 30, 2007 from 5.4% at September 30, 2006. The Bank has five
branches in Pierce County. These branches have been responsible for a
substantial portion of the Bank's construction lending activities. A slowdown
in the Pierce County economy could negatively impact the demand for
construction loans and could negatively impact the Bank's profitability.
Thurston County has a population of 235,000 according to the U.S. Census
Bureau 2006 estimates and a median family income of $64,300 according to 2007
HUD estimates. Thurston County is home of Washington State's capital
(Olympia) and its economic base is largely driven by state government related
employment. According to the Washington State Employment Security Department,
the unemployment rate for the Thurston County area had decreased to 4.2% at
September 30, 2007 from 4.8% at September 30, 2006. The Bank currently has
five branches in Thurston County. This county has a stable economic base
primarily attributable to the state government presence. A slowdown in the
Thurston County economy could negatively impact the Bank's lending
opportunities in this market.
Kitsap County has a population of 241,000 according to the U.S. Census
Bureau 2006 estimates and a median family income of $65,700 according to 2007
HUD estimates. The Bank has two branches in Kitsap County. The economic base
of Kitsap County is largely supported by military related government
employment through the United States Navy. According to the Washington State
Employment Security Department, the unemployment rate for the Kitsap County
area decreased to 4.3% at September 30, 2007 from 5.2% at September 30, 2006.
Reductions in the naval
2
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 1.8 million according to the U.S. Census Bureau 2006 estimates. The
county's median family income is $75,600 according to 2007 HUD estimates.
King County's economic base is diversified with many industries including
shipping, transportation, aerospace (Boeing), computer technology and biotech
industries. According to the Washington State Employment Security Department,
the unemployment rate for the King County area decreased to 3.9% at September
30, 2007 from 4.1% at September 30, 2006. A slowdown in the King County
economy could negatively impact the Bank's lending opportunities in this
market.
Lewis County has a population of 74,000 according to the U.S. Census
Bureau 2006 estimates and a median family income of $49,900 according to 2007
HUD estimates. The economic base in Lewis County is supported by
manufacturing, retail trade, local government and industrial services.
According to the Washington State Employment Security Department, the
unemployment rate in Lewis County decreased to 6.3% at September 30, 2007 from
6.5% at September 30, 2006. The Bank has two branches and a loan production
office located in Lewis County. 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 $515.3 million at September 30, 2007, representing 79.9% of
consolidated total assets, and at that date construction and land development
loans (including undisbursed loans in process), and loans secured by
commercial properties were $314.1 million, or 53.4%, 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 Tier 1 capital. At September 30, 2007, the maximum
amount which the Bank could have lent to any one borrower and the borrower's
related entities was approximately $14.8 million under this policy. At
September 30, 2007, the largest amount outstanding to any one borrower and the
borrower's related entities was $21.9 million (including $7.6 million in
undisbursed loans in process balance). The Board of Directors approved this
exception to the borrowing limit because of the strength of the primary
borrower and the borrower's related entities. These loans represent a
condominium construction project, several one- to four-family speculative
construction projects, and commercial real estate holdings, all of which are
located in Grays Harbor County. These loans were performing according to the
required loan terms at September 30, 2007. The next largest amount
outstanding to any one borrower and the borrower's related entities was $11.6
million. These loans were secured by three multi-family buildings and two
one- to four-family homes, all of which were performing according to terms at
September 30, 2007. The Bank also had 78 borrowers or related borrowers with
total loans outstanding in excess of $1.0 million at September 30, 2007.
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,
--------------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
---------------- ---------------- ---------------- ---------------- ----------------
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)..$102,434 17.40% $ 98,709 20.11% $101,763 23.24% $ 99,835 25.25% $ 95,371 26.21%
Multi-family... 35,157 5.97 17,689 3.60 20,170 4.61 17,160 4.34 18,241 5.01
Commercial..... 127,866 21.72 137,609 28.04 124,849 28.51 108,276 27.39 102,972 28.30
Construction
and land
development... 186,261 31.64 146,855 29.92 112,470 25.68 106,241 26.88 94,117 25.87
Land(2)........ 60,706 10.30 29,598 6.03 24,981 5.71 19,895 5.03 15,628 4.30
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans........ 512,424 87.03 430,460 87.70 384,233 87.75 351,407 88.89 326,329 89.69
Consumer Loans:
Home equity
and second
mortgage...... 47,269 8.02 37,435 7.63 32,298 7.38 23,549 5.96 19,233 5.29
Other.......... 10,922 1.86 11,127 2.27 9,330 2.13 9,270 2.34 8,799 2.42
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
58,191 9.88 48,562 9.90 41,628 9.51 32,819 8.30 28,032 7.71
Commercial
business
loans.......... 18,164 3.09 11,803 2.40 12,013 2.74 11,098 2.81 9,475 2.60
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans... 588,779 100.00% 490,825 100.00% 437,874 100.00% 395,324 100.00% 363,836 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
construction
loans in
process....... (65,673) (59,260) (42,771) (43,563) (34,785)
Deferred loan
origination
fees.......... (2,968) (2,798) (2,895) (3,176) (2,924)
Allowance for
loan losses... (4,797) (4,122) (4,099) (3,991) (3,891)
-------- -------- -------- -------- --------
Total loans
receivable,
net............$515,341 $424,645 $388,109 $344,594 $322,236
======== ======== ======== ======== ========
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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, 2007, $102.4
million, or 17.4%, 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, 2007,
$55.7 million, or 54.4%, 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 2.875% 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. Borrower demand for ARM loans versus
fixed-rate mortgage loans is a function of the level of interest rates, the
expectations of changes in the level of interest rates and the difference
between the initial interest rates and fees charged for each type of loan.
The relative amount of fixed-rate mortgage loans and ARM loans that can be
originated at any time is largely determined by the demand for each in a
competitive
4
environment. At September 30, 2007, $46.7 million, or 45.6%, 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 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). At September 30, 2007 two single
family loans totaling $252,000 were not performing according to their terms.
See "- Lending Activities - Nonperforming Assets and Delinquencies."
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, King, Thurston, and Kitsap
County markets. Competition from other financial institutions has increased
in recent years and it is possible that margins on construction loans may be
reduced in the future.
5
The Bank currently originates three types of residential construction
loans: (i) speculative construction loans, (ii) custom construction loans and
(iii) owner/builder construction loans. The Bank initiated its construction
lending with the 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. 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, 2007 and 2006, the composition of the Bank's
construction and land development loan portfolio was as follows:
At September 30,
------------------------------------------------
2007 2006
----------------------- -----------------------
Outstanding Percent of Outstanding Percent of
Balance Total Balance Total
----------- ---------- ----------- ----------
(In thousands)
Speculative construction..... $ 43,012 23.09% $ 34,363 23.40%
Custom and owner/builder
construction................ 52,375 28.12 46,346 31.56
Multi-family................. 18,064 9.70 7,662 5.22
Land development............. 22,292 11.97 16,086 10.95
Commercial real estate....... 50,518 27.12 42,398 28.87
-------- ------ -------- ------
Total....................... $186,261 100.00% $146,855 100.00%
======== ====== ======== ======
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 eight
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 generally originates and underwrites a separate loan for
each home. Speculative construction loans are generally originated for a term
of 12 months, with current rates ranging from the prime rate to the prime rate
plus 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, 2007, speculative construction
loans totaled $43.0 million, or 23.1%, of the total construction loan
portfolio. At September 30, 2007, the Bank had 21 borrowers each with
aggregate outstanding speculative loan balances of more than $500,000. The
largest aggregate outstanding balance to one borrower amounted to $7.2 million
(including $4.7 million of undisbursed loans in process balance), and the
largest outstanding balance for a single speculative loan was $1.2 million
(including $363,000 of undisbursed loans in process balance). At September
30, 2007, one speculative construction loan with a balance of $1.0 million in
Pierce County was not performing according to its terms. See "- Lending
Activities - Nonperforming Assets and Delinquencies."
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 to purchase the finished home. 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.
6
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
an 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. 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 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, 2007, custom
and owner/builder construction loans totaled $52.4 million, or 28.1%, of the
total construction loan portfolio. At September 30, 2007, the largest
outstanding custom and owner/builder construction loan had an outstanding
balance of $1.0 million (including $552,000 of undisbursed loans in process
balance) and was performing according to its terms.
The Bank originates loans to 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, 2007, the Bank had 17 land
development loans totaling $22.3 million, or 12.0% of construction and land
development loans receivable. Land development loans are secured by a lien on
the property and typically 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 generally 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, 2007, the largest land development loan had an
outstanding loan balance of $3.9 million (including $1.9 million 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 upon
completion. If the estimate of the future value proves to be inaccurate, in
the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank 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, 2007, these loans amounted to $68.6
million, or 36.8% of construction loans. These loans are secured by motels,
apartment buildings, condominiums, mini-storage facilities, office buildings
and retail rental space located in the Bank's primary market area and
currently range in amount from $25,000 to $12.0 million. At September 30,
2007, the largest outstanding multi-family construction loan had a balance of
$7.0 million (including $843,000 of undisbursed loans in process balance) and
was performing according to its terms. At September 30, 2007, the largest
outstanding commercial real estate construction loan had a balance of $12.0
million (including $9.9 million of undisbursed loans in process balance). This
loan was secured by two mini-storage facilities being constructed in King
County and was performing according to its terms.
All construction loans must be approved by a member of 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.
7
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 with construction lending.
The Bank originates construction loan applications primarily through
customer referrals, contacts in the business community and occasionally real
estate brokers seeking financing for their clients.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because 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
and it may incur a loss. Projects may also be jeopardized by disagreements
between borrowers and builders and by the failure of builders to pay
subcontractors. Loans to 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, 2007, the Bank had
outstanding real estate contracts of $461,000.
Multi-Family Lending. At September 30, 2007, the Bank had $35.2 million,
or 6.0% 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. 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 $5.8 million. At
September 30, 2007, the largest multi-family loan had an outstanding principal
balance of $5.8 million and was secured by an apartment building located in
the Bank's primary market area. At September 30, 2007, this loan was
performing according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally 75%
to 80%. The Bank generally requests its multi-family loan borrowers with loan
balances in excess of $750,000 to submit financial statements and rent rolls
on the 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
8
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 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
$127.9 million, or 21.7% of the total loan portfolio at September 30, 2007,
and consisted of 298 loans. The Bank originated $35.9 million of commercial
mortgage loans during the year ended September 30, 2007 compared to $32.2
million originated during the year ended September 30, 2006. 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 $5,000 and $4.8 million. At September 30, 2007, 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, 2007, one commercial real estate
loan with a balance of $90,000 was not performing according to its terms. See
"- Lending Activities - Nonperforming Assets and Delinquencies."
The Bank typically requires appraisals of properties securing commercial
real estate loans. For loans that are less than $250,000, the Bank may use
the tax assessed value and a property inspection in lieu of an appraisal.
Appraisals are performed by independent appraisers designated by the Bank, 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 and reviews their 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 on loans over $750,000.
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, 2007, land loans totaled $60.7
million, or 10.3% of the Bank's total loan portfolio as compared to $29.6
million, or 6.0% of the Bank's total loan portfolio at September 30, 2006.
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 $1.0 million but will occasionally be higher when larger
acreage is involved. The largest land loan had an outstanding balance of $3.7
million at September 30, 2007 and was performing according to its terms. At
September 30, 2007, one land loan totaling $28,000 was not performing
according to its 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 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,
9
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, 2007, consumer loans
amounted to $58.2 million, or 9.9%, of the total loan portfolio.
At September 30, 2007, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $47.3 million, or 8.0%, 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 prime rate or
the 26 week Treasury Bill. 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, 2007, the
Bank did not have any consumer loans delinquent in excess of 90 days. See
"Lending Activities - Non-performing Assets and Delinquencies."
Commercial Business Lending. Commercial business loans totaled $18.2
million, or 3.1% of the loan portfolio at September 30, 2007, and consisted of
60 loans. 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.
Commercial business loans range in principal amount from $1,000 to $2.2
million. The Bank also generally obtains personal guarantees from financially
capable applicants based on a review of personal financial statements. The
largest commercial business loan had an outstanding balance of $2.2 million at
September 30, 2007 and was performing according to its terms. At September
30, 2007, one commercial business loan with a balance of $120,000 was not
performing according to its 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, 2007 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Loans having no stated maturity
and overdrafts are reported as due in one year or less.
After After After
1 Year 3 Years 5 Years
Within Through Through Through After
1 Year 3 Years 5 Years 10 Years 10 Years Total
------ ------- ------- -------- -------- -----
(In thousands)
Mortgage loans:
One- to four-
family (1)........... $ 747 $ 4,321 $ 3,069 $ 4,405 $ 89,892 $102,434
Multi-family.......... 4,436 3,500 5,765 17,995 3,461 35,157
Commercial............ 5,441 9,390 13,199 85,507 14,329 127,866
Construction and land
development(2)....... 177,601 8,570 90 -- -- 186,261
Land.................. 25,250 14,307 17,542 2,359 1,248 60,706
Consumer loans:
Home equity and
second mortgage...... 12,738 880 1,342 4,568 27,741 47,269
Other................. 1,876 915 2,090 1,288 4,753 10,922
Commercial business
loans................. 9,267 1,094 4,142 1,489 2,172 18,164
-------- ------- ------- -------- -------- --------
Total................. $237,356 $42,977 $47,239 $117,611 $143,596 $588,779
======== ======= ======= ======== ======== ========
Less:
Undisbursed portion
of construction loans
in process........... $ 65,673
Deferred loan
origination fees..... 2,968
Allowance for loan
losses............... 4,797
--------
Loans receivable,
net.................. $515,341
- --------------
(1) Includes loans held-for-sale.
(2) Includes construction/permanent loans that convert to permanent mortgage
loans once construction is completed.
The following table sets forth the dollar amount of all loans due after
one year from September 30, 2007, 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)............... $ 55,237 $ 46,450 $101,687
Multi-family......................... 13,581 17,140 30,721
Commercial........................... 17,379 105,046 122,425
Construction and land development.... 2,090 6,570 8,660
Land................................. 25,395 10,061 35,456
Consumer loans:
Home equity and second mortgage...... 26,620 7,911 34,531
Other................................ 8,874 172 9,046
Commercial business loans............. 3,864 5,033 8,897
-------- -------- --------
Total............................... $153,040 $198,383 $351,423
======== ======== ========
- -------------
(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 three
underwriters, can approve one-to four-family mortgage loans and other consumer
loans up to and including the current FHLMC single-family limit. 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 Regional Manager of
Commercial Lending has individual lending authority for loans up to and
including $250,000, excluding speculative construction loans and unsecured
loans. The Bank's Commercial Loan Committee, which consists of the Bank's
President, Chief Lending Officer, Executive Vice President of Commercial
Lending, Executive Vice President of Community Lending, and Regional Manager
of Commercial Lending, may approve commercial real estate loans and commercial
business loans up to and including $1.5 million. The Bank's President, Chief
Lending Officer, Executive Vice President of Commercial Lending and Executive
Vice President of Community Lending also have individual lending authority for
loans up to and including $750,000. The Bank's Board Loan Committee, which
consists of two rotating non-employee Directors and the Bank's President, may
approve loans up to and including $3.0 million. Loans in excess of $3.0
million, as well as loans of any amount granted to a single borrower whose
aggregate loans exceed $3.0 million, must be approved by the Bank's Board of
Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 2007 and 2006, the Bank's total gross loan originations were $279.1
million and $256.3 million, respectively. Periodically, the Bank purchases
participation interests in construction and land development loans, commercial
real estate loans, and multi-family loans, secured by properties generally
located in Washington State, from other lenders. These purchases are
underwritten to the Bank's underwriting guidelines and are without recourse to
the seller other than for fraud. During the years ended September 30, 2007
and 2006, the Bank purchased loan participation interests of $20.4 million and
$155,000, respectively. 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 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, 2007, the Bank's loan servicing portfolio totaled
$161.6 million.
The Bank also periodically sells participation interests in construction
and land development loans, commercial real estate loans, and land loans to
other lenders. These sales are usually made to avoid concentrations in a
particular loan type or concentrations to a particular borrower. The Bank
sold $6.7 million in loan participation interests to other lenders during the
year ended September 30, 2007.
12
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
------------------------------------
2007 2006 2005
--------- --------- ---------
Loans originated: (In thousands)
Mortgage loans:
One- to four-family.................. $ 33,252 $ 33,483 $ 33,290
Multi-family......................... 4,397 3,037 4,685
Commercial........................... 35,886 32,174 32,266
Construction and land development.... 127,082 129,623 104,714
Land................................. 35,066 17,518 15,330
Consumer.............................. 32,354 29,858 29,287
Commercial business loans............. 11,020 10,559 10,233
--------- --------- ---------
Total loans originated................ 279,057 256,252 229,805
Loans purchased:
Mortgage loans:
One- to four-family.................. -- 48 209
Multi-family......................... 5,200 -- --
Commercial........................... -- 79 --
Construction and land development.... 15,175 -- --
Land................................. -- 28 --
--------- --------- ---------
Total loans purchased............... 20,375 155 209
--------- --------- ---------
Total loans originated and
purchased......................... 299,432 256,407 230,014
Loans sold:
Whole loans sold...................... (29,893) (26,445) (25,247)
Participation loans sold.............. (6,650) -- --
Credit card loans sold................ -- -- (1,523)
--------- --------- ---------
Total loans sold...................... (36,543) (26,445) (26,770)
Loan principal repayments.............. (164,935) (177,011) (160,694)
Decrease (increase) in other items,
net................................... (7,258) (16,415) 965
--------- --------- ---------
Net increase in loans receivable....... $ 90,696 $ 36,536 $ 43,515
========= ========= =========
Loan Origination Fees. The Bank receives loan origination fees on a
majority of its mortgage loans and commercial business loans. Loan fees are a
percentage of the loan which are charged to the borrower for funding the loan.
The amount of fees charged by the Bank is generally 0.0% to 2.0% of the loan
amount. Current accounting principles generally accepted in the United States
of America 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 $3.0 million at September 30, 2007.
Non-performing Assets and Delinquencies. The Bank assesses late fees or
penalty charges on delinquent loans of approximately 5% of the monthly loan
payment amount. A majority of loan payments are due on the first day of the
month; however, the borrower is given a 15 day grace period to make the loan
payment. When a mortgage loan borrower fails to make a required payment when
due, the Bank institutes collection procedures. A notice is mailed to the
borrower 16 days after the date the payment is due. Attempts to contact the
borrower by telephone generally begin on or before the 30th day of
delinquency. If a satisfactory response is not obtained, continuous follow-up
contacts are attempted until the loan has been brought current. Before the
90th day of delinquency, attempts are made to establish (i) the cause of the
delinquency, (ii) whether the cause is temporary, (iii) the attitude of the
borrower toward the debt, and (iv) a mutually satisfactory arrangement for
curing the default.
