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:
______________
(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
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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
Other real estate owned ("OREO") and other repossessed assets, net 5 1 (17)
ATM and debit card interchange transaction fees 2,384 1,987 1,943
Federal Deposit Insurance Corporation ("FDIC") insurance 833 711 506
Loan administration and foreclosure 521 503 508
Net income per common share
See Notes to Consolidated Financial Statements
72
Consolidated Statements of Comprehensive Income
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2024, 2023 and 2022
Comprehensive income
Other comprehensive income (loss)
Total other comprehensive income (loss), net of income taxes 1,104 (367) (776)
See Notes to Consolidated Financial Statements
73
Consolidated Statements of Shareholders’ Equity
(Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2024, 2023 and 2022
Common Stock AccumulatedOtherComprehensiveIncome (Loss)
Number of Shares Amount RetainedEarnings Total
Other comprehensive loss — — — (776) (776)
Common stock dividends ($0.87 per common share) — — (7,232) — (7,232)
Stock based compensation expense — 246 — — 246
Other comprehensive loss — — — (367) (367)
Restricted stock grants 26,150 — — — — —
Common stock dividends ($1.01 per common share) — — (8,267) — (8,267)
Stock based compensation expense — 320 — — 320
74
Common Stock AccumulatedOtherComprehensiveIncome (Loss)
Number of Shares Amount RetainedEarnings Total
Other comprehensive income — — — 1,104 1,104
Restricted stock grants, net 28,615 — — — —
Common stock dividends ($0.95 per common share) — — (7,650) — (7,650)
Stock based compensation expense — 390 — — 390
See Notes to Consolidated Financial Statements
75
Consolidated Statements of Cash Flows
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2024, 2023 and 2022
Cash flows from operating activities
Accretion of discount on purchased loans (37) (75) (182)
Gain on sales of investment securities, net — (95) —
Net recoveries on investment securities (12) (9) (22)
Change in fair value of investments in equity securities (55) 24 120
Gain on sales of OREO and other repossessed assets, net — — (2)
Accretion of discounts and premiums on securities (1,051) (1,223) (39)
(Gain) loss on sales/dispositions of premises and equipment, net (2) (19) 13
Valuation adjustment on loan servicing rights, net — — (119)
BOLI death benefit in excess of cash surrender value — (79) —
Increase (decrease) in deferred loan origination fees 182 921 (822)
Cash flows from investing activities
Purchase of investment securities held to maturity (1,919) (15,602) (208,778)
Purchase of investment securities available for sale (43,032) (16,994) —
Proceeds from sales of investment securities available for sale — 8,927 —
Purchase of FHLB stock — (1,408) (91)
Proceeds from redemption of FHLB stock 1,565 — —
Purchase of premises and equipment (1,309) (1,106) (911)
Proceeds from sales of OREO and other repossessed assets — — 159
Proceeds from sales/dispositions of premises and equipment 8 — —
Proceeds from death benefit on BOLI — 546 —
See Notes to Consolidated Financial Statements
76
Consolidated Statements of Cash Flows (continued)
(Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiary
Years Ended September 30, 2024, 2023 and 2022
Cash flows from financing activities
Proceeds from exercise of stock options 659 698 415
Repurchase of common stock, net of taxes (5,958) (4,998) (4,583)
Cash and cash equivalents
Supplemental disclosure of cash flow information
Supplemental disclosure of non-cash investing and financing activities
Operating lease liabilities arising from recording of ROU assets $ — $ 72 $ —
See Notes to Consolidated Financial Statements
77
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Timberland Bancorp, Inc. (“Timberland Bancorp”), its wholly owned subsidiary, Timberland Bank (the “Bank”), and the Bank’s wholly owned subsidiary, Timberland Service Corp. (collectively, the "Company”). All significant intercompany transactions and balances have been eliminated in consolidation.
Nature of Operations
Timberland Bancorp is a bank holding company which operates primarily through its subsidiary, the Bank. The Bank was established in 1915 and, through its 23 branches located in Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties in Washington State, attracts deposits from the general public and uses those funds, along with other borrowings, primarily to provide residential real estate, construction, commercial real estate, commercial business and consumer loans to borrowers primarily in western Washington.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S.") (“GAAP”) and prevailing practices within the banking industry.The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, as of the date of the consolidated balance sheets, and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for credit losses ("ACL"), the valuation of loan servicing rights, the valuation of assets acquired and liabilities assumed in acquisitions and the valuation of goodwill for potential impairment.
