Item 1A. Risk Factors
We assume and manage a certain degree of risk in order to conduct our business. In addition to the risk factors described below, other risks and uncertainties not specifically mentioned, or that are currently known to, or deemed to be immaterial by management, also may materially and adversely affect our financial position, results of operations and/or cash flows. Before making an investment decision, you should carefully consider the risks described below together with all the other information included in this Form 10-K and our other filings with the SEC. If any of the circumstances described in the following risk factors actually occur to a significant degree, the value of our common stock could decline, and you could lose all or part of your investment. This report is qualified in its entirety by these risk factors.
Risks Related to Economic Conditions
Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.
Substantially all our loans are to businesses and individuals in the state of Washington. Recessionary conditions or adverse economic conditions in our local market areas of Grays Harbor, Pierce, Thurston, King, Kitsap and Lewis counties Washington, which we consider to be our primary market area, may reduce our rate of growth, affect our customers' ability to repay loans and adversely impact our business, financial condition, and results of operations. General economic conditions, including inflation, unemployment and money supply fluctuations, also may adversely affect our profitability. Weakness in the global economy and global supply chain issues have adversely affected many businesses operating in our markets that are dependent upon international trade. Changes in agreements or relationships between the United States and other countries may further impact these businesses and, by extension, our operations.
A deterioration in economic conditions in the market areas we serve as a result of inflation, a recession, war, geopolitical conflicts, adverse weather or other factors could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
•loan delinquencies, problem assets and foreclosures may increase;
•we may increase our ACL;
•the sale of foreclosed assets may slow;
•demand for our products and services may decline possibly resulting in a decrease in our total loans, total deposits, or assets;
•collateral for loans made may decline in value, exposing us to increased risk loans, reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
•reduction in our low-cost or noninterest-bearing deposits.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loans are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower's ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, government rules or policies and natural disasters such as fires and earthquakes. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.
External economic factors, such as changes in monetary policy and inflation and deflation, may have an adverse effect on our business, financial condition and results of operations.
Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve. Actions by monetary and fiscal authorities, including the Federal Reserve, could lead to inflation, deflation, or other economic phenomena that could adversely affect our financial performance. Inflation has risen sharply since the end of 2021 and throughout 2022 at levels not seen for over 40 years. Inflationary pressures dissipated throughout fiscal 2024, with the annual inflation rate in the United States decreasing to 2.4% during September 2024 from its high of 7.0% in December 2021,
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as reported by the U.S. Bureau of Labor Statistics. Small to medium-sized businesses may be impacted more during periods of high inflation as they are not able to leverage economies of scale to mitigate cost pressures compared to larger businesses. Consequently, the ability of our business customers to repay their loans may deteriorate, which would adversely impact our results of operations and financial condition. Furthermore, a prolonged period of inflation could cause wages and other costs to the Company to increase, which could adversely affect our results of operations and financial condition.Virtually all our assets and liabilities are monetary in nature. As a result, interest rates tend to have a more significant impact on our performance than general levels of inflation or deflation. Interest rates do not necessarily move in the same direction or by the same magnitude as the prices of goods and services.
Risks Related to our Lending Activities
Our real estate construction and land loans expose us to significant risks.
We specialize in real estate construction loans for individuals and builders, mainly focusing on residential property development. Our loans are initiated regardless of whether the property used as collateral is under a sales contract. As of September 30, 2024, our construction loans totaled $219.20 million, comprising 14.5% of our overall loan portfolio. These were allocated as follows: $172.00 million for residential real estate projects, $29.46 million for commercial projects, and $17.74 million for land development. Notably, approximately $132.10 million of our residential construction loans are structured to convert into permanent loans upon construction completion.
Construction lending involves inherent risks due to estimating costs in relation to project values. Uncertainties in construction costs, market value, and regulatory impacts make accurately evaluating total project funds and loan-to-value ratios challenging. Factors like shifts in housing demand and unexpected building costs can significantly deviate actual results from estimates. Additionally, this type of lending often involves higher principal amounts and might be concentrated among a few builders. A downturn in housing or real estate markets could escalate delinquencies, defaults, foreclosures, and compromise collateral value.
Some builders have multiple outstanding loans, meaning problems with one loan pose a substantial risk to us. Moreover, certain construction loans do not require borrower payments during the term, accumulating interest into the principal. Thus, repayment depends heavily on project success and the borrower's ability to sell, lease, or secure permanent financing, rather than their ability to repay principal and interest directly.
Misjudging a project's value could leave us with inadequate security and potential losses upon completion. Actively monitoring construction loans, involving cost comparisons and on-site inspections, adds complexity and cost. Market interest rate hikes also might significantly impact construction loans, affecting end-purchaser borrowing costs, potentially reducing demand or the homeowner's ability to finance the completed home. Further, properties under construction are hard to sell and often need completion for successful sales, complicating problem loan resolution. This might require additional funds or engaging another builder, incurring additional costs and market risks. Moreover, speculative construction loans pose additional risks, especially regarding finding end-purchasers for finished projects. As of September 30, 2024, $11.50 million of our construction portfolio consisted of speculative one- to four-family construction loans.
We also offer land loans for land acquisition, which can be used for building or recreational purposes. As of September 30, 2024, land loans accounted for $29.37 million, or 1.9% of our total loan portfolio. Loans for land development or future construction carry additional risks due to longer development periods, vulnerability to real estate value declines, economic fluctuations delaying projects, political changes affecting land use, and the collateral's illiquid nature. During this extended financing-to-completion period, the collateral often generates no cash flow.
As of September 30, 2024, all our construction and land loans were performing according to their terms. A significant rise in non-performing construction or land loans could materially impact our financial condition and results of operations.
Our emphasis on commercial real estate lending may expose us to increased lending risks.
Our current business strategy includes an emphasis on commercial real estate lending. This type of lending activity, while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. In addition, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
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At September 30, 2024, we had $599.22 million of commercial real estate loans, representing 39.6% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial real estate loans also expose a lender to greater credit risk than loans secured by residential real estate, because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property to make the payment, which may increase the risk of default or non-payment.
A secondary market for most types of commercial real estate loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all our interest in these loans. As a result of these characteristics, if we foreclose on a commercial real estate loan, our holding period for the collateral typically is longer than for one- to four-family residential mortgage loans because there are fewer potential purchasers of the collateral.Accordingly, charge-offs on commercial real estate loans may be larger as a percentage of the total principal outstanding than those incurred with our residential or consumer loan portfolios.
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
At September 30, 2024, we had $139.00 million, or 9.2%, of total loans in commercial business loans. Our business loans are primarily made based on borrowers’ cash flow, with collateral as a secondary factor. However, the unpredictability of borrowers' cash flow and the fluctuating value of collateral, often in the form of accounts receivable, inventory, or equipment, present significant risks. Loans secured by accounts receivable are contingent on the borrower's ability to collect from their customers, while other collateral may depreciate, be challenging to assess, lack liquidity, and vary in value based on the success of the business. Additionally, economic fluctuations can significantly impact borrowers' repayment abilities, more so than loans secured by real estate.
Our business may be adversely affected by credit risk associated with residential property.
At September 30, 2024, $347.04 million, or 22.9% of our total loan portfolio was secured by one- to four-family mortgage loans and home equity loans. This type of lending is highly sensitive to regional economic conditions, which can affect borrowers' ability to meet their payment obligations and make loss levels difficult to predict. Factors such as higher interest rates, recessionary conditions, lower real estate sales volumes and prices, and elevated unemployment may lead to higher loan delinquencies, problem assets, and reduced demand for our products and services, adversely impacting our capital, liquidity, and financial condition.
A decline in residential real estate values, particularly in the Washington housing market, may reduce the value of collateral securing these loans and increase our risk of loss if borrowers default. Some of our residential mortgage loans are secured by properties with little or no borrower equity, either due to high loan-to-value ratios at origination or declining home values. Loans with higher loan-to-value ratios are more sensitive to declining property values, resulting in a higher risk of default and loss. Additionally, for home equity lines of credit secured by second mortgages, recovering loan proceeds in the event of default may be difficult unless we repay the first mortgage, which may not be justified by the property’s value. Consequently, we may experience higher rates of delinquency, default, and losses on our residential loans.
Our allowance for credit losses on loans may not be sufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business. Every loan carries a risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment.This risk is affected by, among other things:
•the cash flow of the borrower and/or the project being financed;
•the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
•the duration of the loan;
•the credit history of a particular borrower; and
•changes in economic and industry conditions.
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To address these risks, we maintain an allowance for credit losses on loans, which is a reserve established through a provision for credit losses on loans charged against operating income, that we believe is appropriate to provide for expected losses in our loan portfolio. The appropriate level of the allowance of credit losses is determined by management through periodic comprehensive reviews and consideration of several factors, including, but not limited to our collective loss reserve, for loans evaluated on a pool basis with similar risk characteristics based on our life of loan historical default and loss experience, certain macroeconomic factors, reasonable and supportable forecasts, regulatory requirements, management’s expectations of future events and certain qualitative factors.
The ACL is an estimate of the expected credit losses on financial assets measured at amortized cost. The ACL is evaluated and calculated on a collective basis for those loans which share similar risk characteristics. For loans that do not share similar risk characteristics and cannot be evaluated on a collective basis, the Company will evaluate the loan individually using the present value of the expected future cash flows or the fair value of the underlying collateral.
The determination of the appropriate level of the allowance for credit losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for credit losses for loans may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for increases in our allowance for credit losses through the provision for credit losses which is charged against income. Management also recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our allowance may be insufficient to absorb losses without significant additional provisions. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may also require an increase in the allowance for credit losses.
Bank regulatory agencies also periodically review our allowance for credit losses and may require an increase in the provision for possible credit losses or the recognition of further loan charge-offs based on their judgment about information available to them at the time of their examination. If charge-offs in future periods exceed the allowance for credit losses, we may need additional provisions to increase the allowance for credit losses. Any increases in the allowance for credit losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations, liquidity and capital.
If our non-performing assets increase, our earnings will be adversely affected.
At September 30, 2024, our non-performing assets (which consisted solely of non-accruing loans, non-accrual investment securities, and OREO) were $3.94 million, or 0.2% of total assets. Our non-performing assets adversely affect our net income in various ways:
•We do not record interest income on non-accrual loans or non-performing investment securities, except on a cash basis when the collectability of the principal is not in doubt.
•We must recognize expected credit losses through a current period charge to the provision for credit losses.
•Non-interest expense increases if we must write down the value of OREO properties to reflect market declines.