13
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,
------------------------------------------------
2007 2006 2005 2004 2003
-------- -------- -------- -------- --------
Loans accounted for on a (Dollars in thousands)
non-accrual basis:
Mortgage loans:
One- to four-family....... $ 252 $ 80 $ 2,208 $ 430 $ 1,409
Commercial................ 90 -- 261 640 538
Construction and land
development.............. 1,000 -- -- -- 1,185
Land...................... 28 -- 23 322 521
Consumer loans............. -- -- 133 23 212
Commercial business loans.. 120 -- 301 27 30
-------- -------- -------- -------- --------
Total................... 1,490 80 2,926 1,442 3,895
Accruing loans which are
contractually past due 90
days or more.............. -- -- -- -- --
Total of non-accrual and 90
days past due loans....... 1,490 80 2,926 1,442 3,895
Other real estate owned and
other repossessed assets.. -- 15 509 421 1,258
-------- -------- -------- -------- --------
Total nonperforming
assets................. $ 1,490 $ 95 $ 3,435 $ 1,863 $ 5,153
======== ======== ======== ======== ========
Restructured loans......... $ -- $ -- $ -- $ -- $ --
Non-accrual and 90 days
or more past due loans
as a percentage of
loans receivable, net..... 0.29% 0.02% 0.75% 0.41% 1.19%
Non-accrual and 90 days
or more past due loans
as a percentage of
total assets.............. 0.23% 0.01% 0.53% 0.31% 0.87%
Nonperforming assets as
a percentage of total
assets.................... 0.23% 0.02% 0.62% 0.40% 1.15%
Loans receivable, net(1)... $520,138 $428,767 $392,208 $348,585 $326,127
======== ======== ======== ======== ========
Total assets............... $644,848 $577,087 $552,765 $460,419 $449,633
======== ======== ======== ======== ========
- ---------------
(1) Includes loans held-for-sale and is before the allowance for loan losses.
The Bank's non-accrual loans increased by $1.4 million to $1.5 million at
September 30, 2007 from $80,000 at September 30, 2006, primarily as a result
of a $1.0 million increase in construction and land development loans on
non-accrual status, a $172,000 increase in one- to four-family mortgage loans
on non-accrual status and a $90,000 increase in commercial real estate loans
on non-accrual status.
14
Additional interest income which would have been recorded for the year
ended September 30, 2007 had non-accruing loans been current in accordance
with their original terms totaled approximately $42,000.
Other 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 other 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, 2007, the Bank did not have any other real estate owned or
other repossessed items.
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, 2007.
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 $15.7
million at September 30, 2007 and $13.0 million at September 30, 2006. 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 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.
15
The aggregate amounts of the Bank's classified and special mention loans
(as determined by the Bank), and of the Bank's allowances for loan losses at
the dates indicated, were as follows:
At September 30,
-----------------------------
2007 2006 2005
------- ------- -------
(In thousands)
Loss.......................... $ -- $ -- $ --
Doubtful...................... -- -- --
Substandard(1)................ 8,812 3,985 9,876
Special mention(1)............ 6,917 9,015 4,320
------- ------- -------
Total classified and special
mention loans................ $15,729 $13,000 $14,196
======= ======= =======
Allowance for loan losses..... $ 4,797 $ 4,122 $ 4,099
- -------------
(1) For further information concerning the change in classified assets, see
"- Lending Activities - Nonperforming Assets and Delinquencies."
The Bank's classified and special mention loans increased by $2.7 million
from September 30, 2006 to September 30, 2007, primarily as a result of a $4.8
million increase in loans classified as substandard. This increase was
partially offset by a $2.1 million decrease 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. Three loans comprise a majority of the amount
classified as special mention. They include a $3.4 million loan secured by a
commercial office building in Thurston County, a $797,000 loan secured by land
and commercial real estate in Grays Harbor County, and a $687,000 land
development loan in Grays Harbor County. At September 30, 2007 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, 2007 increased by $4.8 million to $8.8 million
from $4.0 million at September 30, 2006. At September 30, 2007, 26 loans were
classified as substandard compared to 23 at September 30, 2006.
That largest loan currently classified as substandard is a $3.6 million
commercial real state loan secured by a mini-storage facility in King County.
This loan was classified as substandard as a result of slower than projected
lease absorption of the storage units. At September 30, 2007, this loan was
54 days past due. The Bank also has a second loan with the borrowers secured
by this mini-storage facility for $542,000. This loan was current at
September 30, 2007 and was also classified as substandard. The Bank believes
that these two loans are adequately collateralized.
The next largest loans classified as substandard include a $1.3 million
commercial business loan secured by two mini-storage facilities in Pierce
County and $1.3 million in loans to a construction company that were secured
by two single family homes and a land parcel in Pierce County. The $1.3
million commercial business loan secured by the mini-storage facilities was
current at September 30, 2007. The $1.3 million in loans to the construction
company were on non-accrual status at September 30, 2007 and management
estimated a $75,000 impairment on one of these loans that had a balance of
$1.0 million.
16
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 or changes in economic conditions, delinquency rates, and
other factors. Using these loss estimate factors, management develops a range
of probable loss for each loan category. Certain individual loans for which
full collectibility may not be assured are evaluated individually with loss
exposure based on estimated discounted cash flows or 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, 2007, the Bank's allowance for loan losses totaled $4.8
million. This represents 0.92% of the total loans receivable and 321.95% of
non-performing loans. The Bank's allowance for loan losses as a percentage of
total loans receivable has decreased to 0.92% at September 30, 2007 from 1.19%
at September 30, 2003 primarily due to improved historical loss performance
(which has translated into lower loss factors assigned to certain loan
categories), decreased levels of non-performing loans, and decreased levels of
classified loans. Partially offsetting the improved credit quality ratios in
recent years, has been a shift in the loan portfolio into a higher percentage
of construction and land development loans, and land loans, which typically
involve more risk than one- to four-family loans.
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.
17
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended September 30,
-----------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
(Dollars in thousands)
Allowance at beginning of
year........................ $4,122 $4,099 $3,991 $3,891 $3,630
Provision for loan losses.... 686 -- 141 167 347
Recoveries:
Mortgage loans:
One- to four-family......... -- -- -- 6 --
Consumer loans:
Home equity and second
mortgage................... -- -- 5 -- --
Other....................... 1 5 3 16 12
Commercial business loans.... -- 20 9 3 70
------ ------ ------ ------ ------
Total recoveries.......... 1 25 17 25 82
Charge-offs:
Mortgage loans:
One- to four-family......... -- -- -- 6 30
Multi-family................ -- -- 1 -- --
Commercial business loans.... -- -- -- 3 --
Land......................... -- -- 1 -- 10
Consumer loans:
Home equity and second
mortgage................... -- -- -- 9 40
Other....................... 12 2 12 68 88
Commercial business loans.... -- -- 36 6 --
------ ------ ------ ------ ------
Total charge-offs......... 12 2 50 92 168
------ ------ ------ ------ ------
Net charge-offs
(recoveries)............. 11 (23) 33 67 86
------ ------ ------ ------ ------
Balance at end of year.... $4,797 $4,122 $4,099 $3,991 $3,891
====== ====== ====== ====== ======
Allowance for loan losses
as a percentage of
total loans receivable
(net)(1) outstanding
at the end of the year...... 0.92% 0.96% 1.05% 1.14% 1.19%
Net charge-offs (recoveries)
as a percentage of average
loans outstanding during
the year.................... 0.00% (0.01%) 0.01% 0.02% 0.03%
Allowance for loan losses
as a percentage of non-
performing loans at end
of year..................... 321.95% 5,152.50% 140.09% 276.77% 99.90%
- -------------
(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,
----------------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
----------------- ------------------ ---------------- ----------------- ------------------
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........ $ 396 17.40% $ 502 20.11% $ 494 23.24% $ 386 25.25% $ 317 26.21%
Multi-family.. 200 5.97 112 3.60 194 4.61 242 4.34 374 5.01
Commercial.... 1,368 21.72 1,222 28.04 1,544 28.51 1,443 27.39 1,041 28.30
Construction.. 1,047 31.64 761 29.92 652 25.68 538 26.88 583 25.87
Land.......... 549 10.30 275 6.03 255 5.71 226 5.03 169 4.30
Non-mortgage loans:
Consumer
loans........ 412 9.88 497 9.90 255 9.51 427 8.30 458 7.71
Commercial
business
loans........ 825 3.09 753 2.40 705 2.74 729 2.81 949 2.60
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total
allowance
for loan
losses...... $4,797 100.00% $4,122 100.00% $4,099 100.00% $3,991 100.00% $3,891 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
19
Investment Activities
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.
At September 30, 2007, the Company's investment portfolio totaled $64.0
million, primarily consisting of $31.9 million of mutual funds
available-for-sale, $13.0 million of mortgage-backed securities
available-for-sale, $19.0 million of U.S. agency securities
available-for-sale, and $71,000 of securities held-to-maturity. This compares
with a total investment portfolio of $81.5 million at September 30, 2006,
primarily consisting of $32.1 million of mutual funds available-for-sale,
$17.6 million of mortgage-backed securities available-for-sale, $31.7 million
of U.S. agency securities available-for-sale, and $75,000 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.
At September 30,
--------------------------------------------------------
2007 2006 2005
----------------- ----------------- ------------------
Percent Percent Percent
Recorded of Recorded of Recorded of
Value Total Value Total Value Total
-------- ------- -------- ------- -------- --------
(Dollars in thousands)
Held-to-Maturity:
Mortgage-backed
securities......... $ 71 0.11% $ 75 0.09% $ 104 0.12%
Available-for-Sale
(at fair value):
U.S. agency
securities......... 18,976 29.66 31,718 38.93 33,695 37.56
Mortgage-backed
securities......... 13,047 20.39 17,603 21.60 23,735 26.46
Mutual funds........ 31,875 49.84 32,087 39.38 32,165 35.86
------- ------ ------- ------ ------- ------
Total portfolio...... $63,969 100.00% $81,483 100.00% $89,699 100.00%
======= ====== ======= ====== ======= ======
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, 2007. 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............. $ -- --% $ -- --% $ -- --% $ 71 5.50%
Available-for-Sale:
U.S. agency securities.. 9,982 4.09 6,997 4.82 1,997 4.04 -- --
Mortgage-backed
securities............. 8 4.50 394 5.73 335 5.94 12,310 5.09
Mutual funds............ 31,875 5.33 -- -- -- -- -- --
------- ---- ------ ---- ------ ---- ------- ----
Total portfolio......... $41,865 5.04% $7,391 4.87% $2,332 4.31% $12,381 5.09%
======= ==== ====== ==== ====== ==== ======= ====
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, 2007
---------------------
Amortized Fair
Cost Value
----------- -------
(In thousands)
Asset Management Fund-Ultra Short Mortgage
Fund (ASARX).................................... $16,600 $16,078
Asset Management Fund-Ultra Short Fund (AULTX).... 10,000 9,719
------- -------
Total............................................. $26,600 $25,797
======= =======
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 and
Pacific Coast Banker's Bank ("PCBB") 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, 2007, the Bank had 29.0% of total deposits in non-interest
bearing accounts and NOW checking accounts.
21
At September 30, 2007 the Bank had $67.3 million of jumbo certificates of
deposit of $100,000 or more. The Bank also had brokered certificates of
deposits totaling $24.1 million at September 30, 2007. The Bank believes that
its jumbo certificates of deposit and its brokered deposits, which represented
19.6% of total deposits at September 30, 2007, present similar interest rate
risk compared to its other deposits.
The following table sets forth information concerning the Bank's deposits
at September 30, 2007.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
- ---------------------------------------- ------------- --------- ----------
(In thousands)
Non-interest bearing.................... --% $ 54,962 11.77%
Negotiable order of withdrawal ("NOW")
checking............................... 0.77 80,372 17.22
Savings................................. 0.71 56,412 12.09
Money market............................ 2.58 48,068 10.30
-------- ------
Subtotal............................... 1.20 239,814 51.38
Certificates of Deposit(1)
- ----------------------------------------
Maturing within 1 year.................. 4.73 208,330 44.63
Maturing after 1 year but within 2
years.................................. 4.06 12,739 2.73
Maturing after 2 years but within 5
years.................................. 4.55 5,731 1.23
Maturing after 5 years.................. 3.85 121 0.03
-------- ------
Total certificates of deposit.......... 4.54 226,921 48.62
-------- ------
Total deposits........................ 2.82% $466,735 100.00%
==== ======== ======
- ----------------
(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, 2007. 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............. $25,403
Over three through six months.... 12,579
Over six through twelve months... 24,485
Over twelve months............... 4,849
-------
Total.......................... $67,316
=======
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,
------------------------------------------------------------------------------------
2007 2006 2005
------------------------------ ----------------------------- -------------------
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.... $ 54,962 11.77% $ (2,943) $ 57,905 13.43% $ 6,114 $ 51,791 12.58%
NOW checking............ 80,372 17.22 (9,137) 89,509 20.77 (3,969) 93,478 22.71
Savings................. 56,412 12.09 (3,823) 60,235 13.97 (4,039) 64,274 15.61
Money market............ 48,068 10.30 5,690 42,378 9.83 (6,917) 49,295 11.98
Certificates of deposit
which mature:
Within 1 year......... 208,330 44.63 54,391 153,939 35.71 49,776 104,163 25.30
After 1 year, but
within 2 years....... 12,739 2.73 (7,298) 20,037 4.65 (10,732) 30,769 7.47
After 2 years, but
within 5 years....... 5,731 1.23 (1,279) 7,010 1.63 (10,735) 17,745 4.31
Certificates maturing
thereafter........... 121 0.03 73 48 0.01 (102) 150 0.04
-------- ------ ------- -------- ------ ------- -------- ------
Total................... $466,735 100.00% $35,674 $431,061 100.00% $19,396 $411,665 100.00%
======== ====== ======= ======== ====== ======= ======== ======
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,
------------------------------
2007 2006 2005
-------- -------- --------
(In thousands)
0.00 - 1.99%......... $ 676 $ 2,176 $ 24,765
2.00 - 3.99%......... 46,810 69,736 125,541
4.00 - 5.99%......... 179,008 108,636 2,034
6.00% - and over..... 427 486 487
-------- -------- --------
Total................ $226,921 $181,034 $152,827
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth
the amount and maturities of certificates of deposit at September 30, 2007.
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%............. $ 496 $ 144 $ 36 $ -- $ 676
2.00 - 3.99%............. 36,370 7,956 2,363 121 46,810
4.00 - 5.99%............. 171,408 4,630 2,970 -- 179,008
6.00% and over........... 56 9 362 -- 427
-------- ------- ------ ---- --------
Total.................... $208,330 $12,739 $5,731 $121 $226,921
======== ======= ====== ==== ========
Deposit Activities. The following table sets forth the savings
activities of the Bank for the periods indicated.
Year Ended September 30,
------------------------------
2007 2006 2005
-------- -------- --------
(In thousands)
Beginning balance...................... $431,061 $411,665 $319,570
Net deposits before interest credited.. 24,382 11,491 86,673
Interest credited...................... 11,292 7,905 5,422
Net increase in deposits............... 35,674 19,396 92,095
-------- -------- --------
Ending balance......................... $466,735 $431,061 $411,665
======== ======== ========
Borrowings. Deposits are generally the primary source of funds for the
Bank's lending and investment activities and for general business purposes.
The Bank has the ability to use 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, 2007, the Bank
maintained an uncommitted credit facility with the FHLB-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 $99.7
million was outstanding. The Bank also utilizes
24
overnight repurchase agreements with customers. These overnight repurchase
agreements are classified as other borrowings and totaled $595,000 at
September 30, 2007, $947,000 at September 30, 2006 and $781,000 at September
30, 2005. At September 30, 2007, the Bank also maintained a $10.0 million
overnight borrowing line with PCBB 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,
-------------------------------
2007 2006 2005
------ ------ ------
(Dollars in thousands)
Average total borrowings.................. $ 85,599 $55,773 $60,537
Weighted average rate paid on total
borrowings.............................. 5.24% 5.22% 5.26%
Total borrowings outstanding at end
of period............................... $100,292 $63,708 $63,134
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated.
Borrowings are considered short-term when the original maturity is less than
one year.
At or For the
Year Ended September 30,
-------------------------------
2007 2006 2005
------ ------ ------
(Dollars in thousands)
Maximum amount outstanding at any month end:
FHLB advances............................ $72,750 $29,000 $ 9,000
Repurchase agreements.................... 4,460 1,895 2,102
PCBB advances............................ -- -- --
Average outstanding during period:
FHLB advances............................ $34,156 $ 3,516 $ 4,529
Repurchase agreements.................... 1,019 1,148 1,345
PCBB advances............................ 32 -- 1
------- ------- -------
Total average outstanding during period... $35,207 $ 4,664 $ 5,875
======= ======= =======
Weighted average rate paid during period:
FHLB advances............................ 5.58% 4.81% 4.53%
Repurchase agreements.................... 4.61 4.27 2.30
PCBB advances............................ 6.45 -- 4.80
Total weighted average rate paid during
period................................... 5.55% 4.67% 4.02%
Outstanding at end of period:
FHLB advances............................ $30,000 $29,000 $ 8,000
Repurchase agreements.................... 595 947 781
PCBB advances............................ -- -- --
------- ------- -------
Total outstanding at end of period........ $30,595 $29,947 $ 8,781
======= ======= =======
Weighted average rate at end of period:
FHLB advances............................ 5.19% 5.49% 3.79%
Repurchase agreements.................... 4.42 5.01 3.14
PCBB advances............................ -- -- --
Total weighted average rate at end of
period................................... 5.17% 5.47% 3.73%
25
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, 2007, the Bank had $12.4 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.
Insurance of Accounts and Regulation by the FDIC
The Bank's deposits are insured up to applicable limits by the Deposit
Insurance Fund of the FDIC. The Deposit Insurance Fund is the successor to
the Bank Insurance Fund and the Savings Association Insurance Fund, which were
merged effective March 31, 2006. 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 any activity the FDIC determines by regulation or
order to pose a serious risk to the insurance fund. The FDIC also has the
authority to initiate enforcement actions against savings institutions, after
giving the Office of Thrift Supervision an opportunity to take such action,
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 recently amended its risk-based assessment system for 2007 to
implement authority granted by the Federal Deposit Insurance Reform Act of
2005, which was enacted in 2006 ("Reform Act"). Under the revised system,
insured institutions are assigned to one of four risk categories based on
supervisory evaluations, regulatory capital levels and certain other factors.
An institution's assessment rate depends upon the category to which it is
assigned. Risk category I, which contains the least risky depository
institutions, is expected to include more than 90% of all institutions.
Unlike the other categories, Risk Category I contains further risk
differentiation based on the FDIC's analysis of financial ratios, examination
component ratings and other information. Assessment rates are determined by
the FDIC and currently range from five to seven basis points for the
healthiest institutions (Risk Category I) to 43 basis points of assessable
deposits for the riskiest (Risk Category IV). The FDIC may adjust rates
uniformly from one quarter to the next, except that no single adjustment can
exceed three basis points. No institution may pay a dividend if in default of
the FDIC assessment.
The Reform Act also provided for a one-time credit for eligible
institutions based on their assessment base as of December 31, 1996. Subject
to certain limitations with respect to institutions that are exhibiting
weaknesses, credits can be used to offset assessments until exhausted. The
Bank's one-time credit is expected to be approximately $223,000. The Reform
Act also provided for the possibility that the FDIC may pay dividends to
insured institutions once the Deposit Insurance Fund reserve ratio equals or
exceeds 1.35% of estimated insured deposits.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980s by the Financing
Corporation to recapitalize a predecessor deposit insurance fund. This
payment is established quarterly and during the calendar year ended September
30, 2007 averaged 1.14 basis points of assessable deposits.
26
The Reform Act provided the FDIC with authority to adjust the Deposit
Insurance Fund ratio to insured deposits within a range of 1.15% and 1.50%, in
contrast to the prior statutorily fixed ratio of 1.25%. The ratio, which is
viewed by the FDIC as the level that the fund should achieve, was established
by the agency at 1.25% for 2007.