Certain prior year amounts have been reclassified to conform to the 2024 fiscal year presentation with no change to previously reported net income or shareholders’ equity.
Segment Reporting
The Company has one reportable operating segment which is defined as community banking in western Washington under the operating name “Timberland Bank.”
Cash and Cash Equivalents and Cash Flows
The Company considers amounts included in the consolidated balance sheets’ captions “Cash and due from financial institutions” and “Interest-bearing deposits in banks,” all of which mature within ninety days, to be cash equivalents for purposes of reporting cash flows.
Interest-bearing deposits in banks as of September 30, 2024 and 2023 included deposits with the Federal Reserve Bank of San Francisco ("FRB") of $134,234,000 and $84,500,000, respectively. The Company also maintains balances in correspondent bank accounts which, at times, may exceed the FDIC insurance limit of $250,000 per correspondent bank. Management believes that its risk of loss associated with such balances is minimal due to the financial strength of the FRB and the correspondent banks.
CDs Held for Investment
CDs held for investment include amounts invested with other FDIC-insured financial institutions for a stated interest rate and with a fixed maturity date. Such CDs generally have maturities of 12 to 60 months from the date of purchase by the Company. Early withdrawal penalties may apply; however, the Company intends to hold these CDs to maturity. The Company generally limits its purchases of CDs to a maximum of $250,000 (the FDIC insurance coverage limit) with any single financial institution.
78
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Investment Securities
Investment securities are classified upon acquisition as held to maturity or available for sale. Investments securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Investment securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of income tax effects. Premiums and discounts are amortized to interest income using the interest method over the contractual lives of the securities. Gains and losses on sales of investment securities are recognized on the trade date and determined using the specific identification method.
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. If the Company is likely to sell an investment security, any noncredit component losses are recognized and are reported in non-interest income.
Investments in Equity Securities
Investments in equity securities are stated at fair value. Changes in the fair value of investments in equity securities are recorded in other non-interest income.
FHLB Stock
The Bank, as a member of the FHLB, is required to maintain an investment in capital stock of the FHLB in an amount equal to 0.06% of the Bank's total assets, with a maximum of $10.00 million and a minimum of $10,000, plus 4.50% of any borrowings from the FHLB. No ready market exists for this stock, and it has no quoted market value. However, redemption of FHLB stock has historically been at par value. The Company's investment in FHLB stock is carried at cost, which approximates fair value.
The Company evaluates its FHLB stock for impairment as needed. The Company's determination of whether this investment is impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared with the capital stock amount and the length of time that any decline has persisted; (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB; (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB; and (4) the liquidity position of the FHLB. Based on its evaluation, the Company determined that there was no impairment of FHLB stock at September 30, 2024 and 2023.
Other Investments
The Bank invests in the Solomon Hess SBA Loan Fund LLC - a private investment fund - to help satisfy compliance with the Bank's Community Reinvestment Act ("CRA") investment test requirements. Shares in this fund are not publicly traded and, therefore, have no readily determinable fair value. The Bank's investment in the fund is recorded at cost. An investor can have its investment in the fund redeemed for the balance of its capital account at any quarter-end with a 60 day notice to the fund.
Loans Held for Sale
Mortgage loans and commercial business loans originated and intended for sale in the secondary market are stated in the aggregate at the lower of cost or estimated fair value. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Gains or losses on sales of loans are recognized at the time of sale. The gain or loss is the difference between the net sales proceeds and the recorded value of the loans, including any remaining unamortized deferred loan origination fees.
79
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed portion of construction loans in process, net deferred loan origination fees and the allowance for credit losses ("ACL").
Interest on loans is accrued daily based on the principal amount outstanding. Generally, the accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to make payments as they become due or when they are past due 90 days as to either principal or interest (based on contractual terms), unless the loan is well secured and in the process of collection. In determining whether a borrower may be able to make payments as they become due, management considers circumstances such as the financial strength of the borrower, the estimated collateral value, reasons for the delays in payments, payment record, the amounts past due and the number of days past due. All interest accrued but not collected for loans that are placed on non-accrual status or charged off is reversed against interest income. Subsequent collections on a cash basis are applied proportionately to past due principal and interest, unless collectability of principal is in doubt, in which case all payments are applied to principal. Loans are returned to accrual status when the loan is deemed current, and the collectability of principal and interest is no longer doubtful, or, in the case of one- to four-family loans, when the loan is less than 90 days delinquent. The categories of non-accrual loans and impaired loans overlap, although they are not identical.
