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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, 2004 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23333
TIMBERLAND BANCORP, INC.
- ------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Washington 91-1863696
- --------------------------------------------- ------------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
624 Simpson Avenue, Hoquiam, Washington 98550
- --------------------------------------------- ------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (360) 533-4747
------------------------
Securities registered pursuant to Section 12(b) of the Act: None
-----------------
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $.01
per share
-----------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
----- -----
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
------
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2):
Yes X NO
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The aggregate market value of the Common Stock outstanding held by
nonaffiliates of the Registrant based on the closing sales price of the
Registrant's Common Stock as quoted on the Nasdaq Stock Market on March 31,
2004 was $90,089,041 (3,903,338 shares at $23.08 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 2005 Annual Meeting
of Stockholders (Part III).
TIMBERLAND BANCORP, INC.
2004 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
PART I. ----
Item 1. Business
General................................................. 1
Recent Developments..................................... 1
Market Area............................................. 2
Lending Activities...................................... 3
Investment Activities................................... 19
Deposit Activities and Other Sources of Funds........... 20
Bank Owned Life Insurance............................... 24
Regulation of the Bank.................................. 24
Regulation of the Company............................... 30
Taxation................................................ 33
Competition............................................. 35
Subsidiary Activities................................... 35
Personnel............................................... 35
Executive Officers of the Registrant.................... 35
Item 2. Properties................................................ 36
Item 3. Legal Proceedings......................................... 38
Item 4. Submission of Matters to a Vote of Security Holders....... 38
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities................................................ 38
Item 6. Selected Financial Data 40
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... 42
General................................................. 42
Operating Strategy...................................... 42
Market Risk and Asset and Liability Management.......... 43
Comparison of Financial Condition at September 30,
2004 and 2003........................................... 45
Comparison of Financial Condition at September 30,
2003 and 2002........................................... 46
Comparison of Operating Results for Years Ended
September 30, 2004 and 2003............................. 47
Comparison of Operating Results for Years Ended
September 30, 2003 and 2002............................. 49
Average Balances, Interest and Average Yields/Cost 51
Rate/Volume Analysis ................................... 53
Liquidity and Capital Resources......................... 53
Effect of Inflation and Changing Prices................. 55
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk.............................................. 55
Item 8. Financial Statements and Supplementary Data............... 55
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 92
Item 9A. Controls and Procedures.................................. 92
Item 9B. Other Information........................................ 92
PART III.
Item 10. Directors and Executive Officers of the Registrant....... 92
Item 11. Executive Compensation................................... 93
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters............... 93
Item 13. Certain Relationships and Related Transactions........... 93
Item 14. Principal Accountant Fees and Services................... 94
PART IV.
Item 15. Exhibits and Financial Statement Schedules............... 94
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 to a Washington-chartered stock savings bank
("Conversion"). The Conversion was completed on January 12, 1998 through the
sale and issuance of 6,612,500 shares of common stock by the Company. At
September 30, 2004, the Company had total assets of $460.4 million, total
deposits of $319.6 million and total shareholders' equity of $72.8 million.
The Company's business activities generally are limited to passive investment
activities and oversight of its investment in the Bank. Accordingly, the
information set forth in this report, including consolidated financial
statements and related data, relates primarily to the Bank and its subsidiary.
The Bank was established in 1915 as "Southwest Washington Savings and
Loan Association." In 1935, the Bank converted from a state-chartered mutual
savings and loan association to a federally chartered mutual savings and loan
association, and in 1972, changed its name to "Timberland Federal Savings and
Loan Association." In 1990, the Bank converted to a federally chartered
mutual savings bank under the name "Timberland Savings Bank, FSB." In 1991,
the Bank converted to a Washington-chartered mutual savings bank and changed
its name to "Timberland Savings Bank, SSB." On December 29, 2000, the Bank
changed its name to "Timberland Bank." The Bank's deposits are insured by the
Federal Deposit Insurance Corporation ("FDIC") up to applicable legal limits
under the Savings Association Insurance Fund ("SAIF"). The Bank has been a
member of the Federal Home Loan Bank ("FHLB") System since 1937. The Bank is
regulated by the Washington Department of Financial Institutions, Division of
Banks ("Division") and the FDIC.
The Bank is a community-oriented bank which has traditionally offered a
variety of savings products to its retail customers while concentrating its
lending activities on real estate mortgage loans. Lending activities have
been focused primarily on the origination of loans secured by one- to
four-family residential dwellings, including an emphasis on construction and
land development loans, as well as the origination of multi-family and
commercial real estate loans. The Bank originates adjustable-rate residential
mortgage loans that do not qualify for sale in the secondary market under
Federal Home Loan Mortgage Corporation ("FHLMC") guidelines. The Bank also
originates commercial business loans and in 1998 established a business
banking division to increase the origination of these loans.
Recent Developments
On June 22, 2004, the Bank entered into a branch purchase and assumption
agreement to purchase seven branches from Venture Bank, a subsidiary of
Venture Financial Group. The branches are located in Grays Harbor County
(Hoquiam, Aberdeen, Montesano, and Elma), Lewis County (Toledo and Winlock)
and Thurston County (Lacey), Washington. On October 9, 2004, the Bank
completed the acquisition of these branches. The transaction included $86.3
million in deposits, which represents a 27% increase to the Bank's deposit
base. In addition, the Bank acquired real estate, branch infrastructure, and
employees for the seven offices. The Bank paid $1.8 million in cash for the
branch buildings and fixed assets. The offices acquired in Hoquiam and
Montesano were consolidated with existing Bank locations on November 15, 2004.
Of the $86.3 million in acquired deposits, 16% are non-interest-bearing
accounts, 18% are NOW checking accounts, 24% are money market accounts, 14%
are savings accounts, and 28% are certificate of deposit accounts. As the
deposits are deployed into loans, the Company anticipates this transaction
will contribute to earnings. The Company believes the acquisition will be
accretive (net of the initial transaction expenses) within one year following
full integration of the new branches into the Bank's system. However during
the initial two quarters, net income may be negatively impacted by the
acquisition as a portion of the acquired deposits will be invested in
short-term investments with lower yields. The Company believes that this
acquisition brings solid potential to generate long-term earnings growth and
increase shareholder value.
1
For additional information on the acquired branches, see "-Market Area"
and "Item 2. Properties."
Market Area
The Bank considered Grays Harbor, Thurston, Pierce, King and Kitsap
Counties as its primary market areas as of September 30, 2004. With the
acquisition of branches from Venture Bank in October 2004, the Bank's market
area expanded to include Lewis County. The Bank conducts operations from:
* its main office in Hoquiam (Grays Harbor County);
* five branch offices in Grays Harbor County (Aberdeen, opened in
1974, Montesano, opened in 1975, Ocean Shores, opened in 1977 and
two branches acquired from Venture Bank in 2004);
* a branch office in King County (Auburn, opened in 1994);
* five branch offices in Pierce County (Edgewood, opened in 1980,
Puyallup, opened in 1996, Spanaway, opened in 1999, Tacoma, opened
in 2001 and Gig Harbor, opened in 2004);
* five branch offices in Thurston County (Lacey, opened in 1997,
Yelm, opened in 1999, Tumwater, opened in 2001, Olympia, opened in
2003 and one branch acquired from Venture Bank in 2004);
* two branch offices in Kitsap County (Poulsbo, opened in 1999 and
Silverdale, opened in 2003);
* and two branch offices in Lewis County that were acquired from
Venture Bank in 2004).
See "-Recent Developments " and "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 five submarkets:
primarily rural Grays Harbor County with its historical dependence on the
timber and fishing industries; Pierce, Thurston and Kitsap Counties with their
dependence on state and federal government; King County with its broadly
diversified economic base; and Lewis County with its dependence on retail
trade, manufacturing, industrial services and local government. Each of these
markets presents operating risks to the Bank. The Bank's expansion into
Pierce, Thurston, King, Kitsap and Lewis Counties represents the Bank's
strategy to diversify its primary market area to become less reliant on the
economy of Grays Harbor County.
Grays Harbor County has a population of 67,000 according to the U.S.
Census Bureau 2000 census. The economic base in Grays Harbor has been
historically dependent on the timber and fishing industries. Other industries
that support the economic base are tourism, agriculture, shipping and
transportation, and technology. According to the Washington State Employment
Security Department, the unemployment rate in Grays Harbor County decreased to
7.2% at September 30, 2004 from 8.5% at September 30, 2003. The Bank has six
branches (including its home office) located throughout the county. Slowdowns
in the Grays Harbor County economy could negatively impact the Bank's
profitability in this market area.
Pierce County is the second most populous county in the state and has a
population of 701,000 according to the U.S. Census Bureau 2000 census. The
economy in Pierce County is diversified with the presence of military related
government employment (Fort Lewis Army Base and McChord Air Force Base),
transportation and shipping employment (Port of Tacoma), and aerospace related
employment (Boeing). According to the Washington State Employment Security
Department, the unemployment rate for the Pierce County area decreased to 5.7%
at September 30, 2004 from
2
7.6% at September 30, 2003. The Bank has five branches in Pierce County.
These branches have been responsible for a substantial portion of the Bank's
construction lending activities. Slowdowns in the Pierce County economy could
negatively impact the demand for loans to facilitate the construction of
single family homes.
Thurston County has a population of 207,000 according to the U.S. Census
Bureau 2000 census. Thurston County is home of Washington State's capital
(Olympia) and its economic base is largely driven by state government related
employment. According to the Washington State Employment Security Department,
the unemployment rate for the Thurston County area had decreased to 4.5% at
September 30, 2004 from 5.8% at September 30, 2003. The Bank currently has
five branches in Thurston County. This county has a stable economic base
primarily due to the state government presence. Slowdowns in the Thurston
County economy could negatively impact the Bank's leading opportunities in
this market.
Kitsap County has a population of 232,000 according to the U.S. Census
Bureau 2000 census. Timberland has two branches in Kitsap County. The
economic base of Kitsap County is largely supported by military related
government employment through the United States Navy. According to the
Washington State Employment Security Department, the unemployment rate for the
Kitsap County area decreased to 4.8% at September 30, 2004 from 6.0% at
September 30, 2003. Reductions in the naval personnel stationed in Kitsap
County could have a negative impact on the county's economy and could
negatively impact the Bank's lending opportunities in this market.
King County is the most populous county in the state and has a population
of 1.7 million according to the U.S. Census Bureau 2000 census. Timberland
has one branch in King County in the city of Auburn. King County's economic
base is diversified with many industries including shipping and
transportation, aerospace (Boeing), and computer technology and biotech
industries. According to the Washington State Employment Security
Department, the unemployment rate for the King County area decreased to 4.9%
at September 30, 2004 from 6.7% at September 30, 2003. The County's overall
economic condition has been weakened over the past couple of years due in
large part to slowing in the aerospace and computer technology industries.
The slowdown in the economy has negatively impacted commercial loan demand and
has decreased the Bank's origination of commercial real estate and commercial
business loans in the Southern King County market.
Lewis County has a population of 69,000 according to the U.S. Census
Bureau 2000 census. The economic base in Lewis County is supported by
manufacturing, retail trade, local government and industrial services.
According to the Washington State Employment Security Department, the
unemployment rate in Lewis County decreased to 6.4% at September 30, 2004 from
8.2% at September 30, 2003. The Bank has two branches located in Lewis
County, which it acquired in October 2004 from Venture Bank.
Lending Activities
General. Historically, the principal lending activity of the Bank has
consisted of the origination of loans secured by first mortgages on
owner-occupied, one- to-four family residences and loans for the construction
of one- to-four family residences. Since 1998, the Bank has emphasized its
origination of construction and land development loans and commercial real
estate loans. The Bank's net loans receivable, including loans held for sale,
totaled approximately $344.6 million at September 30, 2004, representing
approximately 74.8% of consolidated total assets, and at that date
construction and land development loans, and loans secured by commercial
properties were $214.5 million, or 54.3%, of total loans. Construction and
land development loans and commercial real estate loans typically have higher
rates of return than one-to four- family loans; however, they also present a
higher degree of risk. See "- Lending Activities - Construction and Land
Development Lending" and "- Lending Activities - Commercial Real Estate
Lending."
The Bank's internal loan policy limits the maximum amount of loans to one
borrower to 25% of its capital. At September 30, 2004, the maximum amount
which the Bank could have lent to any one borrower and the borrower's related
entities was approximately $15.9 million under this policy. At September 30,
2004, the Bank had no loans to one borrower with an aggregate outstanding
balance in excess of this amount. At that date, the Bank had 64 borrowers or
related borrowers with total loans outstanding in excess of $1.0 million. The
largest amount outstanding to any one borrower and the borrower's related
entities was approximately $8.5 million (including $7.5 million of undisbursed
loans in process balance), which represents a commercial real estate
construction loan in Thurston County. This loan was performing according to
its terms at September 30, 2004.
3
Loan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio
by type of loan as of the dates indicated.
At September 30,
--------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One- to- four
family(1)(2).$ 99,835 25.25% $ 95,371 26.21% $113,144 31.28% $130,082 35.14% $136,825 38.85%
Multi-family.. 17,160 4.34 18,241 5.01 24,135 6.67 29,412 7.95 33,604 9.54
Commercial.... 108,276 27.39 102,972 28.30 97,644 27.00 65,731 17.76 58,632 16.65
Construction
and land
development.. 106,241 26.88 94,117 25.87 80,144 22.16 106,244 28.71 89,903 25.52
Land(2)....... 19,895 5.03 15,628 4.30 15,453 4.27 13,632 3.68 12,561 3.56
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total mortgage
loans....... 351,407 88.89 326,329 89.69 330,520 91.38 345,101 93.24 331,525 94.12
Consumer Loans:
Home equity
and second
mortgage..... 23,549 5.96 19,233 5.29 13,718 3.79 11,039 2.98 9,816 2.79
Other......... 9,270 2.34 8,799 2.42 8,097 2.24 6,825 1.85 6,081 1.72
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
32,819 8.30 28,032 7.71 21,815 6.03 17,864 4.83 15,897 4.51
Commercial
business
loans......... 11,098 2.81 9,475 2.60 9,365 2.59 7,150 1.93 4,808 1.37
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans.. 395,324 100.00% 363,836 100.00% 361,700 100.00% 370,115 100.00% 352,230 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Undisbursed
portion of
construction
loans in
process...... (43,563) (34,785) (32,324) (39,803) (32,831)
Deferred loan
origination
fees......... (3,176) (2,924) (3,218) (3,494) (3,578)
Allowance for
loan losses.. (3,991) (3,891) (3,630) (3,050) (2,640)
Market value
adjustment of
loans held-
for-sale..... -- - -- -- (175)
-------- -------- -------- -------- --------
Total loans
receivable,
net...........$344,594 $322,236 $322,528 $323,768 $313,006
======== ======== ======== ======== ========
- --------------
(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, 2004, $99.8
million, or 25.3%, 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 uses an automated
underwriting program, which preliminarily qualifies a loan as conforming to
FHLMC underwriting standards when the loan is originated. At September 30,
2004, $44.3 million, or 44.4%, 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 and carry no prepayment restrictions.
Borrower demand for ARM loans versus fixed-rate mortgage loans is a function
of the level of interest rates, the expectations of changes in the level of
interest rates and the difference between the initial interest rates and fees
charged for each type of loan. The relative amount of fixed-rate mortgage
loans and ARM loans that can be originated at any time is largely determined
by the
4
demand for each in a competitive environment. At September 30, 2004, $55.5
million, or 55.6%, 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
comparable sales of comparable properties to support value according to
secondary market requirements. These loans are known as non-conforming loans
and the Bank may require additional collateral or lower loan-to-value ratios
to reduce the risk of these loans. The Bank believes that these loans satisfy
a need in its local market area. As a result, subject to market conditions,
the Bank intends to continue to originate these loans.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased interest
to be paid by the customer as a result of increases in interest rates. It is
possible that, during periods of rising interest rates, the risk of default on
ARM loans may increase as a result of repricing and the increased costs to the
borrower. Furthermore, because the ARM loans originated by the Bank generally
provide, as a marketing incentive, for initial rates of interest below the
rates which would apply were the adjustment index used for pricing initially,
these loans are subject to increased risks of default or delinquency. The
Bank attempts to reduce the potential for delinquencies and defaults on ARM
loans by qualifying the borrower based on the borrower's ability to repay the
ARM loan assuming that the maximum interest rate that could be charged at the
first adjustment period remains constant during the loan term. Another
consideration is that although ARM loans allow the Bank to increase the
sensitivity of its asset base due to changes in the interest rates, the extent
of this interest sensitivity is limited by the periodic and lifetime interest
rate adjustment limits. Because of these considerations, the Bank has no
assurance that yield increases on ARM loans will be sufficient to offset
increases in the Bank's cost of funds.
While fixed-rate, single-family residential mortgage loans are normally
originated with 15 to 30 year terms, these loans typically remain outstanding
for substantially shorter periods because borrowers often prepay their loans
in full upon sale of the property pledged as security or upon refinancing the
original loan. In addition, substantially all mortgage loans in the Bank's
loan portfolio contain due-on-sale clauses providing that the Bank may declare
the unpaid amount due and payable upon the sale of the property securing the
loan. Typically, the Bank enforces these due-on-sale clauses to the extent
permitted by law and as business judgment dictates. Thus, average loan
maturity is a function of, among other factors, the level of purchase and sale
activity in the real estate market, prevailing interest rates and the interest
rates received on outstanding loans.
The Bank requires that fire and extended coverage casualty insurance be
maintained on all of its real estate secured loans. Loans originated since
1994 also require flood insurance, if appropriate.
The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 95% of the
lesser of the appraised value or the purchase price. However, the Bank
usually obtains private mortgage insurance ("PMI") on the portion of the
principal amount that exceeds 80% of the appraised value of the security
property. The maximum loan-to-value ratio on mortgage loans secured by
non-owner-occupied properties is generally 80% (90% for loans originated for
sale in the secondary market to the FHLMC).
Construction and Land Development Lending. Prompted by unfavorable
economic conditions in its primary market area in the 1980s, the Bank sought
to establish a market niche and, as a result, began originating construction
loans outside of Grays Harbor County. In recent periods, construction lending
activities have been primarily in the Pierce County, King County, Thurston
County, and Kitsap County markets. Competition from other financial
institutions has increased in recent periods and it is possible that margins
on construction loans may be reduced in the future.
The Bank currently originates three types of residential construction
loans: (i) speculative construction loans, (ii) custom construction loans and
(iii) owner/builder loans. The Bank initiated its construction lending with
the
5
origination of speculative construction loans. As a result, the Bank began to
establish contacts with the building community and increased the origination
of custom construction and land development loans in rural and suburban market
areas. The Bank believes that its computer tracking system has enabled it to
establish processing and disbursement procedures to meet the needs of these
borrowers. To a lesser extent, the Bank also originates construction loans
for the development of multi-family and commercial properties. Subject to
market conditions, the Bank intends to continue to emphasize its construction
lending activities.
At September 30, 2004, the composition of the Bank's construction and
land development loan portfolio was as follows:
Outstanding Percent of
Balance Total
----------- ----------
(In thousands)
Speculative construction................ $ 22,228 20.92%
Custom and owner/builder construction... 43,801 41.23
Multi-family............................ 3,352 3.15
Land development........................ 11,227 10.57
Commercial real estate.................. 25,633 24.13
-------- ------
Total................................. $106,241 100.00%
======== ======
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 55 builders located in the
Bank's primary market area, each of which generally have three to six
speculative loans outstanding from the Bank during a 12 month period. Rather
than originating lines of credit to home builders to construct several homes
at once, the Bank originates and underwrites a separate loan for each home.
Speculative construction loans are originated for a term of 12 months, with
current rates ranging from prime rate plus 0.5% to 7.5%, 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, 2004 speculative construction loans totaled $22.2 million, or
20.9%, of the total construction loan portfolio. At September 30, 2004, the
Bank had 14 borrowers each with aggregate outstanding speculative loan
balances of more than $500,000. The largest aggregate outstanding balance to
one borrower amounted to $2.8 million, and the largest outstanding balance for
a single speculative loan was $880,000. At September 30, 2004, all
speculative construction loans were performing according to terms.
Unlike speculative construction loans, custom construction loans are made
to home builders who, at the time of construction, have a signed contract with
a home buyer who has a commitment for permanent financing for the finished
home with the Bank or another lender. Custom construction loans are generally
originated for a term of 12 months, with fixed interest rates ranging from
6.5% to 7.0% and with loan-to-value ratios of 80% of the appraised estimated
value of the completed property or sales price, whichever is less. During
this 12 month period, the borrower is required to make monthly payments of
accrued interest on the outstanding loan balance.
Owner/builder construction loans are originated to the home owner rather
than the home builder as a single loan that automatically converts to a
permanent loan at the completion of construction. The construction phase of a
owner/builder construction loan generally lasts up to 12 months with fixed
interest rates ranging from 7.0% to 7.5%, and with loan-to-value ratios of 80%
(or up to 95% with PMI) of the appraised estimated value of the completed
property or cost, whichever is less. During the construction period, the
borrower is required to make monthly payments of accrued interest on the
outstanding loan balance. At the completion of construction, the loan
converts automatically to either a
6
fixed-rate mortgage loan, which conforms to secondary market standards, or an
ARM loan for retention in the Bank's portfolio. At September 30, 2004, custom
and owner/builder construction loans totaled $43.8 million, or 41.2%, of the
total construction loan portfolio. At September 30, 2004, the largest
outstanding custom and owner/builder construction loan had an outstanding
balance of $1.3 million (including $950,000 of undisbursed loans in process
balance) and was performing according to its terms.
The Bank originates loans to local real estate developers with whom it
has established relationships for the purpose of developing residential
subdivisions (i.e., installing roads, sewers, water and other utilities)
(generally with ten to 50 lots). At September 30, 2004, subdivision
development loans totaled $11.2 million, or 10.6% of construction and land
development loans receivable. Land development loans are secured by a lien on
the property and made for a period of two to five years with fixed or variable
interest rates, and are made with loan-to-value ratios generally not exceeding
75%. Monthly interest payments are required during the term of the loan.
Land development loans are structured so that the Bank is repaid in full upon
the sale by the borrower of approximately 80% of the subdivision lots.
Substantially all of the Bank's land development loans are secured by property
located in its primary market area. In addition, in the case of a corporate
borrower, the Bank also generally obtains personal guarantees from corporate
principals and reviews their personal financial statements. At September 30,
2004, the largest land development loan had an outstanding loan balance of
$2.5 million, and was performing according to its terms.
Land development loans secured by land under development involve greater
risks than one- to- four family residential mortgage loans because these loans
are advanced upon the predicted future value of the developed property. If
the estimate of the future value proves to be inaccurate, in the event of
default and foreclosure the Bank may be confronted with a property the value
of which is insufficient to assure full repayment. The Bank attempts to
minimize this risk by generally limiting the maximum loan-to-value ratio on
land loans to 75% of the estimated developed value of the secured property.
The Bank also provides construction financing for multi-family and
commercial properties. At September 30, 2004, these loans amounted to $3.4
million, or 3.2% of construction loans. These loans are secured by motels,
apartment buildings, condominiums, office buildings and retail rental space
located in the Bank's primary market area and currently range in amount from
$155,000 to $8.5 million. At September 30, 2004, the largest outstanding
multi- family construction loan had a balance of $2.7 million (including $2.2
million of undisbursed loans in process balance), and was performing according
to its terms. At September 30, 2004, the largest outstanding commercial real
estate construction loan had a balance of $8.5 million (including $7.5 million
of undisbursed loans in process balance), and was performing according to its
terms.
All construction loans must be approved by the Bank's Loan Committee or
the Bank's Board of Directors. See "- Lending Activities - Loan Solicitation
and Processing." Prior to preliminary approval of any construction loan
application, an independent fee appraiser inspects the site and the Bank
reviews the existing or proposed improvements, identifies the market for the
proposed project and analyzes the pro forma data and assumptions on the
project. In the case of a speculative or custom construction loan, the Bank
reviews the experience and expertise of the builder. After preliminary
approval has been given, the application is processed, which includes
obtaining credit reports, financial statements and tax returns on the
borrowers and guarantors, an independent appraisal of the project, and any
other expert reports necessary to evaluate the proposed project. In the event
of cost overruns, the Bank generally requires that the borrower increase the
funds available for construction by depositing its own funds into a secured
savings account, the proceeds of which are used to pay construction costs.