The FDIC has authority to increase insurance assessments. A significant
increase in insurance premiums would likely have an adverse effect on the
operating expenses and results of operations of the Bank. There can be no
prediction as to what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC 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 or the Office of
Thrift Supervision. Management of the Bank is not aware of any practice,
condition or violation that might lead to termination of the Bank's 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, 2007, the Bank was categorized as "well capitalized"
under the prompt corrective action regulations of the FDIC.
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
27
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, 2007, the Bank had a Tier
1 leverage capital ratio of 9.5%. 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 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%. 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. At September 30, 2007, the
Bank's ratio of total capital to risk-weighted assets was 12.1% and the ratio
of Tier 1 capital to risk-weighted assets was 11.2%.
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, 2007, the Bank had a net
worth of 9.3% of total assets.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2007. The definitions of the terms
used in the table are those provided in the capital regulations issued by the
FDIC, and the Bank has not been notified by the FDIC of any higher capital
requirements specifically applicable to it.
At September 30, 2007
-------------------------------
Percent of Adjusted
Amount Total Assets (1)
-------- -------------------
(Dollars in thousands)
Tier 1 (leverage) capital (2).............. $59,308 9.5%
Tier 1 (leverage) capital requirement...... 25,058 4.0
------- ----
Excess $34,250 5.5%
======= ====
Tier 1 risk adjusted capital............... $59,308 11.2%
Tier 1 risk adjusted capital requirement... 21,154 4.0
------- ----
Excess $38,154 7.2%
======= ====
Total risk-based capital................... $64,105 12.1%
Total risk-based capital requirement....... 42,308 8.0
------- ----
Excess..................................... $21,797 4.1%
======= ====
- ---------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $626.5 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $528.9 million.
(footnotes continued on following page)
28
(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.
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.
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. 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
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 all prior
and present "owners and operators" of hazardous waste sites. However, the
U.S. Congress created a safe harbor provision to protect secured creditors by
providing that the term "owner and operator" excludes a person whose ownership
is limited to protecting its security interest in the site. Since the
enactment of the CERCLA, this "secured creditor exemption" has been the
subject of judicial interpretations which have left open the possibility that
lenders could be liable for cleanup costs on contaminated property that they
hold as collateral for a loan.
To the extent that legal uncertainty exists in this area, all creditors,
including the Bank, that have made loans secured by properties with potential
hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
29
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. As of September 30,
2007, the Bank's deposit with the Federal Reserve and vault cash exceeded its
Regulation D reserve requirements.
Affiliate Transactions
The Company and the Bank are separate and distinct legal entities.
Federal laws strictly limit the ability of banks to engage in certain
transactions with their affiliates, including their bank holding companies.
Transactions deemed to be a "covered transaction" under Section 23A of the
Federal Reserve Act and between a subsidiary bank and its parent company or
the nonbank subsidiaries of the bank holding company are limited to 10% of the
bank subsidiary's capital and surplus and, with respect to the parent company
and all such nonbank subsidiaries, to an aggregate of 20% of the bank
subsidiary's capital and surplus. Further, covered transactions that are
loans and extensions of credit generally are required to be secured by
eligible collateral in specified amounts. Federal law also requires that
covered transactions and certain other transactions listed in Section 23B of
the Federal Reserve Act between a bank and its affiliates be on terms as
favorable to the bank as transactions with non-affiliates.
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC-insured
institution has a continuing and affirmative obligation consistent with safe
and sound banking practices to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the FDIC, in connection with its
examination of the Bank, to assess the institution's record of meeting the
credit needs of its community and to take such record into account in its
evaluation of certain applications, such as a merger or the establishment of a
branch, by the Bank. An unsatisfactory rating may be used as the basis for
the denial of an application by the FDIC. As a result of the heightened
attention being given to the CRA in the past few years, the Bank may be
required to devote additional funds for investment and lending in its local
community. The Bank was examined for CRA compliance and received a rating of
"satisfactory" in its latest 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. In addition,
dividends on the Bank's capital stock may not be paid in an aggregate amount
greater than the aggregate retained earnings of the Bank, without the approval
of the Director of the Division.
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.
30
Privacy Standards
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999
("GLBA"), which was enacted in 1999, modernized 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.
Anti-Money Laundering and Customer Identification
Congress enacted the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001
(the "USA Patriot Act") on October 26, 2001 in response to the terrorist
events of September 11, 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. Since its enactment, Congress
has refined certain expiring provisions of the USA Patriot Act.
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.
The Bank Holding Company Act
Under the Bank Holding Company Act, the Company is supervised by the
Federal Reserve. The Federal Reserve has a policy that a bank holding company
is required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound
manner. In addition, the Federal Reserve provides that bank holding companies
should serve as a source of strength to its subsidiary banks by being prepared
to use available resources to provide adequate capital funds to its subsidiary
banks during periods of financial stress or adversity, and should maintain the
financial flexibility and capital raising capacity to obtain additional
resources for assisting its subsidiary banks. A bank holding company's
failure to meet its obligation to serve as a source of strength to its
subsidiary banks will generally be considered by the Federal Reserve to be an
unsafe and unsound banking practice or a violation of the Federal Reserve's
regulations or both.
The Company is required to file quarterly and periodic reports with the
Federal Reserve and provide additional information as the Federal Reserve may
require. The Federal Reserve may examine the Company, and any of its
subsidiaries, and charge the Company for the cost of the examination.
The Company and any subsidiaries that it may control are considered
"affiliates" within the meaning of the Federal Reserve Act, and transactions
between our bank subsidiary and affiliates are subject to numerous
restrictions. With some exceptions, the Company and its subsidiaries, are
prohibited from tying the provision of various services, such as extensions of
credit, to other services offered by the Company, or its affiliates.
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, 2007, the Company's total risk based capital was 13.6% of
risk-weighted assets and its risk based capital of Tier 1 (core) capital was
12.7% of risk-weighted assets.
Sarbanes-Oxley Act of 2002
As a public company, the Company is subject to the Sarbanes-Oxley Act of
2002, which implements a broad range of corporate governance and accounting
measures for public companies designed to promote honesty and transparency in
corporate America and better protect investors from corporate wrongdoing. The
Sarbanes-Oxley Act of 2002 was signed into law by President Bush on July 30,
2002 in response to public concerns regarding corporate accountability in
connection with several 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 includes very specific additional disclosure
requirements and new corporate governance rules, requires the Securities and
Exchange Commission and securities exchanges to adopt extensive additional
disclosure, corporate governance and other related rules and mandates further
studies of certain issues by the SEC and the Comptroller General.
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 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 required 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
33
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 (generally 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, 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.
34
Personnel
As of September 30, 2007, the Bank had 242 full-time employees and 32
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.
Executive Officers of the Company and Bank
Age at Position
September -------------------------------------------------
Name 30, 2007 Company Bank
- ----------------- --------- ------------------------- ----------------------
Michael R. Sand 53 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 40 Executive Vice President, Executive Vice
Chief Financial Officer President, Chief
and Secretary Financial Officer and
Secretary
Robert A. Drugge 56 Executive Vice President Executive Vice
President and
Business Banking
Division Manager
John P. Norawong 42 Executive Vice President Executive Vice
President and
Community Banking
Division Manager
Marci A. Basich 38 Senior Vice President and Senior Vice President
Treasurer and Treasurer
Kathie M. Bailey 56 Senior Vice President Senior Vice President
and Chief Operations
Officer
Biographical Information.
Michael R. Sand has been affiliated with the Bank since 1977 and has
served as President of the Bank and the Company since January 23, 2003. On
September 30, 2003, he was appointed as Chief Executive Officer of the Bank
and Company. Prior to appointment as President and Chief Executive Officer,
Mr. Sand had served as Executive Vice President and Secretary of the Bank
since 1993 and as Executive Vice President and Secretary of the Company since
its formation in 1997.
Dean J. Brydon has been affiliated with the Bank since 1994 and has
served as the Chief Financial Officer of the Company and the Bank since
January 2000 and Secretary of the Company and Bank since January 2004. Mr.
Brydon is a Certified Public Accountant.
Robert A. Drugge has been affiliated with the Bank since April 2006 and
has served as Executive Vice President and Business Banking Manager since
September 2006. Prior to joining Timberland, Mr. Drugge was employed at Bank
of America as an executive officer and most recently served as Senior Vice
President. Mr. Drugge began his banking career at Seafirst in 1974, which was
acquired by Bank America Corp. and became known as Bank of America.
35
John P. Norawong has been affiliated with the Bank since July 2006 and
has served as Executive Vice President and Community Banking Division Manager
since September 2006. Prior to joining Timberland, Mr. Norawong served as
Senior Vice President and Commercial Bank Manager at United Commercial Bank
from February 2006 to July 2006, and as Vice President and Senior Vice
President at Key Bank from 1999 through 2006.
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.
Kathie M. Bailey has been affiliated with the Bank since 1984 and has
served as Senior Vice President and Chief Operations Officer since 2003.
Item 1A. Risk Factors
- ----------------------
We assume and manage a certain degree of risk in order to conduct our
business strategy. In addition to the risk factors described below, other
risks and uncertainties not specifically mentioned, or that are currently
known to, or deemed by, management to be immaterial also may materially and
adversely affect our financial position, results of operation and/or cash
flows. Before making an investment decision, you should carefully consider
the risks described below together with all of the other information included
in this Form 10-K. If any of the circumstances described in the following
risk factors actually occur to a significant degree, the value of our common
stock could decline, and you could lose all or part of your investment.
Our loan portfolio includes increased risk due to changes in category
composition of the portfolio. The percentage of loans secured by first
mortgages on one-to four-family residential properties has decreased as the
portfolio has shifted into higher-yielding loan categories that typically
involve a higher degree of risk.
From September 30, 2003, through September 30, 2007, our total loans have
grown by 59.9%. During this period the percentage of one- to four-family loans
in the loan portfolio has decreased to 17.4% from 26.2%. Our commercial real
estate loans, construction and land development loans, multi-family loans,
land loans, commercial business loans, and consumer loans accounted for
approximately 82.6% of our total loan portfolio as of September 30, 2007. We
consider these types of loans to involve a higher degree of risk compared to
first mortgage loans on one- to four-family, owner-occupied residential
properties, and therefore, may cause higher future loan losses. Accordingly,
as a result of the inherent risks associated with these types of loans, and
the unseasoned nature of a portion of these loans, it may become necessary to
increase the level of our provision for loan losses. An increase in our
provision for loan losses would reduce our profits.
For further information concerning the risks associated with
multi-family, and commercial real estate loans, construction loans, and
consumer loans, see "Item 1. Business - Lending Activities."
We have increased our construction and land development lending which presents
greater risk than one- to four-family and consumer lending.
Construction lending is generally considered to involve a higher level of
risk as compared to single-family residential or consumer lending, as a result
of the concentration of principal in a limited number of loans and borrowers,
and the effects of general economic conditions on developers and builders.
Moreover, a construction loan can involve additional risks because of the
inherent difficulty in estimating both a property's value at completion of the
project and the estimated cost (including interest) of the project. The nature
of these loans is such that they are generally more difficult to evaluate and
monitor. In addition, speculative construction loans to a builder are often
associated with homes that are not pre-sold, and thus pose a greater potential
risk to us than construction loans to individuals on their personal
residences. Construction loans on land under development or held for future
construction also poses additional risk because of the lack of income being
produced by the property and the potential illiquid nature of the security.
36
Fluctuations in interest rates could reduce our profitability and affect the
value of our assets.
Like other financial institutions, we are subject to interest rate risk.
Our primary source of income is net interest income, which is the difference
between interest earned on loans and investment securities and the interest
paid on deposits and borrowings. We expect that we will periodically
experience imbalances in the interest rate sensitivities of our assets and
liabilities and the relationships of various interest rates to each other.
Over any period of time, our interest-earning assets may be more sensitive to
changes in market interest rates than our interest-bearing liabilities, or
vice versa. In addition, the individual market interest rates underlying our
loan and deposit products may not change to the same degree over a given time
period. In any event, if market interest rates should move contrary to our
position, our earnings may be negatively affected. In addition, loan volume
and quality and deposit volume and mix can be affected by market interest
rates. Changes in levels of market interest rates could materially adversely
affect our net interest spread, asset quality, origination volume and overall
profitability.
Interest rates have recently decreased after increasing for several
years. The U.S. Federal Reserve increased its target for the federal funds
rate 17 times, from 1.00% to 5.25% during the period from June 30, 2004 to
June 20, 2006. The U.S. Federal Reserve then decreased its target for the
federal funds rate by 50 basis points on September 18, 2007. A sustained
falling interest rate environment would negatively impact margins as the Bank
has more interest earning assets that would adjust downward than
interest-bearing liabilities that would adjust downward.
We manage our assets and liabilities in order to achieve long-term
profitability while limiting our exposure to the fluctuation of interest
rates. We anticipate periodic imbalances in the interest rate sensitivity of
our assets and liabilities and the relationship of various interest rates to
each other. At any reporting period, we may have earning assets which are
more sensitive to changes in interest rates than interest-bearing liabilities,
or vice versa. The fluctuation of market interest rates can materially affect
our net interest spread, interest margin, loan originations, deposit volumes
and overall profitability. In addition, we may have valuation risk in
measuring our interest rate risk position. The valuation risk is attributable
to calculation methods (modeling risks) and assumptions used in the model,
including loan prepayments and forward interest rates.
For further information on our interest rate risks, see the discussion
included in "Item 7A. Quantitative and Qualitative Disclosure About Market
Risk" of this Form 10-K.
We are required to maintain a higher capital ratio because of our level of
commercial real estate loans.
The FDIC, along with the Federal Reserve and the Office of the
Comptroller of the Currency, has issued final guidance for financial
institutions with concentrations in commercial real estate lending. The
guidance provides that a bank has a concentration in commercial real estate
lending if (i) total reported loans for construction, land development, and
other land represent 100% or more of total capital or (ii) total reported
loans secured by multi-family and non-farm residential properties and loans
for construction, land development, and other land represent 300% or more of
total capital and its construction loan portfolio has increase 50% or more
during the prior 36 months. If a concentration is present, management must
employ heightened risk management practices including board and management
oversight and strategic planning, development of underwriting standards, risk
assessment and monitoring through market analysis and stress testing, and
increasing capital requirements. Based on the Bank's projected commercial
real estate lending levels, it is considered to have a concentration in
commercial real estate lending and must implement the practices outlined in
the final guidance, including maintaining a higher capital ratio.
Our commercial business lending activities involves greater risk than other
types of lending.
Our commercial business lending has increased since 2003 and we intend to
continue to offer commercial business loans to small and medium sized
businesses. Our ability to originate commercial business loans is determined
by the demand for these loans and our ability to attract and retain qualified
commercial lending personnel. Because payments on commercial business loans
generally depend on the successful operation of the business involved,
repayment of commercial business loans may be subject to a greater extent to
adverse conditions in the economy than other types of lending. Although
commercial business loans often have equipment, inventory, accounts receivable
or
37
other business assets as collateral, the sale of the collateral in the event
the borrower does not repay the loan is often not sufficient to repay the loan
because the collateral may be uncollectible and inventories and equipment may
be obsolete or of limited use, among other things. Consequently, there can be
no assurance that we will continue to be successful in these efforts.
Our funding sources may prove insufficient to replace deposits and support our
future growth.
We rely on customer deposits and advances from the FHLB of Seattle and
other borrowings to fund our operations. Although we have historically been
able to replace maturing deposits and advances if desired, no assurance can be
given that we would be able to replace such funds in the future if our
financial condition or the financial condition of the FHLB of Seattle or
market conditions were to change. Our financial flexibility will be severely
constrained if we are unable to maintain our access to funding or if adequate
financing is not available to accommodate future growth at acceptable interest
rates. Finally, if we are required to rely more heavily on more expensive
funding sources to support future growth, our revenues may not increase
proportionately to cover our costs. In this case, our profitability would be
adversely affected.
Although we consider such sources of funds adequate for our liquidity
needs, we may seek additional debt in the future to achieve our long-term
business objectives. There can be no assurance additional borrowings, if
sought, would be available to us or, if available, would be on favorable
terms. If additional financing sources are unavailable or are not available
on reasonable terms, our growth and future prospects could be adversely
affected.
If our allowance for loan losses is not sufficient to cover future loan
losses, our earnings could decrease.
We make various assumptions and judgments about the collectibility of our
loan portfolio, including the creditworthiness of our borrowers and the value
of the real estate and other assets serving as collateral for the repayment of
many of our loans. In determining the amount of the allowance for loan losses,
we review several factors including our loan loss and delinquency experience,
underwriting practices, and economic conditions. If our assumptions are
incorrect, our allowance for loan losses may not be sufficient to cover future
losses in the loan portfolio, resulting in the need for greater additions to
our allowance. Material additions to the allowance could materially decrease
our net income. Our allowance for loan losses was 0.92% of total loans and
321.95% of non-performing loans at September 30, 2007.
In addition, bank regulators periodically review our allowance for loan
losses and may require us to increase our provision for loan losses or
recognize further loan charge-offs. Any increase in our allowance for loan
losses or loan charge-offs as required by these regulatory authorities may
have a material adverse effect on our financial condition and results of
operations.
Our profitability depends significantly on economic conditions in the State of
Washington.
Our success depends primarily on the general economic conditions of the
State of Washington and the specific local markets in which we operate.
Adverse economic conditions unique to the Washington markets could have a
material adverse effect on our financial condition and results of operations.
Further, a significant decline in general economic conditions, caused by
inflation, recession, unemployment, changes in securities markets or other
factors could impact our state and local markets and, in turn, also have a
material adverse effect on our financial condition and results of operations.
Of particular concern are real estate values, which may decline. If
Washington were to experience significant declines in real estate values, this
decline may inhibit our ability to recover on defaulted loans by selling the
underlying real estate.
Competition with other financial institutions could adversely affect our
profitability.
The banking and financial services industry is very competitive. Legal
and regulatory developments have made it easier for new and sometimes
unregulated competitors to compete with us. Consolidation among financial
service providers has resulted in fewer very large national and regional
banking and financial institutions holding a large accumulation of assets.
These institutions generally have significantly greater resources, a wider
geographic presence
38
or greater accessibility. Our competitors sometimes are also able to offer
more services, more favorable pricing or greater customer convenience than we
do. In addition, our competition has grown from new banks and other financial
services providers that target our existing or potential customers. As
consolidation continues among large banks, we expect additional institutions
to try to exploit our market.
Technological developments have allowed competitors including some
non-depository institutions, to compete more effectively in local markets and
have expanded the range of financial products, services and capital available
to our target customers. If we are unable to implement, maintain and use such
technologies effectively, we may not be able to offer products or achieve the
cost-efficiencies necessary to compete in our industry. In addition, some of
these competitors have fewer regulatory constraints and lower cost structures.
The loss of key members of our senior management team could adversely affect
our business.
We believe that our success depends largely on the efforts and abilities
of our senior management. Their experience and industry contacts
significantly benefit us. The competition for qualified personnel in the
financial services industry is intense, and the loss of any of our key
personnel or an inability to continue to attract, retain and motivate key
personnel could adversely affect our business.
We are subject to extensive government regulation and supervision.
We are subject to extensive federal and state regulation and supervision,
primarily through the Bank and certain non-bank subsidiaries. Banking
regulations are primarily intended to protect depositors' funds, federal
deposit insurance funds and the banking system as a whole, not shareholders.