The Company charges fees for originating loans. These fees, net of certain loan origination costs, are deferred and amortized to income on the level-yield basis over the loan term. If the loan is repaid prior to maturity, the remaining unamortized deferred loan origination fee is recognized in income at the time of repayment.
Acquired Loans
Purchased loans, including loans acquired in business combinations, are recorded at their estimated fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an ACL is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit-impaired ("PCI") or purchased non-credit-impaired. PCI loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. The excess of the cash flows expected to be collected over a PCI loan's carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the PCI loan using the effective yield method. The excess of the undiscounted contractual balances due over the cash flows expected to be collected is considered to be the nonaccretable difference. The nonaccretable difference represents the Company's estimate of the credit losses expected to occur and would be considered in determining the estimated fair value of the loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over those expected at the purchase date in excess of fair value are adjusted through a change to the accretable yield on a prospective basis. Any subsequent decreases in expected cash flows attributable to credit deterioration are recognized by recording an ACL on loans. PCI loans were insignificant as of September 30, 2024 and 2023.
For purchased non-credit-impaired loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the life of the loans. Any subsequent deterioration in credit quality is recognized by recording an ACL on loans.
Allowance for Credit Losses
ACL on Available for Sale Investment Securities - Available for sale investment securities in an unrealized loss position, areassessed to determine whether the Company intends to sell, or is more likely than not to be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. Investment securities available-for-sale that do not meet the aforementioned criteria, are evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Company considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded, limited by the amount that the fair value is less than the amortized cost basis.
80
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Accrued interest receivable on investment securities available for sale is excluded from the estimate of expected credit losses. Changes in the ACL on investment securities available for sale are recorded as provision for (recapture of) credit losses on the consolidated income statements. Losses are charged against the ACL when it is believed the uncollectibility of an investment security available for sale is confirmed or when either of the criteria regarding intent or requirement to sell is met.
ACL on Held to Maturity Investment Securities - The Company measures expected credit losses on investment securities held to maturity on a pooled, collective basis by major investment security type with similar risk characteristics. A historical lifetime probability of default and severity of loss in the event of default is derived or obtained from external sources and adjusted for the expected effects of reasonable and supportable forecasts over the expected lives of the investment securities on those historical credit losses. Expected credit losses on investment securities in the held to maturity portfolio that do not share similar risk characteristics with any of the pools are individually measured based on net realizable value, or the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the recorded amortized cost basis of the investment securities.
Accrued interest receivable on investment securities held to maturity is excluded from the estimate of expected credit losses. Changes in the ACL on investment securities held to maturity are recorded as provision for (recapture of) credit losses in the consolidated income statements. Losses are charged against the ACL when it is believed the uncollectibility of an investment security held to maturity is confirmed.
ACL on Loans - The Company adopted the new accounting standard for the ACL, commonly referred to as the current expected credit losses ("CECL") methodology, as of October 1, 2023. All disclosures as of and for the year ended September 30, 2024 are presented in accordance with the new accounting standard. The comparative financial periods prior to the adoption of this new accounting standard are presented and disclosed under previously applicable GAAP's incurred loss methodology, which is not directly comparable to the new, CECL methodology. See also, Note 4 - Loan Receivable and Allowance for Credit Losses. As a result of implementing this new accounting standard, there was a one-time adjustment to the fiscal year 2024 opening allowance balance of $461,000 related to loans held for investment. The Company elected not to measure an ACL for accrued interest receivable and elected to reverse interest income on loans that are placed on nonaccrual status, which is generally when the instrument is 90 days past due, or earlier if the Company believes the collection of interest is doubtful. The Company has concluded that this policy results in the timely reversal of uncollectible interest.
The ACL is a 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. The Company estimates the expected credit losses over the loans' contractual term, adjusted for expected prepayments. The ACL is calculated for loan segments utilizing loan level information and relevant information from internal and external sources related to past events and current conditions. Management has adopted the discounted cash flow ("DCF") methodology for all segments. The Company incorporates a reasonable and supportable forecast that utilizes current period national gross domestic product ("GDP") and national unemployment figures. Each of the loan segments are impacted by those factors. Prepayment rates are established for each segment based on historical averages for the segments, which management believes is an accurate presentation of future prepayment activity. Loans that are evaluated individually are not included in the collective analysis. The ACL on loans that are evaluated individually may be estimated based on their expected cash flows, or in the case of loans for which repayment is expected substantially through the operation or sale of collateral when the borrower is experiencing financial difficulty, may be measured based on the fair value of the collateral less estimated selling costs.