Loan disbursements during the construction period are made to the
builder, materials' supplier or subcontractor, based on a line item budget.
Periodic on-site inspections are made by qualified inspectors to document the
reasonableness of the draw request. For most builders, the Bank disburses
loan funds by providing vouchers to suppliers, which when used by the builder
to purchase supplies are submitted by the supplier to the Bank for payment.
The Bank regularly monitors the construction loan disbursements using an
internal computer program. The Bank believes that its internal monitoring
system helps reduce many of the risks inherent in its construction lending.
7
The Bank originates construction loan applications through customer
referrals, contacts in the business community and occasionally real estate
brokers seeking financing for their clients.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost of
the project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost
proves to be inaccurate, the Bank may be required to advance funds beyond the
amount originally committed to permit completion of the project. If the
estimate of value upon completion proves to be inaccurate, the Bank may be
confronted with a project whose value is insufficient to assure full
repayment. Projects may also be jeopardized by disagreements between
borrowers and builders and by the failure of builders to pay subcontractors.
Loans to builders to construct homes for which no purchaser has been
identified carry more risk because the payoff for the loan depends on the
builder's ability to sell the property prior to the time that the construction
loan is due. The Bank has sought to address these risks by adhering to strict
underwriting policies, disbursement procedures, and monitoring practices. In
addition, because the Bank's construction lending is primarily secured by
properties in its primary market area, changes in the local and state
economies and real estate markets could adversely affect the Bank's
construction loan portfolio.
Real Estate Contracts. The Bank purchases real estate contracts and
deeds of trust from individuals who have privately sold their homes or
property. These contracts are generally secured by one- to four- family
properties, building lots and undeveloped land and range in principal amount
from $10,000 to $200,000, but typically are in amounts between $20,000 and
$40,000. Properties securing real estate contracts purchased by the Bank are
generally located within its primary market area. Prior to purchasing the
real estate contract, the Bank reviews the contract and analyzes and assesses
the collateral for the loan, the down payment made by the borrower and the
credit history on the loan. As of September 30, 2004, the Bank had
outstanding $892,000 of real estate contracts.
Multi-Family Lending. At September 30, 2004, the Bank had $17.2 million,
or 4.3% of the Bank's total loan portfolio, secured by multi-family dwelling
units (more than four units) located primarily in the Bank's primary market
area. At September 30, 2004, approximately 35.7% of the Bank's multi-family
loans represent participation interests in loans, secured by properties
generally located in the Bank's primary market area, purchased from other
lenders. Participation interests are purchased without recourse to the seller
other than for fraud. The Bank underwrites participation interests according
to its own standards.
Multi-family loans are generally originated with variable rates of
interest ranging from 2.00% to 3.50% over the one-year constant maturity U.S.
Treasury Bill Index or a matched term FHLB advance, with principal and
interest payments fully amortizing over terms of up to 30 years. Multi-family
loans currently range in principal balance from $18,000 to $6.0 million. At
September 30, 2004, the largest multi-family loan had an outstanding principal
balance of $6.0 million and was secured by an apartment building located in
the Bank's primary market area. At September 30, 2004, this loan was
performing according to its terms.
The maximum loan-to-value ratio for multi-family loans is generally 75%.
The Bank generally requests its multi-family loan borrowers to submit
financial statements and rent rolls on the subject property annually. The
Bank also inspects the subject property annually. The Bank generally imposes
a minimum debt coverage ratio of approximately 1.10 times for loans secured by
multi-family properties.
Multi-family mortgage lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to four-
family residential lending. However, loans secured by multi-family properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to four-family
residential mortgage loans. Because payments on loans secured by multi-family
properties are often dependent on the successful operation and management of
the properties, repayment of such loans may be affected by adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these
risks by strictly scrutinizing the financial condition of the borrower, the
quality of the collateral and the management of the property
8
securing the loan. If the borrower is other than an individual, the Bank also
generally obtains personal guarantees from the principals based on a review of
personal financial statements.
Commercial Real Estate Lending. Commercial real estate loans totaled
$108.3 million, or 27.4% of total loans receivable at September 30, 2004, and
consisted of 270 loans. The Bank originated $29.1 million of commercial
mortgage loans during the year ended September 30, 2004 compared to $21.0
million originated during the year ended September 30, 2003. 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 $4,000 and $4.9 million. At September 30, 2004, the largest
commercial real estate loan was secured by a commercial property located in
Olympia, Washington. At September 30, 2004, four commercial real estate loans
totaling $640,000 were not performing according to their terms. See "-
Lending Activities - Nonperforming Assets and Delinquencies."
The Bank requires appraisals of all properties securing commercial real
estate loans. Appraisals are performed by independent appraisers designated
by the Bank, all of which are reviewed by management. The Bank considers the
quality and location of the real estate, the credit history of the borrower,
the cash flow of the project and the quality of management involved with the
property. The Bank generally imposes a minimum debt coverage ratio of
approximately 1.10 for originated loans secured by income producing commercial
properties. Loan-to-value ratios on commercial real estate loans are
generally limited to 75%. The Bank generally obtains loan guarantees from
financially capable parties based on a review of personal financial
statements.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to
four-family residential lending. However, loans secured by such properties
usually are greater in amount, more difficult to evaluate and monitor and,
therefore, involve a greater degree of risk than one- to-four family
residential mortgage loans. Because payments on loans secured by commercial
properties often depend upon the successful operation and management of the
properties, repayment of these loans may be affected by adverse conditions in
the real estate market or the economy. The Bank seeks to minimize these risks
by generally limiting the maximum loan-to-value ratio to 75% and strictly
scrutinizing the financial condition of the borrower, the quality of the
collateral and the management of the property securing the loan. The Bank
also requests annual financial information and rent rolls on the subject
property from the borrowers.
Land Lending. The Bank originates loans for the acquisition of land upon
which the purchaser can then build or make improvements necessary to build or
to sell as improved lots. At September 30, 2004, land loans totaled $19.9
million, or 5.0% of the Bank's total loan portfolio. Land loans originated by
the Bank are generally fixed-rate loans and have maturities of five to ten
years. Land loans generally range in principal amount from $5,000 to
$500,000. The largest land loan had an outstanding balance of $417,000 at
September 30, 2004 and was performing according to its terms. At September
30, 2004, four land loans totaling $322,000 were not performing according to
terms. See "- Lending Activities - Nonperforming Assets and Delinquencies."
Loans secured by undeveloped land or improved lots involve greater risks
than one- to four-family residential mortgage loans because these loans are
more difficult to evaluate. If the estimate of value proves to be inaccurate,
in the event of default and foreclosure the Bank may be confronted with a
property the value of which is insufficient to assure full repayment. The
Bank attempts to minimize this risk by generally limiting the maximum
loan-to-value ratio on land loans to 75%.
Consumer Lending. Consumer lending has traditionally been a small part
of the Bank's business. Consumer loans generally have shorter terms to
maturity and higher interest rates than mortgage loans. Consumer loans
include home equity lines of credit, Title I home improvement loans, second
mortgage loans, savings account loans, automobile loans, boat loans,
motorcycle loans, recreational vehicle loans and unsecured loans. Consumer
loans are made with both fixed and variable interest rates and with varying
terms. At September 30, 2004, consumer loans amounted to $32.8 million, or
8.3%, of the total loan portfolio.
9
At September 30, 2004, the largest component of the consumer loan
portfolio consisted of second mortgage loans and home equity lines of credit,
which totaled $23.5 million, or 6.0%, 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 26 week
Treasury Bill or the prime rate. Second mortgage loans and home equity lines
of credit have greater credit risk than one- to- four family residential
mortgage loans because they are secured by mortgages subordinated to the
existing first mortgage on the property, which may or may not be held by the
Bank.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining
deficiency often does not warrant further substantial collection efforts
against the borrower beyond obtaining a deficiency judgment. In addition,
consumer loan collections are dependent on the borrower's continuing financial
stability, and are more likely to be adversely affected by job loss, divorce,
illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount that can be recovered on such loans. The Bank
believes that these risks are not as prevalent in the case of the Bank's
consumer loan portfolio because a large percentage of the portfolio consists
of second mortgage loans and home equity lines of credit that are underwritten
in a manner such that they result in credit risk that is substantially similar
to one- to- four family residential mortgage loans. At September 30, 2004,
the Bank had $23,000 of consumer loans delinquent in excess of 90 days.
Commercial Business Lending. Commercial business loans totaled $11.1
million, or 2.8% of total loans receivable at September 30, 2004, and
consisted of 103 loans. In July 1998, the Bank established a business banking
division staffed by three experienced commercial lenders to increase the
Bank's origination of commercial business loans and commercial real estate
loans. Currently, the division is staffed by a Division Manager and six
commercial lenders. Commercial business loans are generally secured by
business equipment, accounts receivable, inventory or other property and are
made at variable rates of interest equal to a negotiated margin above the
prime rate. The Bank also generally obtains personal guarantees from
financially capable applicants based on a review of personal financial
statements.
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, 2004 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, but does not include
scheduled payments or potential prepayments. Demand loans, loans having no
stated schedule of repayments and no stated maturity, and overdrafts are
reported as due in one year or less.
After After After
One Year 3 Years 5 Years
Within Through Through Through After
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- -------- -------- -------- -------- -------
(In thousands)
Mortgage loans:
One- to four-
family....... $ 1,919 $ 298 $ 2,997 $ 8,268 $ 86,353 $ 99,835
Multi-family.. -- 1,337 807 13,528 1,488 17,160
Commercial.... 3,107 763 9,652 73,655 21,099 108,276
Construction
and land devel-
opment(1).... 33,997 9,561 -- 12,749 49,934 106,241
Land 1,958 4,248 11,052 1,130 1,507 19,895
Consumer loans:
Home equity
and second
mortgage..... 3,396 500 1,224 2,035 16,394 23,549
Other......... 2,362 861 1,218 883 3,946 9,270
Commercial busi-
ness loans.... 4,787 755 1,769 2,373 1,414 11,098
------- ------- ------- -------- -------- --------
Total.......... 51,526 18,323 28,719 114,621 182,135 395,324
------- ------- ------- -------- -------- --------
Less:
Undisbursed
portion of
construction
loans in
process...... (43,563)
Deferred loan
origination
fees......... (3,176)
Allowance for
loan losses.. (3,991)
--------
Loans receivable,
net.......... $344,594
========
- ------------
(1) Includes construction/permanent that convert to a permanent mortgage loan
once construction is completed.
The following table sets forth the dollar amount of all loans due after
September 30, 2004, 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................... $ 44,344 $ 55,491 $ 99,835
Multi-family......................... 5,952 11,208 17,160
Commercial........................... 9,434 98,842 108,276
Construction and land development.... 62,593 43,648 106,241
Land................................. 18,217 1,678 19,895
Consumer loans:
Home equity and second mortgage...... 15,577 7,972 23,549
Other................................ 8,985 285 9,270
Commercial business loans............. 1,083 10,015 11,098
-------- -------- --------
Total............................... $166,185 $229,139 $395,324
======== ======== ========
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 market rates are substantially higher than rates on
existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans are substantially higher than current mortgage loan market
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. The Bank's Consumer Loan
Committee, which consists of four senior management officers, can approve
one-to-four family mortgage loans and other consumer loans up to and including
$334,000. Certain consumer loans up to and including $25,000 may be approved
by individual loan officers and the Bank's Consumer Lending Department Manager
may approve consumer loans up to and including $75,000. The Bank's Commercial
Loan Committee, which consists of the Bank's President, Chief Credit
Administrator, and Business Banking Division Manager, may approve commercial
real estate loans and commercial business loans up to and including $1.5
million. The Bank's President, Chief Credit Administrator, and Business
Banking Division Manager also have individual lending authority for loans up
to and including $500,000. Loans in excess of $1.5 million, as well as loans
of any size granted to a single borrower whose aggregate lending limit exceeds
$1.5 million, must be approved by the Bank's Board of Directors or a committee
consisting of at least two outside Directors.
Loan Originations, Purchases and Sales. During the years ended September
30, 2004 and 2003, the Bank's total gross loan originations were $201.1
million and $255.5 million, respectively. Periodically, the Bank purchases
participation interests in construction and land development loans and
multi-family loans, secured by properties located in the Bank's primary market
area, from other lenders. These purchases are underwritten to the Bank's
underwriting guidelines and are without recourse to the seller other than for
fraud. See "- Lending Activities - Construction and Land Development Lending"
and "- Lending Activities - Multi-Family Lending."
Consistent with its asset/liability management strategy, the Bank's
policy generally is to retain in its portfolio all of the ARM loans originated
and to sell fixed rate one-to-four family mortgage loans in the secondary
market to the FHLMC; however, from time to time, a portion of fixed-rate loans
may be retained in the Bank's portfolio to meet its asset-liability
objectives. Loans sold in the secondary market are generally sold on a
servicing retained basis. At September 30, 2004, the Bank's loan servicing
portfolio totaled $165.2 million.
The following table shows total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended September 30,
-------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Loans originated:
Mortgage loans:
One- to four-family................ $ 36,824 $115,046 $ 83,121
Multi-family....................... 1,150 718 177
Commercial......................... 29,056 21,012 40,478
Construction and land development.. 94,373 90,480 52,596
Land............................... 11,033 7,680 7,224
Consumer............................ 18,952 18,530 13,582
Commercial business loans........... 9,754 2,060 6,418
-------- --------- ---------
Total loans originated............. 201,142 255,526 203,596
(table continued on following page)
12
Year Ended September 30,
-------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Loans purchased:
Mortgage loans:
One- to four-family................. 30 338 106
Multi-family........................ -- -- --
Commercial.......................... -- 800 --
Construction........................ -- -- 6,360
Land................................ -- -- 600
Commercial business loans........... -- -- 31
-------- --------- ---------
Total loans purchased.............. 30 1,138 7,097
-------- --------- ---------
Total loans originated and
purchased........................ 201,172 256,664 210,693
Loans sold or converted to securities:
Total whole loans sold.............. (35,741) (108,812) (70,167)
Participation loans................. -- -- --
Loans converted to securities....... -- -- (12,227)
-------- --------- ---------
Total loans sold or converted to
securities......................... (35,741) (108,812) (82,394)
Loan principal repayments.............(133,943) (145,716) (136,714)
Decrease (increase) in other
items, net........................... (9,130) (2,428) 7,175
-------- --------- ---------
Net increase (decrease) in
loans receivable.....................$ 22,358 $ (292) $ (1,240)
======== ========= =========
The increased origination of one-to four-family mortgage loans in fiscal
2002 and 2003 was primarily the result of refinancing activity prompted by a
decline in interest rates to historically low levels. Increased fixed rate
loan originations resulted in increased loans sold. It is anticipated that
increasing interest rates will diminish the refinancing activity of one- to
four-family loans and, correspondingly, the volume of loans sold.
Loan Origination Fees. The Bank generally receives loan origination
fees. Loan fees are a percentage of the principal amount of the loan which
are charged to the borrower for funding the loan. The amount of fees charged
by the Bank is generally 0.5% to 2.0%. Current accounting standards require
fees received and certain loan origination costs for originating loans to be
deferred and amortized into interest income over the contractual life of the
loan. Net deferred fees or costs associated with loans that are prepaid are
recognized as income at the time of prepayment. Deferred loan origination
fees totaled $3.2 million at September 30, 2004.
Nonperforming Assets and Delinquencies. The Bank assesses late fees or
penalty charges on delinquent loans of approximately 5% of the monthly loan
payment amount. Substantially all fixed-rate and ARM loan payments are due on
the first day of the month; however, the borrower is given a 15 day grace
period to make the loan payment. When a mortgage loan borrower fails to make
a required payment when due, the Bank institutes collection procedures. A
notice is mailed to the borrower 16 days after the date the payment is due.
Attempts to contact the borrower by telephone generally begin on or before the
30th day of delinquency. If a satisfactory response is not obtained,
continuous follow-up contacts are attempted until the loan has been brought
current. Before the 90th day of delinquency, attempts to interview the
borrower, preferably in person, are made to establish (i) the cause of the
delinquency, (ii) whether the cause is temporary, (iii) the attitude of the
borrower toward the debt, and (iv) a mutually satisfactory arrangement for
curing the default.
If the borrower is chronically delinquent and all reasonable means of
obtaining payment on time have been exhausted, foreclosure is initiated
according to the terms of the security instrument and applicable law.
Interest income on loans in foreclosure is reduced by the full amount of
accrued and uncollected interest.
13
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 all
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 Bank's
nonperforming assets at the dates indicated.
At September 30,
-----------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(Dollars in thousands)
Loans accounted for on a
non-accrual basis:
Mortgage loans:
One- to four-family......$ 430 $ 1,409 $ 1,138 $ 863 $ 1,203
Commercial............... 640 538 688 2,091 551
Construction and land
development............. -- 1,185 1,571 491 1,267
Land .................... 322 521 251 610 233
Consumer loans .......... 23 212 49 26 273
Commercial business
loans................... 27 30 44 10 85
-------- -------- -------- -------- --------
Total.................. 1,442 3,895 3,741 4,091 3,612
Accruing loans which are
contractually past due 90
days or more:
Mortgage loans:
Construction and land
development............ -- -- -- -- --
-------- -------- -------- -------- --------
Total.................. -- -- -- -- --
-------- -------- -------- -------- --------
Total of non-accrual and
90 days past due loans... 1,442 3,895 3,741 4,091 3,612
Real estate owned and other
repossessed assets....... 421 1,258 680 1,006 1,966
-------- -------- -------- -------- --------
Total nonperforming
assets................$ 1,863 $ 5,153 $ 4,421 $ 5,097 $ 5,578
======== ======== ======== ======== =========
Restructured loans -- -- -- -- --
Non-accrual and 90 days
or more past due loans
as a percentage of
loans receivable, net.... 0.41% 1.19% 1.15% 1.25% 1.14%
Non-accrual and 90 days
or more past due loans
as a percentage of total
assets................... 0.31% 0.87% 0.87% 1.06% 0.98%
Nonperforming assets as
a percentage of total
assets................... 0.40% 1.15% 1.03% 1.32% 1.52%
Loans receivable, net(1).. $348,585 $326,127 $326,158 $326,818 $315,646
======== ======== ======== ======== ========
Total assets.............. $460,419 $449,633 $431,054 $386,305 $368,080
======== ======== ======== ======== ========
- -------------
(1) Includes loans held-for-sale and is before the allowance for loan losses.
The Bank's non-accrual loans decreased to $1.4 million at September 30,
2004 from $3.9 million at September 30, 2003, primarily as a result of a $1.2
million decrease in construction and land development loans on non-accrual
status, a $979,000 decrease in one- to four-family mortgage loans on
non-accrual status, a $199,000 decrease in land loans on non-accrual status,
and a $189,000 decrease in consumer loans on non-accrual status. Partially
offsetting these decreases was a $102,000 increase in commercial real estate
loans on non-accrual status.
Additional interest income which would have been recorded for the year
ended September 30, 2004 had non-accruing loans been current in accordance
with their original terms totaled approximately $156,000.
14
Real Estate Owned and Other Repossessed Items. Real estate acquired by
the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as real estate owned until sold. When property is acquired, it is
recorded at the lower of its cost, which is the unpaid principal balance of
the related loan plus foreclosure costs, or fair market value. Subsequent to
foreclosure, the property is carried at the lower of the foreclosed amount or
fair value, less estimated selling costs. At September 30, 2004, the Bank had
$421,000 in real estate owned and other repossessed items consisting primarily
of three one- to- four family properties totaling $276,000, five land parcels
totaling $128,000, and mobile homes and vehicles totaling $17,000.
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, 2004.
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.
The aggregate amounts of the Bank's classified assets (as determined by
the Bank), and of the Bank's allowances for loan losses at the dates
indicated, were as follows:
At September 30,
-----------------------------
2004 2003 2002
------- ------- --------
(In thousands)
Loss......................... $ -- $ -- $ --
Doubtful..................... -- -- 3
Substandard(1)............... 11,847 9,112 7,965
Special mention(1)........... 3,676 6,607 12,588
------- ------- -------
Total classified assets...... $15,523 $15,719 $20,556
======= ======= =======
Allowance for loan losses.... $ 3,991 $ 3,891 $ 3,630
- -------------
(1) For further information concerning the increase in classified assets, see
"- Lending Activities - Nonperforming Assets and Delinquencies."
15
The Bank's classified assets decreased by $196,000 from September 30,
2003 to September 30, 2004, primarily as a result of a $2.9 million decrease
in loans classified as special mention and a $2.7 million increase in loans
classified as substandard.
Special mention loan are defined as those credits deemed by management to
have some potential weakness that deserve management's close attention. If
left uncorrected these potential weaknesses may result in the deterioration of
the payment prospects of the loan. Assets in this category are not adversely
classified and currently do not expose the Bank to sufficient risk to warrant
a substandard classification. Two relationships comprise a majority of the
amount classified as special mention. They include a $1.3 million land
development loan in Grays Harbor County, and $1.2 million in commercial
business loans to a company located in Thurston County. At September 30, 2004
both of these loans were current and paying in accordance with the required
loan terms.
Substandard loans are classified as those loans that are inadequately
protected by the current net worth, and paying capacity of the obligor, or of
the collateral pledged. Assets classified as substandard have a well-defined
weakness, or weaknesses that jeopardize the repayment of the debt. If the
weakness, or weaknesses are not corrected there is the distinct possibility
that some loss will be sustained. The aggregate amount of loans classified as
substandard at September 30, 2004 increased by $2.7 million to $11.9 million
from the amount reported at September 30, 2003. At September 30, 2004, 36
loans were classified as substandard compared to 60 at September 30, 2003.
The largest loan currently classified substandard is a $3.4 million loan
secured by a motel in Pierce County. This loan is current and paying in
accordance with the terms of the loan. The next largest loans classified as
substandard include a $1.9 million loan secured by a multi-family property in
Kitsap County, a $1.6 million loan secured by a single family home in Pierce
County, a $1.6 million loan secured by a hotel in Grays Harbor County, and a
$639,000 loan secured by a single family home in King County. At September
30, 2004, the $1.9 million multi-family loan was current, the $1.6 million
single family home loan was current, the $1.6 million hotel loan was 60 days
delinquent and the $639,000 single family home loan was 30 days delinquent.
Subsequent to September 30, 2004, the $1.6 million loan secured by a hotel and
additional collateral was placed on non-accrual status. While management
believes the loan to be adequately secured and collectible, no assurances can
be given that the loan will be collected in full.
Allowance for Loan Losses. The allowance for loan losses is maintained
to cover estimated losses in the loan portfolio. The Bank has established a
systematic methodology for the determination of provisions for loan losses
that takes into consideration the need for an overall general valuation
allowance. The Bank's methodology for assessing the adequacy of its allowance
for loan losses is based on its historic loss experience for various loan
segments; adjusted for changes in economic conditions, delinquency rates, and
other factors. Using these loss estimate factors, management develops a range
of probable loss for each loan category. Certain individual loans for which
full collectibility may not be assured are evaluated individually with loss
exposure based on estimated discounted cash flows or 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, 2004, the Bank had an allowance for loan losses of $3.99
million. Management believes that the amount maintained in the allowance is
adequate to absorb probable losses in the portfolio. Although management
believes that it uses the best information available to make its
determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.
16
While the Bank believes it has established its existing allowance for
loan losses in accordance with accounting principles generally accepted in the
United States of America, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase
significantly its allowance for loan losses. In addition, because future
events affecting borrowers and collateral cannot be predicted with certainty,
there can be no assurance that the existing allowance for loan losses is
adequate or that substantial increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
Any material increase in the allowance for loan losses may adversely affect
the Bank's financial condition and results of operations.
The following table sets forth an analysis of the Bank's allowance for
loan losses for the periods indicated.
