Timberland Bancorp (TSBK) 10-K2024 FY Annual report

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As of December 4, 2024, the registrant had 7,967,916 shares of common stock issued and outstanding.  The aggregate market value of the common stock held by nonaffiliates of the registrant, based on the closing sales price of the registrant’s common stock as quoted on the NASDAQ Global Market on March 31, 2024, was $215.98 million (8,023,121 shares at $26.92).  For purposes of this calculation, common stock held by officers and directors of the registrant was included.

Special Note Regarding Forward-Looking Statements

Certain matters discussed in this Annual Report on Form 10-K may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and often include the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause our actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to:

Any of the forward-looking statements that we make in this 2024 Form 10-K and in the other public statements we make are based upon management's beliefs and assumptions at the time they are made. We do not undertake and specifically disclaim any obligation to publicly update or revise any forward-looking statements included in this annual report to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur and we caution readers not to place undue reliance on any forward-looking statements. These risks could cause our actual results for fiscal 2025 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company's consolidated financial condition and results of operations as well as its stock price performance.

General

Timberland Bancorp, Inc. (“Timberland Bancorp"), a Washington corporation, was organized on September 8, 1997 for the purpose of becoming the holding company for Timberland Bank (the "Bank").  At September 30, 2024, on a consolidated basis, the Company had total assets of $1.92 billion, net loans receivable of $1.42 billion, total 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, including consolidated financial statements and related data, relates primarily to the Bank and its subsidiary, Timberland Service Corp.

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

Market Area

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

Hoquiam, with a population of approximately 8,800, is located in Grays Harbor County which is situated along Washington State’s central Pacific coast.  Hoquiam is located approximately 110 miles southwest of Seattle, Washington and 145 miles northwest of Portland, Oregon.

The Bank considers its primary market area to include six sub-markets: primarily rural Grays Harbor County with its historical dependence on the timber and fishing industries; Thurston and Kitsap counties with their dependence on state and federal government; Pierce and King counties with their broadly diversified economic bases; and Lewis County with its dependence on retail trade, manufacturing, industrial services and local government.  Each of these markets presents operating risks to the Bank.  The Bank’s expansion into Pierce, Thurston, Kitsap, King and Lewis counties represents the Bank’s strategy to expand and diversify its primary market area to become less reliant on the economy of Grays Harbor County.

Grays Harbor County has a population of 77,000 according to the United States ("U.S.") Census Bureau 2023 estimates and a median family income of $90,000 according to 2024 estimates from the Department of Housing and Urban Development (“HUD”).  The economic base in Grays Harbor County has been historically dependent on the timber and fishing industries. Other industries that support the economic base are tourism, agriculture, shipping, transportation and technology.  According to the Washington State Employment Security Department, the unemployment rate in Grays Harbor County increased to 5.5% at September 30, 2024 from 4.8% at September 30, 2023.  The median price of a resale home in Grays Harbor County for the quarter ended September 30, 2024 increased 4.0% to $365,400 from $351,300 for the comparable prior year period.  The number of home sales decreased 13.7% for the quarter ended September 30, 2024 compared to the same quarter one year earlier.  The Bank has six branches (including its home office) located in the county.  

Pierce County is the second most populous county in the state and has a population of 929,000 according to the U.S. Census Bureau 2023 estimates.  The county’s median family income is $112,300 according to 2024 HUD estimates.  The economy in Pierce County is diversified with the presence of military related government employment (Joint Base Lewis-McChord), transportation and shipping employment (Port of Tacoma), and aerospace related employment.  According to the Washington State Employment Security Department, the unemployment rate for the Pierce County area increased to 4.5% at September 30, 2024 from 3.9% at September 30, 2023. The median price of a resale home in Pierce County for the quarter ended September 30, 2024 increased 5.7% to $576,400 from $545,200 for the comparable prior year period.  The number of home sales decreased 13.9% for the quarter ended September 30, 2024 compared to the same quarter one year earlier.  The Bank has five branches located in Pierce County, and these branches have historically been responsible for a substantial portion of the Bank’s construction lending activities. 

