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EX-32 - EXHIBIT 32 - TIMBERLAND BANCORP INCtsbk-9302017x10kxexhibit32.htm
EX-31.2 - EXHIBIT 31.2 - TIMBERLAND BANCORP INCtsbk-9302017x10kxexhibit312.htm
EX-31.1 - EXHIBIT 31.1 - TIMBERLAND BANCORP INCtsbk-9302017x10kxexhibit311.htm
EX-23.1 - EXHIBIT 23.1 - TIMBERLAND BANCORP INCtsbk-9302017x10kxexhibit231.htm
EX-21 - EXHIBIT 21 - TIMBERLAND BANCORP INCtsbk-9302017x10kxexhibit21.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the Fiscal Year Ended September 30, 2017                                                    OR
 
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 0-23333
 
TIMBERLAND BANCORP, INC.
(Exact name of registrant as specified in its charter)
Washington
 
91-1863696
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification 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:
 
 
 
 
 
  Common Stock, par value $.01 per share
 
 The Nasdaq Stock Market LLC
 (Title of Each Class)
 
(Name of Each Exchange on Which Registered)
 
 
 
Securities registered pursuant to Section 12(g) of the Act:
 
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities     Act.    YES            NO    X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the     Act.   YES          NO    X    
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES   X      NO      
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)   YES   X    NO      
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.         
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer [ ]
Accelerated filer [X]
 
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Smaller reporting company [ ]
 
Emerging growth company [ ]
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [_]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  YES         NO    X  
As of November 30, 2017, the registrant had 7,364,627 shares of common stock issued and outstanding.  The aggregate market value of the common stock held by nonaffiliates of the registrant, based on the closing sales price of the registrant’s common stock as quoted on the NASDAQ Global Market on March 31, 2017, was $164.5 million (7,345,477 shares at $22.40).  For purposes of this calculation, common stock held by officers and directors of the registrant was included.
DOCUMENTS INCORPORATED BY REFERENCE
1.   Portions of Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders (Part III).



TIMBERLAND BANCORP, INC.
2017 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I.
Page
 
Item 1.
Business
 
 
 
 
General
 
 
 
Market Area
 
 
 
Lending Activities
 
 
 
Investment Activities
 
 
 
Deposit Activities and Other Sources of Funds
 
 
 
Bank Owned Life Insurance
 
 
 
How We Are Regulated
 
 
 
Taxation
 
 
 
Competition
 
 
 
Subsidiary Activities
 
 
 
Personnel
 
 
 
Executive Officers of the Registrant
 
Item 1A.
Risk Factors
 
Item 1B.
Unresolved Staff Comments 
 
Item 2.
Properties
 
Item 3.    
Legal Proceedings
 
Item 4.    
Mine Safety Disclosures
PART II.
 
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Item 6.
Selected Financial Data
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
General
 
 
 
 
 
 
Operating Strategy
53
 
 
 
Critical Accounting Policies and Estimates
 
 
 
Market Risk and Asset and Liability Management
 
 
 
Comparison of Financial Condition at September 30, 2017 and September 30, 2016
 
 
 
Comparison of Operating Results for Years Ended September 30, 2017 and 2016
 
 
 
Comparison of Operating Results for Years Ended September 30, 2016 and 2015
 
 
 
Average Balances, Interest and Average Yields/Cost
 
 
 
Rate/Volume Analysis
 
 
 
Liquidity and Capital Resources
 
 
 
Effect of Inflation and Changing Prices
 
 
 
New Accounting Pronouncements
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
 
Item 8.
Financial Statements and Supplementary Data
 
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
117
 
Item 9A.
Controls and Procedures
117
 
Item 9B.
Other Information
120
PART III.
 
 
Item 10.
Directors, Executive Officers and Corporate Governance
 
Item 11.
Executive Compensation
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
 
Item 14.
Principal Accounting Fees and Services
PART IV.
 
 
Item 15.
Exhibits and Financial Statement Schedules
 
Item 16.
Form 10-K Summary

As used throughout this report, the terms "we," "our," or "us," refer to Timberland Bancorp, Inc. and its consolidated subsidiary, unless the context otherwise requires.

2


Special Note Regarding Forward-Looking Statements

Certain matters discussed in this Annual Report on Form 10-K may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and often include the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance.  These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause our actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets which may lead to increased losses and non-performing loans in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our loan loss reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;  secondary market conditions for loans and our ability to sell loans in the secondary market; results of examinations of us by the Board of Governors of the Federal Reserve System and of our bank subsidiary by the Federal Deposit Insurance Corporation, the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, institute a formal or informal enforcement action against us or our bank subsidiary which could require us to increase our allowance for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including as a result of Basel III; the impact of the Dodd Frank Wall Street Reform and Consumer Protection Act and implementing regulations; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risks associated with the loans on our consolidated balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; the failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our business strategies; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services; and other risks described elsewhere in this Form 10-K and the Company's other reports filed with or furnished to the SEC.

Any of the forward-looking statements that we make in this Form 10-K and in the other public statements we make are based upon management's beliefs and assumptions at the time they are made. We do not undertake and specifically disclaim any obligation to publicly update or revise any forward-looking statements included in this annual report to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur and we caution readers not to place undue reliance on any forward-looking statements. These risks could cause our actual results for fiscal 2018 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company's financial condition and results of operations as well as its stock price performance.






3


PART I

Item 1.  Business

General

Timberland Bancorp, Inc. (“Timberland Bancorp" or the "Company”), a Washington corporation, was organized on September 8, 1997 for the purpose of becoming the holding company for Timberland Bank (the "Bank").  At September 30, 2017, on a consolidated basis, the Company had total assets of $952.0 million, total deposits of $837.9 million and total shareholders’ equity of $111.0 million.  The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank.  Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to the Bank and its subsidiary, Timberland Service Corporation.

The Bank opened for business in 1915 and serves consumers and businesses across Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis counties, Washington with a full range of lending and deposit services through its 22 branches (including its main office in Hoquiam). The Bank’s deposits are insured up to applicable legal limits by the Federal Deposit Insurance Corporation (“FDIC”).  The Bank has been a member of the Federal Home Loan Bank System since 1937.  The Bank is regulated by the Washington Department of Financial Institutions, Division of Banks (“Division” or “DFI”) and the FDIC. The Company is regulated by the Board of Governors of the Federal Reserve System ("Federal Reserve").

The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail customers while concentrating its lending activities on real estate mortgage loans. Lending activities have been focused primarily on the origination of loans secured by real estate, including residential construction loans, one- to four-family residential loans, multi-family loans, commercial real estate loans and land loans. The Bank originates adjustable-residential mortgage loans that do not qualify for sale in the secondary market. The Bank also originates commercial business loans and other consumer loans.

The Company maintains a website at www.timberlandbank.com.  The information contained on that website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K.  Other than an investor’s own internet access charges, the Company makes available free of charge through that website the Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after these materials have been electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).

Market Area

The Bank considers Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties, Washington as its primary market areas.  The Bank conducts operations from:

its main office in Hoquiam (Grays Harbor County);
five branch offices in Grays Harbor County (Ocean Shores, Montesano, Elma and two branches in Aberdeen);
five branch offices in Pierce County (Edgewood, Puyallup, Spanaway, Tacoma and Gig Harbor);
five branch offices in Thurston County (Olympia, Yelm, Tumwater and two branches in Lacey);
two branch offices in Kitsap County (Poulsbo and Silverdale);
a branch office in King County (Auburn); and
three branch offices in Lewis County (Winlock, Toledo and Chehalis).

For additional information, see “Item 2. Properties.”

Hoquiam, with a population of approximately 8,400, is located in Grays Harbor County which is situated along Washington State’s central Pacific coast.  Hoquiam is located approximately 110 miles southwest of Seattle, Washington and 145 miles northwest of Portland, Oregon.
 
The Bank considers its primary market area to include six sub-markets: primarily rural Grays Harbor County with its historical dependence on the timber and fishing industries; Thurston and Kitsap counties with their dependence on state and federal government; Pierce and King counties with their broadly diversified economic bases; and Lewis County with its dependence on retail trade, manufacturing, industrial services and local government.  Each of these markets presents operating risks to the

4


Bank.  The Bank’s expansion into Pierce, Thurston, Kitsap, King and Lewis counties represents the Bank’s strategy to diversify its primary market area to become less reliant on the economy of Grays Harbor County.

Grays Harbor County has a population of 71,600 according to the United States ("U.S.") Census Bureau 2016 estimates and a median family income of $62,100 according to 2017 estimates from the Department of Housing and Urban Development (“HUD”).  The economic base in Grays Harbor County has been historically dependent on the timber and fishing industries.  Other industries that support the economic base are tourism, agriculture, shipping, transportation and technology.  According to the Washington State Employment Security Department, the unemployment rate in Grays Harbor County decreased to 6.1% at September 30, 2017 from 8.2% at September 30, 2016.  The median price of a resale home in Grays Harbor County for the quarter ended September 30, 2017 increased 18.2% to $167,600 from $141,800 for the comparable prior year period.  The number of home sales increased 16.7% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.  The Bank has six branches (including its home office) located throughout the county.  