Year Ended September 30,
------------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Allowance at beginning of
year....................... $3,891 $3,630 $3,050 $2,640 $2,056
Provision for loan losses... 167 347 992 1,400 885
Recoveries:
Mortgage loans ............. -- -- 96 20 260
Consumer loans.............. 16 12 13 2 2
Commercial business loans... 3 70 -- -- --
------ ------ ------ ------ ------
Total recoveries......... 19 82 109 22 262
Charge-offs:
Mortgage loans.............. 12 81 26 121 270
Consumer loans.............. 68 87 143 224 113
Commercial business loans... 6 -- 352 667 180
------ ------ ------ ------ ------
Total charge-offs........ 86 168 521 1,012 563
------ ------ ------ ------ ------
Net charge-offs.......... 67 86 412 990 301
------ ------ ------ ------ ------
Balance at end of year... $3,991 $3,891 $3,630 $3,050 $2,640
====== ====== ====== ====== ======
Allowance for loan losses
as a percentage of total
loans receivable (net)(1)
outstanding at the end
of the year................ 1.14% 1.19% 1.11% 0.93% 0.84%
Net charge-offs as a
percentage of average
loans outstanding during
the year................... 0.02% 0.03% 0.13% 0.31% 0.01%
Allowance for loan losses
as a percentage of
nonperforming loans at end
of year.................... 276.77% 99.90% 97.03% 74.55% 73.09%
- ---------------
(1) Total loans receivable (net) includes loans held for sale and is before
the allowance for loan losses.
17
The following table sets forth the allocation of the allowance for loan losses by loan category at the
dates indicated.
At September 30,
----------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------- ------------------ ---------------- ----------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in in in in in
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------- -------- -------- -------- ------ -------- ------- -------- ------- ---------
(Dollars in thousands)
Mortgage loans:
One- to four-
family........$ 386 25.25% $ 317 26.21% $ 322 31.28% $ 271 35.14% $ 374 38.85%
Multi-family.. 242 4.34 374 5.01 214 6.67 195 7.95 171 9.54
Commercial.... 1,443 27.39 1,041 28.30 1,072 27.00 793 17.76 662 16.65
Construction.. 538 26.88 583 25.87 536 22.16 845 28.71 968 25.52
Land.......... 226 5.03 169 4.30 152 4.27 96 3.68 220 3.56
Non-mortgage
loans:
Consumer
loans........ 427 8.30 458 7.71 512 6.03 217 4.83 121 4.51
Commercial
business
loans........ 729 2.81 949 2.60 822 2.59 633 1.93 124 1.37
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total
allowance
for loan
losses......$3,991 100.00% $3,891 100.00% $3,630 100.00% $3,050 100.00% $2,640 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
18
Investment Activities
At September 30, 2004, the Company's investment portfolio totaled $60.1
million, primarily consisting of $32.6 million of mutual funds available for
sale, $18.3 million of mortgage-backed securities available for sale, $9.0
million of U.S. agency securities available for sale, and $174,000 of
securities held to maturity. This compares with a total portfolio of $54.3
million at September 30, 2003, comprised of $34.4 million of mutual funds
available for sale, $17.1 million of mortgage-backed securities available for
sale, $2.5 million of U.S. agency securities available for sale and $279,000
of securities held to maturity. The mutual funds invest primarily in
mortgage-backed products and U.S. agency securities. The composition of the
portfolios by type of security, at each respective date is presented in the
table, which follows.
The investment policies of the Company are established and monitored by
the Board of Directors. The policies are designed primarily to provide and
maintain liquidity, to generate a favorable return on investments without
incurring undue interest rate and credit risk, and to compliment the Bank's
lending activities. These policies dictate the criteria for classifying
securities as either available for sale or held to maturity. The policies
permit investment in various types of liquid assets permissible under
applicable regulations, which includes U.S. Treasury obligations, securities
of various federal agencies, certain certificates of deposit of insured banks,
banker's acceptances, federal funds, mortgage-backed securities, and mutual
funds. The Company's investment policy also permits investment in equity
securities in certain financial service companies.
The following table sets forth the investment securities portfolio and
carrying values at the dates indicated.
At September 30,
----------------------------------------------------------------
2004 2003 2002
-------------------- -------------------- --------------------
Carrying Percent of Carrying Percent of Carrying Percent of
Value Total Value Total Value Total
-------- ---------- -------- ---------- --------- ---------
(Dollars in thousands)
Held-to-Maturity:
Mortgage-
backed
securities..$ 174 0.29% $ 279 0.52% $ -- --%
Available-for-Sale
(at fair value):
U.S. agency
securities.. 8,983 14.96 2,511 4.62 --
Mortgage-
backed
securities.. 18,329 30.52 17,098 31.48 17,888 43.02
Municipal
bonds....... -- -- 12 0.02 40 0.10
Mutual
funds....... 32,577 54.23 34,410 63.36 23,654 56.88
------- ------ ------- ------ ------- ------
Total
portfolio....$60,063 100.00% $54,310 100.00% $41,582 100.00%
======= ====== ======= ====== ======= ======
19
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, 2004. Mutual
funds and equity securities, which by their nature do not have maturities, are classified in the less than
one year category.
Less Than One to Five to Over Ten
One Year Five Years Ten Years Years
----------------- ----------------- ----------------- -----------------
Amount Yield Amount Yield Amount Yield Amount Yield
-------- ------- ------- ------- -------- ------- -------- -------
(Dollars in thousands)
Held-to-Maturity:
Mortgage-backed
securities............. $ -- --% $ -- --% $ -- --% $ 174 2.01%
Available-for-Sale:
U.S. agency securities.. -- -- 8,983 2.81 -- -- -- --
Mortgage-backed
securities............. -- -- 231 5.84 1,305 6.17 16,793 4.22
Mutual funds............ 32,577 2.51 -- -- -- -- -- --
------- ---- ------ ---- ------ ---- ------- ----
Total portfolio......... $32,577 2.51% $9,214 2.89% $1,305 6.17% $16,967 4.20%
======= ==== ====== ==== ====== ==== ======= ====
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of the
Bank's funds for lending and other investment purposes. Scheduled loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are influenced significantly by general interest
rates and money market conditions. Borrowings through the FHLB-Seattle may be
used to compensate for reductions in the availability of funds from other
sources.
Deposit Accounts. Substantially all of the Bank's depositors are
residents of Washington. Deposits are attracted from within the Bank's market
area through the offering of a broad selection of deposit instruments,
including money market deposit accounts, checking accounts, regular savings
accounts and certificates of deposit. Deposit account terms vary, according
to the minimum balance required, the time periods the funds must remain on
deposit and the interest rate, among other factors. In determining the terms
of its deposit accounts, the Bank considers current market interest rates,
profitability to the Bank, matching deposit and loan products and its customer
preferences and concerns. In recent periods, the Bank has used deposit
interest rate promotions in connection with the opening of new branch offices.
The Bank actively seeks consumer and commercial checking accounts through a
checking account acquisition marketing program that was implemented in 2000.
At September 30, 2004, the Bank had 35.8% of total deposits in non-interest
bearing accounts and NOW checking accounts.
At September 30, 2004 the Bank had $22.0 million of jumbo certificates of
deposit of $100,000 or more. The Bank does not solicit brokered deposits and
believes that its jumbo certificates of deposit, which represented 6.9% of
total deposits at September 30, 2004, present similar interest rate risk
compared to its other deposit products.
20
The following table sets forth information concerning the Bank's deposits
at September 30, 2004.
Weighted Percentage
Average of Total
Category Interest Rate Amount Deposits
- ------------------------------ ------------- -------- ----------
(In thousands)
Non-Interest Bearing.................. --% $ 37,150 11.63%
Negotiable order of withdrawal
("NOW") Checking..................... 0.74 77,242 24.17
Savings............................... 0.71 48,200 15.08
Money Market Accounts................. 0.86 41,652 13.03
-------- ------
Subtotal............................. 0.62 204,244 63.91
-------- ------
Certificates of Deposit(1)
- ------------------------------
Maturing within 1 year................ 1.95 86,427 27.05
Maturing after 1 year but
within 2 years....................... 2.17 18,058 5.65
Maturing after 2 years but
within 5 years....................... 3.67 10,163 3.18
Maturing after 5 years 5.04 678 0.21
-------- ------
Total certificates of deposit....... 2.15 115,326 36.09
-------- ------
Total deposits.................... 1.18% $319,570 100.00%
======== ======
- ---------------
(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, 2004. 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............... $ 4,573
Over three through six months...... 3,506
Over six through twelve months..... 7,700
Over twelve months................. 6,262
-------
Total........................... $22,041
=======
21
Deposit Flow. The following table sets forth the balances of deposits in the various types of accounts
offered by the Bank at the dates indicated.
At September 30,
------------------------------------------------------------------------------------
2004 2003 2002
------------------------------ ----------------------------- -------------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
-------- ------- ---------- -------- -------- ---------- ------- --------
(Dollars in thousands)
Non-interest-bearing....$ 37,150 11.63% $ 8,017 $ 29,133 9.47% $ 5,548 $ 23,585 8.07%
NOW checking............ 77,242 24.17 19,628 57,614 18.73 15,392 42,222 14.44
Savings accounts........ 48,200 15.08 (1,372) 49,572 16.11 9,244 40,328 13.80
Money market deposit.... 41,652 13.03 2,208 39,444 12.82 (8,444) 47,888 16.38
Certificates of deposit
which mature in the
year ending:
Within 1 year......... 86,427 27.05 (12,814) 99,241 32.26 (9,658) 108,899 37.26
After 1 year, but
within 2 years....... 18,058 5.65 (5,582) 23,640 7.68 4,694 18,946 6.48
After 2 years, but
within 5 years....... 10,163 3.18 3,149 7,014 2.28 (1,971) 8,985 3.07
Certificates maturing
thereafter........... 678 0.21 (1,336) 2,014 0.65 551 1,463 0.50
-------- ------ ------- -------- ------ ------- -------- ------
Total $319,570 100.00% $11,898 $307,672 100.00% $15,356 $292,316 100.00%
======== ====== ======= ======== ====== ======= ======== ======
22
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,
-----------------------------
2004 2003 2002
---- ---- ----
(In thousands)
0.00 - 1.99%........... $ 60,258 $ 50,569 $ 6,674
2.00 - 3.99%........... 46,482 68,274 104,611
4.00 - 4.99%........... 6,328 9,758 18,314
5.00 - 5.99%........... 1,562 1,999 6,284
6.00 - 6.99%........... 551 1,157 2,254
7.00% and over......... 145 152 156
-------- -------- --------
Total.................. $115,326 $131,909 $138,293
======== ======== ========
Certificates of Deposit by Maturities. The following table sets forth
the amount and maturities of certificates of deposit at September 30, 2004.
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%.............. $50,992 $ 8,992 $ 230 $ 44 $ 60,258
2.00 - 3.99%.............. 31,078 8,581 6,519 304 46,482
4.00 - 4.99%.............. 3,652 249 2,427 -- 6,328
5.00 - 5.99%.............. 477 216 869 -- 1,562
6.00 - 6.99%.............. 210 -- 95 246 551
7.00% and over............ 18 20 23 84 145
------- ------- ------- ---- --------
Total..................... $86,427 $18,058 $10,163 $678 $115,326
======= ======= ======= ==== ========
Deposit Activities. The following table sets forth the savings
activities of the Bank for the periods indicated.
Year Ended September 30,
-------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Beginning balance....................... $307,672 $292,316 $242,372
Net deposits before interest credited... 7,730 9,786 42,428
Interest credited....................... 4,168 5,570 7,516
-------- -------- --------
Net increase in deposits................ 11,898 15,356 49,944
-------- -------- --------
Ending balance.......................... $319,570 $307,672 $292,316
======== ======== ========
Borrowings. Deposits are the primary source of funds for the Bank's
lending and investment activities and for general business purposes. The Bank
has the ability to use advances from the FHLB-Seattle to supplement its supply
of lendable funds and to meet deposit withdrawal requirements. The
FHLB-Seattle functions as a central reserve bank providing credit for member
financial institutions. As a member of the FHLB-Seattle, the Bank is required
to own capital stock in the FHLB-Seattle and is authorized to apply for
advances on the security of such stock and certain of its mortgage loans and
other assets (principally securities which are obligations of, or guaranteed
by, the United States
23
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, 2004, 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, under
which $65.4 million was outstanding. At September 30, 2004, the Bank
maintained a $10.0 million overnight borrowing line with Pacific Coast Bankers
Bank under which there was no outstanding balance.
The following table sets forth certain information regarding borrowings
by the Bank at the end of and during the periods indicated:
At or For the
Year Ended September 30,
----------------------------
2004 2003 2002
------ ------ ------
(Dollars in thousands)
Average short-term FHLB
advances outstanding....................$ 633 $ -- $ --
Weighted average rate
paid on short-term FHLB advances........ 1.86% --% --%
Balance of short-term FHLB advances
outstanding at end of period............ 10,485 -- --
Average total FHLB advances.............. 57,778 61,715 63,315
Weighted average rate paid on total
FHLB advances........................... 5.46% 5.47% 5.33%
Total FHLB advances outstanding
at end of period........................ 65,421 61,605 61,759
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, 2004, the Bank had $11.0 million in bank owned life insurance.
REGULATION OF THE BANK
General
As a state-chartered savings bank, the Bank is subject to applicable
provisions of Washington law and regulations of the Division adopted
thereunder. 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.
24
Deposit Insurance
The FDIC is an independent federal agency established originally to
insure the deposits, up to prescribed statutory limits, of federally-insured
depository institutions. The FDIC maintains two separate insurance funds: the
Bank Insurance Fund ("BIF") and the SAIF. The Bank is a member of the SAIF.
Deposits are insured up to the applicable limits by the FDIC and this
insurance is backed by the full faith and credit of the United States
government.
As insurer, the FDIC imposes deposit insurance premiums and is authorized
to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging
in any activity the FDIC determines by regulation or order to pose a serious
risk to the SAIF or the BIF. The FDIC also has the authority to initiate
enforcement actions against savings institutions and may terminate the deposit
insurance if it determines that the institution has engaged in unsafe or
unsound practices or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified
as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of
Tier 1 or core capital, to risk-weighted assets ("Tier 1 risk-based capital")
of at least 6% and a risk-based capital ratio of at least 10%) and considered
healthy pay the lowest premium while institutions that are less than
adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. The FDIC makes risk
classification of all insured institutions for each semi-annual assessment
period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than
the designated reserve ratio of 1.25% of SAIF insured deposits. In setting
these increased assessments, the FDIC must seek to restore the reserve ratio
to that designated reserve level, or such higher reserve ratio as established
by the FDIC. The FDIC may also impose special assessments on SAIF members to
repay amounts borrowed from the United States Treasury or for any other reason
deemed necessary by the FDIC.
Since January 1, 1997, the premium schedule for BIF and SAIF insured
institutions has ranged from 0 to 27 basis points. However, SAIF and BIF
insured institutions are required to pay a Financing Corporation assessment in
order to fund the interest on bonds issued to resolve thrift failures in the
1980s equal to approximately 1.50 points for each $100 in domestic deposits
annually. These assessments, which may be revised based upon the level of BIF
and SAIF deposits, will continue until the bonds mature.
Under the Federal Deposit Insurance Act ("FDIA"), the FDIC may terminate
deposit insurance upon a finding that the institution has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, rule, order or condition
imposed by the FDIC. Management of the Bank does not know of any practice,
condition or violation that might lead to termination of deposit insurance.
Prompt Corrective Action
The FDIC is required to take certain supervisory actions against
undercapitalized savings institutions, the severity of which depends upon the
institution's degree of undercapitalization. Generally, an institution that
has a ratio of total capital to risk-weighted assets of less than 8%, a ratio
of Tier I (core) capital to risk-weighted assets of less than 4%, or a ratio
of core capital to total assets of less than 4% (3% or less for institutions
with the highest examination rating) is considered to be undercapitalized. An
institution that has a total risk-based capital ratio less than 6%, a Tier I
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be significantly undercapitalized and an institution that has a
tangible capital to assets ratio equal to or less than 2% is deemed to be
critically undercapitalized. Subject to a narrow exception, the FDIC is
required to appoint a receiver or conservator for a savings institution that
is critically undercapitalized. FDIC regulations also require that a capital
restoration plan be filed with the FDIC within 45 days of the date a savings
institution receives notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. Compliance with the plan
must be guaranteed by any parent holding company in an amount of up to the
lesser of 5% of the institution's assets or the amount which would bring the
institution
25
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, 2004, 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 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, 2004, the Bank had a Tier
1 leverage capital ratio of 14.2%. The FDIC retains the right to require an
institution to maintain a higher capital level based on the institution's
particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on
ratios of qualifying capital to risk-weighted assets. Assets are placed in
one of four categories and given a percentage weight - 0%, 20%, 50% or 100% -
based on the relative risk of that category. In addition, certain
off-balance-sheet items are converted to balance-sheet credit equivalent
amounts, and each amount is then assigned to one of the four categories.
Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2
capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1
capital to risk-weighted assets must be at least 4%. At September 30, 2004,
the Bank's ratio of total capital to risk- weighted assets was 19.7% and the
ratio of Tier 1 capital to risk-weighted assets was 18.5%. In evaluating the
adequacy of a bank's capital, the FDIC may also consider other factors that
may affect a bank's financial condition. Such factors may include interest
rate risk exposure, liquidity, funding and market risks, the quality and level
of earnings, concentration of credit risk, risks arising from nontraditional
activities, loan and investment quality, the effectiveness of loan and
investment policies, and management's ability to monitor and control financial
operating risks.
The Division requires that net worth equal at least 5% of total assets.
Intangible assets must be deducted from net worth and assets when computing
compliance with this requirement. At September 30, 2004, the Bank had a net
worth of 14.0% of total assets.
26
FDIC capital requirements are designated as the minimum acceptable
standards for banks whose overall financial condition is fundamentally sound,
which are well-managed and have no material or significant financial
weaknesses. The FDIC capital regulations state that, where the FDIC
determines that the financial history or condition, including off-balance
sheet risk, managerial resources and/or the future earnings prospects of a
bank are not adequate and/or a bank has a significant volume of assets
classified substandard, doubtful or loss or otherwise criticized, the FDIC may
determine that the minimum adequate amount of capital for that bank is greater
than the minimum standards established in the regulation.
The Bank's management believes that, under the current regulations, the
Bank will continue to meet its minimum capital requirements in the foreseeable
future. However, events beyond the control of the Bank, such as a downturn in
the economy in areas where the Bank has most of its loans, could adversely
affect future earnings and, consequently, the ability of the Bank to meet its
capital requirements.
The table below sets forth the Bank's capital position relative to its
FDIC capital requirements at September 30, 2004. The definitions of the terms
used in the table are those provided in the capital regulations issued by the
FDIC.
At September 30, 2004
----------------------------
Percent of Adjusted
Amount Total Assets (1)
------ -------------------
(Dollars in thousands)
Tier 1 (leverage) capital (2)................ $63,434 14.2%
Tier 1 (leverage) capital requirement........ 17,848 4.00
------- ----
Excess....................................... $45,586 10.2%
======= ====
Tier 1 risk adjusted capital................. $63,434 18.5%
Tier 1 risk adjusted capital requirement..... 13,694 4.00
------- ----
Excess....................................... $49,740 14.5%
======= ====
Total risk-based capital..................... $67,425 19.7%
Total risk-based capital requirement......... 27,388 8.00
------- ----
Excess....................................... $40,037 11.7%
======= ====
- ------------
(1) For the Tier 1 (leverage) capital and Washington regulatory capital
calculations, percent of total average assets of $446.2 million. For the
Tier 1 risk-based capital and total risk-based capital calculations,
percent of total risk-weighted assets of $342.3 million.
(2) As a Washington-chartered savings bank, the Bank is subject to the
capital requirements of the FDIC and the Division. The FDIC requires
state-chartered savings banks, including the Bank, to have a minimum
leverage ratio of Tier 1 capital to total assets of at least 3%,
provided, however, that all institutions, other than those (i) receiving
the highest rating during the examination process and (ii) not
anticipating any significant growth, are required to maintain a ratio of
1% to 2% above the stated minimum, with an absolute total capital to
risk-weighted assets of at least 8%. The Bank has not been notified by
the FDIC of any leverage capital requirement specifically applicable to
it.
Activities and Investments of Insured State-Financial Institutions
Federal law generally limits the activities and equity investments of
FDIC-insured, state-chartered banks to those that are permissible for national
banks. Under regulations dealing with equity investments, an insured state
bank generally may not directly or indirectly acquire or retain any equity
investment of a type, or in an amount, that is not permissible for a national
bank. An insured state bank is not prohibited from, among other things, (i)
acquiring or retaining a majority interest in a subsidiary, (ii) investing as
a limited partner in a partnership the sole purpose of which
27
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 State has enacted a new law regarding financial institution
parity. 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, among
other things, all prior and present "owners and operators" of hazardous waste
sites. However, the U.S. Congress created a safe harbor provision for secured
creditors by providing that the term "owner and operator" excludes a person
who, without participating in the management of the site, holds indicia of
ownership primarily to protect its security interest in the site. Since the
enactment of the CERCLA, this "secured creditor exemption" has been the
subject of judicial interpretations which have left open the possibility that
lenders could be liable for cleanup costs on contaminated property that they
hold as collateral for a loan.
In response to the uncertainty created by judicial interpretations, in
April 1992, the United States Environmental Protection Agency ("EPA"), an
agency within the Executive Branch of the government, promulgated a regulation
clarifying when and how secured creditors could be liable for cleanup costs
under the CERCLA. Generally, the regulation protected a secured creditor that
acquired full title to collateral property through foreclosure as long as the
creditor did not participate in the property's management before foreclosure
and undertook certain due diligence efforts to divest itself of the property.
However, in February 1994, the U.S. Court of Appeals for the District of
Columbia Circuit held that the EPA lacked authority to promulgate such
regulation on the grounds that Congress meant for decisions on liability under
the CERCLA to be made by the courts and not the Executive Branch. In January
1995, the U.S. Supreme Court denied to review the U.S. Court of Appeal's
decision. In light of this adverse court ruling, in October 1995 the EPA
issued a statement entitled "Policy on CERCLA Enforcement Against Lenders and
Government Entities that Acquire Property Involuntarily" explaining that as an
enforcement policy, the EPA intended to apply as guidance the provisions of
the EPA lender liability rule promulgated in 1992.
To the extent that legal uncertainty exists in this area, all creditors,
including the Bank, that have made loans secured by properties with potential
hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
Federal Reserve System
The Federal Reserve Board requires under Regulation D that all depository
institutions, including savings banks, maintain reserves on transaction
accounts or non-personal time deposits. These reserves may be in the form of
cash or non-interest-bearing deposits with the regional Federal Reserve Bank.
Negotiable order of withdrawal accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any non-personal time deposits at a savings bank. Under Regulation D, a
bank must maintain reserves against net transaction accounts in the amount of
3% on amounts of $37.3
28
million or less, plus 10% on amounts in excess of $37.3 million. In addition,
a bank may designate and exempt $5.0 million of certain reservable liabilities
from these reserve requirements. These amounts and percentages are subject to
adjustment by the Federal Reserve. The reserve requirement on non-personal
time deposits with original maturities of less than 1.5 years is 0%. As of
September 30, 2004, the Bank had a Regulation D reserve requirement of $7.0
million.
Affiliate Transactions
The Company and the Bank are separate and distinct legal entities.
Various legal limitations restrict the Bank from lending or otherwise
supplying funds to the Company (an "affiliate"), generally limiting such
transactions with the affiliate to 10% of the bank's capital and surplus and
limiting all such transactions to 20% of the bank's capital and surplus.
These transactions, including extensions of credit, sales of securities or
assets and provision of services, also must be on terms and conditions
consistent with safe and sound banking practices, including credit standards,
that are substantially the same or at least as favorable to the bank as those
prevailing at the time for transactions with unaffiliated companies.
Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or
other affiliates, on investments in the stock or other securities of
affiliates and on the taking of such stock or securities as collateral from
any borrower. In addition, such banks are prohibited from engaging in certain
tie-in arrangements in connection with any extension of credit or the
providing of any property or service.
Community Reinvestment Act
Banks are also subject to the provisions of the Community Reinvestment
Act of 1977 ("CRA"), which requires the appropriate federal bank regulatory
agency, in connection with its regular examination of a bank, to assess the
bank's record in meeting the credit needs of the community serviced by the
bank, including low and moderate income neighborhoods. The regulatory
agency's assessment of the bank's record is made available to the public.