When available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged against the ACL. The existence of some or all of the following criteria will generally confirm that loss has been incurred: the loans is significantly delinquent and the borrower has not demonstrated the ability or intent to bring the loan current; the Company has no recourse to the borrower, or if it does the borrower has insufficient assets to pay the debt; and/or the estimated fair value of the loan collateral is significantly below the current loan balance, and there is little or no near-term prospect for improvement.
Management's evaluation of the ACL is based on ongoing, quarterly assessments of the known or inherent risks in the loan portfolio. Loss factors are based on the Company's historical loss experiences with additional consideration and adjustments made for changes in economic conditions, changes in the amount and composition of the loan portfolio, delinquency rates, changes in collateral values, seasoning of the loan portfolio, duration of the current business cycle, a detailed analysis of individually evaluated loans and other factors as deemed appropriate. Management also assesses the risk related to reasonable
81
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
and supportable forecasts that are used. These factors are evaluated on a quarterly basis. Loss rates used by the Company are affected as changes in these factors increase or decrease from quarter to quarter. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's ACL and may require the Company to make adjustments to the ACL based on their judgment about information available to them at the time of their examinations. The ACL on loans totaled $17,478,000 at September 30, 2024.
ACL for Unfunded Loan Commitments - The Company maintains a separate ACL related to unfunded loan commitments. Management estimates the amount of expected losses related to unfunded, off-balance sheet commitments over the contractual period in which exposure to credit risk from a contractual obligation to extend credit, unless the Company has determined that obligation is unconditionally cancellable. The methodology for calculating the ACL on unfunded loan commitments is similar to the methodology for calculating the ACL on loans but also includes an estimate of the future utilization of the commitment as determined by historical utilization. Credit risk associated with the unfunded commitments are consistent with the loss ratio for each loan segment within the ACL for loans. The ACL on unfunded commitments is recognized in other liabilities and accrued expenses in the consolidated balance sheets and is adjusted as a provision for (recapture of) credit losses on the consolidated income statements. The ACL on unfunded loan commitments totaled $327,000 at September 30, 2024.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed using the straight-line method over the following estimated useful lives: buildings and improvements - five to forty years; and furniture and equipment - three to seven years. The cost of maintenance and repairs is charged to expense as incurred. Gains and losses on dispositions are reflected in current earnings.
Impairment of Long-Lived Assets
Long-lived assets, consisting of premises and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the recorded amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the recorded amount of an asset to undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the recorded amount of the assets exceeds the discounted recovery amount or estimated fair value of the assets. No events or changes in circumstances have occurred during the years ended September 30, 2024 or 2023 that would cause management to re-evaluate the recoverability of the Company’s long-lived assets.
OREO and Other Repossessed Assets
OREO and other repossessed assets consist of properties or assets acquired through or in lieu of foreclosure, and are recorded initially at the estimated fair value of the properties less estimated costs of disposal, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. When the property is acquired, any excess of the loan balance over the estimated net realizable value is charged to the ACL for OREO. The valuation of real estate is subjective in nature and may be adjusted in future periods because of changes in economic conditions. Management considers third-party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling real estate, in determining the estimated fair values of particular properties. In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes and any related adjustments are generally recorded at the time such information is received. Costs relating to development and improvement of the properties or assets are capitalized, while costs relating to holding the properties or assets are expensed.
BOLI
BOLI policies are recorded at their cash surrender value less applicable cash surrender charges. Income from BOLI is recognized when earned.
82
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Goodwill
Goodwill is initially recorded when the purchase price paid in a business combination exceeds the estimated fair value of the net identified tangible and intangible assets acquired and liabilities assumed. Goodwill is presumed to have an indefinite useful life and is analyzed annually for impairment. The Company performs an annual review during the third quarter of each fiscal year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill is impaired. For purposes of goodwill impairment testing, the services offered through the Bank and its subsidiary are managed as one strategic unit and represent the Company's only reporting unit.
The annual goodwill impairment test begins with a qualitative assessment of whether it is "more likely than not" that the reporting unit's fair value is less than its carrying amount. If an entity concludes that it is not "more likely than not" that the fair value of a reporting unit is less than its carrying amount, it need not perform a two-step impairment test. If the Company's qualitative assessment concluded that it is "more likely than not" that the fair value of its reporting unit is less than its carrying amount, it must perform the two-step impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized, if any. The first step of the goodwill impairment test compares the estimated fair value of the reporting unit with its carrying amount, or the book value, including goodwill. If the estimated fair value of the reporting unit equals or exceeds its book value, goodwill is considered not impaired, and the second step of the impairment test is unnecessary.