Pierce County is the second most populous county in the state and has a population of 861,300 according to the U.S. Census Bureau 2016 estimates.  The county’s median family income is $74,500 according to 2017 HUD estimates.  The economy in Pierce County is diversified with the presence of military related government employment (Joint Base Lewis-McChord), transportation and shipping employment (Port of Tacoma), and aerospace related employment.  According to the Washington State Employment Security Department, the unemployment rate for the Pierce County area decreased to 4.8% at September 30, 2017 from 6.0% at September 30, 2016. The median price of a resale home in Pierce County for the quarter ended September 30, 2017 increased 28.1% to $338,400 from $264,200 for the comparable prior year period.  The number of home sales increased 13.6% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.  The Bank has five branches in Pierce County, and these branches have historically been responsible for a substantial portion of the Bank’s construction lending activities. 

Thurston County has a population of 275,000 according to the U.S. Census Bureau 2016 estimates and a median family income of $76,300 according to 2017 HUD estimates.  Thurston County is home of Washington State’s capital (Olympia), and its economic base is largely driven by state government related employment.  According to the Washington State Employment Security Department, the unemployment rate for the Thurston County area decreased to 4.5% at September 30, 2017 from 5.7% at September 30, 2016. The median price of a resale home in Thurston County for the quarter ended September 30, 2017 increased 12.5% to $289,800 from $257,700 for the same quarter one year earlier.  The number of home sales increased 20.5% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.  The Bank has five branches in Thurston County.  This county has historically had a stable economic base primarily attributable to the state government presence.

Kitsap County has a population of 265,000 according to the U.S. Census Bureau 2016 estimates and a median family income of $77,100 according to 2017 HUD estimates.  The Bank has two branches in Kitsap County.  The economic base of Kitsap County is largely supported by military related government employment through the U.S. Navy.  According to the Washington State Employment Security Department, the unemployment rate for the Kitsap County area decreased to 4.6% at September 30, 2017 from 5.7% at September 30, 2016.  The median price of a resale home in Kitsap County for the quarter ended September 30, 2017 increased 22.2% to $326,500 from $267,100 for the same quarter one year earlier.  The number of home sales increased 13.5% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.  

King County is the most populous county in the state and has a population of 2.2 million according to the U.S. Census Bureau 2016 estimates.  The Bank has one branch in King County.  The county’s median family income is $96,000 according to 2017 HUD estimates.  King County’s economic base is diversified with many industries including shipping, transportation, aerospace, computer technology and biotech.  According to the Washington State Employment Security Department, the unemployment rate for the King County area decreased to 3.9% at September 30, 2017 from 4.0% at September 30, 2016. The median price of a resale home in King County for the quarter ended September 30, 2017 increased 19.2% to $658,400 from $552,400 for the same quarter one year earlier.  The number of home sales increased 8.1% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.  

Lewis County has a population of 77,000 according to the U.S. Census Bureau 2016 estimates and a median family income of $62,100 according to 2017 HUD estimates.  The economic base in Lewis County is supported by manufacturing, retail trade, local government and industrial services.  According to the Washington State Employment Security Department, the unemployment rate in Lewis County decreased to 5.7% at September 30, 2017 from 7.7% at September 30, 2016. The median price of a resale home in Lewis County for the quarter ended September 30, 2017 increased 17.1% to $211,100 from $180,200 for the same quarter one year earlier.  The number of home sales increased 13.5% for the quarter ended September 30, 2017 compared to the same quarter one year earlier.  The Bank currently has three branches located in Lewis County.  




5



Lending Activities

General.  Historically, the principal lending activity of the Bank has consisted of the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences, or by commercial real estate and loans for the construction of one- to four-family residences.  The Bank’s net loans receivable totaled $690.4 million at September 30, 2017, representing 72.5% of consolidated total assets, and at that date commercial real estate, construction (including undisbursed loans in process), and land loans were $521.4 million, or 66.4% of total loans. In addition, multi-family loans totaled $58.6 million, or 7.5% of total loans at September 30, 2017.  Commercial real estate, construction, multi-family, and land loans typically have higher rates of return than one- to four-family loans; however, they also present a higher degree of risk.  

The Bank’s internal loan policy limits the maximum amount of loans to one borrower to 20% of its capital plus surplus. According to the Washington Administrative Code, capital and surplus are defined as a bank's Tier 1 capital, Tier 2 capital and the balance of a bank's allowance for loan losses not included in the bank's Tier 2 capital as reported in the bank's call report. At September 30, 2017, the maximum amount which the Bank could have lent to any one borrower and the borrower’s related entities was approximately $22.8 million under this policy.  At September 30, 2017, the largest amount outstanding to any one borrower and the borrower’s related entities was $18.6 million, which was secured by multi-family properties and commercial buildings located in King, Benton and Grant counties.  These loans were all performing according to their loan repayment terms at September 30, 2017.  The next largest amount outstanding to any one borrower and the borrower’s related entities was $13.1 million (including $963,000 in undisbursed loans in process).  These loans were secured by commercial real estate properties located in Pierce and Kitsap counties and were performing according to their loan repayment terms at September 30, 2017.

6


Loan Portfolio Analysis.  The following table sets forth the composition of the Bank’s loan portfolio by type of loan at the dates indicated.

 
At September 30,
 
2017
 
2016
 
2015
 
2014
 
2013
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Mortgage Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family (1)
$
118,147

 
15.05
%
 
$
118,560

 
16.38
%
 
$
116,664

 
17.42
%
 
$
97,635

 
16.10
%
 
$
102,387

 
17.73
%
Multi-family
58,607

 
7.47

 
62,303

 
8.61

 
52,322

 
7.81

 
46,206

 
7.62

 
51,108

 
8.85

Commercial
328,927

 
41.91

 
312,525

 
43.18

 
291,216

 
43.47

 
294,354

 
48.54

 
291,297

 
50.44

Construction - custom and owner/builder
117,641

 
14.99

 
93,049

 
12.85

 
62,954

 
9.40

 
59,752

 
9.85

 
40,811

 
7.07

Construction - speculative one- to four-family
9,918

 
1.26

 
8,106

 
1.12

 
6,668

 
1.00

 
2,577

 
0.42

 
1,428

 
0.24

Construction - commercial
19,630

 
2.50

 
9,365

 
1.29

 
20,728

 
3.09

 
3,310

 
0.55

 
2,239

 
0.39

Construction - multi-family
21,327

 
2.72

 
12,590

 
1.74

 
20,570

 
3.07

 
2,840

 
0.47

 
143

 
0.01

Construction - land development

 

 

 

 

 

 

 

 
515

 
0.09

Land
23,910

 
3.05

 
21,627

 
2.99

 
26,140

 
3.90

 
29,589

 
4.88

 
31,144

 
5.39

Total mortgage loans
698,107

 
88.95

 
638,125

 
88.16

 
597,262

 
89.16

 
536,263

 
88.43

 
521,072

 
90.21

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Home equity and second mortgage
38,420

 
4.90

 
39,727

 
5.49

 
34,157

 
5.10

 
34,921

 
5.76

 
33,014

 
5.72

Other
3,823

 
0.49

 
4,139

 
0.57

 
4,669

 
0.70

 
4,699

 
0.77

 
5,981

 
1.04

Total consumer loans
42,243

 
5.39

 
43,866

 
6.06

 
38,826

 
5.80

 
39,620

 
6.53

 
38,995

 
6.76

Commercial business loans (2)
44,444

 
5.66

 
41,837

 
5.78

 
33,763

 
5.04

 
30,559

 
5.04

 
17,499

 
3.03

Total loans receivable
784,794

 
100.00
%
 
723,828

 
100.00
%
 
669,851

 
100.00
%
 
606,442

 
100.00
%
 
577,566

 
100.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Undisbursed portion of construction loans in process
(82,411
)
 
 
 
(48,627
)
 
 

 
(53,457
)
 
 

 
(29,416
)
 
 

 
(18,527
)
 
 

Deferred loan origination fees, net
(2,466
)
 
 
 
(2,229
)
 
 

 
(2,193
)
 
 

 
(1,746
)
 
 

 
(1,710
)
 
 

Allowance for loan losses
(9,553
)
 
 
 
(9,826
)
 
 

 
(9,924
)
 
 

 
(10,427
)
 
 

 
(11,136
)
 
 

Total loans receivable, net
$
690,364

 
 
 
$
663,146

 
 

 
$
604,277

 
 

 
$
564,853

 
 

 
$
546,193

 
 

______________
(1)
Does not include loans held-for-sale of $3,515, $3,604, $3,051, $899 and $1,911 at September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
(2)    Does not include loans held-for-sale of $84 at September 30, 2017.