Further, such assessment is required of any bank which has applied, among
other things, to establish a new branch office that will accept deposits,
relocate an existing office or merge or consolidate with, or acquire the
assets or assume the liabilities of, a federally regulated financial
institution. The Bank received a "satisfactory" rating during its most recent
CRA examination.
Dividends
Dividends from the Bank constitute the major source of funds for
dividends which may be paid by the Company. The amount of dividends payable
by the Bank to the Company depends upon the Bank's earnings and capital
position, and is limited by federal and state laws, regulations and policies.
According to Washington law, the Bank may not declare or pay a cash dividend
on its capital stock if it would cause its net worth to be reduced below (i)
the amount required for liquidation accounts or (ii) the net worth
requirements, if any, imposed by the Director of the Division. Dividends on
the Bank's capital stock may not be paid in an aggregate amount greater than
the aggregate retained earnings of the Bank, without the approval of the
Director of the Division.
The amount of dividends actually paid during any one period will be
strongly affected by the Bank's management policy of maintaining a strong
capital position. Federal law further provides that no insured depository
institution may make any capital distribution (which would include a cash
dividend) if, after making the distribution, the institution would be
"undercapitalized," as defined in the prompt corrective action regulations.
Moreover, the federal bank regulatory agencies also have the general authority
to limit the dividends paid by insured banks if such payments should be deemed
to constitute an unsafe and unsound practice.
29
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.
Financial Services Modernization
On November 12, 1999, the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLB Act") was signed into law. The purpose of
this legislation is to modernize the financial services industry by
establishing a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms and other financial service
providers. Generally, the GLB Act:
(1) repealed the historical restrictions and eliminates many federal
and state law barriers to affiliations among banks, securities
firms, insurance companies and other financial service providers;
(2) provided a uniform framework for the functional regulation of the
activities of banks, savings institutions and their holding
companies;
(3) broadened the activities that may be conducted by national banks,
banking subsidiaries of bank holding companies and their
financial subsidiaries;
(4) provided an enhanced framework for protecting the privacy of
consumer information; and
(5) addressed a variety of other legal and regulatory issues
affecting day-to-day operations and long-term activities of
financial institutions.
The GLB Act also imposed certain obligations on financial institutions to
develop privacy policies, restrict the sharing of nonpublic customer data with
nonaffiliated parties at the customer's request, and establish procedures and
practices to protect and secure customer data. These privacy provisions were
implemented by regulations that were effective on November 12, 2000.
Compliance with the privacy provisions was required by July 1, 2001.
The USA Patriot Act
In response to the terrorist events of September 11, 2001, the Uniting
and Strengthening America by Providing Appropriate Tools Required to Intercept
and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") was signed into law
on October 26, 2001. The USA Patriot Act gives the federal government new
powers to address terrorist threats through enhanced domestic security
measures, expanded surveillance powers, increased information sharing, and
broadened anti-money laundering requirements. Title III of the USA Patriot Act
takes measures intended to encourage information sharing among bank regulatory
agencies and law enforcement bodies. Further, certain provisions of Title III
impose affirmative obligations on a broad range of financial institutions.
Among other requirements, Title III of the USA Patriot Act imposes the
following requirements:
30
* Financial institutions must establish anti-money laundering
programs that include (i) internal policies, procedures and
controls, (ii) specific designation of an anti-money laundering
compliance officer, (iii) ongoing employee training programs and
(iv) an independent audit function to test the anti-money
laundering program.
* Financial institutions must implement a risk-based customer
identification program in connection with opening new accounts.
The program must contain requirements for identity verification,
record-keeping, comparison of information to government-maintained
lists and notice to customers.
* Financial institutions that establish, maintain, administer, or
manage private banking accounts or correspondent accounts in the
United States for non-United States persons or their
representatives must establish appropriate, specific and, where
necessary, enhanced due diligence policies, procedures and controls
designed to detect and report money laundering.
* Financial institutions are prohibited from establishing,
maintaining, administering or managing correspondent accounts for
foreign shell banks that do not have a physical presence in any
country and will be subject to certain recordkeeping obligations
with respect to correspondent accounts of foreign banks.
* Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal
Reserve Act and Bank Merger Act applications.
Our policies and procedures have been updated to reflect the requirements
of the USA Patriot Act. No significant changes in our business or customer
practices were required as a result of the implementation of these
requirements.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law
on July 30, 2002 in response to public concerns regarding corporate
accountability in connection with recent accounting scandals. The stated goals
of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide
for enhanced penalties for accounting and auditing improprieties at publicly
traded companies and to protect investors by improving the accuracy and
reliability of corporate disclosures pursuant to the securities laws. The
Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S.,
that file or are required to file periodic reports with the Securities and
Exchange Commission ("SEC"), under the Securities Exchange Act of 1934
("Exchange Act").
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules. The Sarbanes-Oxley Act represents
significant federal involvement in matters traditionally left to state
regulatory systems, such as the regulation of the accounting profession, and
to state corporate law, such as the relationship between a board of directors
and management and between a board of directors and its committees.
The Sarbanes-Oxley Act addresses, among other matters:
* audit committees;
* certification of financial statements by the chief executive
officer and the chief financial officer;
* the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuer's securities by directors and
senior officers in the twelve month period following initial
publication of any financial statements that later require
restatement;
31
* a prohibition on insider trading during pension fund black out
periods;
* disclosure of off-balance sheet transactions;
* a prohibition on personal loans to directors and officers;
* expedited filing requirements for Form 4s;
* disclosure of a code of ethics and filing a Form 8-K for a change
or waiver of such code;
* "real time" filing of periodic reports;
* the formation of a public company accounting oversight board;
* auditor independence; and
* various increased criminal penalties for violations of securities
laws.
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
32
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 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, 2004, the Company's total risk based capital was 22.2% of
risk-weighted assets and its risk based capital of Tier 1 (core) capital was
21.0% of risk-weighted assets.
TAXATION
Federal Taxation
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income. The Bank's deductions with
respect to "qualifying real property loans," which are generally loans secured
by certain interest in real property, were computed using an amount based on
the Bank's actual loss experience, or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted additions to the non-qualifying reserve. Due to the Bank's
loss experience, the Bank generally recognized a bad debt deduction equal to
8% of taxable income.
33
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 eliminate the 8% of taxable income method for deducting additions to the
tax bad debt reserves for all thrifts for tax years beginning after December
31, 1995. These rules also require 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 has previously recorded
deferred taxes equal to the bad debt recapture and as such the new rules will
have 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 new rules allowed an institution to suspend bad
debt reserve recapture for the 1996 and 1997 tax years if the institution's
lending activity for those years was equal to or greater than the institutions
average mortgage lending activity for the six taxable years preceding 1996
adjusted for inflation. For this purpose, only home purchase or home
improvement loans are included and the institution can elect to have the tax
years with the highest and lowest lending activity removed from the average
calculation. If an institution is permitted to postpone the reserve
recapture, it must begin its six year recapture no later than the 1998 tax
year. The unrecaptured base year reserves will not be subject to recapture as
long as the institution continues to carry on the business of banking. In
addition, the balance of the pre-1988 bad debt reserves continue to be subject
to provisions of present law referred to below that require recapture in the
case of certain excess distributions to shareholders. As of September 30,
2004, 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.
34
Competition
The Bank operates in an intensely competitive market for the attraction
of deposits (its primary source of lendable funds) and in the origination of
loans. Historically, its most direct competition for deposits has come from
large commercial banks, thrift institutions and credit unions in its primary
market area. In times of high interest rates, the Bank experiences additional
significant competition for investors' funds from short-term money market
securities and other corporate and government securities. The Bank's
competition for loans comes principally from mortgage bankers, commercial
banks and other thrift institutions. Such competition for deposits and the
origination of loans may limit the Bank's future growth and earnings
prospects.
Subsidiary Activities
The Bank has one wholly-owned subsidiary, Timberland Service Corporation
("Timberland Service"), whose primary function is to act as the Bank's escrow
department and offer non-deposit investment services.
Personnel
As of September 30, 2004, the Bank had 187 full-time employees and 17
part-time employees. The employees are not represented by a collective
bargaining unit and the Bank believes its relationship with its employees is
good.
Executive Officers of the Registrant
The following table sets forth certain information with respect to the
executive officers of the Company and the Bank. Each of the executive
officers holds the same position with the Company and the Bank.
Executive Officers of the Company and Bank
Age at Position
September ----------------------------------------------
Name 30, 2004 Company Bank
- ---------------- --------- --------------------- ---------------------
Clarence E. Hamre 70 Chairman of the Board Chairman of the Board
Michael R. Sand 50 President and Chief President and Chief
Executive Officer Executive Officer
Dean J. Brydon 37 Chief Financial Chief Financial
Officer Officer
Marci A. Basich 36 Treasurer Treasurer
Biographical Information.
Clarence E. Hamre is Chairman of the Board of the Company and the Bank.
He has been affiliated with the Bank since 1969 and served as President and
Chief Executive Officer of the Bank since 1969 and as President and Chief
Executive Officer of the Company since 1997. On January 23, 2003, Mr. Hamre
retired as President of the Bank and the Company and on September 30, 2003, he
retired as Chief Executive Officer of the Bank and the Company.
Michael R. Sand has been affiliated with the Bank since 1977 and has
served as President of the Bank and the Company since January 23, 2003. On
September 30, 2003, he was appointed as Chief Executive Officer of the Bank
and Company. Prior to appointment as President and Chief Executive Officer,
Mr. Sand had served as Executive Vice President and Secretary of the Bank
since 1993 and as Executive Vice President and Secretary of the Company since
its formation in 1997.
35
Dean J. Brydon has been affiliated with the Bank since 1994 and has
served as the Chief Financial Officer of the Company and the Bank since
January 2000 and Secretary of the Company and Bank since January 2004. Mr.
Brydon is a Certified Public Accountant.
Marci A. Basich has been affiliated with the Bank since 1999 and has
served as Treasurer of the Company and the Bank since January 2002. Ms.
Basich is a Certified Public Accountant. From 1998 to 1999, Ms. Basich was
the Senior Accountant of 4th Dimension Computers, Inc., a computer software
and service company.
Item 2. Properties
- -------------------
At September 30, 2004 the Bank operated 16 full service facilities.
Subsequent to September 30, 2004, the Bank acquired seven branch offices from
Venture Bank and consolidated two locations. The newly acquired office in
Hoquiam at 305 8th Street has been consolidated into the Bank's existing
Hoquiam office at 624 Simpson Avenue and the Bank's existing Montesano office
at 314 Main Street South has been consolidated into the newly acquired
Montesano office at 201 Main Street South. The following table sets forth
certain information regarding the Bank's offices, all of which are owned,
except for the Tacoma office, the Gig Harbor office, the Data Center office at
504 8th Street, and the newly acquired Lacey office at 1751 Circle Lane SE,
which are leased.
Approximate Deposits at
Location Year Opened Square Footage September 30, 2004
- --------------------------- ----------- -------------- ------------------
(In thousands)
Main Office:
624 Simpson Avenue 1966 7,700 $ 77,915
Hoquiam, Washington 98550
Branch Offices:
300 N. Boone Street 1974 3,400 29,429
Aberdeen, Washington 98520
314 Main Street South(1) 1975 2,800 21,517
Montesano, Washington 98563
361 Damon Road 1977 2,100 23,332
Ocean Shores, Washington 98569
2418 Meridian East 1980 2,400 42,330
Edgewood, Washington 98371
202 Auburn Way South 1994 4,200 17,380
Auburn, Washington 98002
12814 Meridian East (South Hill) 1996 4,200 19,799
Puyallup, Washington 98373
(table continued on following page)
36
Approximate Deposits at
Location Year Opened Square Footage September 30, 2004
- --------------------------- ----------- -------------- ------------------
(In thousands)
1201 Marvin Road, N.E. 1997 4,400 $ 10,572
Lacey, Washington 98516
101 Yelm Avenue W. 1999 1,800 13,112
Yelm, Washington 98597
20464 Viking Way NW 1999 3,380 7,245
Poulsbo, Washington 98370
2419 224th Street E. 1999 3,865 13,655
Spanaway, Washington 98387
801 Trosper Road SW 2001 3,300 14,044
Tumwater, Washington 98512
7805 South Hosmer Street 2001 5,000 9,931
Tacoma, Washington 98408
2401 NW Bucklin Hill Road 2003 4,000 6,728
Silverdale, Washington 98383
423 Washington Street SE 2003 3,000 10,986
Olympia, Washington 98501
3105 Judson St 2004 2,715 1,595
Gig Harbor, Washington 98335
117 N. Broadway(2) 2004 3,693 --
Aberdeen, Washington 98520
313 West Waldrip(2) 2004 5,922 --
Elma, Washington 98541
305 8th Street(2)(3) 2004 4,074 --
Hoquiam, Washington 98550
1751 Circle Lane SE(2) 2004 892 --
Lacey, Washington 98503
201 Main Street South(2) 2004 3,240 --
Montesano, Washington 98563
101 2nd Street(2) 2004 1,800 --
Toledo, Washington 98591
209 NE 1st Street(2) 2004 3,395 --
Winlock, Washington 98586
(table continued on following page)
37
Approximate Deposits at
Location Year Opened Square Footage September 30, 2004
- --------------------------- ----------- -------------- ------------------
(In thousands)
Data Center:
422 6th Street 1990 2,700 $ --
Hoquiam, Washington 98550
504 8th Street 2003 5,400 --
Hoquiam, Washington 98550
Loan Center:
120 Lincoln Street 2003 5,000 --
Hoquiam, Washington 98550
- --------------
(1) Consolidated into office at 201 Main Street South, Montesano, Washington
on November 15, 2004.
(2) Acquired from Venture Bank on October 9, 2004
(3) Consolidated into office at 624 Simpson Avenue, Montesano, Washington on
November 15, 2004.
Management believes that all facilities, except for the Data Center
building located at 422 6th Street in Hoquiam are appropriately insured and
are adequately equipped for carrying on the business of the Bank. The Data
Center building at 422 6th Street in Hoquiam has sustained structural damage
and is not currently occupied. A pending claim has been filed with the Bank's
previous insurance company.
At September 30, 2004 the Bank operated 17 proprietary ATMs that are part
of a nationwide cash exchange network. Subsequent to September 30, 2004, the
Bank acquired additional ATMs as part of the Venture Bank branch acquisition
and now operates 22 ATMs.
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, 2004.
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 September 30, 2004, there were 3,882,070 shares of
common stock issued and approximately 693 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, 2004 and 2003. This
information was provided by the Nasdaq Stock Market.
38
High Low Dividends
------ ------ ---------
Fiscal 2004
- -----------
First Quarter.......... $24.95 $22.07 $0.14
Second Quarter......... 23.84 22.01 0.14
Third Quarter.......... 23.50 21.00 0.14
Fourth Quarter......... 23.94 22.05 0.15
Fiscal 2003
- -----------
First Quarter.......... $18.32 $16.43 $0.12
Second Quarter......... 19.35 18.00 0.12
Third Quarter.......... 24.39 19.08 0.12
Fourth Quarter......... 24.24 22.21 0.14
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.
Stock Repurchases
The Company has had various buy-back programs since January 1998. On
February 27, 2004, the Company announced a plan to repurchase 360,670 shares
of the Company's stock. This marked the Company's twelfth stock repurchase
plan. As of September 30, 2004, the Company has repurchased 214,086 of these
shares at an average price of $22.83 per share. Cumulatively the Company has
repurchased 3,192,687 shares at an average price of $14.96 per share. This
represents 48.3% of the 6,612,500 shares that were issued when the Company
went public in January 1998.
The following table sets forth the Company's repurchases of its
outstanding Common Stock during the fourth quarter of the year ended September
30, 2004.
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, 2004 -
July 31, 2004.......... 9,000 $22.55 9,000 156,584
August 1, 2004 -
August 31, 2004........ -- -- -- 156,584
September 1, 2004 -
September 30, 2004..... 10,000 22.87 10,000 146,584
------ ------ ------
Total................... 19,000 22.72 19,000
====== ====== ======
39
Item 6. Selected Financial Data
- --------------------------------
The following table sets forth certain information concerning the
consolidated financial position and results of operations of the Company and
subsidiaries at and for the dates indicated. The consolidated data is
derived in part from, and should be read in conjunction with, the Consolidated
Financial Statements of the Company and its subsidiary presented herein.
At September 30,
---------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
Total assets................. $460,419 $449,633 $431,054 $386,305 $368,080
Loans receivable and loans
held for sale, net.......... 344,594 322,236 322,528 323,768 313,006
Investment securities
available-for-sale.......... 41,560 36,933 23,694 10,210 13,356
Mortgage-backed securities
held to maturity............ 174 279 -- -- --
Mortgage-backed securities
available-for-sale.......... 18,329 17,098 17,888 19,159 11,569
FHLB Stock................... 5,682 5,454 5,139 4,830 4,150
Cash and due from financial
institutions, interest-
bearing deposits in banks
and fed funds sold.......... 19,833 38,098 36,073 13,439 12,002
Deposits..................... 319,570 307,672 292,316 242,372 212,611
FHLB advances................ 65,421 61,605 61,759 68,978 81,137
Shareholders' equity......... 72,817 77,611 74,396 71,809 72,312
Year Ended September 30,
---------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(In thousands, except per share data)
SELECTED OPERATING DATA:
Interest and dividend income. $26,968 $27,723 $30,263 $31,692 $28,362
Interest expense............. 7,325 8,946 10,890 13,924 12,427
------- ------- ------- ------- -------
Net interest income.......... 19,643 18,777 19,373 17,768 15,935
Provision for loan losses.... 167 347 992 1,400 885
------- ------- ------- ------- -------
Net interest income after
provision for loan losses... 19,476 18,430 18,381 16,368 15,050
Noninterest income........... 4,179 6,007 4,658 2,927 1,738
Noninterest expense.......... 15,575 14,832 12,716 11,092 7,966
Income before income taxes... 8,080 9,605 10,323 8,203 8,822
Provision for income taxes... 2,492 2,966 3,432 2,741 2,925
------- ------- ------- ------- -------
Net income................... $ 5,588 $ 6,639 $ 6,891 $ 5,462 $ 5,897
======= ======= ======= ======= =======
Earnings per common share:
Basic...................... $ 1.54 $ 1.74 $ 1.76 $ 1.30 $ 1.31
Diluted.................... $ 1.46 $ 1.66 $ 1.71 $ 1.28 $ 1.31
Dividends per share.......... $ 0.57 $ 0.50 $ 0.45 $ 0.41 $ 0.35
Dividend payout ratio........ 37.01% 28.74% 25.57% 31.54% 26.72%
40
At September 30,
---------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
OTHER DATA:
Number of real estate loans
outstanding.................. 4,101 3,522 2,911 3,041 3,000
Deposit accounts.............. 40,348 39,313 36,896 30,893 24,195
Full-service offices.......... 16 15 13 13 11
At or For the Year Ended September 30,
---------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
KEY FINANCIAL RATIOS:
Performance Ratios:
Return on average assets (1). 1.24% 1.52% 1.73% 1.47% 1.75%
Return on average equity (2). 7.52 8.67 9.42 7.53 8.27
Interest rate spread (3)..... 4.40 4.11 4.34 3.95 3.85
Net interest margin (4)...... 4.77 4.61 5.08 4.99 4.95
Average interest-earning
assets to average
interest-bearing
liabilities................. 120.68 122.74 125.73 126.58 128.55
Noninterest expense as a
percent of average
total assets................ 3.46 3.39 3.19 2.99 2.37
Efficiency ratio (5)......... 65.38 59.85 52.91 53.60 45.07
Book value per share (6)..... $18.76 $18.25 $17.14 $15.71 $15.09
Book value per share (7)..... 20.28 19.77 18.69 17.20 16.58
Asset Quality Ratios:
Nonaccrual and 90 days or
more past due loans as a
percent of total loans
receivable, net (8)......... 0.41% 1.19% 1.15% 1.25% 1.14%
Nonperforming assets as a
percent of total assets..... 0.40 1.15 1.03 1.32 1.52
Allowance for loan losses
as a percent of total
loans receivable, net (8)... 1.14 1.19 1.11 0.93 0.84
Allowance for losses as a
percent of nonperforming
loans....................... 276.77 99.90 97.03 74.55 73.09
Net charge-offs to average
outstanding loans........... 0.02 0.03 0.13 0.31 0.01
Capital Ratios:
Total equity-to-assets ratio. 15.82 17.26 17.26 18.59 19.65
Average equity to average
assets (9).................. 16.52 17.49 18.37 19.52 21.19
- ----------------
(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) Loans receivable includes loans held for sale and is before the allowance
for loan losses.
(9) Average total equity divided by average total assets.
41
Item 7. Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations
- ---------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results
of Operations is intended to assist in understanding the consolidated
financial condition and results of operations of the Company. The information
contained in this section should be read in conjunction with the Consolidated
Financial Statements and accompanying notes thereto included in Item 8 of this
Annual Report on Form 10-K.
Certain matters in this report constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements relate to, among others, expectations of the
business environment in which the Company operates, projections of future
performance, perceived opportunities in the market, potential future credit
experience, and statements regarding the Company's mission and vision. These
forward-looking statements are based upon current management expectations, and
may, therefore, involve risks and uncertainties. The Company's actual
results, performance, or achievements may differ materially from those
suggested, expressed, or implied by forward-looking statements due to a wide
range of factors including, but not limited to, the general business
environment, the direction of future interest rates, competitive conditions
between banks and non-bank financial providers, regulatory changes, labor
market competitiveness, and other risks detailed in the Company's reports
filed with the Securities and Exchange Commission.
Operating Strategy
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 primarily on the origination of loans secured by one- to- four
family residential dwellings, including an emphasis on loans for the
construction of residential dwellings. In an effort to meet the credit needs
of borrowers in its primary area, the Bank actively originates one- to- four
family mortgage loans that do not qualify for sale in the secondary market
under FHLMC guidelines. The Bank has also been an active participant in the
secondary market, originating residential loans for sale to the FHLMC on a
servicing retained basis. The Bank occasionally retains fixed-rate
one-to-four family mortgage loans in its portfolio for yield and
asset-liability management purposes.
Diversify Primary Market Area by Expanding Branch Office Network. In an
effort to lessen its dependence on the Grays Harbor County market whose
economy has historically been tied to the timber and fishing industries, the
Bank has opened branch offices in Pierce, King, Thurston and Kitsap Counties.
Thurston, Pierce, King 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.
Subsequent to September 30, 2004, the Bank acquired two branches in Lewis
County from Venture Bank as part of a seven-branch acquisition. For
additional information see "Item 1, Business - Recent Developments" and "-
Market Area."
Limit Exposure to Interest Rate Risk. In recent years, a majority of the
loans that the Bank has retained in its portfolio generally have periodic
interest rate adjustment features or have been relatively short-term in
nature. Loans originated for portfolio retention primarily have included ARM
loans and short-term construction loans. Longer term fixed-rate mortgage
loans have generally been originated for sale in the secondary market.
Management believes that the interest rate sensitivity of these adjustable
rate and short-term loans more closely match the interest rate sensitivity of
the Bank's funding sources than do other longer duration assets with fixed
interest rates.
42
Emphasize the Origination of Commercial Real Estate and Commercial
Business Loans. The Bank established a business banking division in 1998 for
the purpose of increasing the Bank's origination of commercial real estate and
commercial business loans. Originally, three lenders were hired to staff the
division. Currently, a Division Manager and six lenders are active in the
origination of commercial loans.
Increase the Consumer Loan Portfolio. In 2001 the Bank hired a consumer
loan specialist to increase the origination of consumer loans. The consumer
loans generated since that time have been secured primarily by real estate.
The Bank expects to continue expanding its portfolio of consumer loans.
Pursue Low Cost Core Deposits and Deposit Related Fee Income. The Bank
has placed an emphasis on attracting commercial and personal checking
accounts. These transactional accounts typically provide a lower cost of
funding than certificates of deposit accounts and generate non-interest fee
income. The Bank implemented a checking account acquisition program in 2000
to increase these transactional accounts. Subsequent to September 30, 2004,
the Bank increased its transaction account base by acquiring seven branches
and the related deposits from Venture Bank. For additional information, see
"Item 1, Business - Recent Developments."