These regulations affect our lending practices, capital structure, investment
practices, dividend policy and growth, among other things. Congress and
federal regulatory agencies continually review banking laws, regulations and
policies for possible changes. Changes to statutes, regulations or regulatory
policies, including changes in interpretation or implementation of statutes,
regulations or policies, could affect us in substantial and unpredictable
ways. Such changes could subject us to additional costs, limit the types of
financial services and products we may offer and/or increase the ability of
non-banks to offer competing financial services and products, among other
things. Failure to comply with laws, regulations or policies could result in
sanctions by regulatory agencies, civil money penalties and/or reputation
damage, which could have a material adverse effect on our business, financial
condition and results of operations. While we have policies and procedures
designed to prevent any such violations, there can be no assurance that such
violations will not occur. For further information, see "Item 1. Business -
Regulation of the Company."
We rely heavily on the proper functioning of our technology.
We rely heavily on communications and information systems to conduct our
business. Any failure, interruption or breach in security of these systems
could result in failures or disruptions in our customer relationship
management, general ledger, deposit, loan and other systems. While we have
policies and procedures designed to prevent or limit the effect of the
failure, interruption or security breach of our information systems, there can
be no assurance that any such failures, interruptions or security breaches
will not occur or, if they do occur, that they will be adequately addressed.
The occurrence of any failures, interruptions or security breaches of our
information systems could damage our reputation, result in a loss of customer
business, subject us to additional regulatory scrutiny, or expose us to civil
litigation and possible financial liability, any of which could have a
material adverse effect on our financial condition and results of operations.
We rely on third-party service providers for much of our communications,
information, operating and financial control systems technology. If any of our
third-party service providers experience financial, operational or
technological difficulties, or if there is any other disruption in our
relationships with them, we may be required to locate alternative sources of
such services, and we cannot assure that we could negotiate terms that are as
favorable to us, or could obtain services with similar functionality, as found
in our existing systems, without the need to expend substantial resources, if
at all. Any of these circumstances could have an adverse effect on our
business.
39
We rely on dividends from subsidiaries for most of our revenue.
The Company is a separate and distinct legal entity from its
subsidiaries. We receive substantially all of our revenue from dividends from
our subsidiaries. These dividends are the principal source of funds to pay
dividends on our common stock and interest and principal on our debt. Various
federal and/or state laws and regulations limit the amount of dividends that
the Bank may pay to the Company. Also, our right to participate in a
distribution of assets upon a subsidiary's liquidation or reorganization is
subject to the prior claims of the subsidiary's creditors. In the event the
Bank is unable to pay dividends to the Company, we may not be able to service
our debt, pay obligations or pay dividends on our common stock. The inability
to receive dividends from the Bank could have a material adverse effect on our
business, financial condition and results of operations
If we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results or
prevent fraud, and, as a result, investors and depositors could lose
confidence in our financial reporting, which could adversely affect our
business, the trading price of our stock and our ability to attract additional
deposits.
In connection with the enactment of the Sarbanes-Oxley Act of 2002 and
the implementation of the rules and regulations promulgated by the SEC, we
document and evaluate our internal control over financial reporting in order
to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act. This
requires us to prepare an annual management report on our internal control
over financial reporting, including among other matters, management's
assessment of the effectiveness of internal control over financial reporting
and an attestation report by our independent auditors addressing these
assessments. If we fail to identify and correct any significant deficiencies
in the design or operating effectiveness of our internal control over
financial reporting or fail to prevent fraud, current and potential
shareholders and depositors could lose confidence in our internal controls and
financial reporting, which could adversely affect our business, financial
condition and results of operations, the trading price of our stock and our
ability to attract additional deposits.
Changes in accounting standards may affect our performance.
Our accounting policies and methods are fundamental to how we record and
report our financial condition and results of operations. From time to time
there are changes in the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be
difficult to predict and can materially impact how we report and record our
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in
restating prior period financial statements.
Item 1B. Unresolved Staff Comments
- -----------------------------------
Not applicable.
Item 2. Properties
- -------------------
At September 30, 2007 the Bank operated 21 full service facilities and
one loan production office. 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, the Centralia loan production office, and the Check Processing Department
office at 504 8th Street, which are leased.
40
Approximate Deposits at
Location Year Opened Square Footage September 30, 2007
- --------------------------- ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $111,481
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 31,123
Aberdeen, Washington 98520
201Main Street South 2004 3,200 49,363
Montesano, Washington 98563
361 Damon Road 1977 2,100 21,402
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 35,708
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 17,331
Auburn, Washington 98002
12814 Meridian East (South Hill) 1996 4,200 20,896
Puyallup, Washington 98373
1201 Marvin Road, N.E. 1997 4,400 12,023
Lacey, Washington 98516
101 Yelm Avenue W. 1999 1,800 12,515
Yelm, Washington 98597
20464 Viking Way NW 1999 3,400 6,278
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,900 16,913
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 18,270
Tumwater, Washington 98512
7805 South Hosmer Street 2001 5,000 10,165
Tacoma, Washington 98408
2401 Bucklin Hill Road 2003 4,000 10,192
Silverdale, Washington 98383
423 Washington Street SE 2003 3,000 10,340
Olympia, Washington 98501
3105 Judson St 2004 2,700 8,051
Gig Harbor, Washington 98335
(table continued on following page)
41
Approximate Deposits at
Location Year Opened Square Footage September 30, 2007
- --------------------------- ----------- -------------- ------------------
(In thousands)
117 N. Broadway 2004 3,700 10,405
Aberdeen, Washington 98520
313 West Waldrip 2004 5,900 23,003
Elma, Washington 98541
1751 Circle Lane SE 2004 900 10,468
Lacey, Washington 98503
101 2nd Street 2004 1,800 17,652
Toledo, Washington 98591
209 NE 1st Street 2004 3,400 13,156
Winlock, Washington 98586
Loan Production Office:
1641 Kresky Avenue, Suite 2 2006 800
Centralia, Washington 98531
Check Processing Facility:
504 8th Street 2003 5,400
Hoquiam, Washington 98550
Loan Center/Data Center:
120 Lincoln Street 2003 6,000
Hoquiam, Washington 98550
Other Properties:
305 8th Street(1) 2004 4,100
Hoquiam, Washington 98550
314 Main Street South(2) 1975 2,800
Montesano, Washington 98563
422 6th Street(3) 1990 2,700
Hoquiam, Washington 98550
- ----------
(1) Office at 305 8th Street, Hoquiam, Washington was consolidated into the
office at 624 Simpson Avenue, Hoquiam, Washington on November 15, 2004.
The building is currently being used for storage and other administrative
purposes.
(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. The building is currently rented to a third party.
(3) Previously served as the Bank's primary Data Center. The building has
sustained structural damage and is not currently occupied. An insurance
settlement is being negotiated with the Bank's previous insurance company.
42
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.
At September 30, 2007 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, 2007.
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, 2007, there were 6,967,675 shares of
common stock issued and approximately 639 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, 2007 and 2006. This
information was provided by the Nasdaq Stock Market.
High Low Dividends
------ ----- ---------
Fiscal 2007
- -----------
First Quarter................. $18.94 $17.48 $0.09
Second Quarter................ 18.82 17.63 0.09
Third Quarter................. 18.61 15.70 0.09
Fourth Quarter................ 16.40 15.10 0.10
High Low Dividends
------ ----- ---------
Fiscal 2006
- -----------
First Quarter................. $11.98 $11.52 $0.08
Second Quarter................ 14.10 11.63 0.08
Third Quarter................. 15.80 14.00 0.08
Fourth Quarter................ 19.52 15.61 0.09
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.
43
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 May
25, 2007, the Company announced a plan to repurchase 356,950 shares of the
Company's common stock. This marked the Company's 15th stock repurchase plan.
As of September 30, 2007, the Company has repurchased 212,000 of these shares
at an average price of $17.57 per share. Cumulatively, the Company has
repurchased 7,638,984 shares at an average price of $8.89 per share. This
represents 57.8% of the 13,225,000 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, 2007.
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, 2007 -
July 31, 2007......... 60,000 $16.66 60,000 156,950
August 1, 2007 -
August 31, 2007....... -- -- -- 156,950
September 1, 2007 -
September 30, 2007.... 12,000 16.03 12,000 144,950
------ ------
Total.................. 72,000 $16.56 72,000 144,950
====== ======
44
The following graph compares the cumulative total shareholder return on
our common stock with the cumulative total return on the Nasdaq U.S. Companies
Index and with the SNL $250 to $500 Million Asset Thrift Index and the SNL
$500 to $1 Billion Asset Thrift Index, peer group indices. Total return
assumes the reinvestment of all dividends and that the value of the Company's
Common Stock and each index was $100 on September 30, 2002.
[GRAPH APPEARS HERE]
Period Ending
----------------------------------------------------------
Index 09-30-02 09-30-03 09-30-04 09-30-05 09-30-06 09-30-07
- ------------------ -------- -------- -------- -------- -------- --------
Timberland Bancorp,
Inc............... $100.00 $146.44 $147.38 $149.46 $231.54 $210.86
NASDAQ Composite... 100.00 152.46 161.84 183.58 192.69 230.49
SNL $250m-$500 M
Thrift Index...... 100.00 138.10 155.47 152.86 166.34 153.70
SNL $500m-$1 B
Thrift Index...... 100.00 144.02 162.32 165.61 192.39 185.42
* Source: SNL Financial LC, Charlottesville, VA
45
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,
----------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets................. $644,848 $577,087 $552,765 $460,419 $449,633
Loans receivable and loans
held for sale, net.......... 515,341 424,645 388,109 344,594 322,236
Investment securities
available-for-sale.......... 50,851 63,805 65,860 41,560 36,933
Mortgage-backed securities
held-to-maturity............ 71 75 104 174 279
Mortgage-backed securities
available-for-sale.......... 13,047 17,603 23,735 18,329 17,098
FHLB Stock................... 5,705 5,705 5,705 5,682 5,454
Cash and due from financial
institutions, interest-
bearing deposits in banks
and fed funds sold.......... 16,670 22,889 28,718 19,833 38,098
Deposits..................... 466,735 431,061 411,665 319,570 307,672
FHLB advances................ 99,697 62,761 62,353 65,421 61,605
Shareholders' equity......... 74,547 79,365 74,642 72,817 77,611
Year Ended September 30,
----------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend income. $41,944 $35,452 $30,936 $26,571 $27,345
Interest expense............. 15,778 10,814 8,609 7,325 8,946
------- ------- ------- ------- -------
Net interest income.......... 26,166 24,638 22,327 19,246 18,399
Provision for loan losses.... 686 -- 141 167 347
------- ------- ------- ------- -------
Net interest income after
provision for loan losses... 25,480 24,638 22,186 19,079 18,052
Non-interest income.......... 5,962 6,244 6,073 4,576 6,385
Non-interest expense......... 19,451 18,896 18,536 15,575 14,832
Income before income taxes... 11,991 11,986 9,723 8,080 9,605
Federal income taxes......... 3,828 3,829 3,105 2,492 2,966
------- ------- ------- ------- -------
Net income................... $ 8,163 $ 8,157 $ 6,618 $ 5,588 $ 6,639
======= ======= ======= ======= =======
Earnings per common share (1):
Basic....................... $ 1.20 $ 1.16 $ 0.95 $ 0.77 $ 0.87
Diluted..................... $ 1.17 $ 1.12 $ 0.91 $ 0.73 $ 0.83
Dividends per share (1)...... $ 0.37 $ 0.33 $ 0.31 $ 0.29 $ 0.25
Dividend payout ratio........ 32.86% 30.55% 35.01% 41.52% 32.38%
- --------------
(1) Have been restated to reflect the two-for-one split of common stock on
June 5, 2007.
46
At September 30,
----------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
OTHER DATA:
Number of real estate loans
outstanding................. 3,295 3,005 3,022 2,857 2,824
Deposit accounts............. 53,166 51,392 51,496 40,348 39,313
Full-service offices......... 21 21 21 16 15
At or For the Year Ended September 30,
----------------------------------------------
2007 2006 2005 2004 2003
------ ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average assets
(1)........................ 1.34% 1.47% 1.23% 1.24% 1.52%
Return on average equity
(2)........................ 10.67 10.59 9.08 7.52 8.67
Interest rate spread (3).... 4.18 4.49 4.30 4.30 4.02
Net interest margin (4)..... 4.69 4.91 4.60 4.67 4.52
Average interest-earning
assets to average
interest-bearing
liabilities................ 118.01 119.20 116.56 120.68 122.74
Noninterest expense as a
percent of average
total assets............... 3.20 3.41 3.44 3.46 3.39
Efficiency ratio (5)........ 60.54 61.19 65.27 65.38 59.85
Book value per share (6).... $10.72 $10.56 $ 9.93 $ 9.38 $ 9.13
Book value per share (7).... 11.39 11.22 10.65 10.14 9.89
Tangible book value per
share (6)(8)............... 9.73 9.61 8.93 9.38 9.13
Tangible book value per
share (7)(8)............... 10.34 10.21 9.58 10.14 9.89
Asset Quality Ratios:
Non-accrual and 90 days or
more past due loans as a
percent of total loans
receivable, net............ 0.29% 0.02% 0.75% 0.41% 1.19%
Nonperforming assets as a
percent of total assets.... 0.23 0.02 0.62 0.40 1.15
Allowance for loan losses
as a percent of total
loans receivable, net (9).. 0.92 0.96 1.05 1.14 1.19
Allowance for losses as
a percent of
nonperforming loans........ 321.95 5,152.50 140.09 276.77 99.90
Net charge-offs
(recoveries) to average
outstanding loans.......... -- (0.01) 0.01 0.02 0.03
Capital Ratios:
Total equity-to-assets
ratio...................... 11.56% 13.75% 13.50% 15.82% 17.26%
Tangible equity-to-assets
ratio...................... 10.49 12.51 12.15 15.82 17.26
Average equity to average
assets (10)................ 12.58 13.90 13.53 16.52 17.49
- ----------------
(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.
47
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 and Estimates
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 Statements, "Summary of Significant Accounting
Policies," generally describes the Company's accounting policies. Management
believes that the judgments, estimates and assumptions used in the preparation
of the Company's Consolidated Financial Statements are appropriate given the
factual circumstances at the time. However, given the sensitivity of the
Company's Consolidated Financial Statements to these critical policies, the
use of other judgments, estimates and assumptions could result in material
differences in the Company's results of operations or financial condition.
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 amount
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.
48
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 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 evaluated at least annually 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 Supplementary Data."
Operating Strategy
The Company is a bank 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 market areas, the Bank 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.
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 other longer duration assets
with fixed-interest rates.
Emphasize the Origination of Commercial Real Estate and Commercial
Business Loans. The Bank has hired additional commercial loan officers for
the purpose of increasing the Bank's origination of commercial real estate and
commercial business loans.
49
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.
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. 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. Management of the Bank monitors the Bank's interest rate
sensitivity through the use of a model provided for the Bank by FIMAC
Solutions, LLC ("FIMAC"), a company that specializes in providing the
financial services industry interest risk rate risk and balances sheet
management services. Based on a rate shock analysis prepared by FIMAC, an
immediate increase in interest rates of 200 basis points would increase the
Bank's projected net interest income by approximately 3.4%, 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 4.9%, 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 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, 2007, adjustable-rate mortgage loans constituted
$185.3 million or 62.0%, of the Bank's total mortgage loan portfolio due after
one year. 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.
50
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, 2007, the construction and land development, and consumer loan
portfolios amounted to $186.3 million and $58.2 million, or 31.6% and 9.9% of
total loans receivable (including loans held for sale), respectively.
Quantitative Aspects of Market Risk. The model provided for the Bank by
FIMAC estimates the changes in net portfolio value ("NPV") and net interest
income in response to a range of assumed changes in market interest rates.
The model first estimates the level of the Bank's NPV (market value of assets,
less market value of liabilities, plus or minus the market value of any
off-balance sheet items) under the current rate environment. In general,
market values are estimated by discounting the estimated cash flows of each
instrument by appropriate discount rates. The model then recalculates the
Bank's NPV under different interest rate scenarios. The change in NPV under
the different interest rate scenarios provides a measure of the Bank's
exposure to interest rate risk. The following table is provided by FIMAC
based on data at September 30, 2007.
Net Interest Income(1)(2) 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 $27,600 $ 1,296 4.93% $79,293 $(8,833) (10.02)%
+200 27,195 891 3.39 82,143 (5,983) (6.79)
+100 26,752 448 1.70 85,105 (3,021) (3.43)
BASE 26,304 -- -- 88,126 -- --
-100 25,911 (393) (1.49) 90,136 2,010 2.28
-200 25,014 (1,290) (4.90) 88,409 283 0.32
-300 23,879 (2,425) (9.22) 84,752 (3,374) (3.83)
- -----------
(1) Does not include loan fees.
(2) Includes BOLI income, which is included in non-interest income on the
Consolidated Financial Statements.
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 0.3% increase in NPV and a 4.9% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 6.8% decrease in NPV and a 3.4% 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 net interest income in a
declining interest rate scenario and increases in net interest income in a
rising rate scenario. This structure also generally results in decreases in
NPV in a rising rate environment and increases in NVP when rates decrease by
200 basis points or less.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities
or periods to repricing, they may react in different degrees to changes in
market interest rates. Also, the interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types may lag behind changes in market rates.
Additionally, certain assets have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, expected rates of prepayments on loans
and early withdrawals from certificates could possibly deviate significantly
from those assumed in calculating the table.
51
Comparison of Financial Condition at September 30, 2007 and September 30, 2006
The Company's total assets increased by $67.8 million, or 11.7%, to
$644.8 million at September 30, 2007 from $577.1 million at September 30,
2006, primarily attributable to a $90.7 million increase in net loans
receivable. This increase was partially offset by a $17.5 million decrease in
investment and mortgage-backed securities and a $6.1 million decrease in cash
equivalents. This asset growth was primarily funded by a $36.9 million
increase in FHLB advances and a $35.7 million increase in deposits.
The Company's capital decreased by $4.8 million, or 6.1%, to $74.5
million at September 30, 2007 from $79.4 million at September 30, 2006 as the
Company continued to manage its capital level through stock repurchases,
dividends to shareholders and asset growth. During the year the Company
repurchased 687,542 shares of its stock for $12.4 million and paid $2.7
million in dividends to its shareholders. These decreases to capital were
partially offset by retained net income and funds received from stock option
exercises.
A more detailed explanation of the changes in significant balance sheet
categories follows:
Cash Equivalents: Cash equivalents decreased by $6.1 million or 26.9% to
$16.7 million at September 30, 2007 from $22.8 million at September 30, 2006
as a portion of these liquid funds were used to fund loan growth and share
repurchases.
Investment Securities and Mortgage-backed Securities and FHLB Stock:
Investment and mortgage-backed securities (including FHLB stock) decreased by
$17.5 million or 20.1% to $69.7 million at September 30, 2007 from $87.2
million at September 30, 2006, as a result of regular amortization and
prepayments on mortgage-backed securities and the maturity or call of U.S.
agency 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
$90.7 million or 21.4% to $515.3 million at September 30, 2007 from $424.7
million at September 30, 2006. The increase in the portfolio was primarily a
result of a $33.0 million increase in construction loans (net of undisbursed
portion of construction loans in process), a $31.1 million increase in land
loans, a $17.5 million increase in multi-family loans, a $9.6 million increase
in consumer loans, a $6.4 million increase commercial real estate loans and a
$3.7 million increase in one- to four-family loans. These increases were
partially offset by a $9.7 million decrease in commercial real estate loans.