The second step, if necessary, measures the amount of goodwill impairment loss to be recognized. The reporting unit must determine fair value for all assets and liabilities, excluding goodwill. The net of the assigned fair value of assets and liabilities is then compared to the book value of the reporting unit, and any excess book value becomes the implied fair value of goodwill. If the carrying amount of the goodwill exceeds the newly calculated implied fair value of goodwill, an impairment loss is recognized in the amount required to write-down the goodwill to the implied fair value.
Management's qualitative assessment takes into consideration macroeconomic conditions, industry and market considerations, cost or margin factors, financial performance and the share price of the Company's common stock. The Company performed its
fiscal year 2024 goodwill impairment test during the quarter ended June 30, 2024. Based on this assessment, the Company determined that it is not "more likely than not" that the Company's fair value is less than its carrying amount, and, therefore, goodwill was determined not to be impaired at May 31, 2024.
A significant amount of judgment is involved in determining if an indicator of goodwill impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in the Company's stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse assessment or action by a regulator; and unanticipated competition. Any change in these indicators could have a significant negative impact on the Company's financial condition, impact the goodwill impairment analysis or cause the Company to perform a goodwill impairment analysis more frequently than once per year.
As of September 30, 2024, management believes that there were no events or changes in the circumstances since May 31, 2024 that would indicate a potential impairment of goodwill. No assurances can be given, however, that the Company will not record an impairment loss on goodwill in the future. If adverse economic conditions or decreases in the Company's stock price and market capitalization were deemed to be other than temporary, it may significantly affect the fair value of the Company's goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on the Company's results of operation and financial condition.
CDI
CDI represents the future economic benefit of the potential cost savings from acquiring core deposits as part of a business combination compared to the cost of alternative funding sources. CDI is amortized to non-interest expense using an accelerated method based on an estimated runoff of related deposits over a period of ten years. CDI is evaluated for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable, with any changes in estimated useful life accounted for prospectively over the revised remaining life.
83
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Loan Servicing Rights
The Company holds rights to service (1) loans that it has originated and sold to the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and (2) the guaranteed portion of U.S. Small Business Administration ("SBA") loans sold in the secondary market. Loan servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold with the servicing rights retained. Loan servicing rights are amortized to servicing income on loans sold approximately in proportion to and over the period of estimated net servicing income. The value of loan servicing rights at the date of the sale of loans is estimated based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and expected prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the loan servicing assets to those estimated at the time that the loan servicing assets were originated. Fair values are estimated using expected future discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the loan servicing rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized loan servicing rights based on product type and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the loan servicing rights exceeds their fair value. Impairment, if deemed temporary, is recognized through a valuation allowance to the extent that fair value is less than the recorded amount.
Operating Leases
The Company has only identified leases classified as operating leases. Operating leases are recorded as ROU assets and ROU liabilities within operating lease assets and operating lease liabilities, respectively, in the consolidated balance sheet. ROU assets represent the Company's right to use an underlying asset for the lease term and ROU liabilities represent the Company's obligation to make lease payments arising from the lease. Operating lease ROU assets and ROU liabilities are recognized at the lease agreement commencement date based on the present value of lease payments over the lease term. The lease term incorporates options to extend the lease when it is reasonably certain that the Company will exercise that option. As the Company's leases typically do not provide an implicit rate; the Company uses the weighted average discount rate to estimate the present value of future lease payments in calculating the value of the ROU asset. The operating lease ROU assets is further reduced by any lease pre-payments made and lease incentives. The leases may contain various provisions for increases in rental rates based either on changes in the published Consumer Price Index or a predetermined escalation schedule and such variable lease payments are recognized as lease expense as they are incurred. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
The Company excludes operating leases with a term of twelve months or less from being capitalized as ROU assets and ROU liabilities.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Income Taxes
The Company files a consolidated federal and various state income tax returns. The Bank provides for income taxes separately and remits to (receives from) Timberland Bancorp amounts currently due (receivable).
Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements. These temporary differences will result in differences between income for tax purposes and income for financial reporting purposes in future years. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established to reduce the net recorded amount of deferred tax assets if it is determined to be more likely than not that all or some portion of the potential deferred tax asset will not be realized.
84
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
With respect to accounting for uncertainty in incomes taxes, a tax provision is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized upon examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters as income tax expense. The Company is no longer subject to U.S. federal income tax examination by tax authorities for years ended on or before September 30, 2020.
Advertising
Costs for advertising and marketing are expensed as incurred.