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 mismatch between asset and liability maturities and interest rates. The
principal element in achieving this objective is to increase the interest-rate
sensitivity of the Bank's interest-earning assets by retaining in its
portfolio, short-term loans and loans with interest rates subject to periodic
adjustments. The Bank relies on retail deposits as its primary source of
funds. Management believes retail deposits, compared to brokered deposits,
reduce the effects of interest rate fluctuations because they generally
represent a more stable source of funds. As part of its interest rate risk
management strategy, the Bank promotes transaction accounts and certificates
of deposit with terms of up to six years.
The Bank has adopted a strategy that is designed to substantially match
the interest rate sensitivity of assets relative to its liabilities. The
primary elements of this strategy involve originating ARM loans for its
portfolio; maintaining residential construction loans as a portion of total
net loans receivable because of their generally shorter terms and higher
yields than other one- to- four family residential mortgage loans; matching
asset and liability maturities; investing in short-term securities;
originating fixed-rate loans for retention or sale in the secondary market;
and retaining the related loan servicing rights.
Sharp increases or decreases in interest rates may adversely affect the
Bank's earnings. However, based on a rate shock analysis prepared by the
FHLB-Seattle, an increase in interest rates of up to 300 basis points would
increase the Bank's projected net interest income, 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,
further decreases in interest rates would negatively affect net interest
income, as repricing would have the opposite effect. 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 generally are originated for the
immediate or future resale in the secondary mortgage market. At
43
September 30, 2004, adjustable rate mortgage loans and adjustable-rate
mortgage-backed securities constituted $224.8 million or 60.8%, of the Bank's
total combined mortgage loan and mortgage-backed securities portfolio.
Although the Bank has sought to originate ARM loans, the ability to originate
such loans depends to a great extent on market interest rates and borrowers'
preferences. Particularly in lower interest rate environments, borrowers
often prefer fixed-rate loans.
Consumer loans and construction and land development loans typically have
shorter terms and higher yields than permanent residential mortgage loans, and
accordingly reduce the Bank's exposure to fluctuations in interest rates. At
September 30, 2004, the construction and land development, and consumer loan
portfolios amounted to $106.2 million and $32.8 million, or 26.9% and 8.3% of
total loans receivable (including loans held for sale), respectively.
Quantitative Aspects of Market Risk. Management of the Bank monitors the
Bank's interest rate sensitivity through the use of a model provided for the
Bank by the FHLB- Seattle. The model estimates the changes in net portfolio
value ("NPV") and net interest income in response to a range of assumed
changes in market interest rates. The model first estimates the level of the
Bank's NPV (market value of assets, less market value of liabilities, plus or
minus the market value of any off-balance sheet items) under the current rate
environment. In general, market values are estimated by discounting the
estimated cash flows of each instrument by appropriate discount rates. The
model then recalculates the Bank's NPV under different interest rate
scenarios. The change in NPV under the different interest rate scenarios
provides a measure of the Bank's exposure to interest rate risk. The
following table is provided by the FHLB-Seattle based on data at September 30,
2004.
Net Interest Income Current Market Value
Projected ------------------------------ ------------------------------
Interest Rate Estimated $ Change % Change Estimated $ Change % Change
Scenario Value from Base from Base Value from Base from Base
- ------------- --------- --------- --------- -------- --------- ---------
(Dollars in thousands)
+300 $19,432 $ 490 2.58% $56,906 $(1,337) (2.30)%
+200 19,309 367 1.94 58,152 (91) (0.16)
+100 19,193 251 1.32 58,830 587 1.01
BASE 18,942 -- -- 58,243 -- --
-100 18,144 (799) (4.22) 56,707 (1,536) (2.64)
-200 16,556 (2,386) (12.60) 56,026 (2,217) (3.81)
-300 14,479 (4,463) (23.56) 52,956 (5,287) (9.08)
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market
interest rates, loan repayments and deposit decay, and should not be relied
upon as indicative of actual results. Furthermore, the computations do not
reflect any actions management may undertake in response to changes in
interest rates.
In the event of a 200 basis point decrease in interest rates, the Bank
would be expected to experience a 3.8% decrease in NPV and a 12.6% decrease in
net interest income. In the event of a 200 basis point increase in interest
rates, a 0.2% decrease in NPV and a 1.9% increase in net interest income would
be expected. Based upon the modeling described above, the Bank's asset and
liability structure generally results in decreases in NPV and decreases in net
interest income in a declining interest rate scenario. This structure also
generally results in increases in net interest income in a rising interest
rate environment.
As with any method of measuring interest rate risk, certain shortcomings
are inherent in the method of analysis presented in the foregoing table. For
example, although certain assets and liabilities may have similar maturities
or periods to repricing, they may react in different degrees to changes in
market interest rates. Also, the interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types may lag behind changes in market rates.
Additionally, certain assets have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates,
44
expected rates of prepayments on loans and early withdrawals from certificates
could possibly deviate significantly from those assumed in calculating the
table.
Comparison of Financial Condition at September 30, 2004 and 2003
Total Assets: Total assets increased $10.8 million to $460.4 million at
September 30, 2004 from $449.6 million at September 30, 2003 primarily due to
increases of $22.4 million in total loans, $6.7 million in cash and due from
financial institutions, $5.8 million in investment securities and $1.2 million
in fed funds sold. Partially offsetting these increases was a $26.1 million
decrease in interest bearing deposits in banks. The net asset growth was
primarily funded by increased deposits and FHLB advances.
Premises and Equipment: Premises and equipment increased $484,000 to
$13.9 million at September 30, 2004 from $13.4 million at September 30, 2003
primarily due to the opening of a new branch in Gig Harbor during the year.
For additional information on premises and equipment, see Note 6 of the Notes
to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Cash and Due from Financial Institutions, Interest Bearing Deposits in
Banks, and Federal Funds Sold: Cash and due from financial institutions,
interest bearing deposits in banks, and federal funds sold decreased by $18.3
million to $19.8 million at September 30, 2004 from $38.1 million at September
30, 2003. The decrease was a result of using a portion of these short-term
deposits to fund loan growth, to fund the Company's stock repurchase program,
and to fund the purchase of additional investment securities.
Investments, Mortgage-backed Securities and FHLB Stock: Investments,
mortgage-backed securities and FHLB stock increased by $5.9 million to $65.7
million at September 30, 2004 from $59.8 million at September 30, 2003, as
additional U.S. agency securities and mortgage-backed securities were
purchased. For additional details on investments and mortgage-backed
securities, see Item 1, Business Investment Activities" and Note 3 of the
Notes to Consolidated Financial Statements contained in "Item 8, Financial
Statements and Supplemental Data."
Loans Receivable and Loans Held for Sale, net of allowance for loan
losses: Net loans receivable, including loans held-for-sale, increased by
$22.4 million to $344.6 million at September 30, 2004 from $322.2 million at
September 30, 2003. The increase in the portfolio was primarily a result of
increases of $5.3 million in commercial real estate loans, $4.8 million in
consumer loans, $4.5 million in one-to four-family mortgage loans, $4.3
million in land loans, $3.3 million in construction loans (net of undisbursed
portion), and $1.6 million in commercial business loans. These increases were
partially offset by a $1.1 million decrease in multi-family loans.
Loan originations totaled $201.1 million for the year ended September 30,
2004, compared to $255.5 million for the year ended September 30, 2003. The
Bank sold $35.7 million in fixed rate one-to-four family mortgage loans for
the year ended September 30, 2004, compared to $108.8 million for the year
ended September 30, 2003. Loan originations and loan sales were higher in 2003
primarily due to the robust refinance activity of single family mortgage loans
attributed to the low interest rate environment. For additional information
on loans, see "Item 1, Business Lending Activities" and Note 4 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
Real Estate Owned: Real estate owned ("REO") and other repossessed items
decreased $837,000 to $421,000 at September 30, 2004 from $1.3 million at
September 30, 2003. The balance decreased as ten properties were sold and
four properties were added to REO status during the year. For additional
information on REOs, see "Item 1, Business Lending Activities
Nonperforming Assets" and Note 7 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplemental Data."
Deposits: Deposits increased by $11.9 million to $319.6 million at
September 30, 2004 from $307.7 million at September 30, 2003, primarily due to
increases of $19.6 million in NOW checking accounts, $8.0 million in non-
interest bearing accounts, and $2.2 million in money market accounts. These
increases were partially offset by decreases of $16.6 million in certificate
of deposit accounts and $1.4 million in savings accounts. The Bank continues
to focus on
45
attracting transaction accounts rather than higher-rate certificate of deposit
accounts. Transaction accounts represent a stronger core deposit relationship
than other types of deposit accounts. For additional information of deposits,
see "Item 1, Business Deposit Activities and Other Sources of Funds" and
Note 8 of the Notes to Consolidated Financial Statements contained in "Item 8,
Financial Statements and Supplemental Data."
Borrowings: Borrowings increased by $3.8 million to $65.4 million at
September 30, 2004 from $61.6 million at September 30, 2003. The increased
borrowings were used to fund a portion of the Bank's loan portfolio growth.
For additional information on borrowings, see "Item 1, Business Deposit
Activities and Other Sources of Funds Borrowings" and Note 9 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
Shareholders' Equity: Total shareholders' equity decreased by $4.9
million to $72.8 million at September 30, 2004 from $77.6 million at September
30, 2003, primarily due to the repurchase of 482,016 shares of the Company's
stock for $11.1 million, the payment of $2.3 million in dividends to
shareholders and a $324,000 decrease in accumulated other comprehensive
income. Partially offsetting these decreases to equity, were net income of
$5.6 million and a $2.2 million increase to additional paid in capital from
the exercise of stock options and the vesting of shares associated with the
Bank's benefit plans. Also increasing shareholders' equity were decreases of
$645,000 and $529,000 in the equity components related to unearned shares
issued to the Management Recognition and Development Plan ("MRDP") and the
ESOP, respectively, as more shares vested under the MRDP and were released
under the ESOP.
On February 27, 2004, the Company announced a plan to repurchase 360,670
shares of the Company's stock. This marked the Company's twelfth stock
repurchase plan. As of September 30, 2004, the Company has repurchased
214,086 of these shares at an average price of $22.83 per share. Cumulatively
the Company has repurchased 3,192,687 (48.3%) of the 6,612,500 shares that
were issued when the Company went public in January 1998 at an average price
of $14.96 per share.
Comparison of Financial Condition at September 30, 2003 and 2002
Total Assets: Total assets increased $18.5 million to $449.6 million at
September 30, 2003 from $431.1 million at September 30, 2002. This change is
reflected primarily in a $16.7 million increase in investments and interest
bearing deposits in banks and a $1.8 million increase in premises and
equipment.
Premises and Equipment: Premises and equipment increased $1.8 million to
$13.4 million at September 30, 2003 from $11.7 million at September 30, 2002.
The increase is primarily related to the opening of two new branches
(Silverdale and Olympia), the opening of a new facility to house the Bank's
loan servicing department and escrow department, and the purchase of equipment
in conjunction with the Bank's technology improvement initiatives. For
additional information on premises and equipment, see Note 6 of the Notes to
Consolidated Financial Statements contained in "Item 8, Financial Statements
and Supplemental Data."
Cash and Due from Financial Institutions: Cash and due from financial
institutions and interest-bearing deposit balances in banks increased to $38.1
million at September 30, 2003 from $36.1 million at September 30, 2002. The
increase is primarily due to investing the proceeds from increased customer
deposits.
Investments, Mortgage-backed Securities and FHLB Stock: Investments,
mortgage-backed securities and FHLB stock increased $13.0 million to $59.8
million at September 30, 2003 from $46.7 million at September 30, 2002 as
proceeds from increased customer deposits were invested. For additional
details on investments and mortgage-backed securities, see "Item 1, Business -
Investment Activities" and Note 3 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplementary Data."
Loans Receivable and Loans Held for Sale, net of allowance for loan
losses: Net loans receivable, including loans held-for-sale, decreased
slightly to $322.2 million at September 30, 2003 from $322.5 at September 30,
2002. The composition of the portfolio continued to migrate away from the
Bank's historical dependence on one-to-four family mortgage loans as the
percentage of one-to-four family mortgage loans decreased to 26.2% at
September 30, 2003 from
46
31.3% at September 30, 2002. The lower levels of one-to-four family mortgage
loans were partially offset by increased levels of construction loans,
commercial real estate loans, and consumer loans. During the year one-to-four
family mortgage loans decreased by $17.8 million and multi-family mortgage
loans decreased by $5.9 million. However, net construction loans increased by
$11.5 million, commercial mortgage loans increased by $5.3 million, and
consumer loans increased by $6.2 million. Loan volume was very strong during
the year ended September 30, 2003 as the Bank originated loans of $255.5
million and sold $108.8 million in fixed rate one-to-four family mortgage
loans. Management elected to sell a majority of the fixed rate residential
loans originated rather than adding them to the Bank's portfolio due to the
low interest-rate environment. For additional information on loans, see "Item
1, Business - Lending Activities" and Note 4 of the Notes to Consolidated
Financial Statements conained in "Item 8, Financial Statements and
Supplemental Data."
Real Estate Owned: REO and other repossessed items increased $578,000 to
$1.3 million at September 30, 2003 from $680,000 at September 30, 2002. The
balance increased as nine properties totaling $1.0 million were added to REO
status and seven properties totaling $422,000 were sold during the year. For
additional information, see "Item 1, Business - Lending Activities -
Nonperforming Assets" and Note 7 to the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplemental Data."
Deposits: Deposits increased by $15.4 million to $307.7 million at
September 30, 2003 from $292.3 million at September 30, 2002, primarily due to
increases of $15.4 million in NOW checking accounts, $9.2 million in passbook
savings accounts, and $5.5 million in non-interest bearing accounts. These
increases were partially offset by decreases of $8.4 million in money market
accounts and $6.4 million in certificate of deposit accounts. The Bank chose
not to compete for high-rate certificate of deposit accounts, electing instead
to focus on attracting transaction accounts that typically provide more of a
core deposit relationship with customers. For additional information on
deposits, see "Item 1, Business - Deposit Activities and Other Sources of
Funds" and Note 8 of the Notes to Consolidated Financial Statements contained
in "Item 8, Financial Statements and Supplemental Data."
Borrowings: Borrowings decreased $154,000 to $61.6 million at September
30, 2003 from $61.8 million at September 30, 2002 due to scheduled
amortization payments on FHLB advances. For additional information on
borrowings, see "Item 1, Business - Deposit Activities and Other Sources of
Funds - Borrowings" and Note 9 of the Notes to Consolidated Financial
Statements contained in "Item 8, Financial Statements and Supplemental Data."
Shareholders' Equity: Total shareholders' equity increased by $3.2
million to $77.6 million at September 30, 2003 from $74.4 million at September
30, 2002. The components of shareholders' equity were primarily affected by
net income of $6.64 million, the repurchase of 188,367 shares of the Company's
stock for $3.85 million and the payment of $2.15 million in dividends to
shareholders. Also affecting shareholders' equity was a $1.77 million
increase to additional paid in capital from the exercise of stock options and
the vesting of shares associated with the Bank's benefit plans. Also
increasing shareholders' equity were a $364,000 decrease in accumulated other
comprehensive income, and decreases of $644,000 and $528,000 in the equity
components related to unearned shares issued to the MRDP and ESOP,
respectively, as more shares vested under the MRDP and were released under the
ESOP.
On February 14, 2003 the Company announced a plan to repurchase 380,028
shares of the Company's stock. This marked the Company's eleventh stock
repurchase plan. As of September 30, 2003, the Company had purchased 112,108
of these shares and cumulatively had repurchased 2,710,671 (41.0%) of the
6,612,500 shares that were issued when the Company went public in January
1998.
Comparison of Operating Results for Years Ended September 30, 2004 and 2003
Net Income: Net income for the year ended September 30, 2004 was $5.59
million, or $1.46 per diluted share ($1.54 per basic share) compared to $6.64
million, or $1.66 per diluted share ($1.74 per basic share) for the year ended
September 30, 2003. The lower earnings were primarily the result of decreased
income from loan sales and increased non-interest expenses, which were
partially offset by increased net interest income. Specifically, the $0.20
per share decrease in earnings for the year ended September 30, 2004 was a
result of the $1.83 million ($1.21 million net of income tax - $0.32 per
diluted share) decrease in non-interest income and the $743,000 ($490,000 net
of income tax - $0.13 per
47
diluted share) increase in non-interest expense. These items were partially
offset by a $1.05 million ($690,000 net of income tax - $0.18 per diluted
share) increase in net interest income after provision for loan losses and a
lower number of weighted average shares outstanding (due to share
repurchases),which increased diluted earnings per share by approximately
$0.07.
The Company also incurred expenses of approximately $70,000 ($46,000 net
of income tax) in connection with the acquisition of seven Venture Bank
branches. The transaction closed on October 9, 2004 and the Company estimates
that it will incur approximately $200,000 ($132,000 net of income tax) in
additional acquisition related expenses during the first quarter of the next
fiscal year. The Company believes that the transaction will be accretive (net
of the initial transaction expenses) within one year following full
integration of the new branches into the Bank's system. However, during the
initial two quarters, net income may be negatively impacted by the acquisition
as a portion of the acquired deposits will be invested in short-term
investments with lower yields. As the acquired deposits are deployed into
loans, the transaction will contribute to earnings. The Company believes that
this acquisition brings solid potential to generate long-term earnings growth
and increase shareholder value. For additional information on the acquisition
of Venture Bank branches, see "Item 1, Business Recent Developments."
Net Interest Income: Net interest income increased $866,000 to $19.64
million for the year ended September 30, 2004 from $18.78 million for the year
ended September 30, 2003, primarily due to a decrease in the Company's funding
costs. Total interest expense decreased by $1.62 million to $7.33 million
for the year ended September 30, 2004 from $8.95 million for the year ended
September 30, 2003 as the Company's total cost of funds decreased to 2.14%
from 2.69%.
Interest expense on deposits decreased $1.40 million to $4.17 million for
the year ended September 30, 2004 from $5.57 million for the year ended
September 30, 2003 primarily due to lower average rates paid on interest
bearing accounts and a change in the composition of average interest bearing
deposits. In 2003, certificates of deposits, the Company's highest cost of
deposits, comprised 49.3% of average interest bearing deposits. In 2004,
certificates of deposit comprised 44.6% of average interest bearing deposits.
The change in the composition of the deposit base is a result of the continued
focus on attracting transaction accounts rather than higher-rate certificates
of deposit. Interest expense on FHLB advances decreased $219,000 to $3.16
million for the year ended September 30, 2004 from $3.38 million for the year
ended September 30, 2003, primarily due to a reduction in the average
outstanding FHLB advances to $57.78 million for the year ended September 30,
2004 from $61.72 million for the year ended September 30, 2003.
Partially offsetting the decreased interest expense was a decrease in
interest income. Total interest income decreased $755,000 to $26.97 million
for the year ended September 30, 2004 from $27.72 million for the year ended
September 30, 2003, primarily due to a reduction in average yields on earning
assets. The yield on earning assets was 6.55% for the year ended September
30, 2004 compared to 6.80% for the year ended September 30, 2003. As a result
of these changes, the net interest margin increased to 4.77% for the year
ended September 30, 2004 from 4.61% for the year ended September 30, 2003.
Provision for Loan Losses: The provision for loan losses for the year
ended September 30, 2004 decreased by $180,000 to $167,000 from $347,000 for
the year ended September 30, 2003. The provision for loan losses was lower
primarily due to changes in the loss factors used in the allowance for loan
loss analysis and a lower level of net charge-offs experienced. For the years
ended September 30, 2004 and 2003, net charge-offs were $67,000 and $86,000,
respectively.
The Bank has established a systematic methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs and
analysis taking into consideration historic loss experience for various loan
segments, changes in economic conditions, delinquency rates, and other factors
to determine the level of allowance for loan losses needed. The allowance for
loan losses had a net increase of $100,000 to $3.99 million at September 30,
2004 from $3.89 million at September 30, 2003. The increased level of the
allowance for loan losses was primarily due to a larger loan portfolio (loans
receivable and loans held for sale), which increased $22.5 million to $348.6
million at September 30, 2004 from $326.1 million at September 30, 2003.
Partially offsetting the increased allowance tied to loan portfolio growth,
were changes in the loss factors used in the allowance for loan loss analysis
for certain categories.
48
Based on the trends in the historical charge-off and improved economic
conditions, the loss factors used in the allowance for loan loss analysis for
one-to four-family loans, multi-family loans, commercial real estate loans,
land loans, and commercial business loans were decreased during the year.
Based on the systematic methodology, management deemed the allowance for
loan losses of $3.99 million at September 30, 2004 (1.14% of loans receivable
and 276.8% of non-performing loans) adequate to provide for probable losses
based on an evaluation of known and inherent risks in the loan portfolio at
that date. For additional information, see "Item 1, Business Lending
Activities Allowance for Loan Losses."
Non-interest Income: Total non-interest income decreased $1.83 million
to $4.18 million for the year ended September 30, 2004 from $6.01 million for
the year ended September 30, 2003, primarily due to a $1.08 million decrease
in income from loan sales (gain on sale of loans and servicing income on loans
sold), a $141,000 decrease in gain on sale of securities, a $127,000 decrease
in escrow fees, a $104,000 decrease in loan application fees, an $87,000
decrease in ATM transaction fees, an $82,000 decrease in services charges on
deposits, and a $68,000 decrease in BOLI income. Income from loan sales
decreased as mortgage banking activity slowed and the Bank began holding some
fixed rate one-to-four family mortgage loans in its portfolio. The Bank sold
$35.7 million in fixed-rate one- to four-mortgages during the year ended
September 30, 2004 compared to $108.8 million for the same period a year ago.
Non-interest Expense: Total non-interest expense increased by $743,000
to $15.58 million for the year ended September 30, 2004 from $14.83 million
for the year ended September 30, 2003. The increase is primarily a result of
a $493,000 increase in employee expenses, a $91,000 increase in audit and
Sarbanes-Oxley related expenses, an $80,000 increase in premises and equipment
expenses, and $70,000 in expenses related to the Bank's acquisition of Venture
Bank branches. The increased employee expenses are primarily due to a larger
employee base, annual salary adjustments, and increased medical insurance
costs. The number of full-time equivalent employees increased during the year
to 195 at September 30, 2004 from 186 at September 30, 2003 as the Bank opened
a new branch in Gig Harbor and increased staffing levels in several other
departments.
As a result of the increased non-interest expenses, the Company's
efficiency ratio increased to 65.38% for the year ended September 30, 2004
from 59.85% for the year ended September 30, 2003.
Provision for Income Taxes: The provision for income taxes decreased
$474,000 to $2.49 million for the year ended September 30, 2004 from $2.97
million for the year ended September 30, 2003 primarily as a result of lower
income before taxes. The effective tax was 30.8% for the year ended September
30, 2004 and 30.9% for the year ended September 30, 2003.
Comparison of Operating Results for Years Ended September 30, 2003 and 2002
Net Income: Net income for the year ended September 30, 2003 was $6.64
million, or $1.66 per diluted share ($1.74 per basic share) compared to $6.89
million, or $1.71 per diluted share ($1.76 per basic share) for the year ended
September 30, 2002. The lower earnings for the current year were primarily a
result of increased non-interest expenses related to technology improvements,
higher employee costs resulting from a larger employee base, and higher
premises and equipment expenses due to additional branches and remodeling
costs. The increased expenses were, however, partially offset by higher
non-interest income, largely related to mortgage loan sales and earnings on
bank owned life insurance.
During the year a number of technology enhancements were implemented to
provide additional opportunities to serve and expand the Bank's customer base.
The Bank converted to the Kirchman Bankway core processing system from its
in-house supported system, and changed its Internet banking system, its loan
platform system and its ATM service provider. The technology related
conversion expenses totaled $586,000 ($387,000 net of income tax) and reduced
earnings by $0.10 per diluted share. The majority of the Company's planned
technology related conversion expenses occurred during the year ended
September 30, 2003. However, the Company does anticipate additional
conversion expenses related to employee overtime, additional equipment
upgrades, and continued training to occur during the quarters ended December
31, 2003 and March 31, 2004 as additional aspects of the technology upgrades
are
49
fully implemented. While the technology upgrades reduced profitability in the
short term, the Company believes the investment will be beneficial to its
customers and ultimately to its long-term investors.