7


Residential One- to Four-Family Lending.  At September 30, 2017, $118.1 million, or 15.1%, of the Bank’s loan portfolio consisted of loans secured by one- to four-family residences.  The Bank originates both fixed-rate loans and adjustable-rate loans.

Generally, one- to four-family fixed-rate loans and five and seven year balloon reset loans (which are loans that are originated with a fixed interest rate for the initial five or seven years, and thereafter incur one interest rate change in which the new rate remains in effect for the remainder of the loan term) are originated to meet the requirements for sale in the secondary market to the Federal Home Loan Mortgage Corporation ("Freddie Mac").  From time to time, however, a portion of these fixed-rate loans and five and seven year balloon reset loans may be retained in the loan portfolio to meet the Bank’s asset/liability management objectives. The Bank uses an automated underwriting program, which preliminarily qualifies a loan as conforming to Freddie Mac underwriting standards when the loan is originated.  At September 30, 2017, $29.0 million, or 24.5%, of the Bank’s one- to four-family loan portfolio consisted of fixed-rate and five and seven year balloon reset mortgage loans.

The Bank also offers adjustable-rate mortgage (“ARM”) loans.  All of the Bank’s ARM loans are retained in its loan portfolio.  The Bank offers several ARM products which adjust annually after an initial period ranging from one to five years and are typically subject to a limitation on the annual interest rate increase of 2% and an overall limitation of 6%.  These ARM products generally are priced utilizing the weekly average yield on one year U.S. Treasury securities adjusted to a constant maturity of one year plus a margin of 2.88% to 4.00%.  The Bank also offers ARM loans tied to The Wall Street Journal prime lending rate ("Prime Rate") or to the London Inter-Bank Offered Rate (“LIBOR”) indices which typically do not have periodic or lifetime adjustment limits.  Loans tied to these indices normally have margins ranging up to 3.5%.  ARM loans held in the Bank’s portfolio do not permit negative amortization of principal.  Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan.  The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment.  At September 30, 2017, $89.1 million, or 75.5%, of the Bank’s one- to four- family loan portfolio consisted of ARM loans.

A portion of the Bank’s ARM loans are “non-conforming”, because they do not satisfy acreage limits or various other requirements imposed by Freddie Mac.  Some of these loans are also originated to meet the needs of borrowers who cannot otherwise satisfy Freddie Mac credit requirements because of personal and financial reasons (i.e., divorce, bankruptcy, length of time employed, etc.), and other aspects, which do not conform to Freddie Mac’s guidelines.  Such borrowers may have higher debt-to-income ratios, or the loans are secured by unique properties in rural markets for which there are no sales of comparable properties to support the value according to secondary market requirements.  These loans are known as non-conforming loans, and the Bank may require additional collateral or lower loan-to-value ratios to reduce the risk of these loans.  The Bank believes that these loans satisfy a need in its local market area.  As a result, subject to market conditions, the Bank intends to continue to originate these types of loans.

The retention of ARM loans in the Bank’s loan portfolio helps reduce the Bank’s exposure to changes in interest rates.  There are, however, unquantifiable credit risks resulting from the potential of increased interest to be paid by the customer as a result of increases in interest rates.  It is possible that during periods of rising interest rates the risk of default on ARM loans may increase as a result of repricing and the increased costs to the borrower.  The Bank attempts to reduce the potential for delinquencies and defaults on ARM loans by qualifying the borrower based on the borrower’s ability to repay the ARM loan assuming that the maximum interest rate that could be charged was in effect during the loan term.  Another consideration is that although ARM loans allow the Bank to increase the sensitivity of its asset base due to changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits.  Because of these considerations, the Bank has no assurance that yield increases on ARM loans will be sufficient to offset increases in the Bank’s cost of funds.

While fixed-rate, single-family residential mortgage loans are normally originated with 15 to 30 year terms to maturity, these loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan.  In addition, substantially all mortgage loans in the Bank’s loan portfolio contain due-on-sale clauses providing that the Bank may declare the unpaid amount due and payable upon the sale of the property securing the loan.  Typically, the Bank enforces these due-on-sale clauses to the extent permitted by law and as business judgment dictates.  Thus, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates received on outstanding loans.

The Bank requires that fire and extended coverage casualty insurance be maintained on the collateral for all of its real estate secured loans and flood insurance, if appropriate.

The Bank’s lending policies generally limit the maximum loan-to-value ratio on mortgage loans secured by owner-occupied properties to 95% of the lesser of the appraised value or the purchase price.  However, the Bank usually obtains private

8


mortgage insurance (“PMI”) on the portion of the principal amount that exceeds 80% of the appraised value of the security property. The maximum loan-to-value ratio on mortgage loans secured by non-owner-occupied properties is generally 80% (90% for loans originated for sale in the secondary market to Freddie Mac).  At September 30, 2017, seven one- to four-family loans totaling $874,000 were on non-accrual status.  See “Lending Activities - Non-performing Loans and Delinquencies.”

Multi-Family Lending.  At September 30, 2017, $58.6 million, or 7.5%, of the Bank’s total loan portfolio was secured by multi-family dwelling units (more than four units) located primarily in the Bank’s primary market area.  Multi-family loans are generally originated with variable rates of interest ranging from 1.00% to 3.50% over the one-year constant maturity U.S. Treasury Bill Index, the Prime Rate or a matched term Federal Home Loan Bank borrowing, with principal and interest payments fully amortizing over terms of up to 30 years.  At September 30, 2017, the Bank’s largest multi-family loan had an outstanding principal balance of $6.7 million and was secured by an apartment building located in Pierce County. At September 30, 2017, this loan was performing according to its repayment terms.  

The maximum loan-to-value ratio for multi-family loans is generally limited to not more than 80%.  The Bank generally requests its multi-family loan borrowers with loan balances in excess of $750,000 to submit financial statements and rent rolls on the properties securing such loans.  The Bank also inspects such properties annually.  The Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for loans secured by multi-family properties.

Multi-family mortgage lending affords the Bank an opportunity to receive interest at rates higher than those generally available from one- to four- family residential lending.  However, loans secured by multi-family properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, may involve a greater degree of risk than one- to four-family residential mortgage loans.  Because payments on loans secured by multi-family properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks by scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.  If the borrower is other than an individual, the Bank also generally obtains personal guarantees from the principals based on a review of personal financial statements. At September 30, 2017, all multi-family loans were performing according to their repayment terms. See "Lending Activities - Non-performing Loans and Delinquencies."

Commercial Real Estate Lending.  Commercial real estate loans totaled $328.9 million, or 41.9%, of the total loan portfolio at September 30, 2017.  The Bank originates commercial real estate loans generally at variable interest rates with principal and interest payments fully amortizing over terms of up to 30 years.  These loans are secured by properties, such as office buildings, retail/wholesale facilities, mini-storage facilities, motels, nursing homes, restaurants and convenience stores, located in the Bank’s primary market area.  At September 30, 2017, the largest commercial real estate loan was secured by an office building in Thurston County, had a balance of $6.1 million and was performing according to its repayment terms.  At September 30, 2017, two commercial real estate loans totaling $213,000 were on non-accrual status.  See “Lending Activities - Non-performing Loans and Delinquencies.”

The Bank typically requires appraisals of properties securing commercial real estate loans.  For loans that are less than $250,000, the Bank may use the tax assessed value and a property inspection in lieu of an appraisal.  Appraisals are performed by independent appraisers designated by the Bank.  The Bank considers the quality and location of the real estate, the credit history of the borrower, the cash flow of the project and the quality of management involved with the property when making these loans.  The Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for loans secured by income producing commercial properties.  Loan-to-value ratios on commercial real estate loans are generally limited to not more than 80%.  If the borrower is other than an individual, the Bank also generally obtains personal guarantees from the principals based on a review of personal financial statements.

Commercial real estate lending affords the Bank an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending.  However, loans secured by such properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans.  Because payments on loans secured by commercial properties often depend upon the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks by generally limiting the maximum loan-to-value ratio to 80% and scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.  The Bank also generally requests annual financial information and rent rolls on the subject property from the borrowers on loans over $750,000.

Construction Lending.      The Bank currently originates three types of residential construction loans:  (i) custom construction loans, (ii) owner/builder construction loans and (iii) speculative construction loans (on a limited basis).  The Bank believes that its computer tracking system has enabled it to establish processing and disbursement procedures to meet the needs

9


of its borrowers while reducing many of the risks inherent with construction lending.  The Bank also originates construction loans for the development of multi-family and commercial properties.  The Bank's construction loans generally provide for the payment of interest only during the construction phase, which is billed monthly, although during the term of some construction loans no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest reserve. At September 30, 2017, the Bank's construction loans totaled $168.5 million, or 21.5% of the Bank's total loan portfolio, including undisbursed loans in process of $82.4 million.