Stock-Based Compensation
The Company measures compensation cost for all stock-based awards based on the grant-date fair value of the stock-based awards and recognizes compensation cost over the service period of stock-based awards. The fair value of stock options is determined using the Black-Scholes valuation model. Stock option forfeitures are accounted for as they occur. The fair value of restricted stock is determined based on the grant date fair value of the Company's common stock.
Net Income Per Common Share
Basic net income per common share is computed by dividing net income to common shareholders by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Nonvested shares of restricted stock are included in the computation of basic earnings per share because the holder has voting rights and shares in non-forfeitable dividends during the vesting period. Diluted net income per common share is computed by dividing net income to common shareholders by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method at the average share price for the Company's common stock during the period. Common stock equivalents arise from the assumed conversion of outstanding stock options.
Related Party Transactions
The previous Board Chair of the Bank and Timberland Bancorp passed away during the year ended September 30, 2023. He was a member of the law firm that provides general counsel to the Company. Legal and other fees paid to this law firm during the period he served on the Board for the years ended September 30, 2023 and 2022 totaled $24,000 and $48,000, respectively.
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10 and ASU 2019-11. ASU 2016-13 replaces the existing incurred losses methodology with a current expected losses methodology with respect to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held to maturity investment securities and off-balance sheet commitments. In addition, ASU 2016-13 required credit losses relating to available for sale debt securities to be recorded through an ACL rather than as a reduction of the carrying amount. ASU 2016-13 also changed the accounting for Purchase Credit Impaired ("PCI") debt securities and loans. ASU 2016-13 retained many of the current disclosure requirements in GAAP and expanded certain disclosure requirements. As a "smaller reporting company" filer with the U.S. Securities and Exchange Commission, ASU 2016-13 was effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Upon adoption, the Company experienced changes in the processes and procedures to calculate the ACL, including changes in the assumptions and estimates to consider expected credit losses over the life of the loan versus the accounting practices that were utilized with the incurred loss model. In addition, the prior policy for OTTI on investment securities held to maturity was replaced with an allowance approach.
85
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
On October 1, 2023, the Company adopted this ASU. The following table sets forth information on the impact of adopting this ASU (dollars in thousands):
Assets:
ACL on investment securities $ — $ 92 $ 92
Liabilities:
For more information related to the implementation, see Note 3 - Investment Securities, Note 4 - Loans Receivable and Allowance for Credit Losses and Note 16 - Commitments and Contingent Liabilities.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. This ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity has to perform procedures to determine the fair value of its assets and liabilities (including unrecognized assets and liabilities) at the impairment testing date following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity would then recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized would not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity would consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU 2017-04 was effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2022. The adoption of ASU 2017-04 did not have a material impact on the Company's consolidated financial statements.
In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (ASU 2016-13): Troubled Debt Restructurings and Vintage Disclosures. The amendments eliminate the accounting guidance for trouble debt restructurings ("TDR") for creditors, require new disclosures for creditors for certain loan refinancings and restructurings when a borrower is experiencing financial difficulty, and require public business entities to include current-period gross write-offs in the vintage disclosure tables. This ASU was effective upon adoption of ASU 2016-13. On October 1, 2023, the Company adopted this ASU at the same time ASU 2016-13 was adopted.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The amendments in this ASU are intended to provide more transparency about income tax information through improvements to income tax disclosures primarily related to the rate reconciliation and income tax paid information. The ASU requires disclosure in the rate reconciliation of specific categories as well as additional information for reconciling items that meet a quantitative threshold. The amendment requires on an annual basis a reconciliation broken out into specified categories with certain reconciling items further broken out by nature and jurisdiction to the extent those items exceed a specified threshold. In addition, all entities are required to disclose income taxes paid, net of refunds received disaggregated by federal, state/local, and foreign and by jurisdiction if the amount is at least 5% of total income tax payments, net of refunds received. The new standard is effective for annual periods beginning after December 15, 2024, with early adoption permitted. An entity should apply the amendments in this ASU on a prospective basis. The Company expects this ASU to only impact its disclosure requirements and does not expect the adoption of this ASU to have a material impact on its business operations or the Company's consolidated financial statements.
In November 2024, the FASB issued ASU 2024-03, Income Statement (Topic 220): Income Statement-Reporting Comprehensive Income-Expense Disaggregation Disclosures. The amendments in this ASU require disclosure, in notes to the
86
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
financial statements, of specified information about certain costs and expenses. In conjunction with recent standards that enhanced the disaggregation of revenue and income tax information, the disaggregated expense information will enable investors to better understand the major components of an entity's income statement. The new standard is effective for annual periods beginning after December 15, 2026, with early adoption permitted. The Company expects this ASU to only impact its disclosure requirements and does not expect the adoption of the ASU to have a material impact on its business operations or the Company's consolidated financial statements.
Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Company's financial position, results of operations or cash flows.
Note 2 - Restricted Assets
Federal Reserve regulations require that the Bank maintain certain minimum reserve balances on hand or on deposit with the FRB, based on a percentage of transaction account deposits. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratio to zero percent, effective March 26, 2020. Currently, the FRB has not announced plans to re-impose a reserve requirement; however, the FRB may adjust reserve requirement ratios at its sole discretion.
87
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Note 3 - Investment Securities
Held to maturity and available for sale investment securities were as follows as of September 30, 2024 and 2023 (dollars in thousands):
AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses EstimatedFair Value ACL
Held to Maturity
Mortgage-backed securities ("MBS"):
Bank issued trust preferred securities 495 — (18) 477 5
Available for Sale
U.S. government securities $ 3,934 $ 6 $ (1) $ 3,939
Held to Maturity
MBS:
Bank issued trust preferred securities 500 — (51) 449
Available for Sale
88
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2024 (dollars in thousands):
Less Than 12 Months 12 Months or Longer Total
Held to Maturity
MBS:
Bank issued trust preferred securities — — — 477 (18) 1 477 (18)
Available for Sale
U.S. government securities $ 1,962 $ (1) 1 $ — $ — — $ 1,962 $ (1)
Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2023 (dollars in thousands):
Less Than 12 Months 12 Months or Longer Total
Held to Maturity
MBS:
Bank issued trust preferred securities — — — 449 (51) 1 449 (51)
Available for Sale
MBS:
89
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
During the year ended September 30, 2024, the Company recorded a $2,000 net realized loss on 14 held to maturity investment securities, all of which had been recognized previously as a credit loss. During the year ended September 30, 2023, the Company recorded a $11,000 net realized loss on 14 held to maturity investment securities, all of which had been recognized previously as a credit loss. During the year ended September 30, 2022, the Company recorded a $1,000 net realized gain on 16 held to maturity investment securities, all of which had been recognized previously as a credit loss.
There were no realized gains or losses on available for sale securities for the year ended September 30, 2024. During the year ended September 30, 2023, the Company recorded a $95,000 realized gain on sale of two available for sale investment securities. There were no realized gains or losses on available for sale investment securities for the year ended September 30, 2022.
The recorded amount of investment securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits and FHLB collateral totaled $208,810,000 and $201,820,000 at September 30, 2024 and 2023, respectively.
The contractual maturities of debt securities at September 30, 2024 are as follows (dollars in thousands). Expected maturities may differ from scheduled maturities due to the prepayment of principal or call provisions.
Held to Maturity Available for Sale
AmortizedCost EstimatedFairValue AmortizedCost EstimatedFairValue
Credit Quality Indicators and Allowance for Credit Losses
Available for Sale Investment Securities
The Company assesses each available for sale investment security that is an unrealized loss position to determine whether the decline in fair value below the amortized cost basis results from a credit loss or other factors. The Company did not record an ACL on any available for sale investment securities at September 30, 2024 or upon adoption of ASU 2016-13 on October 1, 2023. As of both dates, the Company considered the unrealized losses across the classes of major security-type to be related to fluctuations in market conditions, primarily interest rates, and not reflective of a deterioration in credit value. The Company expects the fair value of these securities to recover as the securities approach their maturity dates or sooner if market yields for such securities decline. The Company does not believe that these securities are impaired because of their credit quality or related to any issuer or industry specific event. The Company has the ability and intent to hold the investments until the fair value recovers.
Held to Maturity Investment Securities
The Company measures expected credit losses on held to maturity investment securities, which are comprised of U.S. government agency and U.S. government mortgage-backed securities, private label mortgage-backed securities, municipal and other bonds. The Company's agency and mortgage-backed securities that are issued by U.S. government entities and agencies are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major rating agencies, and have a long history of no credit losses. As such, no ACL has been established for these securities. The ACL on the private label mortgage-backed securities, municipal, and other bonds within the held to maturity securities schedule is calculated using the probability of default/loss given default ("PD/LGD") method. The calculation is completed on a quarterly basis using the default studies provided by an industry leading source. At September 30, 2024, the ACL on the held to maturity securities portfolio totaled $60,000.