Thurston County has a population of 299,000 according to the U.S. Census Bureau 2023 estimates and a median family income of $116,700 according to 2024 HUD estimates.  Thurston County is home of Washington State’s capital (Olympia), and its economic base is largely driven by state government related employment. According to the Washington State Employment Security Department, the unemployment rate for the Thurston County area increased to 3.8% at September 30, 2024 from 3.4% at September 30, 2023. The median price of a resale home in Thurston County for the quarter ended September 30, 2024 increased 2.4% to $528,800 from $516,300 for the same quarter one year earlier.  The number of home sales decreased 12.2% for the quarter ended September 30, 2024 compared to the same quarter one year earlier.  The Bank has six branches located in Thurston County.  This county has historically had a stable economic base primarily attributable to the state government presence.

Kitsap County has a population of 278,000 according to the U.S. Census Bureau 2023 estimates and a median family income of $119,700 according to 2024 HUD estimates.  The Bank has two branches located in Kitsap County.  The economic base of Kitsap County is largely supported by military related government employment through the U.S. Navy.  According to the Washington State Employment Security Department, the unemployment rate for the Kitsap County area increased to 3.8% at September 30, 2024 from 3.5% at September 30, 2023.  The median price of a resale home in Kitsap County for the quarter ended September 30, 2024 increased 0.3% to $554,100 from $552,700 for the same quarter one year earlier.  The number of home sales decreased 7.8% for the quarter ended September 30, 2024 compared to the same quarter one year earlier.  

King County is the most populous county in the state and has a population of 2.3 million according to the U.S. Census Bureau 2023 estimates.  The Bank has one branch located in King County.  The county’s median family income is $158,700 according to 2024 HUD estimates.  King County’s economic base is diversified with many industries including shipping, transportation, aerospace, computer technology and biotech. According to the Washington State Employment Security Department, the unemployment rate for the King County area increased to 4.2% at September 30, 2024 from 3.6% at September 30, 2023. The median price of a resale home in King County for the quarter ended September 30, 2024 increased 8.4% to $984,200 from $908,100 for the same quarter one year earlier.  The number of home sales decreased 6.1% for the quarter ended September 30, 2024 compared to the same quarter one year earlier.  

Lewis County has a population of 86,000 according to the U.S. Census Bureau 2022 estimates and a median family income of $90,000 according to 2024 HUD estimates. The economic base in Lewis County is supported by manufacturing, retail trade, local government and industrial services. According to the Washington State Employment Security Department, the unemployment rate in Lewis County increased to 4.7% at September 30, 2024 from 4.3% at September 30, 2023. The median price of a resale home in Lewis County for the quarter ended September 30, 2024 increased 3.6% to $425,800 from $410,900 for the same quarter one year earlier. The number of home sales decreased 14.4% for the quarter ended September 30, 2024 compared to the same quarter one year earlier.  The Bank has three branches located in Lewis County.  

Lending Activities

The Bank’s internal loan policy limits the maximum amount of loans to one borrower to 90% of its legal lending limit (which is 20% of its capital plus surplus). According to the Washington Administrative Code, capital and surplus are defined as a bank's Tier 1 capital, Tier 2 capital and the balance of a bank's allowance for credit losses not included in the bank's Tier 2 capital as reported in the bank's call report. At September 30, 2024, the maximum amount which the Bank could have lent to any one borrower and the borrower’s related entities was approximately $49.35 million under this policy.  At September 30, 2024, the largest amount outstanding to any one borrower and the borrower’s related entities was $42.54 million (including $5.83 million in available lines of credit), which was secured by various commercial real estate and residential properties and other business assets located primarily in King and Pierce counties, and these loans were performing according to their repayment terms at September 30, 2024.  The next largest amount outstanding to any one borrower and the borrower’s related entities was $32.48 million (including $2.44 million of undisbursed construction loan proceeds).  These loans were secured by multi-family, one- to four-family and commercial real estate properties located primarily in Thurston County and were performing according to their repayment terms at September 30, 2024.