•Non-interest income decreases when we recognize other-than-temporary impairment on non-performing investment securities.
•There are legal fees and carrying costs (such as taxes, insurance, and maintenance) associated with OREO.
•Managing non-performing assets requires significant management attention, diverting resources from more profitable activities.
If delinquencies increase and we are unable to effectively manage our non-performing assets, our losses and troubled assets could increase significantly, materially impacting our financial condition and results of operations.
Risk Related to our Business Strategy
We may be adversely affected by risks associated with completed and potential acquisitions.
As part of our general growth strategy, on October 1, 2018, we completed the acquisition of South Sound Bank, a Washington-state chartered bank, headquartered in Olympia, Washington. Although our business strategy emphasizes organic expansion, we also look for and evaluate potential acquisition opportunities. There can be no assurance that we will successfully identify suitable acquisition candidates, complete acquisitions or successfully integrate acquired operations into our existing operations or expand into new markets. The consummation of any future acquisitions may dilute shareholder value or may have an
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adverse effect upon our operating results while the operations of the acquired business are being integrated into our operations. In addition, once integrated, acquired operations may not achieve levels of profitability comparable to those achieved by our existing operations, or otherwise perform as expected. Further, transaction-related expenses may adversely affect our earnings. These adverse effects on our earnings and results of operations may have a negative impact on the value of our common stock. Acquiring banks, bank branches or businesses involves risks commonly associated with acquisitions, including:
•We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets, and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;
•We could experience higher than expected deposit attrition;
•The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal adverse effect on the acquired business and its customers, we may not be able to realize the anticipated economic benefits of the acquisition within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful;
•To the extent that our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill. As discussed below, we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operation and financial condition; and
•We expect that our net income will increase following an acquisition; however, we also expect our general and administrative expenses to increase, which could result to an increase in our efficiency ratio. Ultimately, we would expect our efficiency ratio to improve; however, if we are not successful in our integration process, this may not occur, and our acquisition or branching activities may not be accretive to earnings in the short or long-term.
Risk Related to Market Interest Rates
Changes in interest rates may reduce our net interest income and may result in higher defaults in a rising rate environment.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Since March 2022, in response to inflation, the Federal Open Market Committee ("FOMC") of the Federal Reserve has increased the target range for the federal funds rate by 475 basis points, including 50 basis points reduction during the 2024 fiscal year, to a range of 4.75% to 5.00% as of September 30, 2024. The FOMC has reduced the target federal funds rate by an additional 25 basis points in November of 2024 to the target federal funds rate and has not ruled out future decreases but hinted that rates will remain higher for longer. If the FOMC further decreases the targeted federal funds rate, overall interest rates will likely decrease, which may negatively impact our net interest income, but could positively impact both the housing market by increasing refinancing activity and new home purchases and the U.S. economy.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect: (1) our ability to originate and/or sell loans and obtain deposits; (2) the fair value of our financial assets and liabilities, which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of such assets; (3) our ability to obtain and retain deposits in competition with other available investment alternatives; (4) the ability of our borrowers to repay adjustable or variable rate loans; and (5) the average duration of our investment securities portfolio and other interest-earning assets. If the interest rates paid on deposits and borrowings increase at a faster rate than the interest received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments decline more rapidly than the interest rates paid on deposits and other borrowings. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations or by reducing our margins and profitability. Net interest margin is the difference between the yield we earn on interest-earning assets and the rate we pay for deposits and other sources of funding. Changes in interest rates (up or down) could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our interest-earning assets and our funding costs tends to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Changes in the slope of the
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"yield curve," or the spread between short-term and long-term interest rates, could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs. Under these circumstances we are subject to reinvestment risk as we may have to redeploy such repayment proceeds into lower yielding investments, which would likely negatively impact our income.
A sustained increase or decrease in market interest rates could adversely affect our earnings. As is the case with many financial institutions, our emphasis on increasing core deposits, those deposits bearing no or a relatively low rate of interest with no stated maturity, has resulted in our having a significant amount of these deposits which have a shorter duration than our assets. At September 30, 2024, we had $313.82 million in certificates of deposit that mature within one year and $1.28 billion in non-interest bearing, NOW checking, savings and money market accounts. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. In addition, a substantial amount of our residential mortgage loans and home equity lines of credit have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment.
Changes in interest rates also affect the value of our investment securities available for sale. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on investment securities available for sale are reported as a separate component of equity, net of tax. Increases in the fair value of investment securities available for sale resulting from decreases in interest rates could have a positive effect on stockholders' equity. Stockholders' equity, specifically accumulated other comprehensive income (loss) ("AOCI"), is increased or decreased by the amount of change in the estimated fair value of our securities available for sale, net of deferred income taxes. Increases in interest rates generally decrease the fair value of securities available for sale, which adversely impacts stockholders' equity.
Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition, liquidity and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results. For further discussion of how changes in interest rates could impact us, see "Part II, Item 7A. Quantitative and Qualitative Disclosures About Market Risk" for additional information about our interest rate risk management.
Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. The Company analyzes investment securities to determine whether there have been any events or economic circumstances to indicate that a security has incurred a credit-related loss. The Company considers many factors including recent events specific to the issuer or industry, and for securities, external credit ratings and recent downgrades. Credit component losses are reported in allowance for credit losses in the income statement when the present value of expected future cash flows is less than the amortized cost. Noncredit component losses are recorded in other comprehensive income (loss) when the Company (1) does not intend to sell the security or (2) is not more likely than not to have to sell the security prior to the security’s anticipated recovery. There can be no assurance that the declines in market value will not result in ACL on investments, and lead to accounting charges that could have a material adverse effect on our business, financial condition and results of operations.
An increase in interest rates, change in the programs offered by Freddie Mac or our ability to qualify for their programs may reduce our mortgage revenues, which would negatively impact our non-interest income.
The sale of residential mortgage loans to Freddie Mac has historically provided a significant portion of our noninterest income. Any future changes in its program, including our eligibility to participate in such program, the criteria for loans to be accepted or laws that significantly affect the activity of Freddie Mac could, in turn, materially adversely affect our results of operations if we could not find other purchasers. Mortgage banking is generally considered a volatile source of income because it depends largely on the level of loan volume which, in turn, depends largely on prevailing market interest rates. In a rising or higher interest rate environment, the demand for mortgage loans, particularly refinancing of existing mortgage loans, tends to fall and our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold. This would result in a decrease in mortgage revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expense associated with our loan sale activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the
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decline in loan originations. In addition, although we sell loans to Freddie Mac or into the secondary market without recourse, we are required to give customary representations and warranties about the loans we sell. If we breach those representations and warranties, we may be required to repurchase the loans and we may incur a loss on the repurchase.
Risks Related to Laws and Regulations
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors (i) total reported loans for construction, land development and other land represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm non-residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. We have concluded that we do not have a concentration in commercial real estate lending because our balance in commercial real estate loans (including owner-occupied loans) at September 30, 2024 represented 290.74% of total capital. While we believe that we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations that could increase our costs of operations.
The financial services industry is extensively regulated. Federal banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a company's shareholders. These regulations may sometimes impose significant limitations on our operations. These regulations, along with existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Any new regulations or legislation, change in existing regulations or oversight, whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability. In this regard, the U.S. Department of the Treasury's Financial Crimes Enforcement Network ("FinCEN"), published guidelines in 2014 for financial institutions servicing marijuana businesses that are legal under state law. These guidelines allow us to work with marijuana-related businesses that are operating in accordance with state laws and regulations as long as we comply with required regulatory oversight of their accounts with us. In addition, legislation is currently pending in Congress that would allow banks and financial institutions to serve marijuana businesses in states where it is legal without any risk of federal prosecution. At September 30, 2024, approximately 1.1% of our total deposits and a portion of our service charges from deposits are from legal marijuana-related businesses. Any adverse change in this FinCEN guidance, any new regulations or legislation, any change in existing regulations or oversight, whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a negative impact on our non-interest income, as well as the cost of our operations, increasing our cost of regulatory compliance and of doing business and/or otherwise affect us, which may materially affect our profitability.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
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Climate change and related legislative and regulatory initiatives may materially affect our business and results of operations.
Climate change continues to be a pressing concern, prompting heightened awareness and action on a global scale. Efforts include international agreements such as the Paris Agreement, with the United States rejoining, and ongoing initiatives at various governmental levels to address climate-related issues. Under the current administration, additional measures are anticipated, potentially impacting banks' risk management practices, stress testing, credit portfolio concentrations, and investment strategies. The lack of empirical data makes it challenging to predict the precise financial impact of climate change, though its physical effects, such as more frequent weather disasters, could directly affect our real estate collateral and loan portfolios. Inadequate insurance coverage for borrowers may compound these risks, impacting our financial condition. Furthermore, climate change's broader economic effects could adversely affect our customers and the communities we serve, potentially impacting our financial performance.
On March 6, 2024, the SEC implemented new climate-related disclosure rules for U.S. public companies and foreign private issuers. These rules introduce extensive disclosure requirements, increasing reporting costs, risks, and complexity. Challenges include short compliance timelines, interpretive issues, legal liabilities, and global regulatory overlaps. Lawsuits contesting these rules add further uncertainty. However, on March 15, 2024, the Fifth Circuit granted an administrative stay, temporarily halting the implementation of the SEC's climate rules.
Risks Related to Cybersecurity, Third-Parties and Technology
As of September 30, 2024 there has not been any cybersecurity or related breach of the risk factors discussed below that would require disclosure.
The financial services market is undergoing rapid technological changes and, if we are unable to stay current with those changes, we may not be able to effectively compete.
The financial services market, including banking services, is undergoing rapid changes with frequent introductions of new technology-driven products and services. Our future success will depend, in part, on our ability to keep pace with the technological changes and to use technology to satisfy and grow customer demand for our products and services and to create additional efficiencies in our operations. Some of our competitors have substantially greater resources to invest in technological improvements and will be able to invest more heavily in developing and adopting new technologies, which may put us at a competitive disadvantage. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. As a result, our ability to effectively compete to retain or acquire new business may be impaired, and our business, financial condition or results of operations may be adversely affected.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack. Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions. Any compromise of our security could deter customers from using our internet banking services that involve the transmission of confidential information. Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyberattacks and periodically test our security, these
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precautions may not protect our systems from compromises or breaches of our security measures, and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operation.