A portion of the increase in multi-family loan category was a result of
several loans secured by mixed-use properties being internally reclassified to
the multi-family category from the commercial real estate category.
Loan originations (including participation interest purchased) increased
by 16.8% to $299.4 million for the year ended September 30, 2007 from $256.4
million for the year ended September 30, 2006. The Bank sold $29.9 million in
fixed rate one- to four-family mortgage loans during the year ended September
30, 2007 compared to $26.4 million for the fiscal year ended September 30,
2006. 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 Supplementary Data."
Premises and Equipment: Premises and equipment decreased by $155,000 to
$16.6 million at September 30, 2007 from $16.7 million at September 30, 2006.
The decrease was primarily as a result of depreciation and selling a land
parcel in Grays Harbor County that had been previously held for expansion
purposes. 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 Supplementary Data." Other
Real Estate Owned ("OREO"): The Company did not have any OREO or other
repossessed items at September 30, 2007. This compares to an OREO balance of
$15,000 at September 30, 2006. The balance decreased as the land parcel held
last year and other items added to OREO during the year had all been sold at
September 30, 2007.
52
For additional information on OREOs, 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
Supplementary Data."
Goodwill and Core Deposit Intangible ("CDI"): The amortized value of
goodwill and CDI decreased by $285,000 to $6.9 million at September 30, 2007
from $7.2 million at September 30, 2006 due to scheduled amortization of CDI.
The Bank recorded goodwill and CDI in connection with the October 2004
acquisition of seven branches and related deposits. For additional
information of 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 $35.7 million, or 8.3%, to $466.7 million
at September 30, 2007 from $431.1 million at September 30, 2006, primarily as
a result of the addition of $24.1 million in brokered certificate of deposit
accounts. The remainder of the increase was comprised of a $21.8 million
increase in certificate of deposit accounts and a $5.7 million increase in
money market accounts. These increases were partially offset by a $9.1
million decrease in N.O.W. checking accounts, a $3.8 million decrease in
savings accounts, and a $2.9 million decrease in non-interest bearing
accounts. For additional information on deposits, see "Item 1, Business --
Deposit Activities and Other Sources of Funds" and Note 9 of the Consolidated
Financial Statements contained in "Item 8, Financial Statements and
Supplementary Data."
FHLB Advances and Other Borrowings: FHLB advances and other borrowings
increased by $49.5 million, or 57.4%, to $100.3 million at September 30, 2007
from $63.7 million at September 30, 2006 as the Bank used additional advances
to fund loan portfolio growth. For additional information on borrowings, see
"Item 1, Business -- Deposit Activities and Other Sources of Funds -
Borrowings" and Notes 10 and 11 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplementary Data."
Shareholders' Equity: Total shareholders' equity decreased by $4.8
million, or 6.1%, to $74.5 million at September 30, 2007 from $79.4 million at
September 30, 2006, primarily as a result of share repurchases of $12.4
million and dividends to shareholders of $2.7 million. These decreases to
shareholders' equity were partially offset by net income of $8.2 million, an
increase of $1.9 million from the exercise of stock options and vesting
associated with the Company's benefit plans, and a $217,000 net increase in
the fair value of securities available for sale.
During the year ended September 30, 2007 the Company repurchased 687,542
shares of its common stock for $12.4 million at an average price of $18.08 per
share. The Company had 144,950 shares remaining to be purchased on its
existing stock repurchase plan at September 30, 2007. Cumulatively, the
Company has repurchased 7,638,984 shares (57.8%) of the 13,225,000 shares that
were issued in its 1998 initial public offering, at an average price of $8.89
per share. For additional information on shareholders' equity, see the
Consolidated Statements of Shareholders' Equity contained in "Item 8,
Financial Statements and Supplementary Data."
Comparison of Operating Results for the Years Ended September 30, 2007 and
2006
The Company's net income was nearly identical at $8.16 million for the
years ended September 30, 2007 and 2006 as increased net interest income was
offset by increased non-interest expense, increased provision for loan losses,
and decreased non-interest income. Diluted earnings per share, however,
increased by 4.5% to $1.17 for the year ended September 30, 2007 from $1.12
for the year ended September 30, 2006. The increased earnings per diluted
share were primarily a result of a decrease in the weighted average number of
shares outstanding as a result of share repurchases.
The increased net interest income was primarily a result of a larger
interest earning asset base due to an increased loan portfolio. The increase
in net interest income attributable to a larger interest earning asset base
was, however, partially offset by a decrease in the Company's net interest
margin.
The increased provision for loan losses was primarily the result of a
larger loan portfolio and an increase in the level of loans classified as
substandard. Net charge-offs remained low at only $11,000 during the year
ended September 30, 2007, which is equivalent to 0.002% of average outstanding
loans.
53
The increased non-interest expense was primarily a result of increased
employee costs and increased advertising expenses. The increased salary and
employee benefit expenses were primarily because of a larger employee base and
annual salary adjustments, and the increased advertising expenses were
primarily the result of additional advertising campaigns.
The decreased non-interest income was primarily a result of decreased
income from service charges on deposit accounts and decreased fee income from
the sale of non-deposit investment products.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2007 increased
by $6,000 to $8.16 million, or $1.17 per diluted share ($1.20 per basic share)
from $8.16 million, or $1.12 per diluted share ($1.16 per basic share) for the
year ended September 30, 2006. The $0.05 increase in diluted earnings per
share for the year ended September 30, 2007 was primarily the result of a
$1.53 million ($1.01 million net of income tax - $0.14 per diluted share)
increase in net interest income and a lower number of weighted average shares
outstanding which increased diluted earnings per share by approximately $0.05.
These items were partially offset by a $686,000 ($439,000 net of income tax -
$0.06 per diluted share) increase in the provision for loan losses, a $555,000
($366,000 net of income tax - $0.05 per diluted share) increase in
non-interest expense and a $282,000 ($186,000 net of income tax - $0.03 per
diluted share) decrease in non-interest income.
Net Interest Income: Net interest income increased by $1.53 million to
$26.17 million for the year ended September 30, 2007 from $24.64 million for
the year ended September 30, 2006, primarily due to a larger interest earning
asset base. Total interest and dividend income increased by $6.49 million to
$41.94 million for the year ended September 30, 2007 from $33.45 million for
the year ended September 30, 2006 as average total interest earning assets
increased by $56.10 million. The yield on interest earning assets increased
to 7.51% for the year ended September 30, 2007 from 7.06% for the year ended
September 30, 2006. Total interest expense increased by $4.96 million to
$15.78 million for the year ended September 30, 2007 from $10.81 million for
the year ended September 30, 2006 as average interest bearing liabilities
increased by $51.79 million. The average rate paid on interest bearing
liabilities increased to 3.33% for the year ended September 30, 2007 from
2.57% for the year ended September 30, 2006.
The increase in net interest income attributable to a larger interest
earning asset base was, however, partially offset by a compression of the
Company's net interest margin. The net interest margin decreased 22 basis
points to 4.69% for the year ended September 30, 2007 from 4.91% for the year
ended September 30, 2006 as funding costs increased at a greater rate than
yields increased on interest earning assets. This was primarily due to an
increased reliance on wholesale funding (FHLB advances and brokered deposits)
and increased competition for deposits in the Company's primary market areas,
which increased overall funding costs. Also factoring into the decrease in
this year's net interest margin was the collection of prepayment penalties and
non-accrual interest last year which increased the net interest margin for the
year ended September 30, 2006 by approximately 10 basis points.
Provision for Loan Losses: The provision for loan losses increased to
$686,000 for the year ended September 30, 2007 compared to no provision made
during the year ended September 30, 2006. The provision for loan losses
increased primarily due to an increase in the loan portfolio and an increase
in the level of loans classified as substandard. The Bank had a net
charge-off of $11,000 for the year ended September 30, 2007 compared to a net
recovery of $23,000 for the year ended September 30, 2006. The net
charge-offs (recoveries) to average outstanding loans ratio was 0.002% for the
year ended September 30, 2007 and (0.006%) for the year ended September 30,
2006.
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
$675,000 to $4.80 million at September 30, 2007 from $4.12 million at
September 30, 2006. The increased level of the allowance for loan losses was
primarily attributable to a larger loan portfolio (loans receivable and
54
loans held for sale), which increased by $90.7 million to $515.3 million at
September 30, 2007 from $424.6 million at September 30, 2006. Also
contributing to the increased allowance was an increase in the level of loans
classified as substandard.
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $4.80 million at September 30, 2007 (0.92% of loans
receivable and 321.9% 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."
Non-interest Income: Total non-interest income decreased by $282,000 to
$5.96 million for the year ended September 30, 2007 from $6.24 million for the
year ended September 30, 2006, primarily due to a $205,000 decrease in service
charges on deposits and a $166,000 decrease in fees from the sale of
non-deposit investment products, and a $30,000 decrease in gain on sale of
loans. The decreased in income from service charges on deposits was primarily
a result of a decrease in the number of customer overdrafts. The decrease in
gross fees received from that sale of non-deposit investment products was
primarily due to decreased sales and a change in the fee structure with the
Bank's third-party vendor. These decreases were partially offset by a
$112,000 increase in ATM transaction fees and an $80,000 increase in servicing
income on loans sold.
Non-interest Expense: Total non-interest expense increased by $555,000
to $19.45 million for the year ended September 30, 2007 from $18.90 million
for the year ended September 30, 2006. Non-interest expense increased in the
current year primarily due to a $184,000 increase in salary and benefit
expenses, a $155,000 increase in advertising expenses, a $69,000 increase in
ATM expenses, a $49,000 increase in premises and equipment expense and smaller
increases in several other expense categories. The increased salary and
benefit expenses were primarily due to a larger employee base and annual
salary adjustments and the increased advertising expenses were a result of
additional advertising campaigns. Also contributing to the increase in
non-interest expense was a $143,000 change in the other real estate operations
expense category. This change was primarily due to larger gains on the sale
of OREO properties that were included in this category during the 2006 fiscal
year.
These increases to non-interest expense were partially offset by a
$143,000 decrease in professional fees. The decrease in professional fees was
primarily a result of decreased consulting, legal, and audit related expenses.
The Company's efficiency ratio improved to 60.54% for the year ended
September 30, 2007 from 61.19% for the year ended September 30, 2006.
Provision for Income Taxes: The provision for income taxes remained at
$3.83 million for the years ended September 30, 2007 and 2006. The Company's
effective tax rate was 31.92% for the year ended September 30, 2007 and 31.95%
for the year ended September 30, 2006.
Comparison of Operating Results for the Years Ended September 30, 2006 and
2005
The Company's net income increased by 23.3% to $8.16 million for the year
ended September 30, 2006 from $6.62 million for the year ended September 30,
2005. Diluted earnings per share increased by 23.1% to $1.12 for the year
ended September 30, 2006 from $0.91 for the year ended September 30, 2005.
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.
55
The increased net interest income was primarily a result of a larger
interest earning asset base, an increased interest rate spread due to the
increasing interest rate environment, an increase in prepayment penalties
(which are recorded as interest income), and an increase in the level of
non-accrual interest collected.
The increased non-interest income was primarily a result of increased
fees from the sale of non-deposit investment products, increased service
charges on deposits, and increased ATM fees. These increases were partially
offset by a decrease in gains from loan sales.
Partially offsetting the increased net interest income and non-interest
income was an increase in non-interest expenses. The increased expenses were
primarily a result of increased salary and benefit expenses due to a larger
employee base, annual salary adjustments, and increased health insurance
costs.
A more detailed explanation of the income statement categories is
presented below.
Net Income: Net income for the year ended September 30, 2006 increased
by $1.54 million to $8.16 million, or $1.12 per diluted share ($1.16 per basic
share) from $6.62 million, or $0.91 per diluted share ($0.91 per basic share)
for the year ended September 30, 2005. The $0.21 increase in diluted earnings
per share for the year ended September 30, 2006 was primarily the result of a
$2.45 million ($1.62 million net of income tax - $0.22 per diluted share)
increase in net interest income after provision for loan losses and a $171,000
($113,000 net of income tax - $0.02 per diluted share) increase in
non-interest income. These items were partially offset by a $360,000
($238,000 net of income tax - $0.03 per diluted share) increase in
non-interest expense.
Net Interest Income: Net interest income increased by $2.31 million to
$24.64 million for the year ended September 30, 2006 from $22.33 million for
the year ended September 30, 2005, primarily due to a larger interest earning
asset base, an increased interest rate spread, a $327,000 increase in
prepayment penalties (which are recorded as interest income), and the
collection of $162,000 in non-accrual interest. The collection of the
prepayment penalties and the non-accrual interest increased the yearly net
interest margin by approximately 10 basis points. Total interest income
increased $4.51 million to $35.45 million for the year ended September 30,
2006 from $30.94 million for the year ended September 30, 2005 as average
total interest earning assets increased by $16.58 million. The yield on
interest earning assets increased to 7.06% for the year ended September 30,
2006 from 6.37% for the year ended September 30, 2005. Total interest expense
increased by $2.20 million to $10.81 million for the year ended September 30,
2006 from $8.61 million for the year ended September 30, 2005 as average
interest bearing liabilities increased by $4.69 million. The average rate
paid on interest bearing liabilities increased to 2.57% for the year ended
September 30, 2006 from 2.07% for the year ended September 30, 2005. The net
interest margin increased to 4.91% for the year ended September 30, 2006 from
4.60% for the year ended September 30, 2005.
Provision for Loan Losses: The Bank did not make a provision for loan
losses during the year ended September 30, 2006 as credit quality factors
improved. This compares to a provision for loan losses of $141,000 for the
year ended September 30, 2005. The provision for loan losses decreased
primarily due to a decrease in the level of loans classified as substandard
and an increase in the level of net recoveries. The Bank had a net recovery of
$23,000 for the year ended September 30, 2006 compared to a net charge-off of
$33,000 for the year ended September 30, 2005. The net charge-offs
(recoveries) to average outstanding loans ratio was (0.01%) for the year ended
September 30, 2006 and 0.01% for the year ended September 30, 2005.
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 amount 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
$23,000 to $4.12 million at September 30, 2006 from $4.10 million at September
30, 2005. Although there was a decrease in loans classified as substandard,
the Company decided to maintain the current level of the allowance for loan
losses primarily due to a larger loan portfolio, which increased by $36.5
million to $424.6 million at September 30, 2006, from $388.1 million at
September 30, 2005.
56
Based on the comprehensive methodology, management deemed the allowance
for loan losses of $4.12 million at September 30, 2006 (0.96% of loans
receivable and 5,152.50% 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."
Non-interest Income: Total non-interest income increased by $171,000 to
$6.24 million for the year ended September 30, 2006 from $6.07 million for the
year ended September 30, 2005, primarily due to a $217,000 increase in fees
from the sale of non-deposit investment products, a $159,000 increase in
service charges on deposits, and a $155,000 increase in ATM transaction fees.
These increases were partially offset by a $342,000 decrease in gains from
loan sales. Income from loan sales was larger in the period a year ago in
part due to the sale of the Bank's credit card portfolio in December 2004,
which resulted in a gain of $264,000.
Non-interest Expense: Total non-interest expense increased by $360,000
to $18.90 million for the year ended September 30, 2006 from $18.54 million
for the year ended September 30, 2005. Non-interest expense was higher in the
current year primarily due to a $548,000 increase in salary and benefit
expense and a $196,000 increase in premises and equipment expense. The
increased salary and benefit expenses were primarily attributable to a larger
employee base, annual salary adjustments, and increased health insurance
costs. The increased premises and equipment expenses were primarily due to
increased building and equipment maintenance costs. These increases were
partially offset by a $182,000 decrease in real estate operation expenses (due
to gains from the sale of OREO properties) and a $109,000 decrease in
advertising expenses. The Company's efficiency ratio improved to 61.19% for
the year ended September 30, 2006 from 65.27% for the year ended September 30,
2005.
Provision for Income Taxes: The provision for income taxes increased
$724,000 to $3.83 million for the year ended September 30, 2006 from $3.11
million for the year ended September 30, 2005 primarily as a result of
increased income before taxes. The Company's effective tax rate was 31.95%
for the year ended September 30, 2006 and 31.93% for the year ended September
30, 2005.
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.
57
Year Ended September 30,
--------------------------------------------------------------------------------
2007 2006 2005
-------------------------- ------------------------ -------------------------
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).. $477,029 $38,386 8.04% $399,811 $31,397 7.85% $378,113 $27,514 7.28%
Mortgage-backed and
investment securities... 37,411 1,529 4.09 55,373 2,152 3.89 54,541 1,962 3.60
FHLB stock and equity
securities ............. 37,347 1,692 4.53 36,882 1,436 3.89 37,904 1,093 2.88
Federal funds sold........ 5,030 260 5.17 8,414 389 4.62 11,653 282 2.42
Interest-bearing
deposits................ 1,481 77 5.17 1,714 78 4.55 3,405 85 2.50
-------- ------- -------- ------- -------- -------
Total interest-earning
assets................. 558,298 41,944 7.51 502,194 35,452 7.06 485,616 30,936 6.37
Non-interest-earning
assets................... 49,483 52,037 52,786
-------- -------- --------
Total assets............ $607,781 $554,231 $538,402
======== ======== ========
Interest-bearing
liabilities:
Savings accounts......... $ 60,124 425 0.71% $ 62,255 442 0.71% $ 61,798 438 0.71%
Money market accounts.... 46,013 1,186 2.58 43,204 711 1.65 50,337 626 1.24
NOW accounts............. 82,323 638 0.77 91,507 684 0.75 95,471 657 0.69
Certificates of deposit.. 199,046 9,043 4.55 168,578 6,068 3.60 148,483 3,701 2.53
Short-term borrowings(3). 35,206 1,954 5.55 4,664 218 4.67 5,875 236 4.02
Long-term borrowings(4).. 50,393 2,532 5.02 51,109 2,691 5.27 54,662 2,951 5.40
-------- ------- -------- ------- -------- -------
Total interest bearing
liabilities............ 473,105 15,778 3.33 421,317 10,814 2.57 416,626 8,609 2.07
Non-interest bearing
liabilities.............. 58,179 55,870 48,916
-------- -------- --------
Total liabilities....... 531,284 477,187 465,542
Shareholders' equity...... 76,497 77,044 72,860
-------- -------- --------
Total liabilities and
shareholders' equity... $607,781 $554,231 $538,402
======== ======== ========
Net interest income....... $26,166 $24,638 $22,327
======= ======= =======
Interest rate spread...... 4.18% 4.49% 4.30%
====== ====== ======
Net interest margin(5).... 4.69% 4.91% 4.60%
====== ====== ======
Ratio of average
interest-earning
assets to average
interest-bearing
liabilities.............. 118.01% 119.20% 116.56%
====== ====== ======
- ----------------
(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 (2007, $1,794;
2006, $2,137; and 2005, $2,146) included with interest and dividends.
(2) Average balance includes nonaccrual loans.
(3) Includes FHLB advances and PCBB advances with original maturities of less than one year and other
short-term borrowings-repurchase agreements.
(4) Includes FHLB advances with original maturities of one year or greater.
(5) Net interest income divided by total average interest earning assets.