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(2)    Amounts for fiscal 2024 were calculated using the Current Expected Credit Loss (“CECL”) methodology to determine

    the allowance for credit losses. Amounts reported prior to October 1, 2023, were based on the previous incurred loss

Generally, one- to four-family fixed-rate loans are originated to meet the requirements for sale in the secondary market to the Federal Home Loan Mortgage Corporation ("Freddie Mac") or the Federal Home Loan Bank of Des Moines ("FHLB").  From time to time, however, a portion of these fixed-rate loans may be retained in the loan portfolio to meet the Bank’s asset/liability management objectives. The Bank uses an automated underwriting program, which preliminarily qualifies a loan as conforming to Freddie Mac underwriting standards when the loan is originated. At September 30, 2024, $121.70 million, or 40.7%, of the Bank’s one- to four-family loan portfolio consisted of fixed-rate mortgage loans.

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

The retention of ARM loans in the Bank’s loan portfolio helps reduce the Bank’s exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased interest to be paid by the customer as a result of increases in interest rates.  It is possible that during periods of rising interest rates, the risk of default on ARM loans may increase as a result of repricing and the increased costs to the borrower. The Bank attempts to reduce the potential for delinquencies and defaults on ARM loans by qualifying the borrower based on the borrower’s ability to repay the ARM loan assuming a 2.0% increase in the initial interest rate.  Another consideration is that although ARM loans allow the Bank to increase the sensitivity of its asset base due to changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits.  Because of these considerations, the Bank has no assurance that yield increases on ARM loans will be sufficient to offset increases in the Bank’s cost of funds.

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

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

The Bank’s lending policies generally limit the maximum loan-to-value ratio on mortgage loans secured by owner-occupied properties to 85% of the lesser of the appraised value or the purchase price. However, the Bank usually obtains private mortgage insurance (“PMI”) on the portion of the principal amount that exceeds 80% of the appraised value of the security property. The maximum loan-to-value ratio on mortgage loans secured by non-owner-occupied properties is generally 80%

(90% for loans originated for sale in the secondary market to Freddie Mac or the FHLB). At September 30, 2024, one one- to four-family loan of $49,000 was on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”

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

Multi-family mortgage lending affords the Bank an opportunity to receive interest at rates higher than those generally available from one- to four- family residential lending.  However, loans secured by multi-family properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, may involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks by scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.  If the borrower is other than an individual, the Bank also generally obtains personal guarantees from the principals (with ownership interests of 20% or more) based on a review of personal financial statements. At September 30, 2024, all multi-family loans were performing according to their repayment terms. See "Lending Activities - Non-performing Loans and Delinquencies."

The Bank typically requires appraisals of properties securing commercial real estate loans. For loans that are less than $250,000, the Bank may use an evaluation provided by a third-party vendor in lieu of an appraisal. Appraisals are performed by independent appraisers designated by the Bank.  The Bank considers the quality and location of the real estate, the credit history of the borrower, the cash flow of the project and the quality of management involved with the property when making these loans. The Bank generally imposes a minimum debt coverage ratio of approximately 1.20 for loans secured by income producing commercial properties. Loan-to-value ratios on commercial real estate loans are generally limited to not more than 80%.  If the borrower is other than an individual, the Bank also generally obtains personal guarantees from the principals (with ownership interests of 20% or more) based on a review of personal financial statements.

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

for commercial properties, multi-family properties, and land development projects. The Bank's construction loans generally provide for the payment of interest only during the construction phase, which is billed monthly, although during the term of some construction loans, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest reserve. At September 30, 2024, the Bank's construction loans totaled $219.20 million, or 14.5% of the Bank's total loan portfolio, including undisbursed loans in process of $69.88 million. All construction loans were performing according to their repayment terms at September 30, 2024. See "Lending Activities - Non-performing Loans and Delinquencies."

Custom and owner/builder construction loans are originated to home owners and are typically converted to or refinanced into permanent loans at the completion of construction. The construction phase of these loans generally lasts up to 12 months with fixed interest rates typically ranging from 4.88% to 9.50% and with loan-to-value ratios of 80% (or up to 95% with PMI) of the appraised estimated value of the completed property. At the completion of construction, the loan is converted to or refinanced into either a fixed-rate mortgage loan, which conforms to secondary market standards, or an ARM loan for retention in the Bank’s portfolio. At September 30, 2024, the largest outstanding custom and owner/builder construction loan had an outstanding balance of $2.00 million (fully disbursed) and was performing according to its repayment terms.