Our security measures may not protect us from system failures or interruptions. While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. While the Company selects third-party vendors carefully, it does not control their actions. If our third-party providers encounter difficulties, including those resulting from breakdowns, or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third-parties on which we rely. We may not be insured against all types of losses as a result of third-party failures and insurance coverage may be inadequate to cover all losses, resulting from breaches, systems failures or other disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure that we could negotiate terms that are as favorable to us or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our business financial condition and results of operations.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
We are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customers' information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
We rely on other companies to provide key components of our business infrastructure.
We rely on certain external vendors to provide products and services necessary to maintain our day-to-day operations. These third-party vendors are sources of operational and informational security risks to us, including risks associated with operational errors, information system failures, interruptions or breaches and unauthorized disclosures of sensitive or confidential client or customer information. If these vendors encounter any of these issues, or if we have difficulty communicating with them, we could be exposed to disruption of operations, loss of service or connectivity to customers, reputational damage, and litigation risk that could have a material adverse effect on our business and, in turn, our financial condition and results of operations.
Risks Related to Accounting Matters
The Company’s reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates, which, if incorrect, could cause unexpected losses in the future.
The Company’s accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. The Company’s management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment regarding the most appropriate manner to report the Company’s financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances, yet might result in the Company’s reporting materially different results than would have been reported under a different alternative.
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Certain accounting policies, most notably the accounting for credit losses, are critical to presenting the Company’s financial condition and results of operations. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. For more information, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates” contained in this 2024 Form 10-K.
We may experience future goodwill impairment, which could reduce our earnings.
In accordance with GAAP, we record assets acquired and liabilities assumed in a business combination at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. As a result, acquisitions typically result in recording goodwill. We perform a goodwill evaluation at least annually to test for goodwill impairment. Our test of goodwill for potential impairment is based on a qualitative assessment by management that takes into consideration macroeconomic conditions, industry and market conditions, cost or margin factors, financial performance and share price. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If our judgment was incorrect, or if events or circumstances change, and an impairment of goodwill was deemed to exist, we would be required to record a non-cash charge to earnings in our financial statements during the period in which such impairment is determined to exist. Any such charge could have a material adverse effect on our results of operations.
We are subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line items and affect our profitability.
Our business operations are significantly influenced by the extensive body of accounting regulations in the United States. Regulatory bodies periodically issue new guidance, altering accounting rules and reporting requirements, which can substantially affect the preparation and reporting of our financial statements. These changes might necessitate retrospective application, potentially leading to restatements of prior period financial statements.
One such significant change in fiscal 2024 was the implementation of the CECL model, which we adopted on October 1, 2023.Under the CECL model, financial assets carried at amortized cost, such as loans and held-to-maturity debt securities, are presented at the net amount expected to be collected. This forward-looking approach in estimating expected credit losses contrasts starkly with the prior, "incurred loss" model, which delays recognition until a loss is probable. CECL mandates considering historical experience, current conditions, and reasonable forecasts affecting collectability, leading to periodic adjustments of financial asset values. However, this forward-looking methodology, reliant on macroeconomic variables, introduces the potential for increased earnings volatility due to unexpected changes in these indicators between periods. An additional consequence of CECL is an accounting asymmetry between loan-related income, recognized periodically based on the effective interest method, and credit losses, recognized upfront at origination. This asymmetry might create the perception of reduced profitability during loan expansion periods due to the immediate recognition of expected credit losses. Conversely, periods with stable or declining loan levels might seem relatively more profitable as income accrues gradually for loans where losses had been previously recognized.
As a result of the change in methodology from the incurred loss model to the CECL model, on October 1, 2023, the Company recorded a one-time, net of tax charge of $488,000 to retained earnings, a $461,000 increase to the allowance for credit losses on loans, a $92,000 increase to the allowance for credit losses on investment securities and a $65,000 increase to the allowance for credit losses on unfunded commitments.
We may experience decreases in the fair value of our loan servicing rights, which could reduce our earnings.
Loan servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold with servicing rights retained. At September 30, 2024, our loan servicing rights totaled $1.37 million. Loan servicing rights are amortized to servicing income on loans sold over the period of estimated net servicing income. The estimated fair value of loan servicing rights at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans. On a quarterly basis, we evaluate the fair value of loan servicing rights for impairment by comparing actual cash flows and estimated cash flows from the loan servicing assets to those estimated at the time loan servicing assets were originated. Our methodology for estimating the fair value of loan servicing rights is highly sensitive to changes in assumptions, such as prepayment speeds. The effect of changes in market interest rates on estimated rates of loan prepayments represents the predominant risk characteristic underlying the loan servicing rights portfolio. For example, a decrease in interest rates typically increases the prepayment speeds of loan servicing rights and therefore decreases the fair value of the loan servicing rights.
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Future decreases in interest rates could decrease the fair value of our loan servicing rights below their recorded amount, which would decrease our earnings.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation allowances, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property is taken in as OREO, and at certain other times during the asset's holding period. Our net book value (“NBV”) in the loan at the time of foreclosure and thereafter is compared to the updated estimated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s NBV over its fair value. If our valuation process is incorrect or if the property declines in value after foreclosure, the fair value of our OREO may not be sufficient to recover our NBV in such assets, resulting in the need for a valuation allowance.
In addition, bank regulators periodically review any OREO we may have and may require us to recognize further valuation allowances. Significant charge-offs to our OREO may have an adverse effect on our financial condition and results of operations.
Other Risks Related to Our Business
Ineffective liquidity management could adversely affect our financial results and condition.
Liquidity is essential to our business. We rely on several sources to meet our potential liquidity demands. Our primary sources of liquidity are increases in deposit accounts, cash flows from loan payments and our securities portfolio. Borrowings also provide us with a source of funds to meet liquidity demands. An inability to raise funds through deposits, borrowings, the sale of loans or other sources could have a substantial negative effect on our liquidity. Although we have historically been able to replace maturing deposits and borrowings if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or FRB, or market conditions change.Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a downturn in the Washington markets in which our loans and deposits are concentrated, negative operating results, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets. Any decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have a material adverse effect on our business, financial condition and results of operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity” of this Form 10-K.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be exceedingly high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. If we are able to raise capital, it may not be on terms that are acceptable to us. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, any additional capital we obtain may dilute the interests of existing holders of our common stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
Our framework for managing risks may not be effective in mitigating risk and loss to us.
We have established processes and procedures intended to identify, measure, monitor, report, analyze and control the types of risk to which we are subject. These risks include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal and compliance risk, and reputational risk, among others. We also maintain a compliance program to identify, measure, assess and report on our adherence to applicable laws, policies and procedures. While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs, along with other related controls, will effectively mitigate all risk and limit losses in our business. As with any risk management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the future, risks that we have not appropriately
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anticipated or identified. If our risk management framework proves ineffective, we could suffer unexpected losses which could have a material adverse effect on our financial condition and results of operations.
We are dependent on key personnel, and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense, and there are a limited number of qualified persons with knowledge of, and experience in, the community banking industry where the Bank conducts its business. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our Chief Executive Officer and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our directors, and we may not be able to identify and attract suitable candidates to replace such directors.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 1C. Cybersecurity
Cyber Risk Management and Strategy
Safeguarding the confidentiality, integrity and availability of customer and sensitive financial data, records and transactions is essential to Timberland and Timberland Bank. Our risk management program is designed to identify, assess and mitigate risks across various aspects of the Bank, including financial, operational, regulatory, reputational and legal.
Cybersecurity is a critical component of our risk management program; thus we have implemented a Cyber and Information Security Program to protect the confidentiality, integrity and availability of our information and information technology environment. Our program aligns with applicable federal and state regulations, industry frameworks such as the Federal Financial Institutions Examination Council ("FFIEC") and best practices from the National Institute of Standards and Technology ("NIST"). The FFIEC framework offers a set of guidelines to help financial institutions effectively manage and mitigate cybersecurity risks. The framework focuses on ensuring the confidentiality, integrity and availability of sensitive information. NIST is part of the U.S. Department of Commerce, which develops cybersecurity standards, guidelines and other resources.
We have employed a multi-layered, risk-based approach to cyber and information security, incorporating a variety of tools and processes to aid in risk identification, assessment and management. The Bank conducts a variety of information security risk assessments throughout the year. We employ a defense in depth strategy that incorporates preventive, detective, and administrative safeguards including but not limited to, configuration hardening, robust patch management and vulnerability scanning, advanced anti-malware firewall technologies, anti-phishing and web filtering controls. These controls are tested annually by an independent third-party audit firm. Quarterly employee training is performed on cybersecurity, information security, identify theft prevention and data privacy.
The Bank has not experienced any material losses relating to cybersecurity threats or incidents to date.
Incident Response
Response to cyber incidents is guided by the Bank’s Incident Response Policy. The Bank’s plan is based on the National Infrastructure Protection Center ("NIPC") guidelines, with the addition of specific reporting and notification requirements required by regulation. The Incident Response Policy prescribes points of escalation and mechanisms for collaboration should the need arise to engage outside partnerships such as external counsel, cybersecurity forensic examiners, cyber insurance vendors, government agencies and regulatory bodies.
Third Party Service Provider Monitoring
The Bank maintains a robust Vendor Management Program to appropriately measure, monitor and control risks associated with outsourcing products and services, including cybersecurity risks. Under the program, vendors are assigned a risk rating based
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on an assessment of the vendor and its access to network, systems and confidential information. The Bank’s Information Security Officer conducts regular periodic reviews of the adequacy of its oversight of controls over third party relationships.
Cybersecurity Governance
Timberland Bank’s Board of Directors (“Board”) recognizes the significance of cybersecurity risks and provides oversight of the Bank’s Cyber and Information Security Program. The Bank’s Board of Directors is currently comprised of the Chief Executive Officer and seven non-employee directors; one of which has completed and received Cybersecurity Oversight Certification from the National Association of Corporate Directors (“NACD”).The Bank’s primary responsibility for managing cyber risk is vested in the Bank’s Information Security Analyst ("ISA"). The ISA reports to the Chief Risk Officer and serves as the primary custodian of the Bank’s Cyber Security and Information Security Program.
The Technology Steering Committee meets on a regular basis and is tasked with providing oversight and guidance regarding both information technology and cybersecurity related issues of strategic importance to the Bank. The Technology Steering Committee is comprised of numerous members of the management team, Chief Technology Officer ("CTO") and ISA. The Technology Steering committee reports to the Board of Directors through Committee minutes.
The Board Technology Committee assists the Board of Directors in fulfilling its oversight responsibilities with respect to the overall role of technology in executing the business strategy of the institution, including but not limited to major technology investments, technology strategy, operational performance and technology trends that may affect customers. The Board Technology Committee meets regularly and receives reports from the CTO and ISA on cybersecurity and information technology risks. The Board Technology Committee reports to the Board of Directors through Committee minutes.