Net Interest Income: Net interest income decreased $596,000 to $18.78
million for the year ended September 30, 2003 from $19.37 million for the year
ended September 30, 2002. Total interest income decreased $2.54 million to
$27.72 million for the year ended September 30, 2003 from $30.26 million for
the year ended September 30, 2002, primarily due to a reduction in average
yields on earning assets. The yield on earning assets was 6.80% for the year
ended September 30, 2003 compared to 7.93% for the year ended September 30,
2002. In addition to overall lower market rates, the yield on earning assets
was also reduced by a change in the composition of total earning assets. In
2002, loans, the Company's highest yielding class of assets, comprised 84.9%
of average earning assets. In 2003, loans comprised 78.4% of average earning
assets. This change was largely influenced by the decision to sell many of
the loans originated during this low interest rate cycle. That had the effect
of increasing the gain on loans sold, at the expense of interest income. The
impact of lower average yields was, however, partially offset by increased
levels of average earning assets. Total interest expense decreased $1.94
million to $8.95 million for the year ended September 30, 2003 from $10.89
million for the year ended September 30, 2002. The average cost of funds for
each of the Bank's deposit account types for the current period was lower than
a year ago. The overall cost of funds decreased to 2.69% for the year ended
September 30, 2003 from 3.59% for the year ended September 30, 2002. As a
result of these changes, the net interest margin decreased to 4.61% for the
year ended September 30, 2003 from 5.08% for the year ended September 30,
2002.
Provision for Loan Losses: The provision for loan losses decreased
$645,000 to $347,000 for the year ended September 30, 2003 from $992,000 for
the year ended September 30, 2002. The provision for loan losses was lower in
2002 primarily because the Bank experienced a lower level of net charge-offs
in 2003. For the years ended September 30, 2003 and 2002, net charge-offs
were $86,000 and $412,000, respectively.
The Bank has established a systematic methodology for determining the
provision for loan losses. On a quarterly basis the Bank performs an analysis
taking into consideration historic loss experience for various loan segments,
changes in economic conditions, delinquency rates, and other factors to
determine the level of allowance for loan losses needed. The allowance for
loan losses had a net increase of $261,000 to $3.89 million at September 30,
2003 from $3.63 million at September 30, 2002. The increased level of
allowance for loan losses was primarily due to an increased level of loans
classified as substandard and changes in the composition of the loan
portfolio. The level of loans classified as substandard increased the level
of allowance for loan losses deemed necessary by the analysis as the aggregate
amount of substandard loans increased $1.1 million to $9.1 million at
September 30, 2003 from $8.0 million at September 30, 2002. Also contributing
to the higher allowance for loan loss level were changes in the composition of
the loan portfolio. The combined percentage of construction and commercial
real estate loans in the portfolio increased to 54.2% at September 30, 2003
from 49.2% at September 30, 2002, while the percentage of one- to four-family
mortgage loans declined to 26.2% at September 30, 2003 from 31.3% at September
30, 2002. Construction lending and commercial real estate lending typically
involve a greater degree of risk than one- to four-family residential mortgage
lending and therefore construction loans and commercial real estate loans have
been assigned a loss factor that is greater than the loss factor assigned to
one- to four-family residential mortgage loans.
Estimated loss factors used in the allowance for loan loss analysis are
established based in part on historic charge-off data by loan category and
economic conditions. Based on the trends in the historical charge-off
analysis, the loss factors used in the allowance for loan loss analysis for
credit cards were increased during the year ended September 30, 2003 and the
loss factors for commercial business loans were decreased.
Based on the systematic methodology, management deemed the allowance for
loan losses of $3.89 million at September 30, 2003 (1.19% of loans receivable
and 99.9% of non-performing loans) adequate to provide for estimated losses
based on an evaluation of known and inherent risks in the loan portfolio at
that date. For additional information, see "Item 1, Business - Lending
Activities - Allowance for Loan Losses" included herein.
Non-interest Income: For the year ended September 30, 2003 non-interest
income increased $1.35 million to $6.01 million from $4.66 million for the
year ended September 30, 2002. This increase is primarily due to a $494,000
increase in BOLI income, a $475,000 increase in gain on sale of loans, a
$150,000 increase in security sale gains, and
50
a $147,000 increase in service charges on deposits. The increased BOLI
income is a result of having a full year's earnings on the BOLI investment
that was made in September 2002. The increased loan sale gains are primarily
the result of a larger volume of mortgage banking activity due to the strong
refinance demand, which was prompted by a decline in interest rates to
historically low levels. The Bank sold $108.8 million in fixed-rate one- to
four-family mortgages during the year ended September 30, 2003 compared to
$70.2 million for the previous year.
Non-interest Expense: For the year ended September 30, 2003 non-interest
expense increased by $2.12 million to $14.83 million from $12.72 million for
the year ended September 30, 2002. The increase is primarily a result of
increased employee expenses, increased premises and equipment expenses and
technology enhancement expenses.
During the year, the Company converted to the Kirchman Bankway core
processing system from its in-house supported system, and changed its Internet
banking system, its loan platform system and its ATM service provider. The
technology enhancements were undertaken to provide additional opportunities to
serve and expand the Bank's customer base. The technology-related conversion
expenses totaled $586,000 for the year ended September 30, 2003 and are
reflected in the income statement under other non-interest expenses
($290,000), premises and equipment expenses ($210,000) and salaries and
employee benefit expenses ($86,000). While the technology upgrades reduced
profitability in the short term, the Company believes the investment will be
beneficial to its customers and ultimately to its long-term investors.
Salary and benefit expenses increased primarily due to a larger employee
base as the Bank opened two new branches during the year and increased
staffing levels in several other departments. The number of full time
equivalent employees increased during the year to 186 at September 30, 2003
from 159 at September 30, 2002. Premises and equipment expense increased
during the year primarily due to the additional branches opened, expenses
associated with remodeling the Bank's loan center, and the technology related
expenses previously discussed.
As a result of the increased non-interest expenses, the Company's
efficiency ratio increased to 59.85% for the year ended September 30, 2003
from 52.91% for the year ended September 30, 2002.
Provision for Income Taxes: The provision for income taxes decreased to
$2.97 million for the year ended September 30, 2003 from $3.43 million for the
year ended September 30, 2002 primarily as a result of lower income before
taxes and an increased level of tax-exempt income. The effective tax rate was
30.9% for the year ended September 30, 2003 and 33.2% for September 30, 2002.
The lower effective rate was primarily a result of the increased level of
tax-exempt income from the bank owned life insurance program that was
implemented in September 2002.
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 weekly balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from weekly balances. Management does not believe that the use of
weekly balances instead of daily balances has caused any material difference
in the information presented.
51
Year Ended September 30,
---------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- --------------------------- ---------------------------
Interest Interest Interest
Average and Yield/ Average and Yield/ Average and Yield/
Balance Dividends Cost Balance Dividends Cost Balance Dividends Cost
------- --------- ------ ------- --------- ------ ------- --------- ------
(Dollars in thousands)
Interest-earning
assets:
Loans receivable
(1)(2)............ $338,752 $24,898 7.35% $319,583 $25,391 7.95% $323,820 $27,764 8.57%
Mortgage-backed
and investment
securities (3).... 22,376 934 4.17 16,282 873 5.36 23,287 1,416 6.08
FHLB stock and
equity
securities (3).... 39,183 1,021 2.61 36,489 1,064 2.92 20,417 848 4.15
Interest-bearing
deposits.......... 11,547 115 1.00 35,102 395 1.13 13,960 235 1.68
-------- ------- -------- ------- -------- -------
Total interest-
earning assets... 411,858 26,968 6.55 407,456 27,723 6.80 381,484 30,263 7.93
Non-interest-earning
assets............. 37,845 30,353 16,859
-------- -------- --------
Total assets...... $449,703 $437,809 $398,343
======== ======== ========
Interest-bearing
liabilities:
Savings accounts... $ 48,243 342 0.71% $ 47,411 570 1.20 $ 37,311 727 1.95
Money market
accounts.......... 38,558 439 1.14 43,637 704 1.61 38,020 1,101 2.90
NOW accounts....... 70,195 544 0.77 45,999 335 0.73 34,654 410 1.18
Certificates of
deposit........... 126,521 2,843 2.25 133,218 3,961 2.97 130,110 5,278 4.06
FHLB advances-other
borrowed money.... 57,778 3,157 5.46 61,715 3,376 5.47 63,315 3,374 5.33
-------- ------- -------- ------- -------- -------
Total interest
bearing
liabilities...... 341,295 7,325 2.15 331,980 8,946 2.69 303,410 10,890 3.59
Non-interest bearing
liabilities........ 34,115 29,272 21,764
-------- -------- --------
Total liabilities. 375,410 361,252 325,174
Shareholders'
equity............. 74,293 76,557 73,169
-------- -------- --------
Total liabilities
and shareholders'
equity........... $449,703 $437,809 $398,343
======== ======== ========
Net interest income. $19,643 $18,777 $19,373
======= ======= =======
Interest rate
spread............. 4.40% 4.11% 4.34%
====== ====== ======
Net interest
margin (4)......... 4.77% 4.61% 5.08%
====== ====== ======
Ratio of interest-
earning assets
to average
interest-bearing
liabilities........ 120.68% 122.74% 125.73%
====== ====== ======
- --------------
(1) Does not include interest on loans 90 days or more past due. Includes loans originated for sale.
Amortized net deferred loan fees (2004, $1,718; 2003, $2,140; and 2002, $1,930) included with interest
and dividends.
(2) Average balance includes nonaccrual loans.
(3) For purposes of the computation of average yield on investments available for sale, historical cost
balances were utilized, therefore the yield information does not give effect to changes in fair value
that are reflected as a component of shareholders' equity.
(4) Net interest income divided by total average interest earning assets.
52
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes
on net interest income on the Company. Information is provided with respect
to the (i) effects on interest income attributable to changes in volume
(changes in volume multiplied by prior rate), and (ii) effects on interest
income attributable to changes in rate (changes in rate multiplied by prior
volume), and (iii) the net change (sum of the prior columns). Changes in
rate/volume have been allocated to rate and volume variances based on the
absolute values of each.
Year Ended September 30, Year Ended September 30,
2004 Compared to Year 2003 Compared to Year
Ended September 30, 2003 Ended September 30, 2002
Increase (Decrease) Increase (Decrease)
------------------------- -------------------------
Due to Due to
Net Net
Rate Volume Change Rate Volume Change
------ ------ ------ ------ ------ ------
(In thousands)
Interest-earning assets:
Loans receivable(1)...$(2,475) $1,982 $ (493) $(2,014) $(359) $(2,373)
Investments and
mortgage-backed
securities........... (220) 281 61 (200) (343) (543)
FHLB stock and
equity securities.... (118) 75 (43) (307) 523 216
Interest-bearing
deposits............. (52) (228) (280) (99) 259 160
------- ------ ------- ------- ----- -------
Total net change in
income on interest-
earning assets....... (2,865) 2,110 (755) (2,620) 80 (2,540)
Interest-bearing
liabilities:
Savings accounts...... (238) 10 (228) (324) 167 (157)
NOW accounts.......... 20 189 209 (185) 110 (75)
Money market accounts. (167) (98) (265) (542) 145 (397)
Certificate accounts.. (907) (211) (1,118) (1,440) 123 (1,317)
FHLB advances and other
borrowed money....... (4) (215) (219) 41 (39) 2
------- ------ ------- ------- ----- -------
Total net change in
expense on interest-
bearing liabilities... (1,296) (325) (1,621) (2,450) 506 (1,944)
------- ------ ------- ------- ----- -------
Net change in net
interest income.......$(1,569) $2,435 $ 866 $ (170) $(426) $ (596)
======= ====== ======= ======= ===== =======
- --------------
(1) Excludes interest on loans 90 days or more past due. Includes loans
originated for sale.
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds
from principal and interest payments on and the sale of loans, maturing
securities and FHLB advances. While the maturity and scheduled amortization
of loans are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and competition.
The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to fund loan originations and deposit
withdrawals, to satisfy other financial commitments and to take advantage of
investment opportunities. The Bank generally maintains sufficient cash and
short-term investments to meet short-term liquidity needs. At September 30,
2004, 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 17.23%. At September 30, 2004, the Bank also maintained
53
an uncommitted credit facility with the FHLB-Seattle that provided for
immediately available advances up to an aggregate equal to 30% of total
assets, under which $65.4 million was outstanding.
Liquidity management is both a short and long-term responsibility of the
Bank's management. The Bank adjusts its investments in liquid assets based
upon management's assessment of (i) expected loan demand, (ii) projected loan
sales, (iii) expected deposit flows, and (iv) yields available on interest-
bearing deposits. Excess liquidity is invested generally in interest-bearing
overnight deposits and other short-term government and agency obligations. If
the Bank requires funds beyond its ability to generate them internally, it has
additional borrowing capacity with the FHLB and collateral for repurchase
agreements.
The Bank's primary investing activity is the origination of one- to- four
family mortgage loans and construction and land development loans. During the
years ended September 30, 2004, 2003, and 2002, the Bank originated $36.8
million, $115.0 million and $83.1 million of one- to- four family mortgage
loans and $94.4 million, $90.5 million and $52.6 million of construction and
land development loans, respectively. At September 30, 2004, the Bank had
mortgage loan commitments totaling $31.3 million, and undisbursed loans in
process totaling $43.6 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,
2004 totaled $86.4 million. Historically, the Bank has been able to retain a
significant amount of its deposits as they mature.
The Bank's liquidity is also impacted by the volume of loans sold and
loan principal payments. During the years ended September 30, 2004, 2003, and
2002, the Bank sold $35.7 million, $108.8 million and $70.2 million in fixed
rate one- to four-family mortgage loans. The higher loan sales in 2003 and
2002 were due in large part to the refinancing cycle brought on by decreasing
interest rates. During the years ended September 30, 2004, 2003, and 2002,
the Bank received $133.9 million, $145.7 million and $136.7 million in
principal repayments.
The Bank's liquidity has been impacted by increases in deposit levels.
During the years ended September 30, 2004, 2003, and 2002, deposits increased
by $11.9 million, $15.4 million, and $49.9 million. Subsequent to September
30, 2004, the Bank acquired $86.3 million in deposits by acquiring seven
branches from Venture Bank. For additional information, See "Item 1, Business
- - Recent Developments."
Investment and mortgage-backed securities and interest bearing deposits
decreased to $64.6 million at September 30, 2004 from $83.8 million at
September 30, 2003.
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, 2004, the Bank was in compliance with all
applicable capital requirements. For additional details see the regulatory
capital table in Note 18 of the Notes to Consolidated Financial Statements
contained in "Item 8, Financial Statements and Supplementary Data" and "Item
1, Business - Regulation of the Bank - Capital Requirements."
54
Contractual obligations. The following table presents, as of September
30, 2004, 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, 2004.
Payments due by period
--------------------------------------------------
Less than More than
Contractual obligations Total 1 year 1-3 years 3-5 years 5 years
------ --------- --------- --------- ---------
(In thousands)
Short-term debt
obligations............... $10,485 $10,485 $ -- $ -- $ --
Long-term debt
obligations............... 54,936 4,583 10,655 19,698 20,000
Operating lease
obligations............... 971 169 368 309 125
------- ------- ------- ------- -------
Total contractual
obligations............. $66,392 $15,237 $11,023 $20,007 $20,125
======= ======= ======= ======= =======
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.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm................ 56
Consolidated Balance Sheets as of September 30, 2004 and 2003.......... 57
Consolidated Statements of Income For the Years Ended
September 30, 2004, 2003, and 2002.................................. 58
Consolidated Statements of Shareholders' Equity For the
Years Ended September 30, 2004, 2003 and 2002....................... 59
Consolidated Statements of Cash Flows For the Years Ended
September 30, 2004, 2003 and 2002................................... 60
Consolidated Statements of Comprehensive Income For the
Years Ended September 30, 2004, 2003 and 2002....................... 62
Notes to Consolidated Financial Statements............................. 63
55
Report of Independent Registered Public Accounting Firm
The Board of Directors
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited the accompanying consolidated balance sheets of Timberland
Bancorp, Inc. and Subsidiaries as of September 30, 2004 and 2003, and the
related consolidated statements of income, shareholders' equity, cash flows
and comprehensive income for each of the three years in the period ended
September 30, 2004. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
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 Subsidiaries as of September 30, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years
in the period ended September 30, 2004, in conformity with U.S. generally
accepted accounting principles.
/s/ McGladrey & Pullen, LLP
Tacoma, Washington
October 27, 2004
56
Consolidated Balance Sheets
- ------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
2004 2003
Assets
Cash and due from financial institutions $ 15,268 $ 8,587
Interest-bearing deposits in banks 3,385 29,511
Federal funds sold 1,180 - -
Mortgage-backed securities - held to maturity
(market value $166 and $279) 174 279
Investments and mortgage-backed securities -
available for sale 59,889 54,031
Federal Home Loan Bank stock (at cost) 5,682 5,454
Loans receivable, net of allowance for loan losses
of $3,991 and $3,891 343,984 321,235
Loans held for sale 610 1,001
344,594 322,236
Premises and equipment 13,913 13,429
Real estate owned and other repossessed items 421 1,258
Accrued interest receivable 1,828 1,687
Bank owned life insurance (BOLI) 11,028 10,566
Other assets 3,057 2,595
Total assets $460,419 $449,633
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand, non-interest-bearing $ 37,150 $ 29,133
Interest-bearing 282,420 278,539
Total deposits 319,570 307,672
Federal Home Loan Bank advances 65,421 61,605
Other liabilities and accrued expenses 2,611 2,745
Total liabilities 387,602 372,022
Shareholders' Equity
Preferred stock, $0.01 par value; 1,000,000 shares
authorized; none issued - - - -
Common stock, $0.01 par value; 50,000,000 shares
authorized;
2004 - 3,882,070 shares issued and outstanding;
2003 - 4,251,680 shares issued and outstanding 39 43
Additional paid-in capital 24,867 33,775
Unearned shares issued to employee stock ownership
trust (4,362) (4,891)
Unearned shares issued to management recognition and
development plan (537) (1,182)
Retained earnings 52,967 49,699
Accumulated other comprehensive income (loss) (157) 167
Total shareholders' equity 72,817 77,611
Total liabilities and shareholders' equity $460,419 $449,633
See notes to consolidated financial statements.
57
Consolidated Statements of Income
- ------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2004, 2003 and 2002
2004 2003 2002
Interest and Dividend Income
Loans receivable $24,898 $25,391 $27,764
Investments and mortgage-backed securities 934 873 1,416
Dividends from investments 1,021 1,064 848
Interest-bearing deposits in banks 115 395 235
Total interest and dividend income 26,968 27,723 30,263
Interest Expense
Deposits 4,168 5,570 7,516
Federal Home Loan Bank advances 3,157 3,376 3,374
Total interest expense 7,325 8,946 10,890
Net interest income 19,643 18,777 19,373
Provision for Loan Losses 167 347 992
Net interest income after provision for
loan losses 19,476 18,430 18,381
Non-Interest Income
Service charges on deposits 1,927 2,009 1,862
Gain on sale of loans, net 642 1,451 976
Gain (loss) on sale of securities available
for sale, net (6) 135 (15)
BOLI net earnings 462 530 36
Escrow fees 140 267 261
Servicing income (expense) on loans sold (87) 183 326
ATM transaction fees 636 723 632
Other 465 709 580
Total non-interest income 4,179 6,007 4,658
Non-Interest Expense
Salaries and employee benefits 8,794 8,301 6,987
Premises and equipment 1,879 1,799 1,380
Advertising 729 730 777
Real estate owned expense (income) (3) 164 114
ATM expenses 396 564 510
Postage and courier 343 354 294
Other 3,437 2,920 2,654
Total non-interest expense 15,575 14,832 12,716
Income before federal income taxes 8,080 9,605 10,323
Federal Income Taxes 2,492 2,966 3,432
Net income $ 5,588 $ 6,639 $ 6,891
Earnings Per Common Share
Basic $ 1.54 $ 1.74 $ 1.76
Diluted 1.46 1.66 1.71
See notes to consolidated financial statements.
58
Consolidated Statements of Shareholders' Equity
- ------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2004, 2003 and 2002
Unearned
Unearned Shares
Shares Issued to Accumulated
Issued to Management Other
Employee Recognition Compre-
Common Stock Additional Stock and Develop- hensive
Paid-in Ownership ment Retained Income
Shares Amount Capital Trust Plan Earnings (Loss) Total
Balance, September 30,
2001 4,570,995 $46 $ 39,574 ($5,948) ($2,471) $40,332 $276 $71,809
Net income - - - - - - - - - - 6,891 - - 6,891
Repurchase of common
stock (274,272) (3) (4,411) - - - - - - - - (4,414)
Exercise of stock
options 44,253 - - 588 - - - - - - - - 588
Cash dividends ($.45
per share) - - - - - - - - - - (2,013) - - (2,013)
Earned ESOP shares - - 27 529 - - - - - - 556
Earned MRDP shares - - 79 - - 645 - - - - 724
Change in fair value of
securities available
for sale, net of tax - - - - - - - - - - - - 255 255
Balance,
September 30, 2002 4,340,976 43 35,857 (5,419) (1,826) 45,210 531 74,396
Net income - - - - - - - - - - 6,639 - - 6,639
Repurchase of common
stock (188,367) (1) (3,851) - - - - - - - - (3,852)
Exercise of stock
options 99,071 1 1,490 - - - - - - - - 1,491
Cash dividends ($.50
per share) - - - - - - - - - - (2,150) - - (2,150)
Earned ESOP shares - - 120 528 - - - - - - 648
Earned MRDP shares - - 159 - - 644 - - - - 803
Change in fair value of
securities available for
sale, net of tax - - - - - - - - - - - - (364) (364)
Balance,
September 30, 2003 4,251,680 43 33,775 (4,891) (1,182) 49,699 167 77,611
Net income - - - - - - - - - - 5,588 - - 5,588
Repurchase of common
stock (482,016) (5) (11,074) - - - - - - - - (11,079)
Exercise of stock
options 112,406 1 1,747 - - - - - - - - 1,748
Cash dividends ($.57
per share) - - - - - - - - - - (2,320) - - (2,320)
Earned ESOP shares - - 283 529 - - - - - - 812
Earned MRDP shares - - 136 - - 645 - - - - 781
Change in fair value of
securities available
for sale, net of tax - - - - - - - - - - - - (324) (324)
Balance,
September 30, 2004 3,882,070 $39 $24,867 ($4,362) ($ 537) $52,967 ($157) $72,817
See notes to consolidated financial statements.
59
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2004, 2003 and 2002
2004 2003 2002
Cash Flows from Operating Activities
Net income $ 5,588 $ 6,639 $ 6,891
Noncash revenues, expenses, gains and
losses included in net income:
Depreciation 812 697 633
Deferred federal income taxes (benefit) 69 42 (171)
Earned ESOP shares 812 648 556
Earned MRDP shares 691 693 713
Federal Home Loan Bank stock dividends (228) (315) (309)
(Gain) loss on sale of real estate
owned, net (81) (1) 61
(Gain) loss on sale of securities
available for sale 6 (135) 15
Gain on sale of loans (642) (1,451) (976)
Provision for loan and real estate
owned losses 206 431 1,114
Loans originated for sale (35,350) (106,652) (67,531)
Proceeds from loans held for sale 36,383 110,263 71,141
BOLI net earnings (462) (530) (36)
Net change in accrued interest receivable
and other assets, and other liabilities
and accrued expenses (267) (583) (986)
Net cash provided by operating activities 7,537 9,746 11,115
Cash Flows from Investing Activities
Net (increase) decrease in interest-bearing
deposits in banks 26,126 (4,018) (22,071)
Net increase in federal funds sold (1,180) - - - -
Activity in securities held to maturity:
Maturities and prepayments 105 234 - -
Purchases - - (519) - -
Activity in securities available for sale:
Sales 1,600 2,064 12,293
Maturities and prepayments 10,006 8,595 5,326
Purchases (17,965) (23,560) (17,200)
Increase in loans receivable, net (23,365) (3,160) (14,879)
Additions to premises and equipment (1,296) (2,462) (1,641)
Additions to real estate owned (88) (29) (63)
Proceeds from sale of real estate owned 1,138 425 797
Purchase of BOLI - - - - (10,000)
Net cash used in investing activities (4,919) (22,430) (47,438)
(continued)
See notes to consolidated financial statements.