58
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,
2007 Compared to Year 2006 Compared to Year
Ended September 30, 2006 Ended September 30, 2005
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------ ------------------------
Net Net
Rate Volume Change Rate Volume Change
---- ------ -------- ---- ------ ------
(In thousands)
Interest-earning assets:
Loans receivable (1).... $ 793 $6,196 $6,989 $2,252 $1,631 $3,883
Investments and mortgage-
backed securities...... (11) (118) (129) 161 29 190
FHLB stock and equity
securities............. 2 (3) (1) 373 (30) 343
Federal funds sold...... (38) (585) (623) 202 (95) 107
Interest-bearing
deposits............... 237 19 256 48 (55) (7)
Total net change in
income on interest-
earning assets.......... 983 5,509 6,492 3,036 1,480 4,516
Interest-bearing liabilities:
Savings accounts........ -- (17) (17) 1 3 4
NOW accounts............ (3) (43) (46) 55 (28) 27
Money market accounts... 424 51 475 182 (97) 85
Certificate accounts.... 2,356 619 2,975 1,964 403 2,367
Short-term borrowings... 47 1,689 1,736 69 (87) (18)
Long-term borrowings.... (123) (36) (159) (72) (188) (260)
------- ------ ------ ------ ------ ------
Total net change in
expense on interest-
bearing liabilities..... 2,701 2,263 4,964 2,199 6 2,205
------- ------ ------ ------ ------ ------
Net change in net
interest income......... $(1,718) $3,246 $1,528 $ 837 $1,474 $2,311
======= ====== ====== ====== ====== ======
- ----------------
(1) Excludes interest on loans 90 days or more past due. Includes loans
originated for sale.
59
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds
from principal and interest payments on loans, the sale of loans, maturing
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,
2007, 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 9.23%. At September 30, 2007, the Bank 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 $99.7 million was outstanding. The Bank also
maintained a $10.0 million overnight borrowing line with PCBB. At September
30, 2007, the Bank did not have an outstanding balance on this borrowing line.
Liquidity management is both a short and long-term responsibility of the
Bank's management. The Bank adjusts its investments in liquid assets based
upon management's assessment of (i) expected loan demand, (ii) projected loan
sales, (iii) expected deposit flows, and (iv) yields available on interest-
bearing deposits. Excess liquidity is invested generally in interest-bearing
overnight deposits and other short-term government and agency obligations. f
the Bank requires funds beyond its ability to generate them internally, it has
additional borrowing capacity with the FHLB, PCCB 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, 2007, 2006 and 2005, the Bank originated $235.7
million, $215.8 million, and $190.3 million of mortgage loans, respectively.
At September 30, 2007, the Bank had loan commitments totaling $56.3 million
and undisbursed loans in process totaling $65.7 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, 2007 totaled $208.3 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, 2007, 2006, and
2005, the Bank sold $29.9 million, $26.4 million, and $25.2 million in fixed
rate, one- to four-family mortgage loans. The Bank also sold $6.7 million in
participation loans during the year ended September 30, 2007 and $1.5 million
in credit card loans during the year ended September 30, 2005. During the
years ended September 30, 2007, 2006, and 2005, the Bank received $164.9
million, $177.0 million, and $160.7 million in principal repayments.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2007, 2006 and 2005, deposits increased
by $35.7 million, $19.4 million, and $92.1 million, respectively. The
increase in deposits during the year ended September 30, 2005 was primarily a
result of the acquisition of seven offices and related deposits from a
competitor in October 2004.
Investment and mortgage-backed securities, federal funds sold, and
interest bearing deposits decreased to $69.8 million at September 30, 2007
from $89.5 million at September 30, 2006.
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, 2007, the Bank was in compliance with all
applicable capital requirements. For additional details see Note 19 of the
60
Notes to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplementary Data" and "Item 1, Business - Regulation of the
Bank - Capital Requirements."
Contractual obligations. The following table presents, as of September
30, 2007, 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, 2007.
Payments due by period
----------------------------------------------
After After
1 year 3 years
Within through through After
Contractual obligations 1 year 3 years 5 years 5 years Total
------ ------- ------- ------- -------
(In thousands)
Short-term debt obligations... $30,000 $ -- $ -- $ -- $ 30,000
Long-term debt obligations.... 15,069 4,628 -- 50,000 69,697
Operating lease obligations... 219 310 -- -- 529
Capital lease obligations..... 5 6 -- -- 11
------- ------ ----- ------- --------
Total contractual
obligations................ $45,293 $4,944 $ -- $50,000 $100,237
======= ====== ===== ======= ========
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.
61
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
Management's Report on Internal Control Over Financial Reporting
The Company's 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 disposition 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.
The Company's 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, 2007. 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.
62
Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting
McGladrey & Pullen
Certified Public Accountants
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors Shareholders
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited Timberland Bancorp, Inc. and Subsidiary internal control over
financial reporting as of September 30, 2007, based on criteria established in
Internal Control Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Timberland Bancorp, Inc.'s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management's
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audit also included
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, Timberland Bancorp, Inc. and Subsidiary maintained, in all
material respects, effective internal control over financial reporting as of
September 30, 2007, 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 annual consolidated financial
statements of Timberland Bancorp, Inc. and Subsidiary and our report dated
December 10, 2007, expressed an unqualified opinion.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 10, 2007
63
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm............ 65
Consolidated Balance Sheets as of September 30, 2007 and 2006...... 66
Consolidated Statements of Income For the Years Ended
September 30, 2007, 2006, and 2005.............................. 67
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2007, 2006 and 2005................... 68
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2007, 2006 and 2005............................... 69
Consolidated Statements of Comprehensive Income For the
Years Ended September 30, 2007, 2006 and 2005................... 71
Notes to Consolidated Financial Statements......................... 72
64
McGladrey & Pullen
Certified Public Accountants
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited the consolidated balance sheets of Timberland Bancorp, Inc.
and Subsidiary as of September 30, 2007 and 2006, 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, 2007.
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 provide 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, 2007 and 2006, and the
results of their operations and their cash flows for each of the three years
in the period ended September 30, 2007, 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), Timberland Bancorp, Inc. and
Subsidiary's internal control over financial reporting as of September 30,
2007, 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 10, 2007, expressed an unqualified
opinion on the effectiveness of Timberland Bancorp, Inc. and Subsidiary's
internal control over financial reporting.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 10, 2007
65
Consolidated Balance Sheets
- -----------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
2007 2006
Assets
Cash equivalents:
Cash and due from financial institutions $ 10,813 $ 14,870
Interest-bearing deposits in other banks 2,082 2,519
Federal funds sold 3,775 5,400
16,670 22,789
Certificate of deposits ("CDs") held for investment - - 100
Mortgage-backed securities - held to maturity
(market value $70 and $73) 71 75
Investments and mortgage-backed securities -
available for sale 63,898 81,408
Federal Home Loan Bank ("FHLB") stock (at cost) 5,705 5,705
Loans receivable, net of allowance for loan losses
of $4,797 and $4,122 514,584 422,196
Loans held for sale 757 2,449
515,341 424,645
Premises and equipment, net 16,575 16,730
Other real estate owned ("OREO") and other
repossessed items - - 15
Accrued interest receivable 3,424 2,806
Bank owned life insurance ("BOLI") 12,415 11,951
Goodwill 5,650 5,650
Core deposit intangible ("CDI") 1,221 1,506
Mortgage servicing rights 1,051 932
Other assets 2,827 2,775
Total assets $644,848 $577,087
Liabilities and shareholders' equity
Liabilities
Deposits:
Demand, non-interest-bearing $ 54,962 $ 57,905
Interest-bearing 411,773 373,156
Total deposits 466,735 431,061
FHLB advances 99,697 62,761
Other borrowings: repurchase agreements 595 947
Other liabilities and accrued expenses 3,274 2,953
Total liabilities 570,301 497,722
Commitments and contingencies (See Note 17)
Shareholders' equity
Preferred stock, $0.01 par value; 50,000,000
shares authorized; none issued - - - -
Common stock, $0.01 par value;
50,000,000 shares authorized;
2007 - 6,953,360 shares issued and outstanding
2006 - 3,757,676 shares issued and outstanding
on a pre-split basis 70 38
Additional paid-in capital 9,923 20,700
Unearned shares issued to Employee Stock
Ownership Plan ("ESOP") (3,040) (3,305)
Retained earnings 68,378 62,933
Accumulated other comprehensive loss (784) (1,001)
Total shareholders' equity 74,547 79,365
Total liabilities and shareholders' equity $644,848 $577,087
See notes to consolidated financial statements.
66
Consolidated Statements of Income
- -----------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2007, 2006 and 2005
2007 2006 2005
Interest and dividend income
Loans receivable $38,386 $31,397 $27,514
Investments and mortgage-backed securities 1,529 2,152 1,962
Dividends from mutual funds and FHLB stock 1,692 1,436 1,093
Interest-bearing deposits in banks 337 467 367
Total interest and dividend income 41,944 35,452 30,936
Interest expense
Deposits 11,292 7,905 5,422
FHLB advances - short term 1,905 169 205
FHLB advances - long term 2,532 2,691 2,951
Other borrowings 49 49 31
Total interest expense 15,778 10,814 8,609
Net interest income 26,166 24,638 22,327
Provision for loan losses 686 - - 141
Net interest income after provision
for loan losses 25,480 24,638 22,186
Non-interest income
Service charges on deposits 2,776 2,981 2,822
ATM transaction fees 1,138 1,026 871
BOLI net earnings 464 449 430
Gain on sale of loans, net 356 386 728
Servicing income on loans sold 505 425 379
Escrow fees 92 120 141
Fee income from non-deposit investment sales 120 286 69
Other 511 571 633
Total non-interest income 5,962 6,244 6,073
Non-interest expense
Salaries and employee benefits 10,928 10,744 10,196
Premises and equipment 2,452 2,403 2,211
Advertising 843 688 797
OREO and other repossessed items
expense (income) (13) (156) 22
ATM expenses 497 428 465
Postage and courier 478 486 529
Amortization of CDI 285 328 367
State and local taxes 571 564 436
Professional fees 650 793 714
Other 2,760 2,618 2,799
Total non-interest expense 19,451 18,896 18,536
Income before federal income taxes 11,991 11,986 9,723
Federal income taxes 3,828 3,829 3,105
Net income $ 8,163 $ 8,157 $ 6,618
Earnings per common share
Basic $1.20 $1.16 $0.95
Diluted 1.17 1.12 0.91
See notes to consolidated financial statements.
67
Consolidated Statements of Shareholders' Equity
- -----------------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2007, 2006 and 2005
Accumulated
Other
Unearned Compre-
Additional Shares hensive
Common Stock Paid-in Issued to Retained Income
Shares Amount Capital ESOP Earnings (Loss) Total
<s> <c> <c> <c> <c> <c> <c> <c>
Balance,
September 30, 2004 7,764,140 $39 $24,330 ($4,362) $52,967 ($157) $72,817
Net income - - - - - - - - 6,618 - - 6,618
Repurchase of common stock (348,868) (2) (4,062) - - - - - - (4,064)
Exercise of stock options 104,602 1 813 - - - - - - 814
Cash dividends ($.31 per share) - - - - - - - - (2,317) - - (2,317)
Earned ESOP shares - - 293 529 - - - - 822
Management Recognition
Development Plan ("MRDP")
compensation expense - - - - 666 - - - - - - 666
Unrealized holding loss on
securities available for sale,
net of tax - - - - - - - - - - (714) (714)
Balance,
September 30, 2005 7,519,874 $38 $22,040 ($3,833) $57,268 ($871) $74,642
Net income - - - - - - - - 8,157 - - 8,157
Issuance of MRDP shares 12,000 - - - - - - - - - - - -
Repurchase of common stock (217,200) (1) (3,700) - - - - - - (3,701)
Exercise of stock options 200,678 1 1,827 - - - - - - 1,828
Cash dividends ($.33 per share) - - - - - - - - (2,492) - - (2,492)
Earned ESOP shares - - - - 480 528 - - - - 1,008
MRDP compensation expense - - - - 3 - - - - - - 3
Stock option compensation exp. - - - - 50 - - - - - - 50
Unrealized holding loss on
securities available for sale,
net of tax - - - - - - - - - - (130) (130)
Balance,
September 30, 2006 7,515,352 $38 $20,700 ($3,305) $62,933 ($1,001) $79,365
Net income - - - - - - - - 8,163 - - 8,163
Stock split - - 36 - - - - (36) - - - -
Issuance of MRDP shares 15,080 - - - - - - - - - - - -
Repurchase of common stock (687,542) (4) (12,427) - - - - - - (12,431)
Exercise of stock options 110,470 - - 1,207 - - - - - - 1,207
Cash dividends ($.37 per share) - - - - - - - - (2,682) - - (2,682)
Earned ESOP shares - - 354 265 - - - - 619
MRDP compensation expense - - 64 - - - - - - 64
Stock option compensation exp. - - - - 25 - - - - - - 25
Unrealized holding gain on
securities available for sale,
net of tax - - - - - - - - - - 217 217
Balance,
September 30, 2007 6,953,360 $70 $ 9,923 ($3,040) $68,378 ($ 784) $74,547
See notes to consolidated financial statements.
68
Consolidated Statements of Cash Flows
- -----------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2007, 2006 and 2005
2007 2006 2005
Cash flows from operating activities
Net income $ 8,163 $ 8,157 $ 6,618
Non-cash revenues, expenses, gains and losses
included in net income:
Depreciation 1,038 998 933
Deferred federal income taxes (101) 226 64
Amortization of core deposit intangible 285 328 367
Earned ESOP shares 265 528 529
MRDP compensation expense 59 7 537
Stock option compensation expense 25 50 - -
FHLB stock dividends - - - - (23)
Stock option tax effect 464 607 186
Less stock option excess tax benefit (354) (494) - -
Gain on sale of OREO and other
repossessed items, net (19) (158) (5)
Gain on sale of loans (356) (386) (728)
(Gain) loss on sale of premises
and equipment (71) (37) 13
Provision for loan, OREO and other
repossessed item losses 686 - - 161
Loans originated for sale (27,845) (26,153) (26,528)
Proceeds from loans held for sale 29,893 26,445 25,247
Proceeds from credit card portfolio sale - - - - 264
BOLI net earnings (464) (449) (430)
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses (275) (1,906) 397
Net cash provided by operating activities 11,393 7,763 7,602
Cash flows from investing activities
Net (increase) decrease in CD's held
for investment 100 100 (1)
Activity in securities held to maturity:
Maturities and prepayments 3 27 62
Activity in securities available for sale:
Maturities and prepayments 17,806 7,960 8,140
Purchases - - - - (38,977)
Increase in loans receivable, net (93,316) (36,398) (42,272)
Additions to premises and equipment (1,135) (1,924) (837)
Purchase of branches, net of cash and
cash equivalents - - - - 76,630
Proceeds from sale of OREO and other
repossessed items 105 680 549
Proceeds from the disposition of premises
and equipment 323 95 6
Net cash provided (used) by investing
activities (76,114) (29,460) 3,300
(continued)
See notes to consolidated financial statements.
69
Consolidated Statements of Cash Flows
- -----------------------------------------------------------------------------
(concluded) (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2007, 2006 and 2005
2007 2006 2005
Cash flows from financing activities
Increase in deposits $ 35,674 $ 19,396 $ 5,600
Proceeds from FHLB advances - long term 60,000 10,000 - -
Repayment of FHLB advances - long term (24,064) (30,592) (583)
Net increase (decrease) in FHLB advances
- short term 1,000 21,000 (2,485)
Net increase (decrease) in repurchase
agreements (352) 166 781
Proceeds from exercise of stock options 744 1,221 628
ESOP tax effect 354 480 293
MRDP compensation tax effect 5 (4) 129
Stock option excess tax benefit 354 494 - -
Repurchase of common stock (12,431) (3,701) (4,064)
Payment of dividends (2,682) (2,492) (2,317)
Net cash provided (used) by financing
activities 58,602 15,968 (2,018)
Net increase (decrease) in cash equivalents (6,119) (5,729) 8,884
Cash equivalents
Beginning of year 22,789 28,518 19,634
End of year $ 16,670 $ 22,789 $ 28,518
Supplemental disclosures of cash flow information
Income taxes paid $ 3,646 $ 3,755 $ 2,370
Interest paid 15,426 10,496 8,362
Supplemental disclosures of non-cash investing
and financing activities
Change in unrealized holding gain (loss) on
securities available for sale, net of tax $ 217 ($ 130) ($ 714)
Loans transferred to OREO and other
repossessed items 71 28 625
Shares issued to MRDP 263 195 - -
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.
70
Consolidated Statements of Comprehensive Income
- -----------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2007, 2006 and 2005
2007 2006 2005
Comprehensive income
Net income $8,163 $8,157 $6,618
Unrealized holding gain (loss) on
securities available for sale, net of tax 217 (130) (714)
Total comprehensive income $8,380 $ 8,027 $5,904
See notes to consolidated financial statements.
71
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. ("Company"); its wholly owned subsidiary, Timberland Bank
("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 bank 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, construction and land development, commercial real estate, commercial
business, and consumer 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 2007
presentation with no change to net income or shareholders' equity previously
reported.
Stock Split
On June 5, 2007 the Company's common stock was split two-for-one in the form
of a 100% stock dividend. Each shareholder of record as of May 22, 2007
received one additional share for every share owned. All per share amounts
(including stock options) in the consolidated financial statements and
accompanying notes were restated to reflect the split, except as otherwise
noted.
Segment Reporting
The Company provides a broad range of financial services to individuals and
companies located primarily in western Washington. These services include
demand, time and savings deposits; real estate, business and consumer lending;
escrow services; and investment advisory services. While the Company's chief
decision maker monitors the revenue streams from the various products and
services, operations are managed and financial performance is evaluated on a
Company-wide basis. Accordingly, all of the Company's operations are
considered by management to be one reportable operating segment.
(continued)
72
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (continued)
Investments and Mortgage-Backed Securities - Available for Sale
Debt and equity 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. 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 the period to
maturity.
Investments and Mortgage-Backed Securities - Held to Maturity
Debt securities for which the Company 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. Management considers an
investment security to be other than temporarily impaired if the decline in
fair value is due to credit quality deterioration which management believes
will affect repayment of the investment principal, or if for any other reason
the Company does not have the ability and intent to hold the investment until
the decline in fair value recovers. Any other than temporary declines in fair
value are recognized in the statement of income as realized losses.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank of Seattle ("FHLB"), 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 origination 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.
(continued)
73
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (continued)
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 amount and composition
of the loan portfolio, delinquency levels, actual loan loss experience,
current economic conditions, and detailed analysis of individual loans for
which full collectability may not be assured. The detailed analysis includes
methods to estimate the fair value of loan collateral and the existence of
potential alternative sources of repayment. The allowance consists of
specific, general and unallocated components. The specific component relates
to loans that are deemed impaired. For such loans that are classified as
impaired, an allowance is established when the discounted cash flows (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 classified loans that are not evaluated individually
for impairment 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.
In accordance with Statement of Financial Accounting Standards ("SFAS" or
"Statement") 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, may be 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 origination 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 comprehensive analyses 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
(based on contractual terms) 90 days or more are placed on non-accrual status.
Any interest income accrued at that time is reversed. Subsequent collections
are applied proportionately to past due principal and interest, unless
collectability of principal is in doubt, in which case all payments are
applied to principal. Loans are removed from non-accrual status only when the
loan is deemed current, and the collectability of principal and interest is no
longer doubtful, or on one- to four-family loans, when the loan is less than
90 days delinquent.
(continued)
74
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (continued)
Interest on Loans and Loan Fees (concluded)
The Bank charges fees for originating loans. These fees and certain loan
origination costs are deferred and the net is amortized to income, on the
level-yield basis, over the loan term. If the loan is repaid prior to
maturity, the remaining unamortized deferred loan origination fee is
recognized in income at the time of repayment.