The Board’s Audit Committee also has oversight responsibility for audits related to information technology, security and information technology governance.
Item 2. Properties
At September 30, 2024, the Company maintained its headquarters in Hoquiam, Washington, along with 23 full-service bank branches and four administrative offices with an aggregate net book value of $18.51 million. The Company's owns all properties except for one administrative office, the Tacoma branch and the Downtown Lacey branch, which are leased. The lease terms for our branches are not individually material. In addition, the Bank operated 24 proprietary automated teller machines ("ATMs") that are part of a nationwide cash exchange network as of September 30, 2024. In the opinion of management, all properties are adequately covered by insurance, are in a good state of repair and are suitable for the Company's needs. For additional information see "Note 5 - Premises and Equipment" and "Note 9 - Leases" of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
Item 3. Legal Proceedings
Periodically, there have been various claims and lawsuits involving the Company, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Company's business. The Company is not currently a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders
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The Company's common stock is traded on the Nasdaq Global Market under the symbol “TSBK.” As of December 4, 2024, there were approximately 401 shareholders of record of the Company's common stock.
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Dividends
Our cash dividend payout policy is reviewed regularly by management and the Board of Directors. Our Board of Directors has declared quarterly cash dividends on our common stock for 48 consecutive quarters. Any dividends declared and paid in the future would depend upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods. Our future payment of dividends may depend, in part, upon receipt of dividends from the Bank, which are restricted by banking regulations.
Stock Repurchases
The following table sets forth the Company's repurchases of its outstanding common stock during the fourth quarter of the year ended September 30, 2024:
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(1) On July 25, 2023, the Company announced a stock repurchase program to purchase up to 404,708 shares of the Company's common stock, which replaced the Company's then existing repurchase plan which had 74,212 shares available to be repurchased prior to termination. The July 2023 repurchase program does not have a set expiration date and will expire upon repurchase of the full amount of authorized shares. Shares may be repurchased from time to time in the open market or in privately negotiated transactions based upon market conditions and available liquidity.
The Company is subject to certain restrictions on its ability to repurchase its common stock. The Company is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.
Equity Compensation Plan Information.
The equity compensation plan information presented under subparagraph (d) in Part III, Item 12 of this report is incorporated herein by reference.
Five-Year Stock Performance Graph
The following graph compares the cumulative total shareholder return on our common stock with the cumulative total return on the Nasdaq Composite Index and with the S&P SmallCap Banks Index, peer group indices. Total return assumes the reinvestment of all dividends and that the value of the Company’s Common Stock and each index was $100 on September 30, 2019.
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Year Ended
* Source: S&P Global Market Intelligence
Item 6. Reserved
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto included in Item 8 of this Annual Report on Form 10-K.
Overview
Timberland Bancorp, Inc., a Washington corporation, is the holding company for Timberland Bank. The Bank opened for business in 1915 and serves consumers and businesses across Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis counties, Washington with a full range of lending and deposit services through its 23 branches (including its main office in Hoquiam). At September 30, 2024, the Company had total assets of $1.92 billion, net loans receivable of $1.42 billion, total
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deposits of $1.65 billion and total shareholders’ equity of $245.41 million. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report relates primarily to the Bank’s operations.
The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail and business customers while concentrating its lending activities on real estate secured loans. Lending activities have been focused primarily on the origination of loans secured by real estate, including residential construction loans, one- to four-family residential loans, multi-family loans and commercial real estate loans. The Bank originates adjustable-rate residential mortgage loans, some of which do not qualify for sale in the secondary market. The Bank also originates commercial business loans and other consumer loans.
The profitability of the Company’s operations depends primarily on its net interest income after provision for (recapture of) credit losses. Net interest income is the difference between interest income, which is the income that the Company earns on interest-earning assets, which are primarily loans and investments, and interest expense, which is the amount that the Company pays on its interest-bearing liabilities, which are primarily deposits and borrowings (as needed). Net interest income is affected by changes in the volume and mix of interest-earning assets, the interest earned on those assets, the volume and mix of interest-bearing liabilities and the interest paid on those interest-bearing liabilities. Management attempts to maintain a net interest margin and return on average assets ("ROA") placing it within the top quartile of its Washington State peers.
Changes in market interest rates, the slope of the yield curve, and interest we earn on interest earning assets or pay on interest bearing liabilities, as well as the volume and types of interest earning assets, interest bearing and non-interest bearing liabilities and shareholders’ equity, usually have the largest impact on changes in our net interest spread, net interest margin and net interest income during a reporting period. Since March 2022, in response to inflation, the Federal Open Market Committee ("FOMC") of the Federal Reserve has increased the target range for the federal funds, which stood at 4.75% to 5.00% as of September 30, 2024. Subsequent to fiscal year end, the FOMC reduced the target federal funds rate by 25 basis points and has not ruled out future decreases.
On October 1, 2023, the Company adopted the CECL standard to determine estimates of lifetime expected credit losses on loans and recognize the expected credit losses at inception of the loan. The adoption of CECL changed the allowance calculation methodology from a historical incurred loss model to an expected future loss model. The adjustment recorded upon our adoption of the CECL standard was not significant to the overall ACL (including the reserve for unfunded commitments) as compared to the allowance for loan losses at September 30, 2023. The provision for (recapture of) credit losses on loans is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. The ACL on loans reflects the amount that the Company believes is adequate to cover expected credit losses inherent in its loan portfolio. The Company recorded a provision for credit losses on loans of $1.25 million for the year ended September 30, 2024, primarily due to increased loan portfolio growth. The Company recorded a provision for loan losses of $2.1 million for the year ended September 30, 2023, primarily due to increased loan portfolio growth.
Net income is also affected by non-interest income and non-interest expense. For the year ended September 30, 2024, non-interest income consisted primarily of service charges on deposit accounts, gain on sales of loans, ATM and debit card interchange transaction fees, an increase in the cash surrender value of BOLI, escrow fees and other operating income. Non-interest income is also increased by a gain on sale and net recoveries of OTTI on investment securities, if any. Non-interest income is also decreased by valuation allowances on loan servicing rights and increased by recoveries of valuation allowances on loan servicing rights, if any. Non-interest expense consisted primarily of salaries and employee benefits, premises and equipment, advertising, ATM and debit card interchange transaction fees, postage and courier expenses, amortization of CDI, state and local taxes, professional fees, FDIC insurance premiums, loan administration and foreclosure expenses, technology and communications expenses, deposit operation expenses and other non-interest expenses. Non-interest expense in certain periods is reduced by gains on the sale of premises and equipment and by gains on the sale of OREO. Non-interest income and non-interest expense are affected by the growth of the Company's operations and growth in the number and balances of loan and deposit accounts.
Results of operations may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.
Operating Strategy
The Company is a bank holding company which operates primarily through its subsidiary, the Bank. The Company's primary objective is to operate the Bank as a well-capitalized, profitable, independent, community-oriented financial institution, serving
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customers in its primary market area of Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties. The Company's strategy is to provide products and superior service to small businesses and individuals located in its primary market area.
The Company's goal is to deliver returns to shareholders by focusing on the origination of higher-yielding assets (in particular, commercial real estate, construction, and commercial business loans), increasing core deposit balances, managing problem assets, efficiently managing expenses, and seeking expansion opportunities. The Company seeks to achieve these results by focusing on the following objectives:
Expand our presence within our existing market areas by capturing opportunities resulting from changes in the competitive environment. We currently conduct our business primarily in western Washington. We have a community bank strategy that emphasizes responsive and personalized service to our customers. As a result of the consolidation of banks in our market areas, we believe that there is an opportunity for a community and customer focused bank to expand its customer base. By offering timely decision making, delivering appropriate banking products and services, and providing customer access to our senior managers, we believe that community banks, such as Timberland Bank, can distinguish themselves from larger banks operating in our market areas. We believe that we have a significant opportunity to attract additional borrowers and depositors and expand our market presence and market share within our extensive branch footprint.
Portfolio diversification. In recent years, we have limited the origination of speculative construction loans and land development loans in favor of loans that possess credit profiles representing less risk to the Bank. We continue originating owner/builder and custom construction loans, multi-family loans, commercial business loans and commercial real estate loans which offer higher risk adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations than fixed-rate one-to four-family loans. We anticipate capturing more of each customer's banking relationship by cross selling our loan and deposit products and offering additional services to our customers.
Increase core deposits and other retail deposit products. We focus on establishing a total banking relationship with our customers with the intent of internally funding our loan portfolio. We anticipate that the continued focus on customer relationships will increase our level of core deposits. In addition to our retail branches, we maintain technology based products such as business cash management and a business remote deposit product that enable us to compete effectively with banks of all sizes.
Managing exposure to fluctuating interest rates. For many years, the majority of the loans the Bank has retained in its portfolio have generally possessed periodic interest rate adjustment features or have been relatively short-term in nature. Loans originated for portfolio retention have generally included ARM loans, short-term construction loans, and, to a lesser extent, commercial business loans with interest rates tied to a market index such as the Prime Rate. Longer term fixed-rate mortgage loans have generally been originated for sale into the secondary market, although from time to time, the Bank may retain a portion of its fixed-rate mortgage loan originations and extend the initial fixed-rate period of its hybrid ARM commercial real estate loans for asset/liability purposes.
Continue generating revenues through mortgage banking operations. The majority of the fixed-rate residential mortgage loans we originate have historically been sold into the secondary market with servicing retained. This strategy produces gains on the sale of such loans and reduces the interest rate and credit risk associated with fixed-rate residential lending. We continue to originate custom construction and owner/builder construction loans for sale into the secondary market upon the completion of construction.
Maintaining strong asset quality. We believe maintaining strong asset quality is key to our long-term financial success.Non-performing assets, consisting of nonaccrual loans and investment securities, totaled $3.94 million at September 30, 2024, compared to $1.60 million at September 30, 2023. The percentage of non-performing loans to loans receivable, net was 0.27% and 0.11% at September 30, 2024 and 2023, respectively.The percentage of non-performing assets to total assets at September 30, 2024 was 0.20% compared to 0.09% at September 30, 2023. We remain focused on reducing the level of non-performing assets through collections, write-downs and modifications. Our efforts include proactive steps to resolve our non-performing loans such as negotiating payment plans, forbearances, loan modifications and loan extensions, and accepting short payoffs on delinquent loans when appropriate. While the Company continues to emphasize lending in areas such as commercial real estate loans, construction loans, and commercial business loans, we remain committed to managing credit risk through the expertise of seasoned bankers and a conservative lending strategy.