At September 30, 2017 and 2016, the composition of the Bank’s construction loan portfolio was as follows:
 
At September 30,
 
2017
 
2016
 
Outstanding
Balance
 
Percent of
Total
 
Outstanding
Balance
 
Percent of
Total
 
(Dollars in thousands)
Custom and owner/builder
$
117,641

 
69.81
%
 
$
93,049

 
75.58
%
Speculative one-to four-family
9,918

 
5.89

 
8,106

 
6.58

Commercial real estate
19,630

 
11.65

 
9,365

 
7.61

Multi-family
21,327

 
12.65

 
12,590

 
10.23

Total
$
168,516

 
100.00
%
 
$
123,110

 
100.00
%

Custom construction loans are made to home builders who, at the time of construction, have a signed contract with a home buyer who has a commitment to purchase the finished home.  Custom construction loans are generally originated for a term of six to 12 months, with fixed interest rates typically ranging from 4.50% to 6.25% and with loan-to-value ratios of 80% of the appraised estimated value of the completed property or sales price, whichever is less. All of our custom and owner/builder construction loans are structured to convert to permanent mortgage loans once construction is completed.

Owner/builder construction loans are originated to home owners rather than home builders and are typically converted to or refinanced into permanent loans at the completion of construction.  The construction phase of an owner/builder construction loan generally lasts up to 12 months with fixed interest rates typically ranging from 4.50% to 6.25% and with loan-to-value ratios of 80% (or up to 95% with PMI) of the appraised estimated value of the completed property.  At the completion of construction, the loan is converted to or refinanced into either a fixed-rate mortgage loan, which conforms to secondary market standards, or an ARM loan for retention in the Bank’s portfolio.  At September 30, 2017, custom and owner/builder construction loans totaled $117.6 million, or 69.8% of the total construction loan portfolio.  At September 30, 2017, the largest outstanding custom and owner/builder construction loan had an outstanding balance of $1.4 million (including $347,000 of undisbursed loans in process) and was performing according to its repayment terms.

Speculative one-to four-family construction loans are made to home builders and are termed “speculative” because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing with either the Bank or another lender for the finished home.  The home buyer may be identified either during or after the construction period, with the risk that the builder will have to debt service the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until the home buyer is identified and a sale is consummated.  Rather than originating lines of credit to home builders to construct several homes at once, the Bank generally originates and underwrites a separate loan for each home.  Speculative construction loans are generally originated for a term of 12 months, with current rates generally ranging from 6.00% to 6.50%, and with a loan-to-value ratio of no more than 80% of the appraised estimated value of the completed property.  The Bank is currently originating speculative construction loans on a limited basis.  At September 30, 2017, speculative construction loans totaled $9.9 million, or 5.9% of the total construction loan portfolio.  At September 30, 2017, the largest aggregate outstanding balance to one borrower for speculative construction loans totaled $1.9 million (including $1.3 million of undisbursed loans in process) and was comprised of ten loans that were performing according to their repayment terms.  

The Bank also provides construction financing for multi-family and commercial properties.  At September 30, 2017, these loans amounted to $41.0 million, or 24.3%, of construction loans compared to $22.0 million, or 17.8%, of construction loans at September 30, 2016.  These loans are typically secured by apartment buildings, condominiums, mini-storage facilities, office buildings, hotels and retail rental space predominantly located in the Bank’s primary market area.  At September 30, 2017, the largest outstanding multi-family construction loan was secured by an apartment building project in Thurston County and had a balance of $6.7 million (including $6.7 million of undisbursed construction loan proceeds) and was performing according to its repayment terms.  At September 30, 2017, the largest outstanding commercial real estate construction loan was secured by an

10


assisted living facility project in King County and had a balance of $6.1 million (including $2.0 million of undisbursed loans in process). This loan was performing according to its repayment terms at September 30, 2017.

All construction loans must be approved by a member of one of the Bank’s Loan Committees or the Bank’s Board of Directors, or in the case of one- to four-family construction loans that meet Freddie Mac guidelines, by the Regional Manager of Community Lending, the Loan Department Supervisor or a Bank underwriter. See “- Lending Activities - Loan Solicitation and Processing.”  Prior to approval of any construction loan application, an independent fee appraiser inspects the site and the Bank reviews the existing or proposed improvements, identifies the market for the proposed project and analyzes the pro-forma data and assumptions on the project.  In the case of a speculative or custom construction loan, the Bank reviews the experience and expertise of the builder.  After this preliminary review, the application is processed, which includes obtaining credit reports, financial statements and tax returns on the borrowers and guarantors, an independent appraisal of the project, and any other expert reports necessary to evaluate the proposed project.  In the event of cost overruns, the Bank generally requires that the borrower increase the funds available for construction by paying the cost of such overruns directly or by depositing its own funds into a secured savings account, the proceeds of which are used to pay construction costs.

Loan disbursements during the construction period are made to the builder, materials supplier or subcontractor, based on a line item budget.  Periodic on-site inspections are made by qualified independent inspectors to document the reasonableness of draw requests.  For most builders, the Bank disburses loan funds by providing vouchers to borrowers, which when used by the borrower to purchase supplies are submitted by the supplier to the Bank for payment.

The Bank originates construction loan applications primarily through customer referrals, contacts in the business community and occasionally real estate brokers seeking financing for their clients.

Construction lending (including custom, owner/builder and speculative construction loans) affords the Bank the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does its single-family permanent mortgage lending.  Construction lending, however, is generally considered to involve a higher degree of risk than single-family permanent mortgage lending because funds are advanced upon the collateral for the project based on an estimate of the costs that will produce a future value at completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio.  With regard to loans originated to builders for speculative projects, changes in the demand, such as for new housing and higher than anticipated building costs, may cause actual results to vary significantly for those estimated. A downturn in the housing, or the real estate market, could increase loan delinquencies, defaults, and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Some builders who have borrowed from us to fund construction projects on a speculative basis have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.

In addition, during the term of many of our construction loans granted to builders who are building residential units for sale, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest reserve. As a result, these loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers' borrowing costs, thereby reducing the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction. Furthermore, in the case of speculative construction loans, there is an added risk associated with identifying an end-purchaser for the finished project. At September 30, 2017 all construction loans were performing according to their repayment terms. See "Lending Activities - Non-performing Loans and Delinquencies."

The Bank historically originated loans to real estate developers with whom it had established relationships for the purpose of developing residential subdivisions (i.e., installing roads, sewers, water and other utilities; generally with ten to 50 lots). The Bank is not currently originating any new land development loans and at September 30, 2017, the Bank had no land development loans outstanding.  Although the Bank is not currently originating land development loans, it may do so in the future. Historically land development loans were secured by a lien on the property and typically were made for a period of two to five years with fixed or variable interest rates, and were made with loan-to-value ratios generally not exceeding 75%.  Land development loans were

11


generally structured so that the Bank was repaid in full upon the sale by the borrower of approximately 80% of the subdivision lots.  In addition, in the case of a corporate borrower, the Bank also generally obtained personal guarantees from corporate principals and reviewed their personal financial statements. Land development loans secured by land under development involve greater risks than one- to four-family residential mortgage loans because these loans are advanced upon the predicted future value of the developed property upon completion.  If the estimate of the future value proves to be inaccurate, in the event of default and foreclosure the Bank may be confronted with a property the value of which is insufficient to assure full repayment.  The Bank has historically attempted to minimize this risk by generally limiting the maximum loan-to-value ratio on land loans to 75% of the estimated developed value of the secured property.  

Land Lending. The Bank has historically originated loans for the acquisition of land upon which the purchaser can then build or make improvements necessary to build or to sell as improved lots.  Currently the Bank is originating land loans on a limited basis.  At September 30, 2017, land loans totaled $23.9 million, or 3.0%, of the Bank’s total loan portfolio as compared to $21.6 million, or 3.0%, of the Bank’s total loan portfolio at September 30, 2016.  Land loans originated by the Bank generally have maturities of five to ten years.  The largest land loan is secured by land in Grays Harbor County, had an outstanding balance of $2.7 million and was performing according to its repayment terms at September 30, 2017.  At September 30, 2017, five land loans totaling $566,000 were on non-accrual status.  See “Lending Activities - Non-performing Loans and Delinquencies.”

Loans secured by undeveloped land or improved lots involve greater risks than one- to four-family residential mortgage loans because these loans are more difficult to evaluate.  If the estimate of value proves to be inaccurate, in the event of default and foreclosure the Bank may be confronted with a property the value of which is insufficient to assure full repayment. Land loans also pose additional risk because of the lack of income being produced by the property and potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions.  The Bank attempts to minimize these risks by generally limiting the maximum loan-to-value ratio on land loans to 75%.