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 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 indefinite useful life and
is analyzed, at least annually, for impairment. An annual review is performed
at the end of the third quarter of each fiscal year, or more frequently if
indicators of potential impairment exist, to determine if the recorded
goodwill is impaired. If the fair value of the reporting unit exceeds the
recorded value of the reporting unit, goodwill is not considered impaired and
no additional analysis is necessary. As of June 30, 2007 the fair value of
the reporting unit exceeded the recorded value. As of September 30, 2007,
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 40 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.
(continued)
75
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (continued)
Other Real Estate Owned and Other Repossessed Items
Other real estate owned and other repossessed items consist 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 a charge to earnings
is recorded if the recorded value of a property exceeds its estimated net
realizable value.
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.
The Bank currently calculates the bad debt deduction based on actual
experience.
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.
(continued)
76
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (continued)
Cash Equivalents and Cash Flows
The Company considers amounts included in the balance sheets' captions "Cash
and due from financial institutions", "Interest-bearing deposits in other
banks" and "Federal funds sold" to be cash equivalents. Cash flows from
loans, deposits, FHLB advances short term, and other borrowings are
reported net.
Advertising
Costs for advertising and marketing are expensed as incurred.
Stock-Based Compensation
Prior to October 1, 2005, the Company accounted for stock-based compensation
expense using the intrinsic value method as required by Accounting Principals
Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and as
permitted by SFAS No. 123, Accounting for Stock-Based Compensation. No
compensation expense for stock options was reflected in net income for the
fiscal year ended September 30, 2005, as all stock options granted had an
exercise price equal to the market price of the underlying common stock at the
date of the grant. In April 2005, the Company accelerated the vesting of
55,000 stock options that had an exercise price greater than the current
market value. The vesting acceleration on these stock options increased the
pro forma stock-based compensation expense by $54,000, net of tax for the year
ended September 30, 2005. The Company accelerated the vesting primarily to
reduce reported compensation expense in future periods.
On October 1, 2005, the Company adopted SFAS No. 123(R) which requires
measurement of the compensation cost for all stock-based awards based on the
grant-date fair value and recognition of compensation cost over the service
period of stock-based awards. The fair value of stock options is determined
using the Black-Scholes valuation model, which is consistent with the
Company's valuation methodology previously utilized for options in footnote
disclosure required under SFAS No. 123. The Company has adopted SFAS No.
123(R) using the modified prospective method, which provides for no
restatement of prior periods and no cumulative adjustment to equity accounts.
It also provides for expense recognition, for both new and existing
stock-based awards.
As a result of adopting SFAS No. 123(R), the Company's net income was reduced
by $17,000 and $33,000 respectively, for the fiscal years ended September 30,
2007 and 2006. Basic and diluted earnings per share for the fiscal years
ended September 30, 2007 and 2006 were not changed by the additional expense.
(continued)
77
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (continued)
The following table provides pro forma disclosures for the fiscal year ended
September 30, 2005 had the Company accounted for stock-based compensation
under SFAS No. 123(R). The pro forma amounts are as follows (dollars in
thousands, except per share amounts)
2005
Net income, as reported $6,618
Less total stock-based compensation expense determined
under fair value method for all qualifying awards, net of tax 256
Pro forma net income $6,362
Earnings Per Share
Basic:
As reported $0.95
Pro forma 0.92
Diluted:
As reported 0.91
Pro forma 0.88
The Company's stock compensation plans are described more fully in Note 15.
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 plans and Management
Recognition and Development Plan ("MRDP").
Recent Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 159, The Fair Value Options for Financial Assets and Financial
Liabilities Including an Amendment of FASB Statement No. 115. This
Statement permits entities to choose to measure many financial instruments and
certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities
differently without having to apply complex hedge accounting provisions. This
Statement is expected to expand the use of fair value measurement, which is
consistent with the FASB's long-term measurement objectives for accounting for
financial instruments. This Statement is effective as of the beginning of an
entity's first fiscal year that begins after November 15, 2007. The adoption
of this Statement is not expected to have a material impact on the Company's
Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
which defines fair value, establishes a framework for measuring fair value
under Generally Accepted Accounting Principles ("GAAP"), and expands
disclosures about fair value measurements. This Statement expands other
accounting pronouncements that require or permit fair value measurements.
This Statement is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. Management is assessing the impact of adoption of SFAS 157 on the
Company's Consolidated Financial Statements.
(continued)
78
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 1 - Summary of Significant Accounting Policies (concluded)
In June 2006, the FASB issued Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109
("FIN 48"). The interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. The new
interpretation is effective for fiscal years beginning after December 15,
2006. The Company adopted the provisions of FIN 48 on October 1, 2007 and
does not expect FIN 48 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 transaction account deposits. The amount of the
reserve requirement balance for the years ended September 30, 2007 and 2006
was approximately $679,000 and $517,000, respectively.
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, 2007
Held to Maturity
Mortgage-backed securities $71 $ - - ($1) $70
Available for Sale
Mortgage-backed securities $13,148 $31 ($131) $13,048
Mutual funds 32,938 - - (1,063) 31,875
U.S. agency securities 19,000 - - (25) 18,975
Total $65,086 $31 ($1,219) $63,898
September 30, 2006
Held to Maturity
Mortgage-backed securities $75 $ - - ($2) $73
Available for Sale
Mortgage-backed securities $17,989 $14 ($400) $17,603
Mutual funds 32,938 - - (851) 32,087
U.S. agency securities 31,997 - - (279) 31,718
Total $82,924 $14 ($1,530) $81,408
(continued)
79
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
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, 2007 are as follows (in thousands):
Less Than 12 Months 12 Months or Longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Losses Value Losses Value Losses
<s> <c> <c> <c> <c> <c> <c>
Mutual funds $ - - $ - - $31,875 ($1,063) $31,875 ($1,063)
Mortgage-backed securities 69 (1) 8,187 (130) 8,256 (131)
U.S. agency securities - - - - 18,975 (25) 18,975 (25)
Total $ 69 ($1) $59,037 ($1,218) $59,106 ($1,219)
The Company has evaluated these securities and has determined that the decline
in their value is temporary and is not related to any company or industry
specific event. The unrealized losses are generally due to increases in the
market interest rate environment. The fair value of the mortgage-backed
securities and the U.S. agency securities is expected to recover as the
securities approach their maturity date and / or as market interest rates
change. The fair value of the mutual funds is expected to recover as interest
rates decline and the yield curve regains a steeper slope. 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
$31,869,000 and $49,513,000 at September 30, 2007 and 2006, respectively.
The contractual maturities of debt securities at September 30, 2007 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 $ - - $ - - $ 10,009 $ 9,990
Due after one year to five years - - - - 7,392 7,391
Due after five to ten years - - - - 2,331 2,332
Due after ten years 71 70 12,416 12,310
Mutual funds - - - - 32,938 31,875
Total $ 71 $ 70 $ 65,086 $ 63,898
There were no gross realized gains or gross realized losses on sales of
securities available for sale for the years ended September 30, 2007, 2006 and
2005.
81
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
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):
2007 2006
Mortgage loans:
One- to four-family $ 101,677 $ 96,260
Multi-family 35,157 17,689
Commercial 127,866 137,609
Construction and land development 186,261 146,855
Land 60,706 29,598
Total mortgage loans 511,667 428,011
Consumer loans:
Home equity and second mortgage 47,269 37,435
Other 10,922 11,127
Total consumer loans 58,191 48,562
Commercial business loans 18,164 11,803
Total loans receivable 588,022 488,376
Less:
Undisbursed portion of construction loans in process 65,673 59,260
Deferred loan origination fees 2,968 2,798
Allowance for loan losses 4,797 4,122
73,438 66,180
Loans receivable, net 514,584 422,196
Loans held for sale (one- to four-family) 757 2,449
Total loans receivable and loans held for sale $515,341 $424,645
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, 2007 and 2006. Activity in related party loans
during the years ended September 30 is as follows (in thousands):
2007 2006
Balance, beginning of year $2,622 $1,395
New loans 490 1,495
Repayments (326) (268)
Balance, end of year $2,786 $2,622
(continued)
81
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
At September 30, 2007, 2006 and 2005, the Bank had non-accruing loans
totaling $1,490,000, $80,000 and $2,926,000, respectively. All non-accrual
loans are considered impaired. At September 30, 2007 and 2006, 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, 2007, 2006 and 2005 was $58,000, $384,000 and $189,000, respectively. The
average investment in non-accrual loans for the years ended September 30, 2007
and 2006 was $623,000 and $1,938,000, respectively.
An analysis of the allowance for loan losses for the years ended September 30
follows (in thousands):
2007 2006 2005
Balance, beginning of year $4,122 $4,099 $3,991
Provision for loan losses 686 - - 141
Loans charged off (12) (2) (50)
Recoveries 1 25 17
Net recovery (charge-off) (11) 23 (33)
Balance, end of year $4,797 $4,122 $4,099
Following is a summary of information related to impaired loans at September
30 (in thousands):
2007 2006 2005
Impaired loans without a valuation allowance $ 490 $ 80 $2,601
Impaired loans with a valuation allowance 1,000 - - 325
$ 1,490 $ 80 $2,926
Valuation allowance related to impaired loans $ 75 $ - - $ 49
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, 2007, 2006 and 2005 were $161,565,000,
$156,187,000 and $155,864,000, respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (in thousands):
2007 2006 2005
Balance, at beginning of year $ 932 $ 928 $ 930
Additions 391 241 200
Amortization (272) (237) (202)
Balance, end of year $ 1,051 $ 932 $ 928
(continued)
82
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 5 - Loan Servicing (concluded)
At September 30, 2007, 2006 and 2005 the fair value of mortgage servicing
rights totaled $1,958,000, $1,891,000 and $1,433,000, respectively. The fair
values for 2007, 2006, and 2005 were estimated using premium rates of 9.58%,
9.59% and 9.62% and prepayment speed factors of 194, 204 and 313,
respectively. There was no valuation allowance at September 30, 2007, 2006 or
2005.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (in
thousands):
2007 2006
Land $ 3,760 $ 3,760
Buildings and improvements 14,260 13,169
Furniture and equipment 6,302 5,506
Property held for future expansion 40 299
Construction and purchases in progress 160 890
24,522 23,624
Less accumulated depreciation 7,947 6,894
Total premises and equipment $ 16,575 $ 16,730
The Bank leases premises under operating leases. Rental expense of leased
premises was $242,000, $207,000, and $199,000 for the years ended September
30, 2007, 2006 and 2005, 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):
2008 $219
2009 159
2010 151
2011 - -
Total minimum payments required $529
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
83
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 7 - Other Real Estate Owned and Other Repossessed Items
Other real estate owned and other repossessed items consisted of the following
at September 30 (in thousands):
2007 2006
Other real estate acquired through foreclosure - - $15
Total other real estate owned and other repossessed items - - $15
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 $1,221,000 and $1,506,000 at September 30, 2007 and 2006,
respectively. Amortization expense related to the core deposit intangible for
the years ended September 30, 2007 and 2006 was $285,000 and $328,000,
respectively.
Amortization expense for the core deposit intangible for future years ending
September 30 is estimated to be as follows (in thousands):
2008 $ 249
2009 217
2010 190
2011 167
2012 148
Thereafter 250
Total $1,221
84
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 9 - Deposits
Deposits consisted of the following at September 30 (in thousands):
2007 2006
Non-interest-bearing $ 54,962 $ 57,905
NOW checking 80,372 89,509
Savings 56,412 60,235
Money market accounts 48,068 42,378
Certificates of deposit 202,844 181,034
Certificates of deposit - brokered 24,077 - -
Total deposits $466,735 $431,061
Certificates of deposit of $100,000 or greater totaled $67,316,000 and
$52,851,000 at September 30, 2007 and 2006, respectively.
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (in thousands):
2008 $208,330
2009 12,739
2010 3,304
2011 692
2012 1,735
Thereafter 121
Total $226,921
Interest expense by account type is as follows for the years ended September
30 (in thousands):
2007 2006 2005
NOW checking $ 638 $ 684 $ 657
Savings 425 442 438
Money market accounts 1,186 711 625
Certificates of deposit 8,818 6,068 3,702
Certificates of deposit - brokered 225 - - - -
Total $11,292 $7,905 $5,422
85
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 10 - Other Borrowings - Repurchase Agreements
Other borrowings at September 30, 2007 and 2006 consisted of overnight
repurchase agreements with customers totaling $595,000 and $947,000,
respectively.
Information concerning repurchase agreements is summarized as follows at
September 30 (dollars in thousands):
2007 2006
Average daily balance during the period $ 1,019 $ 1,148
Average daily interest rate during the period 4.61% 4.27%
Maximum month-end balance during the period $ 4,460 $ 1,895
Weighted average rate at end of period 4.42% 5.01%
Securities underlying the agreements at the end of period:
Recorded value $ 1,701 $ 2,606
Fair value 1,701 2,606
The securities underlying the agreements at September 30, 2007 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 FHLB 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):
2007 2006
Short-term $ 30,000 $ 29,000
Long-term 69,697 33,761
Total $ 99,697 $ 62,761
Information concerning short-term FHLB advances is summarized as follows at or
for the year ended September 30 (dollars in thousands):
2007 2006
Average daily balance during the period $34,156 $ 3,516
Average daily interest rate during the period 5.58% 4.81%
Maximum month-end balance during the period $72,750 $ 29,000
Weighted average rate at end of the period 5.19% 5.49%
(continued)
86
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 11 - Federal Home Loan Bank ("FHLB") Advances and Other Borrowing Lines
(concluded)
The short-term borrowing as of September 30, 2007 matures in October 2007 and
bears interest at 5.19%. The long-term borrowings mature at various dates
through September 2017 and bear interest at rates ranging from 3.69% to 6.18%.
Advances totaling $4,697,000 have monthly payments aggregating $6,000 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):
2008 $45,069
2009 4,628
2010 - -
2011 - -
2012 - -
Thereafter 50,000
$99,697
A portion of these advances have a putable feature and may be called earlier
by the FHLB than the above schedule indicates.
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, 2007 and 2006 the Bank did not have any outstanding
advances on this borrowing line.
Note 12 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses were comprised of the following at
September 30 (in thousands):
2007 2006
Accrued deferred compensation and profit sharing
plans payable $ 605 $ 541
Accrued interest payable on deposits, FHLB advances
and other borrowings 1,378 1,026
Accounts payable and accrued expenses - other 1,291 1,386
Total other liabilities and accrued expenses $3,274 $2,953
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)
87
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 13 - Federal Income Taxes (continued)
The components of the provision for income taxes at September 30 are as
follows (in thousands):
2007 2006 2005
Current $3,929 $3,603 $3,041
Deferred (101) 226 64
Total federal income taxes $3,828 $3,829 $3,105
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):
2007 2006
Prepaid federal income taxes $ 1,154 $ 777
Net deferred tax assets 884 877
Total $ 2,038 $ 1,654
The components of the Company's deferred tax assets and liabilities at
September 30 are as follows (in thousands):
2007 2006
Deferred Tax Assets
Accrued interest on loans $ 1 $ 1
Accrued vacation 106 145
Deferred compensation 69 79
Unearned ESOP shares 438 420
Allowance for loan losses 1,679 1,454
CDI 189 141
Unearned MRDP shares 26 2
Net unrealized securities losses 404 498
Stock option compensation expense 20 12
Total deferred tax assets 2,932 2,752
Deferred Tax Liabilities
FHLB stock dividends 906 906
Depreciation 243 243
Goodwill 396 264
Certificate of deposit valuation 23 25
Mortgage servicing rights 368 326
Prepaid expenses 112 111
Total deferred tax liabilities 2,048 1,875
Net deferred tax assets $ 884 $ 877
(continued)
88
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 13 - Federal Income Taxes (concluded)
The provision for federal income taxes for the years ended September 30
differs from that computed at the statutory corporate tax rate as follows
(dollars in thousands):
2007 2006 2005
Amount Percent Amount Percent Amount Percent
Taxes at
statutory rate $4,197 35.0% $4,195 35.0% $3,403 35.0%
BOLI income (162) (1.4) (157) (1.3) (151) (1.6)
Other - net (207) (1.7) (209) (1.8) (147) (1.5)
Federal income
taxes $3,828 31.9% $3,829 31.9% $3,105 31.9%
Note 14 - Employee Stock Ownership and 401(k) Plan ("KSOP")
Effective October 3, 2007, the Bank established the Timberland Bank Employee
Stock Ownership and 401(k) Plan ("KSOP") by combining the existing Timberland
Bank Employee Stock Ownership Plan and the Timberland Bank 401(k) Profit
Sharing Plan. The KSOP is comprised of two components, the Employee Stock
Ownership Plan ("ESOP") and the 401(k) Plan. The KSOP benefits employees with
at least one year of service who are 21 years of age or older. It may be
funded by Bank contributions in cash or stock for the ESOP and in cash only
for the 401(k) profit sharing. Employee vesting occurs over six years.
ESOP
- ----
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. Dividends of $351,000, $326,000, and
$306,000 were used to service the debt during the years ended September 30,
2007, 2006 and 2005, respectively. As of September 30, 2007, 134,372 ESOP
shares had been distributed to participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase
1,058,000 shares of common stock of the Company. The term of the loan was
extended by 75 months in December 2006. The extension of the loan reduces the
annual number of shares allocated to participants. The loan is being
repaid primarily from the Bank's contributions to the ESOP and is scheduled to
be fully repaid by March 31, 2019. The interest rate on the loan is 8.5%.
Interest expense on the ESOP debt was $375,000, $411,000, and $454,000 for the
years ended September 30, 2007, 2006 and 2005, respectively. The
balance of the loan at September 30, 2007 was $4,293,000.
Shares held by the ESOP as of September 30 were classified as follows:
2007 2006 2005
Unallocated shares 405,562 440,830 511,364
Shares released for allocation 518,066 542,216 481,672
Total ESOP shares 923,628 983,046 993,036
The approximate fair market value of the Bank's unallocated shares at
September 30, 2007, 2006 and 2005, was $6,347,000, $7,737,000 and $5,932,000,
respectively. Compensation expense recognized under the ESOP was $274,000,
$683,000 and $516,000 for the years ended September 30, 2007, 2006 and 2005,
respectively.
(continued)
89
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 14 - Employee Stock Ownership and 401(K) Plan (concluded)
401(k)
- ------
Eligible employees may contribute up to the maximum established by the
Internal Revenue Service. Contributions by the Bank are at the discretion of
the board of directors except for a 3% Safe Harbor contribution which is
mandatory per the plan. Bank contributions totaled $371,000, $558,000 and
$641,000 for the years ended September 30, 2007, 2006 and 2005, respectively.
Note 15 - Stock Compensation Plans
Stock Options Plans
- -------------------
Under the Company's stock option plans (1999 Stock Option Plan and 2003 Stock
Option Plan), the Company may grant options for up to 1,622,500 shares of
common stock to employees, officers and directors. Shares issued may be
purchased in the open market or may be issued from authorized and unissued
shares. The exercise price of each option equals the fair market value of the
Company's stock on the date of grant. The options vest over a ten-year
period, which may be accelerated if the Company meets certain performance
criteria. Generally, options vest in annual installments of 10% on each of
the ten anniversaries from the date of grant and if the Company meets three of
four established performance criteria the vesting is accelerated to 20% for
that year. These four performance criteria are: (i) generating a return on
assets which exceeds that of the median of all thrifts in the 12th FHLB
District having assets within $250 million of the Company; (ii) generating an
efficiency ratio which is less than that of the median of all thrifts in the
12th FHLB District having assets within $250 million of the Company; (iii)
generating a net interest margin which exceeds the median of all thrifts in
the 12th FHLB District having assets within $250 million of the Company; and
(iv) increasing the Company's earnings per share over the prior fiscal year.