Selected Financial Data
The following table sets forth certain information concerning the consolidated financial position and results of operations of the Company and its subsidiary at and for the dates indicated. The consolidated data is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and its subsidiary presented herein.
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At September 30,
(In thousands)
SELECTED FINANCIAL CONDITION DATA:
OREO and other repossessed assets — — — 157 1,050
Year Ended September 30,
(In thousands, except per share data)
SELECTED OPERATING DATA:
Net income per common share:
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(1)Cash dividends to common shareholders divided by net income to common shareholders.
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At September 30,
OTHER DATA:
At or For the Year Ended September 30,
KEY FINANCIAL RATIOS:
Performance Ratios:
Asset Quality Ratios:
Net charge-offs (recoveries) to average outstanding loans — — — — —
Capital Ratios:
__________________
(1)Net income divided by average total assets.
(2)Net income divided by average total equity.
(3)Difference between weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities.
(4)Net interest income before provision for (recapture of) credit losses as a percentage of average interest-earning assets.
(5)Non-interest expenses divided by the sum of net interest income and non-interest income.
(6)Non-performing assets include non-accrual loans, loans past due 90 days or more and still accruing, non-accrual investment securities, OREO and other repossessed assets.
(7)Loans receivable is before the allowance for credit losses.
(8)Non-performing loans include non-accrual loans and loans past due 90 days or more and still accruing. For periods prior to 2024, TDRs that were on accrual status are not included.
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Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit committee of our Board of Directors.
See "Note 1-Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements contained in Item 8 of this report for a summary of significant accounting policies and the effect on our financial statements and the following:
Allowance for Credit Losses
The ACL is considered a critical accounting policy due to the significant judgment and subjectivity involved in its determination, as well as the potential for economic changes that could impact its adequacy. Adjustments to the ACL are made through the provision (recapture) for credit losses to ensure the ACL remains at an appropriate level, based on management’s assessment of general and specific loss reserves. Establishing the ACL involves material estimates, including economic conditions, collateral value, guarantor strength, loss exposure at default, the timing and amount of future cash flows on impaired loans, applicable loss factors for portfolio segments, and forecasted cash flow collectability over the contractual term of financial assets. These estimates are inherently subject to change and require careful evaluation. To ensure adequacy, we use systematic methodologies outlined in a formal policy that address both general valuation allowances and specific reserves for individual problem loans. Adjustments to the ACL are reflected through provisions for credit losses, which increase the ACL, or recaptures, which reduce it, both of which impact current period earnings.
The ACL is maintained at a level sufficient to provide for expected credit losses based on evaluating known and inherent risks in the loan portfolio and upon our continuing analysis of the factors underlying the quality of the loan portfolio. The ACL is comprised of a general component and a specific component. The general component establishes a reserve rate using historical life-of-loan default rates, current loan portfolio information, economic forecasts, and business cycle data. Statistical analysis determines life-of-loan default and loss rates for the quantitative component, while qualitative factors adjust expected loss rates for current and forecasted conditions. The qualitative factor methodology involves a blend of quantitative analysis and management judgement, reviewed quarterly. The specific component relates to loans that have been individually evaluated because all contractual amounts of principal and interest will not be paid as scheduled. Based on the individual analysis, a specific reserve may be established. The ACL is based upon factors and trends identified by us at the time financial statements are prepared. Although we use the best information available, future adjustments to the ACL may be necessary due to economic, operating, regulatory, and other conditions beyond our control. While we believe the estimates and assumptions used in our determination of the adequacy of the ACL are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the ACL is subject to review the by Bank's regulators as part of the routine examination process, which may result in adjustments to the ACL based upon their judgment of information available to them at the time of their examination.
Fair Value Accounting and Measurement
We use fair value measurements to record fair value adjustments to certain financial assets and liabilities and to determine fair value disclosures. We include in the Notes to the Consolidated Financial Statements information about the extent to which fair value is used to measure financial assets and liabilities, the valuation methodologies used and the impact on our results of operations and financial condition. Additionally, for financial instruments not recorded at fair value we disclose, where required, our estimate of their fair value. For more information regarding fair value accounting, please refer to "Note 21-Fair Value Measurements" in the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Loan Servicing Rights
Loan servicing rights are recognized as separate assets when rights are acquired through purchase or through sale of loans. Generally, purchased loan servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans, the value of the loan servicing right is estimated and capitalized. Fair value is based on market prices for comparable loan servicing contracts. The fair value of the loan servicing rights includes an estimate of the life of the underlying loans which is affected by estimated prepayment speeds. The estimate of prepayment speeds is based on current market conditions. Actual
55
market conditions could vary significantly from current conditions which could result in the estimated life of the underlying loans being different which would change the fair value of the loan servicing right. Capitalized loan servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
Valuation of OREO
Real estate properties acquired through foreclosure or by deed-in-lieu of foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. Fair value is generally determined by management based on a number of factors, including third-party appraisals of fair value in an orderly sale. Accordingly, the valuation of OREO is subject to significant external and internal judgment. If the carrying value of the loan at the date a property is transferred into OREO exceeds the fair value less estimated costs to sell, the excess is charged to the allowance for credit losses. Management periodically reviews OREO values to determine whether the property continues to be carried at the lower of its recorded book value or fair value, net of estimated costs to sell. Any further decreases in the value of OREO are considered an allowance for credit losses. Expenses and income from the maintenance and operations and any gains or losses from the sales of OREO are included in non-interest expense.
Business Combinations
The Company applies the acquisition method of accounting for business combinations. Under the acquisition method, the acquiring entity in a business combination recognizes all the identifiable assets acquired and liabilities assumed at their acquisition date fair values. Management utilizes prevailing valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than the purchase price, a bargain purchase gain is recognized. Acquisition-related costs are expensed as incurred unless they are directly attributable to the issuance of the Company's common stock in a business combination and the Company chooses to record these acquisition-related costs through stockholders' equity. There were no business combinations during the years ended September 30, 2024, 2023 and 2022, respectively.
Goodwill
Goodwill represents the excess of the purchase consideration paid over the fair value of the assets acquired, net of the fair values of liabilities assumed in a business combination and is not amortized but is reviewed annually, or more frequently as current circumstances and conditions warrant, for impairment. An assessment of qualitative factors is completed to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The qualitative assessment involves judgment by management on determining whether there have been any triggering events that have occurred which would indicate potential impairment. If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The quantitative goodwill impairment test is used to identify the existence of impairment and the amount of impairment loss and compares the reporting unit's estimated fair values, including goodwill, to its carrying amount. If the fair value exceeds the carry amount, then goodwill is not considered impaired. If the carrying amount exceeds its fair value, an impairment loss would be recognized equal to the amount of excess, limited to the amount of total goodwill allocated to the reporting unit. The impairment loss would be recognized as a charge to earnings.
Market Risk and Asset and Liability Management
General. Market risk is the risk of loss from adverse changes in market prices and rates. The Bank's market risk arises primarily from interest rate risk inherent in its lending, investment, deposit and borrowing activities. The Bank, like other financial institutions, is subject to interest rate risk to the extent that its interest-earning assets reprice differently than its interest-bearing liabilities. Management actively monitors and manages its interest rate risk exposure. Although the Bank manages other risks, such as credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Bank's financial condition and results of operations. The Bank does not maintain a trading account for any class of financial instruments nor does it engage in hedging activities. Furthermore, the Bank is not subject to foreign currency exchange rate risk or commodity price risk.
Qualitative Aspects of Market Risk. The Bank's principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Bank has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the difference between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest rate sensitivity of the Bank's interest-earning assets by retaining in its portfolio, short-term loans and loans with interest rates subject to periodic adjustments. The Bank
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relies on retail deposits as its primary source of funds. As part of its interest rate risk management strategy, the Bank promotes transaction accounts and certificates of deposit with terms of up to five years.
The Bank has adopted a strategy that is designed to substantially match the interest rate sensitivity of assets relative to its liabilities. The primary elements of this strategy involve originating ARM loans for its portfolio, maintaining residential construction loans as a portion of total net loans receivable because of their generally shorter terms and higher yields than other one- to four-family residential mortgage loans, matching asset and liability maturities, investing in short-term securities, and originating fixed-rate loans for retention or sale in the secondary market while retaining the related loan servicing rights.
Sharp increases or decreases in interest rates may adversely affect the Bank's earnings. Management of the Bank monitors the Bank's interest rate sensitivity using a model provided by Kinective, a company that specializes in providing interest rate risk and balance sheet management services to the financial services industry. Based on an interest rate shock analysis prepared by Kinective using data at September 30, 2024, an immediate increase in interest rates of 100 basis points would decrease the Bank’s projected net interest income by approximately 1.5%. An immediate decrease in interest rates of 100 basis points would decrease the Bank's projected net interest income by approximately 1.4%. See “Quantitative Aspects of Market Risk” below for additional information. Management has sought to sustain the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Pursuant to this strategy, the Bank actively originates adjustable-rate loans for retention in its loan portfolio. Fixed-rate mortgage loans with maturities greater than seven years generally are originated for the immediate or future resale in the secondary mortgage market. Although the Bank has sought to originate ARM loans, the ability to originate such loans depends to a great extent on market interest rates and borrowers' preferences.
Consumer, commercial business and construction loans typically have shorter terms and higher yields than permanent residential mortgage loans and, accordingly, reduce the Bank’s exposure to fluctuations in interest rates. At September 30, 2024, the consumer, commercial business and construction loan portfolios amounted to $51.04 million, $139.00 million and $219.20 million, respectively, or 3.4%, 9.2% and 14.5%, respectively, of total loans receivable.
Quantitative Aspects of Market Risk. The model provided for the Bank by Kinective estimates the changes in the economic value of equity ("EVE") and net interest income in response to a range of assumed changes in market interest rates. The model first estimates the level of the Bank's EVE (market value of assets, less market value of liabilities, plus or minus the market value of any off-balance sheet items) under the current rate environment. In general, market values are estimated by discounting the estimated cash flows of each instrument by appropriate discount rates. The model then recalculates the Bank's EVE under different interest rate scenarios. The change in EVE under the different interest rate scenarios provides a measure of the Bank's exposure to interest rate risk. The following table is provided by Kinective based on data at September 30, 2024:
Hypothetical Net Interest Income (1) Economic Value of Equity
Interest Rate $ Change % Change $ Change % Change
Scenario (2) from Base from Base from Base from Base
(Basis Points) (Dollars in thousands)
BASE — — — —
___________
(1)Does not include loan fees and includes BOLI income, which is included in non-interest income in the consolidated financial statements.