All construction loans must be approved by a member of one of the Bank’s Loan Committees or the Bank’s Board of Directors, or in the case of one- to four-family construction loans that meet Freddie Mac guidelines, by the Regional Manager of Community Lending, the Loan Department Supervisor or a Bank underwriter. See “Lending Activities - Loan Solicitation and Processing.” Prior to approval of any construction loan application, an independent fee appraiser inspects the site and prepares an appraisal on an "as completed" basis, and the Bank reviews the existing or proposed improvements, identifies the market for the proposed project and analyzes the pro-forma data and assumptions on the project.  In the case of a speculative or custom construction loan, the Bank reviews the experience and expertise of the builder. After this preliminary review, the application is processed, which includes obtaining credit reports, financial statements and tax returns or verification of income on the

borrowers and guarantors, an independent appraisal of the project, and any other expert reports necessary to evaluate the proposed project.  In the event of cost overruns, the Bank generally requires that the borrower increase the funds available for construction by paying the cost of such overruns directly or by depositing its own funds into a secured savings account, the proceeds of which are used to pay construction costs or to, the extent available, authorizes disbursements from a loan contingency line in the construction budget.

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

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

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

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

Loans secured by undeveloped land or improved lots involve greater risks than one- to four-family residential mortgage loans because these loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in the event of default and foreclosure, the Bank may be confronted with a property the value of which is insufficient to assure full repayment. Land loans also pose additional risk because of the lack of income being produced by the property and potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions. The Bank attempts to minimize these risks by generally limiting the maximum loan-to-value ratio on land loans to 65%.

Home equity lines of credit and second mortgage loans are made for purposes such as the improvement of residential properties, debt consolidation and education expenses, among others. The majority of these loans are made to existing customers and are secured by a first or second mortgage on residential property. The loan-to-value ratio is typically 90% or less, when considering both the first and second mortgage loans. Second mortgage loans typically carry fixed interest rates with a fixed payment over a term between five and 15 years.  Home equity lines of credit are generally made at interest rates tied to the Prime Rate.  Second mortgage loans and home equity lines of credit have greater credit risk than one- to four-family residential mortgage loans in which the Bank is in the first lien position, because they are generally secured by mortgages subordinated to the existing first mortgage on the property. For those second mortgage loans and home equity lines credit on which the Bank does not hold the existing first mortgage on the property, it is unlikely that the Bank will be successful in recovering all or a portion of the loan balance in the event of default unless the Bank is prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.

    

Consumer loans generally carry greater risk than residential mortgage loans, especially when they are unsecured or secured by assets that depreciate quickly, such as automobiles. In such cases, repossessed collateral from a defaulted loan may not fully cover the outstanding balance due to depreciation, damage, or loss. Often, the remaining deficiency does not justify significant collection efforts beyond obtaining a deficiency judgment. Additionally, the repayment of consumer loans relies heavily on the borrower’s financial stability, making them more susceptible to disruptions caused by job loss, divorce, illness, or personal bankruptcy. Federal and state laws, including bankruptcy and insolvency regulations, can further limit recovery efforts on these loans. However, the Bank believes these risks are less pronounced in its consumer loan portfolio, as a significant portion consists of second mortgage loans and home equity lines of credit. These loans are underwritten to maintain credit risk comparable to one- to four-family residential mortgage loans. At September 30, 2024, three consumer loans totaling $618,000 were on non-accrual status. See “Lending Activities - Non-performing Loans and Delinquencies.”

    

The Bank has increased commercial business loan originations made under the U.S. Small Business Administration ("SBA") 7(a) program. Loans made by the Bank under the SBA 7(a) program generally are made to small businesses to provide working capital or to provide funding for the purchase of businesses, real estate, or equipment. These loans generally are secured by a combination of assets that may include equipment, receivables, inventory, business real property, and sometimes a lien on the personal residence of the borrower. The terms of these loans vary by purpose and type of underlying collateral. The loans are primarily underwritten on the basis of the borrower's ability to service the loan from income. Under the SBA 7(a) program, the loans carry an SBA guaranty for up to 75% of the loan. Typical maturities for this type of loan vary but can be up to ten years. SBA 7(a) loans are all adjustable-rate loans based on the Prime Rate. Under the SBA 7(a) program, the Bank can sell in the secondary market the guaranteed portion of its SBA 7(a) loans and retain the related unguaranteed portion of these loans, as

well as the servicing on such loans, for which it is paid a fee. The loan servicing spread is generally a minimum of 1.00% on all SBA 7(a) loans. The Bank generally offers SBA 7(a) loans within a range of $50,000 to $1.50 million.

Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending.  Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default.  Although commercial business loans are often collateralized by equipment, inventory, accounts receivable and/or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things.  Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.

    

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

Loan applications are initiated by loan officers and must be approved by an authorized loan officer, Bank underwriter, the Bank’s Loan Committees, or the Bank’s Board of Directors. The Bank’s Consumer Loan Committee consists of underwriters who can approve one- to four-family mortgage loans and other consumer loans up to the current Freddie Mac single-family limit. Loan officers may be granted individual approval authority for loans up to $250,000 on a case-by-case basis by the Bank's Chief Credit Officer or Chief Executive Officer.

Construction loans must be approved by a member of one of the Bank's Loan Committees or the Bank's Board of Directors. For one- to four-family construction loans meeting Freddie Mac guidelines, approval may be granted by the Regional Manager of Community Lending, the Loan Department Supervisor, or a Bank underwriter, subject to their individual or Loan Committee limits. The Bank’s Commercial Loan Committee, composed of the Bank’s Chief Executive Officer, Chief Credit Officer, Chief Lending Officer, and a commercial underwriter may approve commercial real estate and business loans up to $3.00 million.

The Bank’s Chief Executive Officer, Chief Credit Officer, and Chief Lending Officer have individual authority to approve loans up to $750,000. The Bank’s Board Loan Committee, which includes one permanent non-employee Director, one rotating non-employee Director, and the Bank’s Chief Executive Officer, may approve loans up to $5.00 million. Loans exceeding $5.00 million, as well as loans of any amount that cause a single borrower’s total loans to exceed $5.00 million, must be approved by the Bank’s Board of Directors.

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

market are generally sold on a servicing retained basis. At September 30, 2024, the Bank’s loan servicing portfolio, which is not included in the Company’s consolidated financial statements, totaled $370.56 million.

The Bank also periodically sells participation interests in construction loans, commercial real estate loans, multi-family and commercial business loans to other lenders.  These sales are usually made to avoid concentrations in a particular loan type or concentrations to a particular borrower and to generate fee income. During the year ended September 30, 2024, the Bank sold loan participation interests of $5.80 million. The Bank did not sell loan participation interests during the year ended September 30, 2023. During the year ended September 30, 2022, the Bank sold loan participation interests of $14.39 million.

The following table shows total loans originated, purchased, sold and repaid during the years indicated.

Accounting principles generally accepted in the United States of America ("GAAP") require fees received and certain loan origination costs for originating loans to be deferred and amortized into interest income over the contractual life of the loan.  Net deferred fees or costs associated with loans that are prepaid are recognized as income/expense at the time of prepayment.  Unamortized net deferred loan origination fees totaled $5.43 million at September 30, 2024.

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

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

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

The following table sets forth information with respect to the Company's non-performing assets at the dates indicated:

(2)    For the years ended September 30, 2023 and 2022, does not include troubled debt restructured loans on accrual status.

The Bank’s non-accrual loans increased by $2.37 million to $3.89 million at September 30, 2024 from $1.51 million at September 30, 2023, as a result of increases in non-accrual loans of $1.77 million in commercial business loans, $475,000 in commercial real estate loans and $441,000 in consumer loans, partially offset by a $319,000 decrease in one- to four-family mortgage loans on non-accrual status. A discussion of the Bank's largest non-performing loans is set forth below under “Asset Classification.”

enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower experiences financial difficulty. No loans to borrowers experiencing financial difficulty were modified in the years ended September 30, 2024 and 2023. The Bank had TDRs at September 30, 2023 and 2022 totaling $2.50 million and $2.61 million, none of which were on non-accrual status. None of the ACL was allocated to TDRs at September 30, 2023 or 2022.