Consumer Lending.  Consumer loans generally have shorter terms to maturity and higher interest rates than mortgage loans.  Consumer loans include home equity lines of credit, second mortgage loans, savings account loans, automobile loans, boat loans, motorcycle loans, recreational vehicle loans and unsecured loans.  Consumer loans are made with both fixed and variable interest rates and with varying terms.  At September 30, 2017, consumer loans amounted to $42.2 million, or 5.4%, of the Bank's total loan portfolio.

At September 30, 2017, the largest component of the consumer loan portfolio consisted of second mortgage loans and home equity lines of credit, which totaled $38.4 million, or 4.9%, of the Bank's total loan portfolio.  Home equity lines of credit and second mortgage loans are made for purposes such as the improvement of residential properties, debt consolidation and education expenses, among others.  The majority of these loans are made to existing customers and are secured by a first or second mortgage on residential property.  The loan-to-value ratio is typically 80% or less, when taking into account both the first and second mortgage loans.  Second mortgage loans typically carry fixed interest rates with a fixed payment over a term between five and 15 years.  Home equity lines of credit are generally made at interest rates tied to the Prime Rate or the 26 week U.S. Treasury Bill.  Second mortgage loans and home equity lines of credit have greater credit risk than one- to four-family residential mortgage loans in which the Bank is in the first lien position because they are generally secured by mortgages subordinated to the existing first mortgage on the property. For those second mortgage loans and home equity lines credit which the Bank does not hold the existing first mortgage on the property, it is unlikely that the Bank will be successful in recovering all or a portion of the loan balance in the event of default unless the Bank is prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.
    
Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability and are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.  The Bank believes that these risks are not as prevalent in the case of the Bank’s consumer loan portfolio because a large percentage of the portfolio consists of second mortgage loans and home equity lines of credit that are underwritten in a manner such that they result in credit risk that is substantially similar to one- to four-family residential mortgage loans.  At September 30, 2017, three consumer loans totaling $258,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”
    
Commercial Business Lending.  Commercial business loans totaled $44.4 million, or 5.7%, of the loan portfolio at September 30, 2017.  Commercial business loans are generally secured by business equipment, accounts receivable, inventory

12


and/or other property and are made at variable rates of interest equal to a negotiated margin above the Prime Rate.  The Bank also generally obtains personal guarantees from the principals based on a review of personal financial statements. The largest commercial business loan had an outstanding balance of $2.0 million at September 30, 2017 and was performing according to its repayment terms.  At September 30, 2017, all commercial business loans were performing according to their repayment terms.  See “Lending Activities - Non-performing Loans and Delinquencies.”
    
The Bank has recently increased commercial business loan originations made under the U.S. Small Business Administration ("SBA") 7(a) program. Loans made by the Bank under the SBA 7(a) program generally are made to small businesses to provide working capital or to provide funding for the purchase of businesses, real estate, or equipment. These loans generally are secured by a combination of assets that may include equipment, receivables, inventory, business real property, and sometimes a lien on the personal residence of the borrower. The terms of these loans vary by purpose and type of underlying collateral. The loans are primarily underwritten on the basis of the borrower's ability to service the loan from income. Under the SBA 7(a) program the loans carry a SBA guaranty up to 85% of the loan. Typical maturities for this type of loan vary up to ten years. SBA 7(a) loans are all adjustable rate loans based on the Prime Rate. Under the SBA 7(a) program, the Bank can sell in the secondary market the guaranteed portion of its SBA 7(a) loans and retain the related unguaranteed portion of these loans, as well as the servicing on such loans, for which it is paid a fee. The loan servicing spread is generally a minimum of 1.00% on all SBA 7(a) loans. The Bank generally offers SBA 7(a) loans within a range of $50,000 to $1.0 million.

Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending.  Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default.  Although commercial business loans are often collateralized by equipment, inventory, accounts receivable and/or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things.  Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.
    
Loan Maturity.  The following table sets forth certain information at September 30, 2017 regarding the dollar amount of loans maturing in the Bank’s portfolio based on their contractual terms to maturity but does not include scheduled payments or potential prepayments.  Loans having no stated maturity and overdrafts are reported as due in one year or less.
 
Within
1 Year
 
After
1 Year
Through
3 Years
 
After
3 Years
Through
5 Years
 
After
5 Years
Through
10 Years
 
After
10 Years
 
Total
 
(Dollars in thousands)
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
566

 
$
1,153

 
$
3,926

 
$
37,196

 
$
75,306

 
$
118,147

Multi-family
2,148

 
1,658

 
8,721

 
45,604

 
476

 
58,607

Commercial
17,590

 
25,041

 
77,884

 
205,061

 
3,351

 
328,927

Construction (1)
168,516

 

 

 

 

 
168,516

Land
11,978

 
6,012

 
2,038

 
2,772

 
1,110

 
23,910

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
Home equity and second mortgage
5,990

 
4,047

 
7,764

 
14,086

 
6,533

 
38,420

Other
1,020

 
309

 
442

 
692

 
1,360

 
3,823

Commercial business loans
24,068

 
3,835

 
8,493

 
7,560

 
488

 
44,444

Total
$
231,876

 
$
42,055

 
$
109,268

 
$
312,971

 
$
88,624

 
784,794

Less:
 

 
 

 
 

 
 

 
 

 
 

Undisbursed portion of construction loans in process
 

 
 

 
 

 
 

 
 

 
(82,411
)
Deferred loan origination fees, net
 

 
 

 
 

 
 

 
 

 
(2,466
)
Allowance for loan losses
 

 
 

 
 

 
 

 
 

 
(9,553
)
Total loans receivable, net
 

 
 

 
 

 
 

 
 

 
$
690,364

_____________
(1)    Includes $117.6 million of construction/permanent loans, a portion of which may convert to permanent mortgage loans once construction is completed.

13



The following table sets forth the dollar amount of all loans due after one year from September 30, 2017, which have fixed interest rates and have floating or adjustable interest rates.
 
Fixed
Rates
 
Floating or
Adjustable Rates
 
Total
 
 (Dollars in thousands)
Mortgage loans:
 
 
 
 
 
One- to four-family
$
28,580

 
$
89,001

 
$
117,581

Multi-family
1,299

 
55,160

 
56,459

Commercial
40,632

 
270,705

 
311,337

Land
4,208

 
7,724

 
11,932

Consumer loans:
 

 
 
 
 

Home equity and second mortgage
9,887

 
22,543

 
32,430

Other
2,224

 
579

 
2,803

Commercial business loans
10,228

 
10,148

 
20,376

Total
$
97,058

 
$
455,860

 
$
552,918

    
Scheduled contractual principal repayments of loans do not reflect the actual life of these assets.  The average life of loans is substantially less than their contractual terms because of prepayments.  In addition, due-on-sale clauses on loans generally give the Bank the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.  The average life of mortgage loans tends to increase when current mortgage loan interest rates are substantially higher than interest rates on existing mortgage loans and, conversely, decrease when interest rates on existing mortgage loans are substantially higher than current mortgage loan interest rates.

Loan Solicitation and Processing.  Loan originations are obtained from a variety of sources, including walk-in customers and referrals from builders and realtors.  Upon receipt of a loan application from a prospective borrower, a credit report and other data are obtained to verify specific information relating to the loan applicant’s employment, income and credit standing.  An appraisal of the real estate offered as collateral generally is undertaken by a certified appraiser retained by the Bank.

Loan applications are initiated by loan officers and are required to be approved by an authorized loan officer or Bank underwriter, one of the Bank’s Loan Committees or the Bank’s Board of Directors.  The Bank’s Consumer Loan Committee consists of several underwriters, each of whom can approve one- to four-family mortgage loans and other consumer loans up to and including the current Freddie Mac single-family limit. Loan officers may also be granted individual approval authority for certain loans up to a maximum of $250,000. The approval authority for individual loan officers is granted on a case by case basis by the Bank's Chief Credit Administrator or President.  All construction loans must be approved by a member of one of the Bank's Loan Committees or the Bank's Board of Directors, or in the case of one- to four- family construction loans that meet Freddie Mac guidelines, by the Regional Manager of Community Lending, the Loan Department Supervisor or a Bank underwriter, subject to their individual or Loan Committee loan limit. The Bank’s Commercial Loan Committee, which consists of the Bank’s President, Chief Credit Administrator, Executive Vice President of Lending and Regional Manager of Community Lending, may approve commercial real estate loans and commercial business loans up to and including $1.5 million. The Bank’s President, Chief Credit Administrator and Executive Vice President of Lending also have individual lending authority for loans up to and including $750,000. The Bank’s Board Loan Committee, which consists of two rotating non-employee Directors and the Bank’s President, may approve loans up to and including $3.0 million.  Loans in excess of $3.0 million, as well as loans of any amount granted to a single borrower whose aggregate loans exceed $3.0 million, must be approved by the Bank’s Board of Directors.