(2)No rates in the model are allowed to go below zero.
Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan repayments and deposit decay, and should not be relied upon as indicative of actual results. Furthermore, the computations do not reflect any actions management may undertake in response to changes in interest rates.
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In the event of a 100 basis point decrease in interest rates, the Bank would be expected to experience a 2.2% decrease in EVE and a 1.4% decrease in net interest income. In the event of a 100 basis point increase in interest rates, a 0.3% decrease in EVE and a 1.5% decrease in net interest income would be expected. Based upon the modeling described above, the Bank's asset and liability structure generally results in modest decreases in net interest income and EVE in both rising and falling interest rate scenarios.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag changes in market rates. Additionally, certain assets have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates of deposit could possibly deviate significantly from those assumed in calculating the table.
Comparison of Financial Condition at September 30, 2024 and September 30, 2023
Total assets increased by $83.57 million, or 4.5%, to $1.92 billion at September 30, 2024 from $1.84 billion at September 30, 2023. The increase in total assets was primarily due to increases in total cash and cash equivalents and loans receivable net, partially offset by a decrease in investment securities.
Net loans receivable increased by $119.22 million, or 9.2%, to $1.42 billion at September 30, 2024 from $1.30 billion at September 30, 2023, primarily due to increases in one- to four-family loans, multi-family loans, commercial real estate loans, home equity loans and smaller increases in several other loan categories that were partially offset by decreases in construction and land development loans.
Investment securities (including investments in equity securities) decreased by $67.58 million, or 21.6%, to $245.22 million at September 30, 2024 from $312.80 million at September 30, 2023, primarily due to the maturities of U.S. Treasury investment securities and to a lesser extent, scheduled amortization. Partially offsetting these decreases, was the purchase of additional U.S. government agency mortgage-backed investment securities and U.S. Treasury investment securities, all of which were classified as available for sale.
Total deposits increased by $86.73 million, or 5.6%, to $1.65 billion at September 30, 2024 from $1.56 billion at September 30, 2023, primarily due to increases in money market and certificate of deposit account balances. These increases were partially offset by decreases in non-interest bearing demand, NOW checking, and savings account balances.
Shareholders' equity increased by $12.34 million, or 5.3%, to $245.41 million at September 30, 2024 from $233.07 million at September 30, 2023. The increase was primarily due to net income for the year ended September 30, 2024 of $24.28 million, partially offset by $7.65 million in dividends paid to shareholders and the repurchase of 218,976 shares of common stock for $5.96 million.
A more detailed explanation of the changes in significant balance sheet categories follows:
Cash and Cash Equivalents and CDs Held for Investment: Cash and cash equivalents and CDs held for investment increased by $31.03 million, or 21.6%, to $174.94 million at September 30, 2024 from $143.91 million at September 30, 2023. The increase was primarily a result of increased deposits.
Investment Securities: Investment securities (including investments in equity securities) decreased by $67.58 million, or 21.6%, to $245.22 million at September 30, 2024 from $312.80 million at September 30, 2023. The decrease was primarily due $100.87 million of maturities, prepayments and scheduled amortization on held to maturity securities and $14.12 million in maturities, prepayments and scheduled amortization on available for sale investment securities. These decreases were partially offset by the purchase of $43.03 million in available for sale investment securities and $1.90 million in held to maturity investment securities. For additional details on investment securities, see "Item 1. Business - Investment Activities" and "Note 3 - Investment Securities" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
FHLB Stock: FHLB stock decreased by $1.57 million, or 43.5%, to $2.04 million at September 30, 2024 from $3.60 million at September 30, 2023, due to the repayment of a portion of FHLB borrowings and the restructuring of stock ownership requirement by FHLB.
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Other Investments: Other investments consist solely of the Company's investment in the Solomon Hess SBA Loan Fund LLC, which was unchanged at both September 30, 2024 and 2023. This investment is utilized to help satisfy compliance with the Company's Community Reinvestment Act ("CRA") investment test requirements.
Loans Held for Sale: There were no loans held for sale at September 30, 2024 compared to $400,000 at September 30, 2023, primarily due to the timing and volume of mortgage banking loan sales. The Company generally sells longer-term fixed-rate residential loans and the guaranteed portion of SBA commercial business loans for asset-liability management purposes and to generate non-interest income. The Company sold $14.75 million in loans during the year ended September 30, 2024 compared to $11.54 million for the year ended September 30, 2023. Sales of loans over the past year has increased slightly, primarily due to construction loans converting to permanent financing as higher interest rates have slowed down refinancing and purchase activity.
Loans Receivable, Net of Allowance for Credit Losses: Net loans receivable increased by $119.22 million, or 9.2%, to $1.42 billion at September 30, 2024 from $1.30 billion at September 30, 2023. The increase was primarily due to a $50.17 million increase in multi-family loans, a $45.90 million increase in one- to four-family loans, a $33.32 million decrease in the undisbursed portion of construction loans, a $30.95 million increase in commercial real estate loans, a $9.63 million increase in home equity loans and smaller changes in other categories. These increases were partially offset by a $54.64 million decrease in gross construction loans, with the largest decreases occurring in commercial and multi-family construction loans as they converted to permanent financing and smaller decreases in several other loan categories.
Loan originations decreased by $110.35 million, or 30.5%, to $251.44 million for the year ended September 30, 2024 from $361.79 million for the year ended September 30, 2023. The decrease in loan originations was primarily due to decreases in originations of one- to four- family loans, commercial real estate, construction and commercial business loans. These decreases were partially offset by an increase in originations of multi-family and land loans. For additional information on loans, see "Item 1. Business - Lending Activities" and "Note 4-Loans Receivable and Allowance for Credit Losses" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Premises and Equipment, Net: Premises and equipment decreased by $156,000, or 0.7%, to $21.49 million at September 30, 2024 from $21.64 million at September 30, 2023. The decrease was primarily due to normal depreciation. For additional information on premises and equipment, see "Item 2. Properties" and "Note - 5 Premises and Equipment" of the Notes of the Consolidated Financial Statements contained in Item 8 of this report.
Bank Owned Life Insurance ("BOLI"): BOLI increased by $645,000, or 2.8%, to $23.61 million at September 30, 2024 from $22.97 million at September 30, 2023. The increase was due to net BOLI earnings, representing the increase in the cash surrender value of the BOLI policies.
Goodwill: The recorded amount of goodwill remained unchanged at $15.13 million at both September 30, 2024 and September 30, 2023. The Company performed its annual review of goodwill during the quarter ended June 30, 2024 and determined that there was no impairment. As of September 30, 2024, management believes that there had been no subsequent events or changes in circumstances that would indicate a potential impairment of goodwill. For additional information on goodwill, see "Note 7 - Goodwill and CDI" of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
CDI: CDI decreased by $226,000 or 33.4%, to $451,000 at September 30, 2024 from $677,000 at September 30, 2023 due to scheduled amortization. For additional information on CDI, see "Note 7 - Goodwill and CDI" of the Consolidated Financial Statements contained in Item 8 of this report.
Loan Servicing Rights, Net: Loan servicing rights decreased by $752,000, or 35.4%, to $1.37 million at September 30, 2024 from $2.12 million at September 30, 2023, primarily due to the amortization of servicing rights and partially offset by additional capitalized Freddie Mac servicing rights for loans being sold with servicing retained. The principal amount of loans serviced for Freddie Mac and the SBA decreased by $15.94 million to $370.56 million at September 30, 2024 from $386.50 million at September 30, 2023. For additional information on loan servicing rights, see "Note 8 - Loan Servicing Rights" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Operating Lease Right-of-Use Assets: Operating lease ROU assets decreased by $297,000, or 16.8%, to $1.48 million at September 30, 2024 from $1.77 million at September 30, 2023, primarily due to the amortization of the ROU assets. The operating lease ROU assets at September 30, 2024 represented the present value of two operating leases on branch facilities and one administrative office. For additional information on leases, see "Note 9 - Leases" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
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Other Assets: Other assets increased by $2.67 million, or 74.7%, to $6.24 million at September 30, 2024 from $3.57 million at September 30, 2023. The increase was primarily due to increases in miscellaneous receivables (including income tax receivables) and prepaid expenses.
Deposits: Deposits increased by $86.73 million, or 5.6%, to $1.65 billion at September 30, 2024 from $1.56 billion at September 30, 2023. The increase consisted of a $137.05 million increase in money market account balances and a $68.21 million increase in certificate of deposit account balances. The increases were partially offset by a $53.40 million decrease in NOW account balances, a $42.75 million decrease in non-interest bearing account balances and a $22.37 million decrease in savings account balances. For additional information on deposits, see "Item 1. Business - Deposit Activities and Other Sources of Funds" and "Note 10 - Deposits" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
FHLB Borrowings: The Company has short- and long-term borrowing lines with the FHLB with total credit available on the lines equal to 45% of the Bank's total assets, limited by available collateral. At September 30, 2024, the Company had an available borrowing capacity of $606.04 million. The Company had $20.00 million in FHLB borrowings at September 30, 2024 compared to $35.00 million at September 30, 2023. At September 30, 2024, FHLB borrowings consisted of three long-term borrowings: two totaling $15.00 million with scheduled maturities in May 2026, both bearing interest at 3.95% and one $5.00 million borrowing maturing in August 2026 with an interest rate of 4.03%. For additional information on FHLB borrowings, see "Note 11 - FHLB Borrowings and Other Borrowings" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Operating Lease Liabilities: Operating lease liabilities decreased by $292,000 or 15.6%, to $1.58 million at September 30, 2024 from $1.87 million at September 30, 2023, primarily due to required annual lease payments. The operating lease liability at September 30, 2024 represented the present value of two operating leases on branch facilities and one administrative office. For additional information on leases, see "Note 9 - Leases" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Other Liabilities and Accrued Expenses: Other liabilities and accrued expenses decreased by $211,000, or 2.3%, to $8.82 million at September 30, 2024 from $9.03 million at September 30, 2023. The decrease was primarily due to timing differences in the normal course of business and an increase in accrued interest payable.
Shareholders' Equity: Total shareholders' equity increased by $12.34 million, or 5.3%, to $245.41 million at September 30, 2024 from $233.07 million at September 30, 2023. The increase was primarily due to net income of $24.28 million for the year ended September 30, 2024, which was partially offset by the payment of $7.65 million in dividends to common shareholders and the repurchase of 218,976 shares of the Company's common stock for $5.96 million during the year ended September 30, 2024. In addition, shareholder’s equity was positively impacted by unrealized gains on available for sale securities reflecting the decrease in market interest rates during the year, resulting in a recovery of $1.10 million of accumulated other comprehensive loss, net of tax at September 30, 2024. For additional information on shareholders' equity, see the Consolidated Statements of Shareholders' Equity contained in Item 8 of this report.