60
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------
(concluded) (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2004, 2003 and 2002
2004 2003 2002
Cash Flows from Financing Activities
Increase in deposits $11,898 $ 15,356 $49,944
Repayment of Federal Home Loan Bank
advances - long term (6,669) (154) (16,119)
Proceeds from Federal Home Loan Bank
advances - long term - - - - 8,900
Net increase in Federal Home Loan Bank
advances - short term 10,485 - - - -
Proceeds from exercise of stock options 1,748 1,491 588
Repurchase of common stock (11,079) (3,852) (4,414)
Payment of dividends (2,320) (2,150) (2,013)
Net cash provided by financing activities 4,063 10,691 36,886
Net increase (decrease) in cash 6,681 (1,993) 563
Cash and Due from Financial Institutions
Beginning of year 8,587 10,580 10,017
End of year $15,268 $ 8,587 $10,580
Supplemental Disclosures of Cash Flow
Information
Income taxes paid $ 2,095 $ 2,790 $ 3,700
Interest paid 7,107 9,011 11,073
Supplemental Disclosures of Non-Cash
Investing and Financing Activities
Market value adjustment of securities
held for sale, net of tax ($324) ($ 364) $ 255
Loans transferred to real estate owned 344 1,157 689
Investment securities acquired in loan
securitization - - - - 12,227
Financed sale of real estate owned 169 - - 256
See notes to consolidated financial statements.
61
Consolidated Statements of Comprehensive Income
- ------------------------------------------------------------------------------
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2004, 2003 and 2002
2004 2003 2002
Comprehensive Income
Net income $5,588 $6,639 $6,891
Change in fair value of
securities available for sale, net
of tax (324) (364) 255
Total comprehensive income $5,264 $6,275 $7,146
See notes to consolidated financial statements.
62
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland
Bancorp, Inc. (the Company); its wholly owned subsidiary, Timberland Bank (the
Bank); and the Bank's wholly owned subsidiary, Timberland Service Corp. All
significant intercompany transactions and balances have been eliminated.
Nature of Operations
The Company is a holding company which operates primarily through its
subsidiary, the Bank. The Bank was established in 1915 and, through its
sixteen branches located in Grays Harbor, Pierce, Thurston, Kitsap and King
Counties in Washington State, attracts deposits from the general public, and
uses those funds, along with other borrowings, to provide residential real
estate, retail and commercial loans to borrowers in western Washington, and to
invest in investment securities and mortgage-backed securities.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
practices within the banking industry. The preparation of consolidated
financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, and the disclosure
of contingent assets and liabilities, as of the date of the balance sheet, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and the valuation of real
estate owned and deferred tax assets.
Certain prior year amounts have been reclassified to conform to the 2004
presentation with no change to net income or shareholders' equity previously
reported. Unallocated ESOP shares and unvested MRDP shares were previously
not considered outstanding. As of September 30, 2004 these shares are
considered outstanding and prior years' shares outstanding on the consolidated
statements of shareholders' equity were restated.
Investments and Mortgage-Backed Securities - Available for Sale
Debt and equity securities that will be held for indefinite periods of time,
including securities that may be sold in response to changes in market
interest rates, prepayment rates, need for liquidity, and changes in the
availability of and the yield of alternative investments, are considered
securities available for sale, and are reported at fair value. Fair value is
determined using published quotes as of the close of business on reporting
dates. Unrealized gains and losses are excluded from earnings, and are
reported as a separate component of shareholders' equity, net of the related
deferred tax effect, entitled "Accumulated other comprehensive income (loss)."
Realized gains and losses on securities available for sale, determined using
the specific identification method, are included in earnings. Amortization of
premiums and accretion of discounts are recognized in interest income over the
period to maturity.
(continued)
63
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies (continued)
Investments and Mortgage-Backed Securities - Held for Maturity
Debt securities for which the Bank has the positive intent and ability to hold
to maturity are reported at cost, adjusted for amortization of premiums and
accretion of discounts, which are recognized in interest income over the
period to maturity.
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. Such
write-downs would be included in earnings as realized losses.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank (FHLB) system, is
required to maintain an investment in capital stock of the FHLB in an amount
equal to the greater of 1% of its outstanding home loans or 5% of advances
from the FHLB. The recorded amount of FHLB stock equals its fair value
because the shares can only be redeemed by the FHLB at the $100 per share par
value.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
stated in the aggregate at the lower of cost or estimated market value. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income. Gains or losses on sales of loans are recognized at the
time of sale. The gain or loss is the difference between the net sales
proceeds and the recorded value of the loans, including any remaining
unamortized deferred loan fees.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed
portion of loans in process, unearned income and an allowance for loan losses.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to provide
for estimated loan losses based on evaluating known and inherent risks in the
loan portfolio. The allowance is provided based upon management's continuing
analysis of the pertinent factors underlying the quality of the loan
portfolio. These factors include changes in the size and composition of the
loan portfolio, delinquency levels, actual loan loss experience, current
economic conditions, and detailed analysis of individual loans for which full
collectibility may not be assured. The detailed analysis includes techniques
to estimate the fair value of loan collateral and the existence of potential
alternative sources of repayment. The allowance consists of specific, general
and unallocated components. The specific component relates to loans that are
classified as doubtful, substandard or special mention. For such loans that
are also classified as impaired, an allowance is established when the
discounted cash flows (or collateral value or observable market price) of the
impaired loan is lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss
experience adjusted for qualitative factors. An unallocated component is
maintained to cover uncertainties that could affect management's estimate of
probable losses. The unallocated component of the allowance reflects the
margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the portfolio. The
appropriateness of the allowance for losses on loans is estimated based upon
these factors and trends identified by management at the time financial
statements are prepared.
(continued)
64
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (concluded)
When available information confirms that specific loans or portions thereof
are uncollectible, identified amounts are charged against the allowance for
loan losses. The existence of some or all of the following criteria will
generally confirm that a loss has been incurred: the loan is significantly
delinquent and the borrower has not demonstrated the ability or intent to
bring the loan current; the Bank has no recourse to the borrower, or if it
does, the borrower has insufficient assets to pay the debt; the estimated fair
value of the loan collateral is significantly below the current loan balance,
and there is little or no near-term prospect for improvement.
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a
Loan, and SFAS No. 118, an amendment of SFAS No. 114, a loan is considered
impaired when it is probable that a creditor will be unable to collect all
amounts (principal and interest) due according to the contractual terms of the
loan agreement. Smaller balance homogenous loans, such as residential mortgage
loans and consumer loans, are collectively evaluated for potential loss. When
a loan has been identified as being impaired, the amount of the impairment is
measured by using discounted cash flows, except when, as a practical
expedient, the current fair value of the collateral, reduced by costs to sell,
is used. When the measurement of the impaired loan is less than the recorded
investment in the loan (including accrued interest and net deferred loan fees
or costs), an impairment is recognized by creating or adjusting an allocation
of the allowance for loan losses. Uncollected accrued interest is reversed
against interest income. If ultimate collection of principal is in doubt, all
cash receipts on impaired loans are applied to reduce the principal balance.
A provision for loan losses is charged against income and is added to the
allowance for loan losses based on quarterly assessments of the loan
portfolio. The allowance for loan losses is allocated to certain loan
categories based on the relative risk characteristics, asset classifications
and actual loss experience of the loan portfolio. While management has
allocated the allowance for loan losses to various loan portfolio segments,
the allowance is general in nature and is available for the loan portfolio in
its entirety.
The ultimate recovery of all loans is susceptible to future market factors
beyond the Bank's control. These factors may result in losses or recoveries
differing significantly from those provided in the consolidated financial
statements. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses,
and may require the Bank to make additions to the allowance based on their
judgment about information available to them at the time of their
examinations.
Interest on Loans and Loan Fees
Interest on loans is accrued daily based on the principal amount outstanding.
Allowances are established for uncollected interest on loans for which the
interest is determined to be uncollectible. Generally, all loans past due 90
days or more are placed on nonaccrual status and internally classified as
substandard. Any interest income accrued at that time is fully reversed.
Subsequent collections are applied proportionately to past due principal and
interest, unless collectibility of principal is in doubt, in which case all
payments would be applied to principal. Loans are removed from nonaccrual
status only when the loan is deemed current, and the collectibility of
principal and interest is no longer doubtful, or on 1-4 family loans, when the
loan is less than 90 days delinquent.
The Bank charges fees for originating loans. These fees, net of certain loan
origination costs, are deferred and amortized to income, on the level-yield
basis, over the loan term. If the loan is repaid prior to maturity, the
remaining unamortized deferred loan fee is recognized in income at the time of
repayment.
(continued)
65
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies (continued)
Loan Servicing Rights
Loan servicing rights are capitalized when acquired through the origination of
loans that are subsequently sold or securitized with the servicing rights
retained and are amortized as an offset to servicing income on loans sold in
proportion to and over the period of estimated net servicing income. The
value of loan 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.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed on the
straight-line method over the following estimated useful lives: buildings and
improvements - up to forty years; furniture and equipment - three to seven
years; and automobiles - five years. The cost of maintenance and repairs is
charged to expense as incurred. Gains and losses on dispositions are
reflected in earnings.
Real Estate Owned and Other Repossessed Items
Real estate owned consists of properties 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 are capitalized while costs
relating to holding the properties are expensed.
Valuations are periodically performed by management, and an allowance for
losses is established by a charge to earnings if the recorded value of a
property exceeds its estimated net realizable value.
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 Bank, (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 Bank does not maintain effective control over the transferred assets
through an agreement to repurchase them before their maturity.
(continued)
66
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies (continued)
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, 2004, all federal tax bad debt
reserves had been recaptured.
Deferred federal income taxes result from temporary differences between the
tax basis of assets and liabilities, and their reported amounts in the
consolidated financial statements. These will result in differences between
income for tax purposes and income for financial reporting purposes in future
years. As changes in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes.
Employee Stock Ownership Plan
The Bank sponsors a leveraged Employee Stock Ownership Plan (ESOP). The ESOP
is accounted for in accordance with the American Institute of Certified Public
Accountants Statement of Position 93-6, Employers' Accounting for Employee
Stock Ownership Plan. Accordingly, the debt of the ESOP is recorded as other
borrowed funds of the Bank, and the shares pledged as collateral are reported
as unearned shares issued to the employee stock ownership trust on the
consolidated balance sheets. The debt of the ESOP is with the Company and is
thereby eliminated in the consolidated financial statements. As shares are
released from collateral, compensation expense is recorded equal to the
average market price of the shares for the period, and the shares become
available for earnings per share calculations.
Cash Equivalents and Cash Flows
The Company considers all amounts included in the balance sheets caption "Cash
and due from financial institutions" to be cash equivalents. Cash flows from
interest-bearing deposits in banks, federal funds sold, loans, deposits, and
Federal Home Loan Bank advances - short-term are reported net.
(continued)
67
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 1 - Summary of Significant Accounting Policies (concluded)
Stock-Based Compensation
At September 30, 2004, the Company has a stock-based option plan, which is
described more fully in Note 14. The Company applies APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in
accounting for this plan. Accordingly, no compensation cost has been
recognized for the plan. Had compensation cost for the Company's stock option
plan been determined based on the fair value at the grant dates for awards
granted under this plan, consistent with the method prescribed in SFAS No.
123, the Company's reported and pro forma net income and earnings per share
for the years ended September 30 would be as follows (dollars in thousands,
except per share amounts):
2004 2003 2002
Net income, as reported $5,588 $6,639 $6,891
Less total stock-based compensation
expense determined under fair value
method for all qualifying awards,
net of tax 172 224 259
Pro forma net income $5,416 $6,415 $6,632
Earnings Per Share
Basic:
As reported $ 1.54 $ 1.74 $ 1.76
Pro forma 1.49 1.68 1.70
Diluted:
As reported 1.46 1.66 1.71
Pro forma 1.41 1.61 1.66
Earnings Per Share
Basic earnings per share exclude dilution and are computed by dividing net
income by the weighted average number of common shares outstanding. Diluted
earnings per share reflect the potential dilution that could occur if common
shares were issued under the Company's stock option and management recognition
and development plans.
68
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain
minimum reserve balances on hand or on deposit with the Federal Reserve Bank,
based on a percentage of deposits. The amount of such balances for the years
ended September 30, 2004 and 2003 was approximately $6,960,000 and $5,423,000,
respectively.
Note 3 - Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities have been classified according to
management's intent (dollars in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
September 30, 2004
Held to Maturity
Mortgage-backed securities $ 174 $- - ($8) $166
Available for Sale
Mortgage-backed securities $18,193 $236 ($100) $18,329
Mutual funds 32,939 - - (362) 32,577
U.S. Agency Securities 8,994 4 (15) 8,983
Total $60,126 $240 ($477) $59,889
September 30, 2003
Held to Maturity
Mortgage-backed securities $ 279 $- - $ - - $ 279
Available for Sale
Mortgage-backed securities $16,722 $402 ($ 26) $17,098
Municipal bonds 11 1 - - 12
Mutual funds 34,546 12 (148) 34,410
U.S. Agency Securities 2,500 11 - - 2,511
Total $53,779 $426 ($174) $54,031
(continued)
69
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
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, 2004 are as follows (dollars in thousands):
Less Than 12 Months 12 Months or Longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Value Losses Value Losses Value Losses
Securities
Mutual funds $- - $- - $32,577 ($362) $32,577 ($362)
All of the securities are adjustable rate. The Company has evaluated these
securities and has determined that the decline in their value is temporary.
The decline in the value is not related to any company or industry specific
event. The Company anticipates full recovery of the value with respect to
these securities and has the ability to hold the investments until the market
rate on the investments become favorable.
Mortgage-backed and agency securities pledged as collateral for public fund
deposits, federal treasury tax and loan deposits, FHLB collateral, and
Aberdeen Neighborhood Housing deposits totaled $25,228,000 and $16,757,000 at
September 30, 2004 and 2003, respectively.
The contractual maturities of debt securities at September 30, 2004 are as
follows (dollars in thousands). Expected maturities may differ from scheduled
maturities due to the prepayment of principal or call provisions.
Held to Maturity Available for Sale
Amortized Fair Amortized Fair
Cost Value Cost Value
Due within one year $ - - $ - - $ - - $ - -
Due from one year to five years - - - - 9,218 9,214
Due from five to ten years - - - - 1,249 1,305
Due after ten years 174 166 16,720 16,793
Mutual funds - - - - 32,939 32,577
Total $174 $166 $60,126 $59,889
There were no gains on sales of securities available for sale for the year
ended September 30, 2004. Gross realized gains on sales of securities
available for sale were $135,000 and $8,000 for the years ended September 30,
2003 and 2002, respectively. Gross realized losses on sales of securities
available for sale were $6,000 and $23,000 for the years ended September 30,
2004 and 2002, respectively. There were no losses on sales of securities
available for sale for the year ended September 30, 2003.
70
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable and loans held for sale consisted of the following at
September 30 (dollars in thousands):
2004 2003
Mortgage loans:
One- to four-family $ 99,225 $ 94,370
Multi-family 17,160 18,241
Commercial 108,276 102,972
Construction and land development 106,241 94,117
Land 19,895 15,628
Total mortgage loans 350,797 325,328
Consumer loans:
Home equity and second mortgage 23,549 19,233
Other 9,270 8,799
Total consumer loans 32,819 28,032
Commercial business loans 11,098 9,475
Total loans receivable 394,714 362,835
Less:
Undisbursed portion of construction loans
in process 43,563 34,785
Deferred loan origination fees 3,176 2,924
Allowance for loan losses 3,991 3,891
50,730 41,600
Loans receivable, net 343,984 321,235
Loans held for sale (one- to four-family) 610 1,001
Total loans receivable and loans held for sale $344,594 $322,236
Certain related parties of the Bank, principally Bank directors and officers,
were loan customers of the Bank in the ordinary course of business during 2004
and 2003. Activity in related party loans during the years ended September 30
is as follows (dollars in thousands):
2004 2003
Balance, beginning of year $1,041 $1,348
New loans 484 1,640
Repayments (58) (1,947)
Balance, end of year $1,467 $1,041
(continued)
71
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
At September 30, 2004 and 2003, the Bank had non-accruing loans totaling
approximately $1,442,000 and $3,895,000, respectively. At September 30, 2004
and 2003, 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, 2004, 2003 and 2002 was $43,000, $50,000 and $78,000,
respectively. The average investment in non-accrual loans for the years ended
September 30, 2004 and 2003 was $3,432,000 and $3,478,000, respectively.
An analysis of the allowance for loan losses for the years ended September 30
follows (dollars in thousands):
2004 2003 2002
Balance, beginning of year $3,891 $3,630 $3,050
Provision for loan losses 167 347 992
Loans charged off (86) (168) (521)
Recoveries 19 82 109
Net charge-offs (67) (86) (412)
Balance, end of year $3,991 $3,891 $3,630
Following is a summary of information relating to impaired loans as of
September 30 (dollars in thousands):
2004 2003
Impaired loans without a valuation allowance $1,122 $3,560
Impaired loans with a valuation allowance 320 335
$1,442 $3,895
Valuation allowance related to impaired loans $ 93 $ 61
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, 2004 and 2003 were $165,206,000 and $161,702,000,
respectively.
Following is an analysis of the changes in mortgage servicing rights for the
years ended September 30 (dollars in thousands):
2004 2003 2002
Balance, at beginning of year $1,017 $ 834 $ 508
Additions 273 837 620
Amortization (360) (654) (294)
Balance, end of year $ 930 $1,017 $ 834
(continued)
72
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 5 - Loan Servicing (concluded)
At September 30, 2004, the fair value of servicing rights totaled $1,718,000,
which was estimated using a premium rate of 4.05% and a prepayment speed
factor of 250.
There was no valuation allowance at September 30, 2004 or 2003.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (dollars in
thousands):
2004 2003
Land $ 3,239 $ 3,241
Buildings and improvements 11,321 9,388
Furniture and equipment 4,653 3,956
Property held for future expansion 253 253
Construction and purchases in progress 213 1,546
19,679 18,384
Less accumulated depreciation 5,766 4,955
Total premises and equipment $13,913 $13,429
The Bank leases premises under operating leases. Rental expense of leased
premises was $171,000, $109,000 and $109,000 for September 30, 2004, 2003 and
2002, respectively, which is included in occupancy 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 (dollars in thousands):
2005 $169
2006 184
2007 184
2008 184
2009 125
Thereafter 125
Total minimum payments required $971
Certain leases contain renewal options from five to ten years and escalation
clauses based on increases in property taxes and other costs.
73
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 7 - Real Estate Owned and Other Repossessed Items
Real estate owned and other repossessed items consisted of the following at
September 30 (dollars in thousands):
2004 2003
Real estate acquired through foreclosure $501 $1,450
Items acquired through repossession 17 12
Allowance for possible losses (97) (204)
Total real estate owned and other repossessed items $421 $1,258
An analysis of the allowance for possible losses for the years ended September
30 follows (dollars in thousands):
2004 2003 2002
Balance, beginning of year $204 $220 $137
Provision for additional losses 39 84 241
Write-downs (146) (100) (158)
Balance, end of year $ 97 $204 $220
Note 8 - Deposits
Deposits consisted of the following at September 30 (dollars in thousands):
2004 2003
Non-interest-bearing $ 37,150 $ 29,133
NOW checking 77,242 57,614
Savings 48,200 49,572
Money market accounts 41,652 39,444
Certificates of deposit 115,326 131,909
Total deposits $319,570 $307,672
Certificates of deposit of $100,000 or greater totaled $22,041,000 and
$22,189,000 at September 30, 2004 and 2003, respectively.
(continued)
74
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 8 - Deposits (concluded)
Scheduled maturities of certificates of deposit for future years ending
September 30 are as follows (dollars in thousands):
2005 $ 86,427
2006 18,058
2007 3,521
2008 2,615
2009 4,027
Thereafter 678
Total $115,326
Interest expense by account type is as follows for the years ended September
30 (dollars in thousands):
2004 2003 2002
NOW checking $ 544 $ 335 $ 410
Savings 342 570 727
Money market accounts 439 704 1,101
Certificates of deposit 2,843 3,961 5,278
Total $4,168 $5,570 $7,516
Note 9 - Federal Home Loan Bank Advances
The Bank has long- and short-term borrowing lines with the Federal Home Loan
Bank of Seattle with a maximum total credit on the lines equal to 30% of the
Bank's total assets. Borrowings are considered short-term when the original
maturity is less than 90 days.
Total short-term borrowings under these lines were $10,485,000 at September
30, 2004. There were no short-term borrowings outstanding at September 30,
2003. The short-term borrowings mature at various dates through October 2004;
bear interest at 1.9%, with principal due at maturity.
Total long-term borrowings under these lines were $54,936,000 and $61,605,000
at September 30, 2004 and 2003, respectively.
(continued)
75
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 9 - Federal Home Loan Bank Advances (concluded)
The long-term borrowings mature at various dates through January 2011, bear
interest at rates ranging from 3.8% to 6.6%, and advances totaling $5,536,000
have monthly payments aggregating $14,000 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 (dollars in
thousands):
2005 $ 4,583
2006 10,591
2007 64
2008 15,070
2009 4,628
Thereafter 20,000
$54,936
Note 10 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses comprise the following at September 30
(dollars in thousands):
2004 2003
Accrued pension and profit sharing payable $ 925 $ 998
Accrued interest payable on deposits and FHLB advances 461 243
Accounts payable and accrued expenses - other 1,225 1,504
Total other liabilities and accrued expenses $2,611 $2,745
Note 11 - 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)
76
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 11 - Federal Income Taxes (concluded)
The components of the provision for income taxes at September 30 are as
follows (dollars in thousands):
2004 2003 2002
Current $2,423 $2,924 $3,603
Deferred (benefit) 69 42 (171)
Total federal income taxes $2,492 $2,966 $3,432
The components of the Company's deferred tax assets and liabilities at
September 30 are as follows (dollars in thousands):
2004 2003
Deferred Tax Assets
Accrued interest on loans $ 11 $ 96
Accrued vacation 106 100
Deferred compensation 92 92
Unearned ESOP shares 404 363
Allowance for possible losses 1,394 1,255
Unearned MRDP shares 38 36
Unrealized securities losses 81 - -
Acquisition costs 8 - -
Total deferred tax assets 2,134 1,942
Deferred Tax Liabilities
FHLB stock dividends 898 794
Depreciation 232 168
Unrealized securities gains - - 86
Mortgage servicing rights 254 242
Total deferred tax liabilities 1,384 1,290
Net deferred tax assets $ 750 $ 652
The provision for federal income taxes differs from that computed at the
statutory corporate tax rate as follows (dollars in thousands):
2004 2003 2002
Amount Percent Amount Percent Amount Percent
Taxes at statutory
rate $2,828 35.0% $3,362 35.0% $3,613 35.0%
BOLI income (197) (2.5) (185) (1.9) (13) (.1)
Other - net (139) (1.7) (211) (2.2) (168) (1.7)
Federal income
taxes $2,492 30.8% $2,966 30.9% $3,432 33.2%
77
Notes to Consolidated Financial Statements
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Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 12 - Profit Sharing Plans
The Bank has established a 401(k) profit sharing plan for those employees who
meet the eligibility requirements set forth in the plan. Eligible employees
may contribute up to the IRS maximum. Contributions by the Bank are at the
discretion of the board of directors. Bank contributions totaled $524,000,
$497,000 and $385,000 for the years ended September 30, 2004, 2003 and 2002,
respectively.
In addition, the Bank has an employee bonus plan based on net income. Bonuses
accrued for the years ended September 30, 2004, 2003 and 2002 totaled
$175,000, $261,000 and $275,000, respectively.
Note 13 - Employee Stock Ownership Plan
In 1998, the Bank established an Employee Stock Ownership Plan (ESOP) that
benefits all employees with at least one year of service who are 21 years of
age or older. The ESOP may be funded by Bank contributions in cash or stock.