The Company performs the accelerated vesting analysis in February of each year
based on the results of the most recently completed fiscal year. At September
30, 2007, options for 279,416 shares are available for future grant under
these plans.
The Company uses the Black-Scholes option pricing model to estimate the fair
value of stock-based awards with the weighted average assumptions noted in the
following table. The risk-free interest rate is based on the U.S. Treasury
rate of a similar term as the stock option at the particular grant date. The
expected life is based on historical data, vesting terms, and estimated
exercise dates. The expected dividend yield is based on the most recent
quarterly dividend on an annualized basis. The expected volatility is based
on historical volatility of the Company's stock price. There were no options
granted during the fiscal years ended September 30, 2007, 2006 or 2005.
(continued)
90
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 15 - Stock Compensation Plans (continued)
Stock option activity is summarized in the following table:
Weighted
Average
Number of Exercise
Shares Price
Outstanding September 30, 2004 829,424 $ 6.82
Options exercised (104,602) 6.01
Outstanding September 30, 2005 724,822 6.93
Options exercised (200,678) 6.09
Outstanding September 30, 2006 524,144 7.26
Options exercised (110,470) 6.73
Options forfeited (1,000) 7.60
Outstanding September 30, 2007 412,674 7.39
The total grant date fair value of options that vested during the years ended
September 30, 2007, 2006 and 2005 was $52,000, $65,000 and $192,000,
respectively.
A summary of unvested options as of September 30, 2007 and changes during the
year ended September 30, 2007 were as follows:
Total Unvested Options
------------------------
Weighted
Average
Grant Date
Shares Fair Value
Unvested options, beginning of period 45,008 $2.15
Vested 25,004 2.07
Forfeited 1,000 1.99
Unvested options, end of period 19,004 $2.25
Proceeds, related tax benefits realized from options exercised and intrinsic
value of options exercised for the years ended September 30 were as follows
(in thousands):
2007 2006 2005
Proceeds from options exercised $ 744 $1,221 $628
Related tax benefit recognized 463 607 186
Intrinsic value of options exercised 1,231 1,785 613
(continued)
91
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 15 - Stock Compensation Plans (continued)
Additional information regarding options outstanding at September 30, 2007 is
as follows:
Options Outstanding Options Exercisable
----------------------------- ------------------------------
Weighted Weighted
Average Average
Weighted Remaining Weighted Remaining
Range of Average Contractual Average Contractual
Exercise Exercise Life Exercise Life
Prices Number Price (Years) Number Price (Years)
$ 6.00 - 6.19 233,810 $6.00 1.4 233,810 $6.00 1.4
6.80 - 7.45 66,638 7.35 3.7 66,638 7.35 3.7
7.60 - 7.98 6,000 7.91 4.6 4,000 7.91 4.6
9.52 56,680 9.52 5.4 39,676 9.52 5.4
11.46 - 11.63 49,546 11.51 6.3 49,546 11.51 6.3
412,674 $7.39 3.0 393,670 $7.30 2.8
The aggregate intrinsic value of all options outstanding at September 30, 2007
was $3.41 million. At September 30, 2007, there were 19,004 unvested options,
all of which are assumed to vest, with an aggregate intrinsic value of
$120,000. The aggregate intrinsic value of all options that were
exercisable at September 30, 2007 was $3.29 million.
Management Recognition and Development Plan ("MRDP")
- ----------------------------------------------------
In November 1998, the Board of Directors adopted the MRDP. In January 1999,
shareholders approved the adoption of the MRDP for the benefit of employees,
officers and 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 529,000 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. Awards under the MRDP
are 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 is recognized over a five-year vesting period, with 20% vesting
on each of the five anniversaries from the date of the grant. There were no
MRDP shares granted and no MRDP shares that vested during the year ended
September 30, 2005. During the year ended September 30, 2006, there were
12,000 MRDP shares granted to officers with a weighted average grant date fair
value of $16.22 and no shares vested. During the year ended September 30,
2007, there were 15,080 MRDP shares granted to officers and directors with a
weighted average grant date fair value of $17.44 and 2,400 shares vested with
an aggregate grant date fair value of $39,000. At September 30, 2007, there
were 24,680 unvested MRDP shares with an aggregate grant date fair value of
$419,000 and there were 92,066 shares available for future grant under the
MRDP.
(continued)
92
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 15 - Stock Compensation Plans (concluded)
Expense for Stock Compensation Plans
- ------------------------------------
Compensation expense recorded in the financial statements for all stock-based
plans were as follows for the years ended September 30 follows (in thousands):
2007 2006 2005
Stock options $ 25 $ 50 $ - -
MRDP stock grants 66 8 556
Less: related tax benefit recognized (31) (20) (189)
$ 60 $ 38 $ 367
The compensation expense yet to be recognized for stock based awards that been
awarded but not vested for the years ending September 30 is as follows (in
thousands):
Stock
Stock Grants Total
Options (MRDP) Awards
2008 $ 5 $ 92 $ 97
2009 2 92 94
2010 1 92 93
2011 -- 85 85
2012 -- 32 32
$ 8 $393 $401
Note 16 - Deferred Compensation Plans
The Bank has a deferred compensation/non-competition arrangement with its
former chief executive officer, which provides 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, 2007 and 2006, $153,000 and
$177,000, respectively, has been accrued under the agreement and is included
in other liabilities on the consolidated balance sheets.
The Company adopted the Timberland Bancorp, Inc. Directors Deferred
Compensation Plan in 2004. This Plan allows directors to defer a portion of
their monthly directors' fees until retirement with no income tax payable by
the director until retirement benefits are received. The Company accrues
interest on the liability at a rate of 1.00% over the Bank's one-year CD rate.
The liability accrued for under the plan as of September 30, 2007 and 2006 was
$10,000 and is included in other liabilities on the Consolidated Balance
Sheets.
93
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 17 - 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.
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):
2007 2006
Undisbursed portion of construction
loans in process (see Note 4) $65,673 $59,260
Undisbursed lines of credit 20,522 18,479
Commitments to extend credit 35,784 20,695
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, land, and income-producing commercial
properties.
In March 2007 the Bank adopted the Timberland Bank Employee Severance
Compensation Plan, which replaced the existing employee severance compensation
agreement adopted in 1998. The new plan, which expires in 2017, was adopted
to provide severance pay 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 (except those who have signed separate employment
related agreements) 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 or officer rank with the Bank.
The maximum payment for any eligible employee would be equal to 24 months of
their current compensation.
In April 2007 the Bank and the Company entered into employment agreements with
the Chief Executive Officer and the Chief Financial Officer. The employment
agreements provide for a severance payment and other benefits if the officers
are involuntarily terminated following a change in control of the Company or
the Bank. The maximum value of the severance benefits under the employment
agreements is 2.99 times the officer's average annual compensation during the
five-year period prior to the effective date of the change in control.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these
claims, if any, will not have a material effect on the financial position of
the Company.
94
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 18 - 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, 2007, the Bank had
$559,693,000 (including $65,673,000 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, land, and a variety of
commercial real estate property types. At September 30, 2007, 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.
Note 19 - 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, 2007, 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.
(continued)
95
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 19 - Regulatory Matters (concluded)
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 Adequacy Corrective Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
September 30, 2007
Tier 1 capital
(to average
assets):
Consolidated $67,397 10.7% $25,116 4.0% N/A N/A
Timberland Bank 59,308 9.5 25,058 4.0 $31,323 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 67,397 12.7 21,172 4.0 N/A N/A
Timberland Bank 59,308 11.2 21,154 4.0 31,731 6.0
Total capital (to
risk-weighted
assets):
Consolidated 72,194 13.6 42,344 8.0 N/A N/A
Timberland Bank 64,105 12.1 42,308 8.0 52,885 10.0
September 30, 2006
Tier 1 capital (to
average assets):
Consolidated $72,360 13.1% $22,151 4.0% N/A N/A
Timberland Bank 63,222 11.5 22,017 4.0 $27,521 5.0%
Tier 1 capital (to
risk-weighted
assets):
Consolidated 72,360 16.6 17,446 4.0 N/A N/A
Timberland Bank 63,222 14.6 17,314 4.0 25,970 6.0
Total capital (to
risk-weighted
assets):
Consolidated 76,482 17.5 34,892 8.0 N/A N/A
Timberland Bank 67,344 15.6 34,627 8.0 43,284 10.0
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.
96
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 20 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(In Thousands)
2007 2006
Assets
Cash and due from financial institutions $ 73 $ 368
Interest-bearing deposits in banks 1,253 630
Investments and mortgage-backed securities -
available for sale 2,064 2,079
Loan receivable from Bank 4,293 4,507
Investment in Bank 66,434 70,211
Other assets 1,906 1,648
Total assets $76,023 $79,443
Liabilities and shareholders' equity
Loan payable to Bank $ 1,400 $ - -
Accrued expenses 76 78
Shareholders' equity 74,547 79,365
Total liabilities and shareholders' equity $76,023 $79,443
Condensed Statements of Income - Years Ended September 30
(In Thousands)
2007 2006 2005
Operating income
Interest-bearing deposits in banks $ 26 $ 27 $ 11
Interest on loan receivable from Bank 375 411 454
Dividends on investments 108 91 66
Dividends from Bank 12,823 4,500 5,029
Total operating income 13,332 5,029 5,560
Non-Operating Income - - 3 - -
Operating expenses 633 465 507
Income before income taxes and equity
in undistributed income of Bank 12,699 4,567 5,053
Federal income taxes (benefit) (166) (91) (96)
Income before equity in undistributed income
of Bank 12,865 4,658 5,149
Equity in undistributed income of bank
(dividends in excess of income of bank) (4,702) 3,499 1,469
Net income $ 8,163 $ 8,157 $ 6,618
(continued)
97
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 20 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(In Thousands)
2007 2006 2005
Cash flows from operating activities
Net income $ 8,163 $ 8,157 $ 6,618
Adjustments to reconcile net income to net
cash provided:
(Equity in undistributed income of Bank)
dividends in excess of income of Bank 4,702 (3,499) (1,469)
ESOP shares earned 265 528 529
MRDP compensation expense 59 7 537
Stock option compensation expense 25 50 - -
Stock option tax effect 464 607 186
Less stock option excess tax benefit (354) (494) - -
Other, net (256) (462) (340)
Net cash provided by operating activities 13,068 4,894 6,061
Cash flows from investing activities
Investment in Bank (698) (1,062) (1,377)
Principal repayments on loan receivable
from Bank 214 525 483
Net cash used in investing activities (484) (537) (894)
Cash flows from financing activities
Increase in borrowings from Bank 1,400 - - - -
Proceeds from exercise of stock options 744 1,221 628
Repurchase of common stock (12,431) (3,701) (4,064)
Payment of dividends (2,682) (2,492) (2,317)
ESOP tax effect 354 480 293
MRDP compensation tax effect 5 (4) 129
Stock option tax effect 354 494 - -
Net cash used in financing activities (12,256) (4,002) (5,331)
Net increase (decrease) in cash 328 355 (164)
Cash equivalents
Beginning of year 998 643 807
End of year $ 1,326 $ 998 $ 643
98
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 21 - 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 MRDP. 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 ESOP 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):
2007 2006 2005
Basic EPS Computation
Numerator - net income $8,163 $8,157 $6,618
Denominator - weighted average common
shares outstanding 6,775,822 7,032,662 6,950,800
Basic EPS $ 1.20 $ 1.16 $ 0.95
Diluted EPS Computation
Numerator - net income $8,163 $8,157 $6,618
Denominator - weighted average common
shares outstanding 6,775,822 7,032,662 6,950,800
Effect of dilutive stock options 204,636 249,090 265,464
Effect of dilutive MRDP shares 1,649 144 39,714
Weighted average common shares outstanding-
assuming dilution 6,982,107 7,281,896 7,255,978
Diluted EPS $ 1.17 $ 1.12 $ 0.91
99
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 22 - 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 Expense Net-of-Tax
Amount (Benefit) Amount
2007
Unrealized holding gains arising during
the year $329 $112 $217
Net unrealized gains $329 112 $217
2006
Unrealized holding losses arising during
the year ($196) ($66) ($130)
Net unrealized losses ($196) ($66) ($130)
2005
Unrealized holding losses arising during
the year ($1,083) ($369) ($714)
Net unrealized losses ($1,083) ($369) ($714)
100
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 23 - Fair Value of Financial Instruments
SFAS 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)
101
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 23 - Fair Value of Financial Instruments (concluded)
The estimated fair value of financial instruments at September 30 were as
follows (in thousands):
2007 2006
Recorded Fair Recorded Fair
Amount Value Amount Value
Financial Assets
Cash and due from financial
institutions and interest-
bearing deposits in banks $ 12,895 $ 12,895 $ 17,489 $ 17,489
Federal funds sold 3,775 3,775 5,400 5,400
Investments and mortgage-backed
securities 63,969 63,968 81,483 81,481
FHLB stock 5,705 5,705 5,705 5,705
Loans receivable 515,341 510,924 424,645 416,518
Accrued interest receivable 3,424 3,424 2,806 2,806
Financial Liabilities
Deposits $466,735 $466,648 $431,061 $431,581
FHLB advances - short term 30,000 30,000 29,000 29,000
FHLB advances - long term 69,697 69,556 33,761 33,685
Other borrowings: repurchase
agreements 595 595 947 947
Accrued interest payable 1,378 1,378 1,026 1,026
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 24 - Stock Repurchase Plan
The Company repurchased 687,542 shares of stock during the year ended
September 30, 2007. The Company had 144,950 shares remaining to be purchased
on its existing stock repurchase plan at September 30, 2007. It is
anticipated that these remaining shares will be repurchased during the year
ending September 30, 2008.
Note 25 - Subsequent Events
On October 23, 2007, the board of directors approved a dividend in the amount
of $0.10 per share to be paid on November 27, 2007 to shareholders of record
as of November 13, 2007.
102
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2007 and 2006
Note 26 - 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,
2007 2007 2007 2006
Interest and dividend
income $11,197 $10,814 $10,168 $ 9,765
Interest expense (4,453) (4,156) (3,680) (3,489)
Net interest income 6,744 6,658 6,488 6,276
Provision for loan losses (270) (260) (156) - -
Non-interest income 1,557 1,501 1,424 1,480
Non-interest expense (4,854) (4,761) (4,939) (4,897)
Income before income
taxes 3,177 3,138 2,817 2,859
Federal income taxes 1,022 1,000 901 905
Net income $ 2,155 $ 2,138 $ 1,916 $ 1,954
Basic earnings per share $ 0.330 $ 0.318 $ 0.279 $ 0.279
Diluted earnings per share 0.322 0.309 0.270 0.270
September 30, June 30, March 31, December 31,
2007 2007 2007 2006
Interest and dividend
income $ 9,283 $ 9,074 $ 8,649 $ 8,446
Interest expense (3,023) (2,786) (2,587) (2,418)
Net interest income 6,260 6,288 6,062 6,028
Provision for loan losses - - - - - - - -
Non-interest income 1,653 1,528 1,508 1,555
Non-interest expense (4,750) (4,791) (4,718) (4,637)
Income before income
taxes 3,163 3,025 2,852 2,946
Federal income taxes 1,019 964 906 940
Net income $ 2,144 $ 2,061 $ 1,946 $ 2,006
Basic earnings per share $ 0.305 $ 0.292 $ 0.277 $ 0.286
Diluted earnings per share 0.295 0.282 0.267 0.276
103
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
Exchange Act) that occurred during the quarter ended September 30, 2007, 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 2008 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."
104
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, 2007. The Code of Ethics requires the
Company's officers, directors and employees to maintain the highest standards
of professional conduct. The Company's Code of Ethics was filed as an exhibit
to its Annual Report on Form 10-K for the year ended September 30, 2003 and is
available on our website at www.timberlandbank.com.
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.
105
(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, 2007.
Number of
securities
remaining
available for
future issuance
under equity
Number of securities Weighted-average compensation
to be issued upon exercise price of plans (excluding
exercise of outstanding securities
outstanding options, options, warrants 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............ -- $ -- 92,066
1999 Stock
Option Plan..... 400,542 7.26 3,678
2003 Stock
Option Plan..... 12,132 11.63 275,738
Equity
compensation
plans not
approved
by security
holders.......... -- -- --
Total.......... 412,674 $ 7.39 371,482
Item 13. Certain Relationships and Related Transactions, and Director
- ------------------------------------------------------------------------
Independence
- ------------
The information contained under the section captioned "Meetings and
Committees of the Board of Directors And Corporate Governance Matters -
Corporate Governance - Related Party Transactions" and "Meetings and
Committees of the Board of Directors and Corporate Governance Matters -
Corporate Governance - Director Independence" are included in the Company's
Proxy Statement and are incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
- ------------------------------------------------
The information contained under the section captioned "Independent
Auditor" is included in the Company's Proxy Statement and is incorporated
herein by reference.
PART IV
Item 15. Exhibits, 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 (4)
10.3 1999 Stock Option Plan (5)
10.4 2003 Stock Option Plan (6)
10.5 Form of Incentive Stock Option Agreement (7)
10.6 Form of Non-qualified Stock Option Agreement (7)
10.7 Management Recognition and Development Plan (5)
10.8 Form of Management Recognition and Development Award
Agreement (6)
10.10 Employment Agreement with Michael R. Sand (8)
10.11 Employment Agreement with Dean J. Brydon (8)
14 Code of Ethics (9)
106
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
- -----------------
(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; and to the Registrant's
Current Report on Form 8-K dated April 13, 2007.
(4) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended December 31, 1997.
(5) Incorporated by reference to Exhibit 99 included in the Registrant's
Registration Statement on Form S-8 (333-32386)
(6) Incorporated by reference to Exhibit 99.2 included in the Registrant's
Registration Statement on Form S-8 (333-1161163)
(7) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2005.
(8) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated April 13, 2007.
(9) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2003.
107
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 10, 2007 By:/s/Michael R. Sand
-------------------------------------
Michael R. Sand
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/Michael R. Sand President, Chief Executive Officer December 10, 2007
- ---------------------- and Director
Michael R. Sand (Principal Executive Officer)
/s/Clarence E. Hamre Chairman of the Board December 10, 2007
- ----------------------
Clarence E. Hamre
/s/Dean J. Brydon Chief Financial Officer December 10, 2007
- ---------------------- (Principal Financial and
Dean J. Brydon Accounting Officer)
/s/Andrea M. Clinton Director December 10, 2007
- ----------------------
Andrea M. Clinton
/s/David A. Smith Director December 10, 2007
- ----------------------
David A. Smith
/s/Harold L. Warren Director December 10, 2007
- ----------------------
Harold L. Warren
/s/Jon C. Parker Director December 10, 2007
- ----------------------
Jon C. Parker
/s/James C. Mason Director December 10, 2007
- ----------------------
James C. Mason
/s/Ronald A. Robbel Director December 10, 2007
- ----------------------
Ronald A. Robbel
108
EXHIBIT INDEX
Exhibit No. Description of Exhibit
- ----------- -----------------------------------------------------
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 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
McGladrey & Pullen
Certified Public 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 10, 2007, 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, 2007.
/s/McGladrey & Pullen, LLP
Seattle, Washington
December 10, 2007
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 10, 2007
/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 10, 2007
/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 10, 2007