Comparison of Operating Results for the Years Ended September 30, 2024 and 2023
Net income for the year ended September 30, 2024 decreased by $2.84 million, or 10.5%, to $24.28 million from $27.12 million for the year ended September 30, 2023. Net income per diluted common share decreased by $0.28, or 8.5%, to $3.01 for the year ended September 30, 2024 from $3.29 for the year ended September 30, 2023. The decrease in net income was primarily due to a $4.19 million decrease in net interest income and a $373,000 increase in non-interest expense, partially offset by a $981,000 decrease in the provision for credit losses and a $753,000 decrease in the provision for income taxes. Non-interest income remained relatively unchanged at $11.14 million for the years ended September 30, 2024 and 2023.
A more detailed explanation of the income statement categories is presented below.
Net Interest Income: Net interest income decreased by $4.19 million, or 6.1%, to $64.17 million for the year ended September 30, 2024 from $68.36 million for the year ended September 30, 2023. The decrease was due to higher interest expense resulting from increases in both the average yields and balances of interest-bearing liabilities, which outpaced the increase in interest income and dividend income resulting from increases in the average yield and balance on loans and, to a lesser extent, the average yields on investment securities and interest-bearing deposit in banks and CDs.
Total interest and dividend income increased by $14.87 million, or 18.6%, to $94.83 million for the year ended September 30, 2024 from $79.95 million for the year ended September 30, 2023, due to an increase in the average yields on interest-earning assets, as well as an increase in the average balance of loans. The average yield on interest-earning assets increased to 5.24% for the year ended September 30, 2024 from 4.63% for the year ended September 30, 2023. Average total interest-earning
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assets increased by $82.49 million, or 4.77%, to $1.81 billion for the year ended September 30, 2024 from $1.73 billion for the year ended September 30, 2023, due to an increase in the average balance of loans receivable which was partially offset by a decrease in the average balance of investment securities and interest-bearing deposits in banks and CDs. Interest income on loans receivable and loans held for sale increased by $14.28 million, or 22.61%, to $77.43 million for the year ended September 30, 2024 from $63.15 million for the year ended September 30, 2023, primarily due to a $149.43 million increase in the average balance of loans receivable coupled with an increase in the average yield on loans receivable to 5.61% for the year ended September 30, 2024 from 5.13% for the year ended September 30, 2023.
During the year ended September 30, 2024, the accretion of the purchase accounting fair value discount on loans acquired increased interest income on loans by $37,000 compared to $75,000 for the year ended September 30, 2023. The accretion of the net fair value discount on acquired loans had a minor effect on the average yield on loans for the year ended September 30, 2024 and a one basis point increase for the year ended September 30, 2023. The incremental accretion and the impact on loan yield will change during any period based on the volume of prepayments, and has decreased over time as the balance of the net discount declines. The remaining net discount on acquired loans was $155,000 at September 30, 2024. During the year ended September 30, 2024, a total of $376,000 in non-accrual interest, pre-payment penalties and late fees was collected compared to $398,000 for the year ended September 30, 2023.
Interest income on investment securities decreased by $255,000, or 2.7%, to $9.13 million for the year ended September 30, 2024 from $9.38 million for the year ended September 30, 2023, due to a $45.91 million decrease in the average balance of investment securities, partially offset by a 49 basis point increase in the average yield on investment securities.
Interest income on interest-bearing deposits in banks and CDs increased by $762,000, or 10.7%, to $7.91 million for the year ended September 30, 2024 from $7.14 million for the year ended September 30, 2023, due to an 112 basis point increase in the average yield resulting from increased market interest rates, partially offset by a $20.85 million decrease in the average balance of interest-bearing deposits in banks and CDs.
Total interest expense increased by $19.07 million, or 164.5%, to $30.66 million for the year ended September 30, 2024 from $11.59 million for the year ended September 30, 2023. The increase in interest expense was primarily due to an increase in the average cost of interest-bearing deposits. The average cost of interest-bearing liabilities increased to 2.52% for the year ended September 30, 2024 from 1.06% for the year ended September 30, 2023 as market interest rates for deposits increased. Average interest-bearing deposits increased by $108.92 million, or 10.0%, to $1.19 billion for the year ended September 30, 2024 from $1.09 billion for the year ended September 30, 2023, primarily due to competitive pricing pressure which resulted in rate matching to retain deposits. Average short-term borrowings increased by $5.42 million, or 555.8% to $6.4 million for the year ended September 30, 2024 from $975,000 for the year ended September 30, 2023. Average long-term borrowings increased by $9.8 million, or 164.9% to $15.8 million for the year ended September 30, 2024 from $6.0 million for the year ended September 30, 2023.
As a result of these changes, the net interest margin decreased 41 basis points to 3.54% for the year ended September 30, 2024 from 3.95% for the year ended September 30, 2023.
Provision for Credit Losses: A $1.15 million provision for credit losses was recorded for the year ended September 30, 2024 consisting of a $1.25 million provision for credit losses on loans which was primarily due to an increase in loans receivable, a $32,000 recapture of credit losses on investment securities which was primarily due to lower balances resulting from maturities and principal payments and a $71,000 recapture of credit losses on unfunded commitments which was primarily due to a decrease in the balance of unfunded loan commitments. A $2.13 million provision for loan losses, under the prior incurred loan loss method, was recorded for the year ended September 30, 2023.
The Company had net charge-offs of $54,000 for the year ended September 30, 2024 compared to $18,000 for the year ended September 30, 2023. Net charge-offs (recoveries) to average outstanding loans was 0.0% for the years ended September 30, 2024 and 2023. The level of delinquent loans (loans 30 or more days past due) increased by $2.81 million, or 168.9%, to $4.48 million at September 30, 2024 from $1.67 million at September 30, 2023. Loan classified as substandard increased by $2.05 million, or 32.1%, to $8.44 million at September 30, 2024 from $6.39 million at September 30, 2023, while loans classified as doubtful totaled $202,000 at September 30, 2024 compared to none at September 30, 2023. Loans designated as special mention totaled $4.40 million at September 30, 2024 compared to none at September 30, 2023. Non-accrual loans increased by $2.37 million, or 156.6%, to $3.89 million at September 30, 2024 from $1.51 million at September 30, 2023.
While management believes the estimates and assumptions used in its determination of the adequacy of the ACL are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions will not have a material adverse impact on our financial condition and results of operations. A further decline in national and local economic
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conditions, as a result of the effects of inflation, a recession or slowed economic growth, among other factors, could result in a material increase in the ACL and have a material adverse impact on the financial condition and results of operations. In addition, the determination of the amount of the ACL is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination and have a material adverse impact on the financial condition and results of operations.
In accordance with GAAP, acquired loans are recorded at their estimated fair value, resulting in a net discount to the loans' contractual amounts, with a portion of this discount reflecting possible credit losses. Credit discounts are included in the determination of fair value. With the adoption of CECL, purchased loans are evaluated for impairment in the same manner as the rest of the loan portfolio. The remaining fair value discount associated with acquired loans was $155,000 at September 30, 2024. This discount will continue to accrete into income as these loans continue to pay down.
For additional information, see "Item 1. Business - Lending Activities -- Allowance for Credit Losses" and "Note 4 - Loans Receivable and Allowance for Credit Losses" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Non-interest Income: Total non-interest income was $11.14 million for both the years ended September 30, 2024 and 2023. Changes in non-interest income include a $128,000 decrease in ATM and debit card interchange transaction fees, a $95,000 decrease in net gain on sale of investment securities and smaller decreases in other categories, offset by a $238,000 increase in service charges on deposits and smaller increases in other categories.
Non-interest Expense: Total non-interest expense increased by $373,000, or 0.9%, to $43.75 million for the year ended September 30, 2024 from $43.37 million for the year ended September 30, 2023. The increase was primarily due to a $719,000 increase in technology and communications, a $397,000 increase in ATM and debit card processing fees, a $172,000 increase in deposit operations, a $168,000 increase in salaries and employee benefits, a $122,000 increase in FDIC insurance expense, a $103,000 increase in state and local taxes, a $83,000 increase in premises and smaller increases in several other expense categories. These increases were partially offset by a $761,000 decrease in professional fees and smaller decreases in several other categories. The increase in technology and communications was primarily due to the addition of several new technology products, increased costs and processing volumes. The increase in ATM and debit card processing fees and deposit operations was mainly due to fraud related expenses. The increase in salaries and employee benefits was primarily due to annual salary adjustments.
The efficiency ratio for the year ended September 30, 2024 was 58.09% compared to 54.56% for the year ended September 30, 2023.The change in the efficiency ratio was the result of higher non-interest expenses, coupled with a decrease in overall revenues resulting from the decline in net interest income.
Provision for Income Taxes: The provision for income taxes decreased by $753,000, or 11.0% to $6.12 million for the year ended September 30, 2024 from $6.88 million for the year ended September 30, 2023. The decrease was primarily due to lower pre-tax income. The Company's effective income tax rate was 20.1% for the year ended September 30, 2024 compared to 20.2% for the year ended September 30, 2023. For additional information on income taxes, see "Note 13-Income Taxes" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Comparison of Results of Operations for the Years Ended September 30, 2023 and 2022
See Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended September 30, 2023 previously filed with the SEC.
Average Balances, Interest and Average Yields/Cost
The earnings of the Company depend largely on the spread between the yield on interest-earning assets and the cost of interest-bearing liabilities, as well as the relative amount of the Company's interest-earning assets and interest- bearing liability portfolios.
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The following table sets forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs. Yields and costs for the periods indicated are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the periods presented.
Year Ended September 30,
(Dollars in thousands)
Interest-earning assets:
Interest-bearing liabilities:
_______________________________________________
(1)Does not include interest on loans on non-accrual status. Includes loans held for sale and interest earned on loans held for sale. Amortized net deferred loan fees, late fees, extension fees and prepayment penalties (year ended September 30, 2024 - $1,429; year ended September 30, 2023 - $1,373 and year ended September 30, 2022 - $3,600) are included with interest and dividends. Accretion of the fair value discount on loans for the years ended September 30, 2024, 2023 and 2022 of $37, $75 and $182 respectively, is included with interest and dividends.
(2)Average balances include loans and investment securities on non-accrual status.