Employee vesting occurs over six years. The amount of the annual contribution
is discretionary, except that it must be sufficient to enable the ESOP to
service its debt. All dividends received by the ESOP are used to pay debt
service. As of September 30, 2004, 20,892 ESOP shares had been distributed to
participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase
529,000 shares of common stock of the Company. The loan will be repaid
primarily from the Company's contributions to the ESOP over 15 years. The
interest rate on the loan is 8.5%. The balance of the loan at September 30,
2004 was $5,516,000.
Shares held by the ESOP as of September 30 were classified as follows:
2004 2003 2002
Unallocated shares 290,949 326,216 361,483
Shares released for allocation 217,159 185,826 162,918
Total ESOP shares 508,108 512,042 524,401
The approximate fair market value of the Bank's unallocated shares at
September 30, 2004, 2003 and 2002, is $6,829,000, $7,797,000 and $6,051,000,
respectively. Compensation expense recognized under the ESOP was $524,000,
$454,000 and $320,000 for the years ended September 30, 2004, 2003 and 2002,
respectively.
Note 14 - Stock Options
Under the Company's stock option plans, the Company may grant options for up
to 811,250 shares of its common stock to certain key employees and directors.
The exercise price of each option equals the fair market value of the
Company's stock on the date of grant. An option's maximum term is ten years.
Options are exercisable on a cumulative basis in annual installments of 10% on
each of the ten anniversaries from the date of grant. If certain Company
performance criteria are met vesting will be accelerated to 20% per year.
These criteria were met in 2004, 2003 and 2002. At September 30, 2004,
options for 139,208 shares are available for future grant under these plans.
(continued)
78
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 14 - Stock Options (continued)
The fair value of stock-based awards to employees is calculated through the
use of option pricing models, even though such models were developed to
estimate the fair value of freely tradable, fully transferable options without
vesting restrictions, which significantly differ from the Company's stock
option awards. The Company's calculations were made using the Black-Scholes
option pricing model with the following weighted average assumptions.
Risk Free Expected Expected Expected
Interest Rate Life (Years) Dividends Volatility
Fiscal 2004 3.6% 8 2.4% 21.5%
Fiscal 2003 3.4 8 2.5 24.1
Fiscal 2002 4.7 8 2.9 19.3
The average fair value of options granted in 2004, 2003 and 2002 was $5.25,
$4.62 and $4.05, respectively.
Stock option activity is summarized in the following table:
Weighted
Average
Number of Exercise
Shares Price
Outstanding September 30, 2001 609,233 $12.16
Grants 15,000 15.62
Options exercised (44,253) 12.00
Forfeited (11,630) 12.00
Outstanding September 30, 2002 568,350 12.27
Grants 30,840 19.37
Options exercised (99,071) 12.02
Outstanding September 30, 2003 500,119 12.75
Grants 28,338 23.06
Options exercised (112,406) 12.11
Forfeited (1,339) 12.00
Outstanding September 30, 2004 414,712 13.63
(continued)
79
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 14 - Stock Options (concluded)
Additional information regarding options outstanding as of September 30, 2004
is as follows:
Options Outstanding Options Exercisable
--------------------- ----------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Contractual Number Exercise Number Exercise
Prices Life (Years) Outstanding Price Exercisable Price
$12.00 - 12.38 4.4 310,195 $12.01 308,195 $12.01
13.59 - 14.90 6.7 33,339 14.70 20,003 14.70
15.20 - 15.96 7.5 12,000 15.56 3,000 15.37
19.05 8.4 28,340 19.05 5,668 19.05
22.92 - 23.25 9.3 30,838 23.06 500 23.10
5.3 414,712 $13.63 337,366 $12.33
Note 15 - Deferred Compensation/Non-Competition Agreement and Employee
Severance Compensation Agreement
The Bank has a deferred compensation/noncompetition arrangement with its
former chief executive officer which will provide monthly payments of $2,000
per month upon retirement. Payments under this agreement began in March 2004
and will continue until his death, at which time payments will continue to his
surviving spouse until her death or for 60 months. The present value of the
payments as of September 30, 2004 and 2003, $225,000 and $239,000,
respectively, has been accrued under the agreement and is included in other
liabilities on the consolidated balance sheets.
In connection with the January 1998 conversion, the Bank adopted an Employee
Severance Compensation Plan, which expires in ten years, to provide benefits
to eligible employees in the event of a change in control of the Company or
the Bank (as defined in the plan). In general, all employees with two or more
years of service will be eligible to participate in the plan. Under the plan,
in the event of a change in control of the Company or the Bank, eligible
employees who are terminated or who terminate employment (but only upon the
occurrence of events specified in the plan) within 12 months of the effective
date of a change in control would be entitled to a payment based on years of
service with the Bank. The maximum payment for any eligible employee would be
equal to 24 months of their current compensation.
Note 16 - Management Recognition and Development Plan
On November 10, 1998, the Board of Directors adopted a Management Recognition
and Development Plan (MRDP). On January 25, 1999, shareholders approved the
adoption of the MRDP for the benefit of officers, employees and non-employee
directors of the Company. The objective of the MRDP is to retain personnel of
experience and ability in key positions by providing them with a proprietary
interest in the Company.
(continued)
80
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 16 - Management Recognition and Development Plan (concluded)
The Plan allows for the issuance to participants of up to 264,500 shares of
the Company's common stock. Shares issued may be purchased in the open market
or may be issued from authorized and unissued shares. On July 26, 2001, the
Company awarded 204,927 shares under the Plan to employees and directors. No
shares were awarded during the years ended September 30, 2004 and 2003.
Awards under the MRDP were made in the form of restricted shares of common
stock that are subject to restrictions on the transfer of ownership.
Compensation expense in the amount of the fair value of the common stock at
the date of the grant to the plan participants will be recognized over a
five-year vesting period, with 20% vesting immediately upon grant. At
September 30, 2004, participants were vested in 163,941 of the shares
initially awarded. Compensation expense related to MRDP was $691,000,
$693,000 and $713,000 for the years ended September 30, 2004, 2003 and 2002,
respectively.
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.
At September 30, 2004, the Bank maintained a $10.0 million overnight borrowing
line with Pacific Coast Bankers' Bank under which there was no outstanding
balance.
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 (dollars in thousands):
2004 2003
Commitments to extend credit $31,333 $37,448
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
many of the commitments expire without being drawn upon, the total commitment
amounts do not necessarily represent future cash requirements. The Bank
evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Bank upon extension
of credit, is based on management's credit evaluation of the party.
Collateral held varies, but may include accounts receivable, inventory,
property and equipment, residential real estate, and income-producing
commercial properties.
Because of the nature of its activities, the Company is subject to various
pending and threatened legal actions which arise in the ordinary course of
business. In the opinion of management, liabilities arising from these
claims, if any, will not have a material effect on the financial position of
the Company.
81
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 18 - 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.
As of September 30, 2004, the most recent notification from the Bank's
regulator categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier 1
risk-based, and Tier 1 leverage ratios as set forth in the table. There are
no conditions or events since that notification that management believes have
changed the Bank's category.
The Company's and the Bank's actual capital amounts (dollars in thousands) and
ratios are also presented in the table.
To be Well
Capitalized
Under Prompt
Capital Corrective
Adequacy Action
Actual Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
September 30, 2004
Tier 1 capital
(to average
assets):
Consolidated $72,512 16.2% $17,883 4.0% N/A N/A
Timberland Bank 63,434 14.2 17,848 4.0 $22,310 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 72,512 21.0 13,813 4.0 N/A N/A
Timberland Bank 63,434 18.5 13,694 4.0 20,541 6.0
Total capital
(to risk-weighted
assets):
Consolidated 76,503 22.2 27,626 8.0 N/A N/A
Timberland Bank 67,425 19.7 27,388 8.0 34,235 10.0
September 30, 2003
Tier 1 capital
(to average
assets):
Consolidated $77,000 17.2% $17,946 4.0% N/A N/A
Timberland Bank 65,790 14.8 17,764 4.0 $22,205 5.0%
Tier 1 capital
(to risk-weighted
assets):
Consolidated 77,000 23.6 13,039 4.0 N/A N/A
Timberland Bank 65,790 20.2 13,003 4.0 19,505 6.0
Total capital
(to risk-weighted
assets):
Consolidated 80,891 24.8 26,078 8.0 N/A N/A
Timberland Bank 69,681 21.4 26,007 8.0 32,509 10.0
(continued)
82
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 18 - Regulatory Matters (concluded)
Restrictions on Retained Earnings
The Bank is subject to certain restrictions on the amount of dividends that it
may declare without prior regulatory approval.
At the time of conversion of the Bank from a Washington-chartered mutual
savings bank to a Washington-chartered stock savings bank, the Bank
established a liquidation account in an amount equal to its retained earnings
of $23,866,000 as of June 30, 1997, the date of the latest statement of
financial condition used in the final conversion prospectus. The liquidation
account will be maintained for the benefit of eligible withdrawable account
holders who have maintained their deposit accounts in the Bank after
conversion. The liquidation account reduces annually to the extent that
eligible account holders have reduced their qualifying deposits as of each
anniversary date. Subsequent increases will not restore an eligible account
holder's interest in the liquidation account. In the event of a complete
liquidation of the Bank (and only in such an event), eligible depositors who
have continued to maintain accounts will be entitled to receive a distribution
from the liquidation account before any liquidation may be made with respect
to common stock. The Bank may not declare or pay cash dividends if the effect
thereof would reduce its regulatory capital below the amount required for the
liquidation account.
Note 19 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(Dollars in Thousands)
2004 2003
Assets
Cash and due from financial institutions $ 137 $ 143
Interest-bearing deposits in banks 670 1,352
Investments and mortgage-backed securities
(available for sale) 2,109 3,723
Loan receivable from Bank 5,515 5,959
Investment in Bank 63,724 66,159
Other assets 732 329
Total assets $72,887 $77,665
Liabilities and Shareholders' Equity
Note payable to Bank $ - - $ 35
Accrued expenses 70 19
Shareholders' equity 72,817 77,611
Total liabilities and shareholders' equity $72,887 $77,665
(continued)
83
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 19 - Condensed Financial Information - Parent Company Only (continued)
Condensed Statements of Income - Years Ended September 30
(Dollars in Thousands)
2004 2003 2002
Operating Income
Interest-bearing deposits in banks $ 9 $ 12 $ 4
Interest on loan receivable from Bank 494 528 561
Dividends on investments 63 88 130
Gain (loss) on sale of investment
securities available for sale (6) - - 5
Dividends from Bank 9,169 6,650 5,010
Total operating income 9,729 7,278 5,710
Operating Expenses 507 329 237
Income before income taxes and equity
in undistributed income of Bank 9,222 6,949 5,473
Income Taxes (Benefit) (77) 16 83
Income before equity in undistributed
income of Bank 9,299 6,933 5,390
Equity in Undistributed Income of Bank
(Dividends in Excess of Income of Bank) (3,711) (294) 1,501
Net income $ 5,588 $6,639 $6,891
(continued)
84
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 19 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(Dollars in Thousands)
2004 2003 2002
Cash Flows from Operating Activities
Net income $ 5,588 $6,639 $6,891
Adjustments to reconcile net income to net
cash provided:
(Equity in undistributed income of Bank)
dividends in excess of income of Bank 3,711 294 (1,501)
ESOP shares earned 781 648 556
MRDP shares earned 812 803 724
(Gain) loss on sale of securities
available for sale 6 - - (5)
Other, net (349) (291) (739)
Net cash provided by operating activities 10,549 8,093 5,926
Cash Flows from Investing Activities
Net (increase) decrease in interest-bearing
deposits in banks 682 (1,093) (32)
Investment in Bank (1,595) (1,515) (1,280)
Proceeds from sales of securities available
for sale 1,600 - - 126
Principal repayments on loan receivable
from Bank 444 408 376
Net cash provided by (used in) investing
activities 1,131 (2,200) (810)
Cash Flows from Financing Activities
Increase (decrease) in note payable (35) (1,290) 750
Proceeds from exercise of stock options 1,748 1,491 588
Repurchase of common stock (11,079) (3,852) (4,414)
Payment of dividends (2,320) (2,150) (2,013)
Net cash used in financing activities (11,686) (5,801) (5,089)
Net increase (decrease) in cash (6) 92 27
Cash and Due from Financial Institutions
Beginning of year 143 51 24
End of year $ 137 $ 143 $ 51
85
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 20 - Earnings Per Share Disclosures
Basic earnings per share are computed by dividing net income applicable to
common stock by the weighted average number of common shares outstanding
during the period, without considering any dilutive items. Diluted earnings
per share are computed by dividing net income applicable to common stock by
the weighted average number of common shares and common stock equivalents for
items that are dilutive, net of shares assumed to be repurchased using the
treasury stock method at the average share price for the Company's common
stock during the period. Common stock equivalents arise from assumed
conversion of outstanding stock options and from assumed vesting of shares
awarded but not released under the Company's Management Recognition and
Development Plan. In accordance with Statement of Position 93-6, Employers'
Accounting for Employee Stock Ownership Plans, issued by the American
Institute of Certified Public Accountants, shares owned by the Bank's Employee
Stock Ownership Plan that have not been allocated are not considered to be
outstanding for the purpose of computing earnings per share. Information
regarding the calculation of basic and diluted earnings per share for the
years ended September 30 is as follows (dollars in thousands, except per share
amounts):
2004 2003 2002
Basic EPS Computation
Numerator - net income $ 5,588 $ 6,639 $ 6,891
Denominator - weighted average common
shares outstanding 3,637,510 3,814,344 3,905,544
Basic EPS $ 1.54 $ 1.74 $ 1.76
Diluted EPS Computation
Numerator - net income $ 5,588 $ 6,639 $ 6,891
Denominator - weighted average common
shares outstanding 3,637,510 3,814,344 3,905,544
Effect of dilutive stock options 161,808 158,238 108,563
Effect of dilutive MRDP shares 28,679 31,619 19,078
Weighted average common shares
outstanding-assuming dilution 3,827,997 4,004,201 4,033,185
Diluted EPS $ 1.46 $ 1.66 $ 1.71
86
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 21 - Comprehensive Income
Net unrealized gains and losses included in comprehensive income were computed
as follows for the years ended September 30 (dollars in thousands):
Tax
Before-Tax (Benefit) Net-of-Tax
Amount Expense Amount
2004
Unrealized holding losses arising
during the year ($497) ($169) ($328)
Reclassification adjustment for
losses included in net income 6 2 4
Net unrealized losses ($491) ($167) ($324)
2003
Unrealized holding losses arising
during the year ($417) ($142) ($275)
Reclassification adjustment for gains
included in net income (135) (46) (89)
Net unrealized losses ($552) ($188) ($364)
2002
Unrealized holding gains arising
during the year $372 $127 $245
Reclassification adjustment for losses
included in net income 15 5 10
Net unrealized gains $387 $132 $255
87
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 22 - Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures About Fair
Value of Financial Instruments, requires disclosure of estimated fair values
for financial instruments. Such estimates are subjective in nature, and
significant judgment is required regarding the risk characteristics of various
financial instruments at a discrete point in time. Therefore, such estimates
could vary significantly if assumptions regarding uncertain factors were to
change. Major assumptions, methods and fair value estimates for the Company's
significant financial instruments are set forth below:
Cash and Due from Financial Institutions, Interest-Bearing Deposits in
Banks, and Federal Funds Sold
The recorded amount is a reasonable estimate of fair value.
Investments and Mortgage-Backed Securities
The fair value of investments and mortgage-backed securities has been based
on quoted market prices or dealer quotes.
Federal Home Loan Bank Stock
The recorded values of stock holdings approximate fair value.
Loans Receivable and Loans Held for Sale
Fair values for loans are 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.
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)
88
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 22 - Fair Values of Financial Instruments (concluded)
The estimated fair values of financial instruments at September 30 were as
follows (dollars in thousands):
2004 2003
Recorded Fair Recorded Fair
Amount Value Amount Value
Financial Assets
Cash and due from financial
institutions and interest-bearing
deposits in banks $ 18,653 $ 18,653 $ 38,098 $ 38,098
Federal funds sold 1,180 1,180 - - - -
Investments and mortgage-backed
securities 60,063 60,055 54,310 54,310
Federal Home Loan Bank stock 5,682 5,682 5,454 5,454
Loans receivable 344,594 342,700 322,236 324,374
Accrued interest receivable 1,828 1,828 1,687 1,687
Financial Liabilities
Deposits $319,570 $319,909 $307,672 $309,087
Federal Home Loan Bank advances -
short term 10,485 10,485 - - - -
Federal Home Loan Bank advances -
long term 54,936 58,435 61,605 67,274
Accrued interest payable 461 461 243 243
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 values 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 rate obligations are less likely to prepay in a rising
rate environment and more likely to prepay in a falling rate environment.
Conversely, depositors who are receiving fixed rates are more likely to
withdraw funds before maturity in a rising rate environment and less likely to
do so in a falling rate environment. Management monitors 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 23 - Stock Repurchase Plan
In February 2004, the Company initiated a stock repurchase plan for the
purchase of 360,170 shares of stock, which had not been completed as of
September 30, 2004. As of September 30, 2004, 214,086 shares had been
repurchased. The remainder is anticipated to be purchased during the year
ending September 30, 2005.
89
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 24 - Subsequent Event
On October 26, 2004, the board of directors approved a dividend in the amount
of $.15 per share to be paid on November 23, 2004 to shareholders of record as
of November 9, 2004.
On October 9, 2004, the Bank completed the acquisition of seven branch offices
and related deposits in three western Washington counties from Venture Bank.
The Bank acquired approximately $86 million in deposits. In addition, the
Bank acquired the real estate, branch infrastructure and employees of the
seven branches The Bank paid $1.8 million cash for the branch buildings and
fixed assets. Two of the acquired branches will be consolidated with existing
Bank branches.
Note 25 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data are presented for the quarters ended
(dollars in thousands, except per share amounts):
September 30, June 30, March 31, December 31,
2004 2004 2004 2003
Interest and dividend
income $6,782 $6,627 $6,718 $6,841
Interest expense (1,743) (1,711) (1,892) (1,979)
Net interest income 5,039 4,916 4,826 4,862
Provision for loan losses (73) (14) (30) (50)
Noninterest income 967 1,083 1,117 1,012
Noninterest expense (4,012) (3,894) (3,843) (3,826)
Income before income taxes 1,921 2,091 2,070 1,998
Federal income taxes 589 645 647 611
Net income $1,332 $1,446 $1,423 $1,387
Basic earnings per share $ .38 $ .41 $ .38 $ .36
Diluted earnings per share .36 .39 .36 .34
(continued)
90
Notes to Consolidated Financial Statements
- ------------------------------------------------------------------------------
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2004 and 2003
Note 25 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30, June 30, March 31, December 31,
2003 2003 2003 2002
Interest and dividend
income $6,748 $6,774 $6,994 $7,207
Interest expense (2,064) (2,178) (2,243) (2,461)
Net interest income 4,684 4,596 4,751 4,746
Provision for loan losses - - (66) (108) (173)
Noninterest income 1,214 1,648 1,499 1,646
Noninterest expense (3,864) (3,943) (3,534) (3,491)
Income before income taxes 2,034 2,235 2,608 2,728
Federal income taxes 594 694 818 860
Net income $1,440 $1,541 $1,790 $1,868
Basic earnings per share $ .38 $ .41 $ .47 $ .48
Diluted earnings per share .36 .39 .45 .46
91
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)
or Rule 15(d)-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: In the year ended September 30,
2004, the Company did not make any significant changes in, nor take any
material corrective actions regarding, its internal controls or other factors
that could significantly affect these controls. A number of internal control
procedures were, however, modified during the year in conjunction with the
Bank's conversion to a new core processing system. The Company also continued
to implement suggestions from its internal auditor and independent auditors on
ways to strengthen existing controls.
Item 9B. Other Information
- ---------------------------
There was no information to be disclosed by the Company in a report on
Form 8-K during the fourth quarter of fiscal 2004 that was not so disclosed.
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information contained under the sections captioned "Proposal I -
Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" is included in the Company's Definitive Proxy Statement for the
2005 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."
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, 2004. 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.
92
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.
(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, 2004.
Number of securities
remaining available
for future
Number of securities Weighted-average issuance under
to be issued upon exercise price of equity compensation
exercise of outstanding plans (excluding
outstanding options, options, warrants, securities reflected
Plan category warrants and rights and rights in column (a))
- --------------- ------------------- ----------------- --------------------
(a) (b) (c)
Equity compensation
plans approved
by security
holders:
Management
Recognition and
Development Plan.. -- $ -- 59,573
1999 Stock Option
Plan.............. 402,581 13.34 1,339
2003 Stock Option
Plan.............. 12,131 23.25 137,869
Equity compensation
plans not approved
by security
holders............ -- -- --
------- ------ -------
Total............ 414,712 $13.63 198,781
======= ====== =======
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information contained under the section captioned "Certain
Relationships and Related Transactions" is included in the Company's Proxy
Statement and is incorporated herein by reference.
93
Item 14. Principal Accountant Fees and Services
- ------------------------------------------------
The information contained under the section captioned "Independent
Auditors" is included in the Company's Proxy Statement and is incorporated
herein by reference.
PART IV
Item 15. Exhibits and Financial Statement Schedules
- ----------------------------------------------------
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (1)
3.2 Bylaws of the Registrant (1)
3.3 Amendment to Bylaws(2)
10.1 Employee Severance Compensation Plan (3)
10.2 Employee Stock Ownership Plan (3)
10.3 1999 Stock Option Plan (4)
10.4 2003 Stock Option Plan (5)
10.5 Management Recognition and Development Plan (4)
14 Code of Ethics (5)
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.
(4) Incorporated by reference to the Registrant's 1999 Annual Meeting Proxy
Statement dated December 15, 1998.
(5) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended September 30, 2003.
94
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
TIMBERLAND BANCORP, INC.
Date: December 6, 2004 By:/s/Michael R. Sand
--------------------------------------
Michael R. Sand
President and Chief Executive Officer
Pursuant to the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
SIGNATURES TITLE DATE
/s/Michael R. Sand President, Chief Executive Officer December 6, 2004
- ---------------------- and Director
Michael R. Sand (Principal Executive Officer)
/s/Clarence E. Hamre Chairman of the Board November 23, 2004
- ----------------------
Clarence E. Hamre
/s/Dean J. Brydon Chief Financial Officer December 6, 2004
- ---------------------- (Principal Financial and
Dean J. Brydon Accounting Officer)
/s/Andrea M. Clinton Director November 23, 2004
- ----------------------
Andrea M. Clinton
- ---------------------- Director ________ __, 2004
Richard R. Morris, Jr.
/s/David A. Smith Director November 23, 2004
- ----------------------
David A. Smith
/s/Harold L. Warren Director November 23, 2004
- ----------------------
Harold L. Warren
/s/Jon C. Parker Director November 23, 2004
- ----------------------
Jon C. Parker
/s/James A. Mason Director November 23, 2004
- ----------------------
James A. Mason
/s/Ronald A. Robbel Director November 23, 2004
- ----------------------
Ronald A. Robbel
95
Exhibit 21
Subsidiaries of the Registrant
Parent
- --------------------------------
Timberland Bancorp, Inc.
Percentage Jurisdiction or
Subsidiaries of Ownership State of Incorporation
- --------------------------------- -------------- ----------------------
Timberland Bank 100% Washington
Timberland Service Corporation (1) 100% Washington
- ---------------
(1) This corporation is a wholly owned subsidiary of Timberland Bank.
Exhibit 23
Consent of Accountants
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statements No.
333-32386 and No. 333-116163 of Timberland Bancorp, Inc. on Form S-8 of our
report dated October 27, 2004, appearing in this Annual Report on Form 10-K of
Timberland Bancorp, Inc. for the year ended September 30, 2004.
/s/McGladrey & Pullen, LLP
MCGLADREY & PULLEN, LLP
Tacoma, WA
December 10, 2004
Exhibit 31.1
Certification Required
by Rules 13a-14 and 15d-14 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)) 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) 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
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: December 6, 2004 /s/Michael R. Sand
-------------------------
Michael R. Sand
Chief Executive Officer
Exhibit 31.2
Certification Required
by Rules 13a-14 and 15d-14 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)) 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) 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
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: December 6, 2004 /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.
/s/Michael R. Sand /s/Dean J. Brydon
- -------------------------- -----------------------------
Michael R. Sand Dean J. Brydon
Chief Executive Officer Chief Financial Officer
Dated: December 6, 2004