Loan Originations, Purchases and Sales.  During the years ended September 30, 2017, 2016 and 2015, the Bank’s total gross loan originations were $340.6 million, $267.4 million and $262.4 million, respectively.  Periodically, the Bank purchases loan participation interests in construction, commercial real estate and multi-family loans, secured by properties generally located in Washington State, from other banks.  These participation loans are underwritten in accordance with the Bank’s underwriting guidelines and are without recourse to the seller other than for fraud.  During the years ended September 30, 2017, 2016 and 2015, the Bank purchased loan participation interests of $13.1 million, $898,000 and $7.3 million, respectively. 

Consistent with its asset/liability management strategy, the Bank’s policy generally is to retain in its portfolio all ARM loans originated and to sell fixed rate one- to four-family mortgage loans in the secondary market to Freddie Mac; however, from time to time, a portion of fixed-rate loans may be retained in the Bank’s portfolio to meet its asset-liability objectives. The Bank also began selling the guaranteed portion of SBA 7(a) loans in the secondary market during the year ended September 30,

14


2016.  Loans sold in the secondary market are generally sold on a servicing retained basis.  At September 30, 2017, the Bank’s loan servicing portfolio, which is not included in the Company’s consolidated financial statements, totaled $358.2 million.

The Bank also periodically sells participation interests in construction loans, commercial real estate loans, multi-family and commercial business loans to other lenders.  These sales are usually made to avoid concentrations in a particular loan type or concentrations to a particular borrower and to generate fee income.  During the years ended September 30, 2017, 2016 and 2015, the Bank sold loan participation interests of $9.3 million, $321,000, and $3.6 million, respectively.

The following table shows total loans originated, purchased, sold and repaid during the periods indicated.
 
Year Ended September 30,
 
2017
 
2016
 
2015
Loans originated:
(Dollars in thousands)
Mortgage loans:
 
 
 
 
 
   One- to four-family
$
88,642

 
$
74,131

 
$
83,593

   Multi-family
7,841

 
18,340

 
12,643

   Commercial
58,777

 
43,942

 
35,921

   Construction
144,349

 
95,029

 
100,875

   Land
14,056

 
4,515

 
6,570

Consumer
21,999

 
22,569

 
15,140

Commercial business loans
4,947

 
8,824

 
7,699

Total loans originated
340,611

 
267,350

 
262,441

 
 
 
 
 
 
Loans and loan participations purchased:
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

   One- to four-family

 

 
313

   Construction
11,100

 
400

 
5,500

Commercial business
2,000

 
498

 
1,500

Total loans purchased
13,100

 
898

 
7,313

Total loans originated and purchased
353,711

 
268,248

 
269,754

 
 
 
 
 
 
Loans sold:
 

 
 

 
 

Loan participation interests sold
(9,284
)
 
(321
)
 
(3,600
)
Whole loans sold
(72,158
)
 
(58,582
)
 
(53,948
)
Total loans sold
(81,442
)
 
(58,903
)
 
(57,548
)
 
 
 
 
 
 
Loan principal repayments
(211,303
)
 
(155,368
)
 
(148,797
)
Other items, net
(33,748
)
 
4,892

 
(23,985
)
Net increase in loans receivable
$
27,218

 
$
58,869

 
$
39,424


Loan Origination Fees.  The Bank receives loan origination fees on many of its mortgage loans and commercial business loans.  Loan fees are a percentage of the loan which are charged to the borrower for funding the loan.  The amount of fees charged by the Bank is generally up to 2.0% of the loan amount.  Accounting principles generally accepted in the United States of America ("GAAP") require fees received and certain loan origination costs for originating loans to be deferred and amortized into interest income over the contractual life of the loan.  Net deferred fees or costs associated with loans that are prepaid are recognized as income/expense at the time of prepayment.  Unamortized net deferred loan origination fees totaled $2.5 million at September 30, 2017.

Non-performing Loans and Delinquencies.  The Bank assesses late fees or penalty charges on delinquent loans of approximately 5% of the monthly loan payment amount.  A majority of loan payments are due on the first day of the month; however, the borrower is given a 15 day grace period to make the loan payment.  When a mortgage loan borrower fails to make a required payment when due, the Bank institutes collection procedures. A notice is mailed to the borrower 16 days after the date the payment is due.  Attempts to contact the borrower by telephone generally begin on or before the 30th day of delinquency.  If

15


a satisfactory response is not obtained, continuous follow-up contacts are attempted until the loan has been brought current.  Before the 90th day of delinquency, attempts are made to establish (i) the cause of the delinquency, (ii) whether the cause is temporary, (iii) the attitude of the borrower toward repaying the debt, and (iv) a mutually satisfactory arrangement for curing the default.

If the borrower is chronically delinquent and all reasonable means of obtaining payment on time have been exhausted, foreclosure is initiated according to the terms of the security instrument and applicable law.  Interest income on loans in foreclosure is reduced by the full amount of accrued and uncollected interest.

When a consumer loan borrower or commercial business borrower fails to make a required payment on a loan by the payment due date, the Bank institutes similar collection procedures as for its mortgage loan borrowers.  All loans becoming 90 days or more past due are placed on non-accrual status, with any accrued interest reversed against interest income, unless they are well secured and in the process of collection.

The Bank’s Board of Directors is informed monthly as to the status of loans that are delinquent by more than 30 days and the status of all foreclosed and repossessed property owned by the Bank.

The following table sets forth information with respect to the Company's non-performing assets at the dates indicated.
 
At September 30,
 
2017
 
2016
 
2015
 
2014
 
2013
Loans accounted for on a non-accrual basis:
(Dollars in thousands)
Mortgage loans:
 
 
 
 
 
 
 
 
 
   One- to four-family (1)
$
874

 
$
914

 
$
2,368

 
$
4,376

 
$
6,985

   Multi-family

 

 
760

 

 

   Commercial
213

 
612

 
1,016

 
1,468

 
3,435

   Construction

 
367

 

 

 
659

   Land
566

 
548

 
1,558

 
4,564

 
2,146

Consumer loans
258

 
432

 
338

 
501

 
385

Total
1,911

 
2,873

 
6,040

 
10,909

 
13,610

 
 
 
 
 
 
 
 
 
 
Accruing loans which are contractually past due 90 days or more

 
135

 
151

 
812

 
436

Total of non-accrual and 90 days past due loans
1,911

 
3,008

 
6,191

 
11,721

 
14,046

 
 
 
 
 
 
 
 
 
 
Non-accrual investment securities
533

 
734

 
932

 
1,101

 
2,187

 
 
 
 
 
 
 
 
 
 
Other real estate owned and other repossessed assets (2)
3,301

 
4,117

 
7,854

 
9,092

 
11,720

Total non-performing assets (3)
$
5,745

 
$
7,859

 
$
14,977

 
$
21,914

 
$
27,953

 
 
 
 
 
 
 
 
 
 
Troubled debt restructured loans on accrual status (4)
$
3,342

 
$
7,629

 
$
12,485

 
$
16,804

 
$
18,573

 
 

 
 

 
 

 
 

 
 

Non-accrual and 90 days or more past due loans as a percentage of loans receivable, net (5)
0.27
%
 
0.45
%
 
1.02
%
 
2.08
%
 
2.57
%
 
 

 
 

 
 

 
 

 
 

Non-accrual and 90 days or more past due loans as a percentage of total assets
0.20
%
 
0.34
%
 
0.76
%
 
1.57
%
 
1.88
%
 
 
 
 
 
 
 
 
 
 
Non-performing assets as a percentage of total assets
0.60
%
 
0.88
%
 
1.84
%
 
2.94
%
 
3.75
%
 
 
 
 
 
 
 
 
 
 
Loans receivable, net (5)
$
699,917

 
$
672,972

 
$
614,201

 
$
575,280

 
$
557,359

Total assets
$
952,024

 
$
891,388

 
$
815,815

 
$
745,565

 
$
745,648


16


_______________
(1)    Includes non-accrual one- to four-family properties in the process of foreclosure totaling $100, $138,
$1,105, $1,147 and $3,721 as of September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
(2)    Includes foreclosed residential real estate property totaling $875, $1,071, $2,868, $2,903, and $1,752
as of September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
(3)    Does not include troubled debt restructured loans on accrual status.
(4)    Does not include troubled debt restructured loans totaling $253, $531, $1,233, $2,284 and $4,031
recorded as non-accrual loans as of September 30, 2017, 2016, 2015, 2014 and 2013, respectively.
(5)    Loans receivable, net for this table includes the deductions for the undisbursed portion of construction loans in process
and deferred loan origination fees and does not include the deduction for the allowance for loan losses.

The Bank’s non-accrual loans decreased by $1.0 million to $1.9 million at September 30, 2017 from $2.9 million at September 30, 2016, primarily as a result of a $399,000 decrease in commercial real estate loans, a $367,000 decrease in construction loans, and a $174,000 decrease in consumer loans secured by real estate, on non-accrual status.  A discussion of the Bank's largest non-performing loans is set forth below under “Asset Classification.”