The aggregate amounts of the Bank’s classified and special mention loans (as determined by the Bank), and the ACL at the dates indicated, were as follows:

the SBA guarantee. There were no loans classified as doubtful at September 30, 2023 and 2022. Two commercial real estate loans were classified as special mention at September 30, 2024 and were performing according to repayment terms. There were no loans classified as special mention at September 30, 2023 and 2022.

Management's evaluation of the ACL is based on ongoing assessments of the known and inherent risks in the loan portfolio. Loss factors are based on the Company's historical loss experience 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 business cycle, a detailed analysis of individually evaluated loans and other factors as deemed appropriate. Management also assesses the risk related to reasonable and supportable forecasts that are used. These factors are evaluated at least quarterly. Loss rates used by the Bank are affected as changes in these factors increase or decrease.

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

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

The Bank’s ACL as a percentage of total loans receivable and as a percentage of non-performing loans was 1.21% and 449.88%, at September 30, 2024 and 1.20% and 1,044.72%, at September 30, 2023, respectively. The $260,000 and $466,000 of SBA PPP loans were omitted from the foregoing percentages at September 30, 2024 and 2023, respectively, as these loans are fully guaranteed by the SBA.

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

While the Bank believes that it has established its existing ACL in accordance with GAAP, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its ACL.  In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing ACL is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate.  A further decline in national and local economic conditions, as a result of the effects of inflation, a recession or slowing economic growth, among other factors could result in a material increase in the ACL which may adversely affect the Company's financial condition and results of operations.

For further explanation of the CECL model, ACL calculation and the effects of adoption of the new accounting standard see "Note 1 - Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements in Item 8 of this report.

Credit Ratios

    Amounts reported prior to October 1, 2023, were based on the previous incurred loss methodology, which is not

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

For additional information regarding investment securities, see “Item 1A. Risk Factors – Our investment securities portfolio may be negatively impacted by fluctuations in market value and interest rates and result in losses” and "Note 3-Investment Securities" of the Notes to the Consolidated Financial Statements contained in Item 8 of this report.

Deposit Activities and Other Sources of Funds

minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Bank considers current market interest rates, profitability to the Bank, matching deposit and loan products and its customer preferences and concerns. The Bank actively seeks consumer and commercial checking accounts through checking account acquisition marketing programs. The Bank also has checking accounts owned by businesses associated with the marijuana (or Initiative-502) industry in Washington State. It is generally permissible in Washington State to handle accounts associated with this industry in compliance with federal regulatory guidelines. At September 30, 2024, the Bank had $17.76 million, or 1.1% of total deposits, from businesses associated with the marijuana industry. See "Item 1A. Risk Factors" - We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations that could increase our costs of operations.

At September 30, 2024, the Bank had $113.58 million of jumbo certificates of deposit of $250,000 or more. The Bank had $62.80 million in reciprocal negotiable order of withdrawal ("NOW") checking deposits and $30.67 million in reciprocal money market deposits at September 30, 2024. At September 30, 2024, the Bank had $48.76 million in brokered certificates of deposit. The Bank believes that its jumbo certificates of deposit, which represented 6.9% of total deposits at September 30, 2024, present similar interest rate risks as compared to its other deposits.

The following table sets forth information concerning the Bank's deposits at September 30, 2024:

The following table indicates the amount of the Bank's jumbo certificates of deposit by time remaining until maturity as of September 30, 2024.  Jumbo certificates of deposit have principal balances of $250,000 or more, and the rates paid on these accounts are generally negotiable.

As of September 30, 2024, 2023 and 2022 approximately $471.08 million, $407.61 million and $122.69 million, respectively, of the Bank’s deposit portfolio was uninsured. These amounts are estimates based on methodologies and assumptions used for regulatory reporting purposes. The Bank is an approved public funds deposit institution in Washington, where applicable laws require public funds to be secured by qualified investment securities. As of September 30, 2024, $177.40 million of the Bank's uninsured deposits were public funds, all of which were fully secured by qualified investment securities.

The following table sets forth the portion of our time deposits that are in excess of the FDIC insurance limit, by remaining time until maturity, as of September 30, 2024 (dollars in thousands).