90
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
The following table sets forth information for the year ended September 30, 2024 regarding activity in the ACL by portfolio segment (dollars in thousands):
MBS:
Private label residential $ — $ 82 $ (27) $ 55
Bank issued trust preferred securities — 10 (5) 5
The ACL on held to maturity securities is included within investment securities held to maturity on the consolidated balance sheets. Changes in the ACL are recorded through the provision for (recapture of) credit losses on the consolidated income statements.
Accrued interest receivable on held to maturity investment securities totaled $455,000 at September 30, 2024 and is included in accrued interest receivable on the consolidated balance sheet. This amount is excluded from the estimate of expected credit losses. Held to maturity investment securities are typically classified as non-accrual when the contractual payment of principal and interest has become 90 days past due or management has serious doubts about the further collectability of principal or interest. When held to maturity debt securities are placed on non-accrual status, unpaid interest credited to income is reversed. The Company had $51,000 of private label mortgage-backed held to maturity investment securities in non-accrual status at September 30, 2024.
The Company monitors the credit quality of debt securities held to maturity using credit ratings from Moody's, S&P and Fitch. The Company monitors the credit ratings on a quarterly basis.
The following table sets forth the Company's held to maturity investment securities at September 30, 2024 by credit quality indicator (dollars in thousands):
Credit Ratings
As of September 30, 2024 AAA/AA/A BBB/BB/B Unrated Total
Held to Maturity
U.S. Treasury and U.S. government agency securities $ 92,312 $ — $ — $ 92,312
MBS:
Bank issued trust preferred securities — — 495 495
91
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Prior to adopting ASU 2016-13, the Company bifurcated OTTI into (1) amounts related to credit losses which are recognized through earnings and (2) amounts related to all other factors which are recognized as a component of other comprehensive income (loss). To determine the component of the gross OTTI related to credit losses, the Company compared the amortized cost basis of the OTTI security to the present value of its revised expected cash flows, discounted using its pre-impairment yield. The revised expected cash flow estimates for individual securities are based primarily on an analysis of the default rates, prepayment speeds and third-party analytic reports. Significant judgment by management was required in this analysis that included, but not limited to, assumptions regarding the collectability of principal and interest, net of related expenses, on the underlying loan. The amounts written off due to credit loss remain and continue to be recovered on a cash basis.
The following table represents a roll forward of the credit loss component of held to maturity investment securities that have been written down for OTTI with the credit loss component recognized in earning for the years ended September 30, 2024, 2023 and 2022 (dollars in thousands):
Subtractions:
Net realized gain (losses) previously recorded as credit losses (2) (11) 1
Recovery of prior credit loss (11) (9) (18)
92
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Note 4 - Loans Receivable and Allowance for Credit Losses
Loans receivable by portfolio segment consisted of the following at September 30, 2024 and 2023 (dollars in thousands):
Mortgage loans:
Construction – speculative one- to four-family 11,495 17,099
Consumer loans:
Commercial loans:
SBA Paycheck Protection Program ("PPP") 260 466
Less:
Undisbursed portion of construction loans in process 69,878 103,194
Deferred loan origination fees, net 5,425 5,242
Loans receivable at September 30, 2024 and 2023 are reported net of unamortized discounts totaling $155,000 and $192,000, respectively.
Significant Concentrations of Credit Risk
Most of the Company’s lending activity is with customers located in the state of Washington and involves real estate. At September 30, 2024, the Company had $1,372,172,000 (including $69,878,000 of undisbursed construction loans in process) in loans secured by real estate, which represented 90.69% of total loans receivable. The real estate loan portfolio is primarily secured by one- to four-family properties, multi-family properties, land, and a variety of commercial real estate property types. At September 30, 2024, there were no concentrations of real estate loans to a specific industry or secured by a specific collateral type that equaled or exceeded 20% of the Company’s total loan portfolio, other than loans secured by one-to four-family properties. The ultimate collectability of a substantial portion of the loan portfolio is susceptible to changes in economic and market conditions in the region and the impact of those changes on the real estate market. The Company typically originates real estate loans with loan-to-value ratios of no greater than 85%. Collateral and/or guarantees are required for all loans.
93
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiary
September 30, 2024 and 2023
Related Party Loans
Certain related parties of the Company, principally Bank directors and officers, are loan customers of the Bank in the ordinary course of business. Such related party loans were performing according to their repayment terms at September 30, 2024 and 2023. Activity in related party loans during the years ended September 30, 2024, 2023 and 2022 was as follows (dollars in thousands):
Balance, beginning of year $ 102 $ 50 $ 466