Additional interest income which would have been recorded for the year ended September 30, 2017 had non-accruing loans been current in accordance with their original terms totaled $548,000.

Other Real Estate Owned and Other Repossessed Assets.  Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned (“OREO”) until sold.  When property is acquired, it is recorded at the estimated fair market value less estimated costs to sell.  At September 30, 2017, the Bank had $3.3 million of OREO and other repossessed assets consisting of 15 individual properties and one travel trailer, a decrease of $816,000 from $4.1 million at September 30, 2016.  The OREO properties consisted of 11 land parcels totaling $1.9 million, two single family homes totaling $875,000, two commercial real estate properties totaling $533,000, and one travel trailer with a balance of $28,000.  The largest OREO property at September 30, 2017 was an undeveloped land parcel with a balance of $948,000 located in Lewis County.

Restructured Loans.  Under GAAP, the Bank is required to account for certain loan modifications or restructurings as “troubled debt restructurings” or "troubled debt restructured loans."  A troubled debt restructured ("TDR") loan is a loan for which the Company, for reasons related to a borrower's financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. Examples of such concessions include but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market rates; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-amortizations, extensions, deferrals and renewals. TDR loans are considered impaired and are individually evaluated for impairment. TDR loans are classified as either accrual or non-accrual. TDR loans are classified as non-performing loans unless they have been performing in accordance with their modified terms for a period of at least six months. The Bank had TDR loans at September 30, 2017 and 2016 totaling $3.6 million and $8.2 million, respectively, of which $253,000 and $531,000, respectively, were on non-accrual status. The allowance for loan losses allocated to TDR loans at September 30, 2017 and 2016 was $10,000 and $465,000, respectively.

Impaired Loans. In accordance with GAAP, a loan is considered impaired when based on current information and events it is probable that a creditor will be unable to collect all amounts (principal and interest) when due according to the contractual terms of the loan agreement. Smaller balance homogeneous loans, such as residential mortgage loans and consumer loans, may be collectively evaluated for impairment. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when, as an alternative, the current estimated fair value of the collateral, reduced by estimated costs to sell (if applicable), or observable market price is used. The valuation of real estate collateral is subjective in nature and may be adjusted in future periods because of changes in economic conditions. Management considers third-party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling real estate, in determining the estimated fair value of particular properties. In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes and any related adjustments are generally recorded at the time such information is received. When the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest and net deferred loan origination fees or costs), impairment is recognized by creating or adjusting an allocation of the allowance for loan losses and uncollected accrued interest is reversed against interest income. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance.

The categories of non-accrual loans and impaired loans overlap, although they are not identical.  The Bank considers all circumstances regarding the loan and borrower on an individual basis when determining whether an impaired loan should be placed on non-accrual status, such as the financial strength of the borrower, the collateral value, reasons for delay, payment record,

17


the amount past due and the number of days past due.  At September 30, 2017, the Bank had $7.0 million in impaired loans.  For additional information on impaired loans, see Note 4 of the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

Other Loans of Concern.  Loans not reflected in the table above as non-performing, but where known information about possible credit problems of borrowers causes management to have doubts as to the ability of the borrower to comply with present repayment terms and that may result in disclosure of such loans as non-performing assets in the future, are commonly referred to as “other loans of concern” or “potential problem loans.”  The amount included in potential problem loans results from an evaluation, on a loan-by-loan basis, of loans classified as “substandard” and “special mention,” as those terms are defined under “Asset Classification” below.  The amount of potential problem loans (not included in the table above as non-performing) was $9.1 million at September 30, 2017. The vast majority of these loans are collateralized by real estate.  See “Asset Classification” below for additional information regarding the Bank's problem loans.

Asset Classification.  Applicable regulations require that each insured institution review and classify its assets on a regular basis.  In addition, in connection with examinations of insured institutions, regulatory examiners have authority to identify problem assets and, if appropriate, require them to be classified.  There are three classifications for problem assets:  substandard, doubtful and loss.  Substandard loans are classified as those loans that are inadequately protected by the current net worth and paying capacity of the obligor, or of the collateral pledged.  Assets classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt.  If the weakness or weaknesses are not corrected there is the distinct possibility that some loss will be sustained.  Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the Bank is not warranted.  When the Bank classifies problem assets as either substandard or doubtful, it is required to establish allowances for loan losses in an amount deemed prudent by management.  These allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities and the risks associated with particular problem assets.  When the Bank classifies problem assets as loss, it charges off the balance of the asset against the allowance for loan losses.  Assets which do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated by the Bank as special mention.  Special mention loans are defined as those credits deemed by management to have some potential weakness that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in the deterioration of the payment prospects of the loan.  Assets in this category are not adversely classified and currently do not expose the Bank to sufficient risk to warrant a substandard classification. The Bank’s determination of the classification of its assets and the amount of its valuation allowances is subject to review by the FDIC and the Division which can require a different classification and the establishment of additional loss allowances.
    
The aggregate amounts of the Bank’s classified and special mention loans (as determined by the Bank), and of the Bank's  allowances for loan losses at the dates indicated, were as follows:
 
At September 30,
 
2017
 
2016
 
2015
 
(Dollars in thousands)
Loss
$

 
$

 
$

Doubtful

 

 

Substandard (1)(2)
3,253

 
5,036

 
12,717

Special mention (1)
7,783

 
15,065

 
17,016

Total classified and special
   mention loans
$
11,036

 
$
20,101

 
$
29,733

 
 
 
 
 
 
Allowance for loan losses
$
9,553

 
$
9,826

 
$
9,924

_____________
(1)
For further information concerning the change in classified assets, see “Non-performing Loans and Delinquencies" above.
(2)
Includes non-performing loans.
       
Loans classified as substandard decreased by $1.8 million to $3.3 million at September 30, 2017 from $5.0 million at September 30, 2016.  At September 30, 2017, 26 loans were classified as substandard compared to 34 loans at September 30, 2016. Of the $3.3 million in loans classified as substandard at September 30, 2017, $1.9 million were on non-accrual status.  The largest loan classified as substandard at September 30, 2017 had a balance of $524,000 and was secured by a single family home

18


in Pierce County. This loan was performing according to its restructured payment terms at September 30, 2017.  The next largest loan classified as substandard at September 30, 2017 had a balance of $398,000 and was secured by a commercial building in Pierce County. This loan was on non-accrual status at September 30, 2017.

Loans classified as special mention decreased by $7.3 million to $7.8 million at September 30, 2017 from $15.1 million at September 30, 2016, primarily as a result of loans being upgraded to an improved risk grade category and loans being paid off during the year ended September 30, 2017. At September 30, 2017, 19 loans were classified as special mention. The largest loan classified as special mention at September 30, 2017 had a balance of $1.1 million and was secured by an apartment building in Grays Harbor County. This loan was performing according to its payment terms at September 30, 2017. The next largest loan classified as special mention at September 30, 2017 had a balance of $676,000 and was secured by land in Grays Harbor County. This loan was performing according to its payment terms at September 30, 2017.

Allowance for Loan Losses.  The allowance for loan losses is maintained to absorb probable losses inherent in the loan portfolio.  The Bank has established a comprehensive methodology for the determination of provisions for loan losses that takes into consideration the need for an overall general valuation allowance.  The Bank’s methodology for assessing the adequacy of its allowance for loan losses is based on its historic loss experience for various loan segments; adjusted for changes in economic conditions, delinquency rates and other factors.  Using these loss estimate factors, management develops a range of probable loss for each loan category.  Certain individual loans for which full collectibility may not be assured are evaluated individually with loss exposure based on estimated discounted cash flows or net realizable collateral values.  The total estimated range of loss based on these two components of the analysis is compared to the loan loss allowance balance.  Based on this review, management will adjust the allowance as necessary.

In originating loans, the Bank recognizes that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan.  The Bank increases its allowance for loan losses by charging provisions for loan losses against the Bank's operating income.

The Board of Directors reviews the adequacy of the allowance for loan losses at least quarterly based on management's assessment of current economic conditions, past loss and collection experience, and risk characteristics of the loan portfolio.

At September 30, 2017, the Bank’s allowance for loan losses totaled $9.6 million.  The Bank’s allowance for loan losses as a percentage of total loans receivable and non-performing loans was 1.36% and 499.90%, respectively, at September 30, 2017 and 1.46% and 326.66%, respectively, at September 30, 2016. The decrease in the allowance for loan losses as a percentage of total loans receivable was primarily due to a decrease in non-performing loans and overall improvements in other underlying credit quality metrics in the loan portfolio.

Management believes that the amount maintained in the allowance for loan losses is adequate to absorb probable losses inherent in the portfolio. Although management believes that it uses the best information available to make its determinations, future adjustments to the allowance for loan losses may be necessary, and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations.

While the Bank believes it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its allowance for loan losses.  In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.  Any material increase in the allowance for loan losses may adversely affect the Bank's financial condition and results of operations.