(3)Includes FHLB borrowings with original maturities of one year or greater.
(4)Net interest income divided by total average interest-earning assets.
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Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on net interest income on the Company. Information is provided with respect to the (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate), (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) the net change (sum of the prior columns). Changes in both rate and volume have been allocated to rate and volume variances based on the absolute values of each.
Rate Volume NetChange Rate Volume NetChange
(Dollars in thousands)
Interest-earning assets:
Interest-bearing liabilities:
______________
(1)Excludes interest on loans on non-accrual status. Includes loans held for sale and interest earned on loans held for sale.
Liquidity and Capital Resources
The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on loans, the sale of loans, maturing investment securities, maturing CDs held for investment and FHLB borrowings (if needed). While the maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The Bank must maintain an adequate level of liquidity to help ensure the availability of sufficient funds to fund its operations. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2024, the Bank's regulatory liquidity ratio (net cash, and short-term and marketable assets, as a percentage of net deposits and short-term liabilities) was 12.6%. At September 30, 2024, the Bank maintained an unused credit facility with the FHLB that provided for immediately available borrowings up to an aggregate amount equal to 45% of total assets, limited by available collateral, under which $20.00 million of the $626.04 million available for borrowings with the FHLB was outstanding at September 30, 2024. The Bank maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. At September 30, 2024, the Bank had no outstanding balance on the FRB borrowing line, under which $86.63 million was available for future borrowings. The Bank also maintains a $50.00 million overnight borrowing line with Pacific Coast Bankers' Bank ("PCBB"). At September 30, 2024, the Bank did not have an outstanding balance on this borrowing line. Subject to market conditions, the Bank expects to utilize these borrowing facilities from time to time in the
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future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible.
Liquidity management is both a short and long-term responsibility of the Bank's management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, and (iv) yields available on interest-bearing deposits. Excess liquidity is invested generally in interest-bearing overnight deposits, CDs held for investment and short-term government and agency obligations. If the Bank requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB, the FRB and PCBB.
The Bank's primary investing activity is the origination of loans and, to a lesser extent, the purchase of investment securities. During the years ended September 30, 2024, 2023 and 2022, the Bank originated $251.44 million, $361.79 million and $572.46 million of loans, respectively. At September 30, 2024, the Bank had loan commitments, consisting of undisbursed lines of credit and commitment to extend credit, totaling $146.15 million and undisbursed construction loans in process totaling $69.88 million. Investment securities purchased during the years ended September 30, 2024, 2023 and 2022 totaled $44.95 million, $32.60 million and $208.78 million, respectively.
The Bank’s liquidity is also affected by the volume of loans sold and loan principal payments. During the years ended September 30, 2024, 2023 and 2022, the Bank sold $14.75 million, $11.54 million and $73.50 million, respectively, in loans and loan participation interests. During the years ended September 30, 2024, 2023 and 2022, the Bank received $142.78 million, $177.31 million and $324.23 million, respectively, in loan principal repayments.
The Bank’s liquidity has been impacted by changes in deposit levels. During the year ended September 30, 2024, deposits increased by $86.73 million. During the years ended September 30, 2023 and 2022, deposits decreased by $71.24 million and increased $61.60 million, respectively. Our liquid assets in the form of cash and cash equivalents, CDs held for investment and investment securities available for sale increased to $247.19 million at September 30, 2024 from $185.68 million at September 30, 2023. The increase was primarily a result of increased deposits and a decrease in total investment securities, due to maturities and prepayments outpacing purchases. Historically, the Bank has been able to retain a significant amount of its deposits as they mature.
Capital expenditures are incurred on an ongoing basis to expand and improve the Bank's product offerings, enhance and modernize technology infrastructure, and to introduce new technology-based products to compete effectively in the various markets. Capital expenditure projects are evaluated based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and the expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations. Based on current objectives, there are no projects scheduled for capital investments in premises and equipment during the fiscal year ending September 30, 2025 that would materially impact liquidity.
For the fiscal year ending September 30, 2025, the Bank projects that fixed commitments will include $336,000 of operating lease payments. There are no scheduled payments and maturities of FHLB borrowings during fiscal year 2025. In addition, at September 30, 2024, there were other future obligations and accrued expenses of $8.82 million. For additional information, see "Note 12 - FHLB Borrowings and Other Borrowings" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
The Bank's management believes that the liquid assets combined with the available lines of credit provide adequate liquidity to meet current financial obligations for at least the next 12 months.
Timberland Bancorp is a separate legal entity from the Bank and must provide for its own liquidity and pay its own operating expenses. In addition to its operating expenses, Timberland Bancorp is responsible for paying dividends declared, if any, to its shareholders and funds paid for Company stock repurchases. Sources of capital and liquidity for Timberland Bancorp include distributions from the Bank and the issuance of debt or equity securities. At September 30, 2024, Timberland Bancorp (on an unconsolidated basis) had liquid assets of $1.43 million.
The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. The current quarterly common stock dividend rate is $0.25 per share, as approved by the Board of Directors, which is a dividend rate per share that enables the Company to balance multiple objectives of managing and investing in the Bank and returning a substantial portion of cash to shareholders. Assuming continued payment during fiscal year 2025 at the rate of $0.25 per share, the average total dividend paid each quarter would be approximately $1.99 million based on the number of current outstanding shares at September 30, 2024.
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In addition, from time to time, our Board of Directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans may also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On July 25, 2023, the Company announced the adoption of a stock repurchase program authorizing the repurchase of up to 404,708 shares of Company common stock, of which 155,166 shares remained available for future purchases as of September 30, 2024. The repurchase program may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, the availability of alternative investment opportunities, liquidity, and other factors deemed appropriate. The repurchase program does not obligate the Company to purchase any particular number of shares. For additional information on the Company’s stock repurchases, see “Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” contained in Part II of this report.
Bank holding companies and federally-insured state-chartered banks are required to maintain minimum levels of regulatory capital. At September 30, 2024, Timberland Bancorp and the Bank were in compliance with all applicable capital requirements. For additional details, see "Note 17 - Regulatory Matters" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report and “Item 1. Business - Regulation of the Bank - Capital Requirements".
New Accounting Pronouncements
For a discussion of new accounting pronouncements and their impact on the Company, see "Note 1-Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk and Asset and Liability Management” of this Form 10-K is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
Page
Consolidated Balance Sheets as of September 30, 2024 and 2023 68
Consolidated Statements of Income for the Years Ended
Consolidated Statements of Comprehensive Income for the
Consolidated Statements of Shareholders' Equity for the
Consolidated Statements of Cash Flows for the Years Ended
Notes to Consolidated Financial Statements 77
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of
Timberland Bancorp, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Timberland Bancorp, Inc. and Subsidiary (collectively, "the Company") as of September 30, 2024 and 2023, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended September 30, 2024, and the related notes (collectively, "the financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2024 and 2023, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2024, in conformity with accounting principles generally accepted in the United States of America (U.S.).
Adoption of New Accounting Standard
As described in Notes 1, 3, and 4 to the financial statements, the Company has changed its method of accounting for credit losses effective October 1, 2023 due to the adoption of Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, including all related amendments.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
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Allowance for Credit Losses for Loans
Critical Audit Matter Description
As described in Notes 1 and 4 to the financial statements, the Company's allowance for credit losses for loans as of September 30, 2024, was $17.48 million on a total loan portfolio, net of deferred fees, of $1.44 billion. The allowance for credit losses for loans reflects an estimate of lifetime expected credit losses in the loan portfolio. The measurement of expected credit losses is based on relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the Company's loan portfolio.
We identified the Company’s estimate of the allowance for credit losses for loans as a critical audit matter. The principal considerations for our determination of the allowance for credit losses for loans as a critical audit matter related to the high degree of subjectivity in the Company’s judgments in determining the qualitative factors, model assumptions, forecasts and forecasting periods. Auditing these complex judgments and assumptions by the Company involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.
How the Critical Audit Matter Was Addressed in the Audit
The primary audit procedures we performed to address this critical audit matter included the following, among others:
•We obtained an understanding of the relevant controls related to management’s establishment of the qualitative factors, assessment, review and approval of the qualitative factors, and the data used in determining the qualitative factors.
•We evaluated the relevance and the reasonableness of assumptions related to evaluation of the loan portfolio, current and forecasted economic conditions, and other risk factors used in development of the qualitative factors.
•We tested the completeness and accuracy of the significant inputs into the model including the underlying data used to develop the qualitative factors and forecasts.
•We validated the mathematical accuracy of the calculation.
•We evaluated the reasonableness of assumptions and data used by the Company in developing the qualitative factors by comparing these data points to internally developed and third-party sources, as well as other audit evidence gathered.
•We performed analytical procedures to evaluate the directional consistency of changes that occurred in the allowance for credit losses for loans.
/s/ Delap LLP
We have served as the Company's auditors since 2010.
Lake Oswego, Oregon
December 11, 2024
68
Consolidated Balance Sheets
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Assets
Cash and cash equivalents:
Cash and due from financial institutions $ 29,071 $ 25,390
Certificates of deposit (“CDs”) held for investment, at cost 10,209 15,188
Investment securities available for sale, at fair value 72,257 41,771
Investments in equity securities, at fair value 866 811
Federal Home Loan Bank of Des Moines (“FHLB”) stock, at cost 2,037 3,602
Loans held for sale — 400
Core deposit intangible (“CDI”), net 451 677
Operating lease right-of-use ("ROU") assets 1,475 1,772
Liabilities and shareholders’ equity
Liabilities
Deposits:
Other liabilities and accrued expenses 8,819 9,030
Commitments and contingencies (See Note 16)
See Notes to Consolidated Financial Statements
69
Consolidated Balance Sheets (continued)
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Accumulated other comprehensive income (loss) 20 (1,084)
See Notes to Consolidated Financial Statements
70
Consolidated Statements of Income
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2024, 2023 and 2022
Interest and dividend income
Dividends from mutual funds, FHLB stock and other investments 361 270 120
Interest expense
Provision for (recapture of) credit losses
Recapture of credit losses - investment securities (32) — —
Recapture of credit losses - unfunded commitments (71) — —
Non-interest income
Net recoveries on investment securities 12 9 22
Gain on sales of investment securities, net — 95 —
ATM and debit card interchange transaction fees 5,066 5,194 5,210
Valuation recovery on loan servicing rights, net — — 119
See Notes to Consolidated Financial Statements
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Consolidated Statements of Income (continued)
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2024, 2023 and 2022
Non-interest expense
(Gain) loss on sales/dispositions of premises and equipment, net (2) (19) 13