19


The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated.
 
Year Ended September 30,
 
2017
 
2016
 
2015
 
2014
 
2013
 
(Dollars in thousands)
Allowance at beginning of year
$
9,826

 
$
9,924

 
$
10,427

 
$
11,136

 
$
11,825

(Recapture of) provision for loan losses
(1,250
)
 

 
(1,525
)
 

 
2,925

 
 
 
 
 
 
 
 
 
 
Recoveries:
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

One- to four-family
21

 
56

 
264

 
194

 
95

Multi-family

 

 
3

 

 

Commercial
1,061

 

 
4

 
4

 
55

Construction - custom and owner/builder

 

 

 

 
26

Construction - speculative one- to four-family
6

 
2

 
2

 

 

Construction - multi-family

 
181

 
1,125

 
251

 

Construction - land development

 

 

 
287

 
146

Land
19

 
24

 
37

 
418

 
54

Consumer loans:
 

 
 

 
 

 
 

 
 

Home equity and second mortgage

 

 
2

 
7

 
5

Other
3

 
2

 
4

 
2

 

Commercial business loans

 
5

 
5

 
24

 
105

Total recoveries
1,110

 
270

 
1,446

 
1,187

 
486

 
 
 
 
 
 
 
 
 
 
Charge-offs:
 

 
 

 
 

 
 

 
 

Mortgage loans:
 

 
 

 
 

 
 

 
 

One- to four-family

 
(72
)
 
(220
)
 
(1,106
)
 
(769
)
Multi-family

 

 

 

 

Commercial
(13
)
 
(209
)
 

 
(463
)
 
(667
)
Construction - custom and owner/builder

 

 

 

 
(26
)
Construction - commercial

 

 

 

 

Construction - multi-family

 

 

 

 
(116
)
Construction - land development

 

 

 

 
(17
)
Land
(110
)
 
(61
)
 
(145
)
 
(260
)
 
(2,307
)
Consumer loans:
 

 
 

 
 

 
 

 
 

Home equity and second mortgage

 
(18
)
 
(50
)
 
(47
)
 
(184
)
Other
(10
)
 
(8
)
 
(9
)
 
(6
)
 
(14
)
Commercial business loans

 

 

 
(14
)
 

Total charge-offs
(133
)
 
(368
)
 
(424
)
 
(1,896
)
 
(4,100
)
Net recoveries (charge-offs)
977

 
(98
)
 
1,022

 
(709
)
 
(3,614
)
 
 
 
 
 
 
 
 
 
 
Allowance at end of year
$
9,553

 
$
9,826

 
$
9,924

 
$
10,427

 
$
11,136

 
 
 
 
 
 
 
 
 
 
Allowance for loan losses as a percentage of total loans receivable (net) outstanding at the end of the year (1)
1.36
%
 
1.46
 %
 
1.62
%
 
1.81
 %
 
2.00
 %
 
 

 
 
 
 

 
 
 
 
Net recoveries (charge-offs) as a percentage of average loans outstanding during the year
0.14
%
 
(0.02
)%
 
0.17
%
 
(0.12
)%
 
(0.65
)%
 
 

 
 

 
 

 
 

 
 

Allowance for loan losses as a percentage of non-performing loans at end of year
499.90
%
 
326.66
 %
 
160.30
%
 
88.96
 %
 
79.28
 %
______________
(1)
Loans receivable, net for this table includes the deductions for the undisbursed portion of construction loans in process and net deferred loan origination fees and does not include the deduction for the allowance for loan losses.

20


The following table sets forth the allocation of the allowance for loan losses by loan category at the dates indicated.

 
At September 30,
 
2017
 
2016
 
2015
 
2014
 
2013
 
Amount
 
Percent
of Loans
in Category
to Total
Loans
 
Amount
 
Percent
of Loans
in Category
to Total
Loans
 
Amount
 
Percent
of Loans
in Category
to Total
Loans
 
Amount
 
Percent
of Loans
in Category
to Total
Loans
 
Amount
 
Percent
of Loans
in Category
to Total
Loans
 
(Dollars in thousands)
Mortgage loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four-family
$
1,082

 
15.05
%
 
$
1,239

 
16.38
%
 
$
1,480

 
17.42
%
 
$
1,650

 
16.10
%
 
$
1,449

 
17.73
%
Multi-family
447

 
7.47

 
473

 
8.61

 
392

 
7.81

 
387

 
7.62

 
749

 
8.85

Commercial
4,184

 
41.91

 
4,384

 
43.18

 
4,065

 
43.47

 
4,836

 
48.54

 
5,275

 
50.44

Construction - custom and owner/builder
699

 
14.99

 
619

 
12.85

 
451

 
9.40

 
605

 
9.85

 
262

 
7.07

Construction - speculative one- to four-family
128

 
1.26

 
130

 
1.12

 
123

 
1.00

 

 
0.42

 
96

 
0.24

Construction - commercial
303

 
2.50

 
268

 
1.29

 
426

 
3.09

 

 
0.55

 
56

 
0.39

Construction - multi-family
173

 
2.72

 
316

 
1.74

 
283

 
3.07

 

 
0.47

 

 
0.01

Construction - land development

 

 

 

 

 

 

 

 

 
0.09

Land
918

 
3.05

 
820

 
2.99

 
1,021

 
3.90

 
1,434

 
4.88

 
1,940

 
5.39

Non-mortgage loans:
 
 
 

 
 

 
 
 
 

 
 

 
 
 
 

 
 

 
 

Consumer loans
1,104

 
5.39

 
1,095

 
6.06

 
1,260

 
5.80

 
1,055

 
6.53

 
982

 
6.76

Commercial business loans
515

 
5.66

 
482

 
5.78

 
423

 
5.04

 
460

 
5.04

 
327

 
3.03

Total allowance for loan losses
$
9,553

 
100.00
%
 
$
9,826

 
100.00
%
 
$
9,924

 
100.00
%
 
$
10,427

 
100.00
%
 
$
11,136

 
100.00
%


21


Investment Activities

The investment policies of the Bank are established and monitored by the Board of Directors.  The policies are designed primarily to provide and maintain liquidity, to generate a favorable return on investments without incurring undue interest rate and credit risk, and to compliment the Bank’s lending activities.  These policies dictate the criteria for classifying securities as either available for sale or held to maturity.  The policies permit investment in various types of liquid assets permissible under applicable regulations, which include U.S. Treasury obligations, securities of various federal agencies, certificates of deposit of insured banks, federal funds, mortgage-backed securities, municipal bonds and mutual funds.  The Company's investment policy also permits investment in equity securities in certain financial service companies.

At September 30, 2017, the Bank’s investment portfolio totaled $8.4 million, consisting of $6.0 million of U.S. Treasury and U.S. government agency securities held to maturity, $1.1 million of mortgage-backed securities held to maturity, $952,000 of mutual funds available for sale and $289,000 of mortgage-backed securities available for sale.  The Bank does not maintain a trading account for any investments.  This compares with a total investment portfolio of $8.9 million at September 30, 2016, consisting of $6.0 million of U.S. Treasury and U.S. government agency securities held to maturity, $1.5 million of mortgage-backed securities held to maturity, $366,000 of mortgage-backed securities available for sale and $976,000 of mutual funds available for sale.  The composition of the portfolios by type of security at the dates indicated is presented in the following table.
 
At September 30,
 
2017
 
2016
 
2015
 
Recorded
Amount
 
Percent of
Total
 
Recorded
Amount
 
Percent of
Total
 
Recorded
Amount
 
Percent of
Total
 
(Dollars in thousands)
Held to Maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S.Treasury and U.S. government agency securities
$
6,008

 
71.69
%
 
$
6,006

 
67.84
%
 
$
6,004

 
64.52
%
Mortgage-backed securities
1,131

 
13.50

 
1,505

 
17.00

 
1,909

 
20.52

 
 
 
 
 
 
 
 
 
 
 
 
Available for Sale:
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
289

 
3.45

 
366

 
4.13

 
421

 
4.52

Mutual funds
952

 
11.36

 
976

 
11.03

 
971

 
10.44

 
 
 
 
 
 
 
 
 
 
 
 
Total portfolio
$
8,380

 
100.0
%
 
$
8,853

 
100.0
%
 
$
9,305

 
100.0
%

The following table sets forth the maturities and weighted average yields of the securities in the Bank's portfolio at September 30, 2017.  Mutual funds, which by their nature do not have maturities, are classified in the one year or less category.
 
One Year or Less
 
After One to
Five Years
 
After Five to
Ten Years
 
After Ten
Years
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
(Dollars in thousands)
Held to Maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and U.S. government agency securities
$

 
%
 
$
5,995

 
1.60
%
 
$

 
%
 
$

 
%
Mortgage-backed securities
14

 
3.98

 
1

 
2.33

 
28

 
2.90

 
1,101

 
7.72

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available for Sale: