Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Exhibits
EX-31.1
tsbk-12312018x10qxexhibit311.htm
EX-31.2
tsbk-12312018x10qxexhibit312.htm
EX-32
tsbk-12312018x10qxexhibit32.htm
Timberland Bancorp Earnings 2018-12-31
TSBK 10Q Quarterly Report
Balance Sheet
Income Statement
Cash Flow
10-Q 1 tsbk-12312018x10q.htm 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____ to _____.
Commission file number 000-23333
TIMBERLAND BANCORP, INC.
(Exact name of registrant as specified in its charter)
Washington
91-1863696
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
624 Simpson Avenue, Hoquiam, Washington
98550
(Address of principal executive offices)
(Zip Code)
(360) 533-4747
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes _X_ No __
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer ☐ Smaller reporting company ☒ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ___ No _X_
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Certificates of deposit (“CDs”) held for investment (at cost, which
approximates fair value)
65,830
63,290
Investment securities held to maturity, at amortized cost (estimated fair value $32,472 and $13,264)
31,950
12,810
Investment securities available for sale, at fair value
2,197
237
Investments in equity securities, at fair value
925
917
Federal Home Loan Bank of Des Moines (“FHLB”) stock
1,395
1,190
Other investments, at cost
3,000
3,000
Loans held for sale
2,988
1,785
Loans receivable, net of allowance for loan losses of $9,533 and $9,530
857,070
725,391
Premises and equipment, net
22,884
18,953
Other real estate owned (“OREO”) and other repossessed assets, net
2,026
1,913
Accrued interest receivable
3,497
2,877
Bank owned life insurance (“BOLI”)
22,599
19,813
Goodwill
14,620
5,650
Core deposit intangible (“CDI”), net
2,374
—
Mortgage servicing rights (“MSRs”), net
2,338
2,028
Escrow deposit for business combination
—
6,900
Other assets
2,879
2,672
Total assets
$
1,200,315
$
1,018,290
Liabilities and shareholders’ equity
Liabilities
Deposits:
Non-interest-bearing demand
$
271,251
$
233,258
Interest-bearing
763,926
656,248
Total deposits
1,035,177
889,506
Other liabilities and accrued expenses
8,233
4,127
Total liabilities
1,043,410
893,633
* Derived from audited consolidated financial statements.
See notes to unaudited consolidated financial statements
3
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (continued)
December 31, 2018 and September 30, 2018
(Dollars in thousands, except per share amounts)
December 31, 2018
September 30, 2018
(Unaudited)
*
Shareholders’ equity
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued
$
—
$
—
Common stock, $0.01 par value; 50,000,000 shares authorized;
8,313,403 shares issued and outstanding - December 31, 2018 7,401,177 shares issued and outstanding - September 30, 2018
42,951
14,394
Unearned shares issued to Employee Stock Ownership Plan (“ESOP”)
(67
)
(133
)
Retained earnings
114,166
110,525
Accumulated other comprehensive loss
(145
)
(129
)
Total shareholders’ equity
156,905
124,657
Total liabilities and shareholders’ equity
$
1,200,315
$
1,018,290
* Derived from audited consolidated financial statements.
See notes to unaudited consolidated financial statements
4
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended December 31, 2018 and 2017
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended December 31,
2018
2017
Interest and dividend income
Loans receivable and loans held for sale
$
11,782
$
9,328
Investment securities
278
58
Dividends from mutual funds, FHLB stock and other investments
39
26
Interest-bearing deposits in banks and CDs
1,216
623
Total interest and dividend income
13,315
10,035
Interest expense
Deposits
971
601
Total interest expense
971
601
Net interest income
12,344
9,434
Provision for loan losses
—
—
Net interest income after provision for loan losses
12,344
9,434
Non-interest income
Recoveries (other than temporary impairment "OTTI") on investment securities
11
27
Adjustment for portion of OTTI transferred from other comprehensive income (loss) before income taxes
—
(5
)
Net recoveries on investment securities
11
22
Service charges on deposits
1,216
1,179
ATM and debit card interchange transaction fees
949
845
BOLI net earnings
157
136
Gain on sales of loans, net
386
521
Escrow fees
56
59
Servicing income on loans sold
148
116
Fee income from non-deposit investment sales
31
19
Other, net
312
240
Total non-interest income, net
3,266
3,137
See notes to unaudited consolidated financial statements
5
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (continued)
For the three months ended December 31, 2018 and 2017
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended December 31,
2018
2017
Non-interest expense
Salaries and employee benefits
$
4,606
$
3,950
Premises and equipment
954
768
Advertising
191
209
OREO and other repossessed assets, net
50
113
ATM and debit card interchange transaction fees
422
331
Postage and courier
110
105
Amortization of CDI
109
—
State and local taxes
196
161
Professional fees
265
218
Federal Deposit Insurance Corporation ("FDIC") insurance
74
65
Loan administration and foreclosure
87
79
Data processing and telecommunications
673
467
Deposit operations
294
278
Other
531
432
Total non-interest expense
8,562
7,176
Income before income taxes
7,048
5,395
Provision for income taxes
1,433
1,781
Net income
$
5,615
$
3,614
Net income per common share
Basic
$
0.68
$
0.49
Diluted
$
0.66
$
0.48
Weighted average common shares outstanding
Basic
8,293,212
7,312,531
Diluted
8,457,703
7,508,169
Dividends paid per common share
$
0.23
$
0.11
See notes to unaudited consolidated financial statements
6
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended December 31, 2018 and 2017
(Dollars in thousands)
(Unaudited)
Three Months Ended December 31,
2018
2017
Comprehensive income
Net income
$
5,615
$
3,614
Unrealized holding loss on investment securities available for sale, net of income taxes of ($22) and ($2), respectively
(86
)
(7
)
Change in OTTI on investment securities held to maturity, net of income taxes:
Adjustments related to other factors for which OTTI was previously recognized, net of income taxes of ($1) and ($6), respectively
(3
)
(21
)
Amount reclassified to credit loss for previously recorded market loss, net of income taxes of $0 and $1, respectively
—
4
Accretion of OTTI on investment securities held to maturity, net of income taxes of $3 and $3, respectively
10
12
Total other comprehensive loss, net of income taxes
(79
)
(12
)
Total comprehensive income
$
5,536
$
3,602
See notes to unaudited consolidated financial statements
7
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the three months ended December 31, 2018 and 2017
(Dollars in thousands, except per share amounts)
(Unaudited)
Common Stock
Unearned
Shares Issued to ESOP
Accumulated
Other
Compre-hensive Loss
Number of Shares
Amount
Retained
Earnings
Total
Balance, September 30, 2017
7,361,077
$
13,286
$
(397
)
$
98,235
$
(124
)
$
111,000
Net income
—
—
—
3,614
—
3,614
Other comprehensive loss
—
—
—
—
(12
)
(12
)
Exercise of stock options
6,250
61
—
—
—
61
Common stock dividends ($0.11 per common share)
—
—
—
(810
)
—
(810
)
Earned ESOP shares, net of income taxes
—
149
66
—
—
215
Stock option compensation expense
—
44
—
—
—
44
Balance, December 31, 2017
7,367,327
13,540
(331
)
101,039
(136
)
114,112
Balance, September 30, 2018
7,401,177
14,394
(133
)
110,525
(129
)
124,657
Net income
—
—
—
5,615
—
5,615
Other comprehensive loss
—
—
—
—
(79
)
(79
)
Common stock issued for business combination
904,826
28,267
—
—
—
28,267
Exercise of stock options
7,400
71
—
—
—
71
Common stock dividends ($0.23 per common share)
—
—
—
(1,911
)
—
(1,911
)
Earned ESOP shares, net of income taxes
—
166
66
—
—
232
Stock option compensation expense
—
53
—
—
—
53
Adoption of ASU 2016-01
—
—
—
(63
)
63
—
Balance, December 31, 2018
8,313,403
$
42,951
$
(67
)
$
114,166
$
(145
)
$
156,905
See notes to unaudited consolidated financial statements
8
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended December 31, 2018 and 2017
(Dollars in thousands)
(Unaudited)
Three Months Ended December 31,
2018
2017
Cash flows from operating activities
Net income
$
5,615
$
3,614
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation
390
310
Accretion of discount on purchased loans
(87
)
—
Amortization of CDI
109
—
Earned ESOP shares
232
215
Stock option compensation expense
53
44
Net recoveries on investment securities
(11
)
(22
)
Change in fair value of investments in equity securities
(8
)
—
Gain on sales of OREO and other repossessed assets, net
—
(12
)
Provision for OREO losses
3
94
Gain on sales of loans, net
(386
)
(521
)
Loans originated for sale
(16,932
)
(15,193
)
Proceeds from sales of loans
16,115
15,906
Amortization of MSRs
153
120
BOLI net earnings
(157
)
(136
)
Increase in deferred loan origination fees
238
38
Net change in accrued interest receivable and other assets, and other liabilities and accrued expenses
1,447
1,301
Net cash provided by operating activities
6,774
5,758
Cash flows from investing activities
Net decrease (increase) in CDs held for investment
433
(10,494
)
Proceeds from sale of investment securities available for sale
2,332
—
Proceeds from maturities and prepayments of investment securities held to maturity
580
11
Proceeds from maturities and prepayments of investment securities available for sale
644
126
Increase in loans receivable, net
(10,377
)
(15,105
)
Additions to premises and equipment
(984
)
(199
)
Cash acquired, net of cash consideration paid in business combination
14,284
—
Escrow deposit for business combination
6,900
—
Proceeds from sales of OREO and other repossessed assets
—
495
Net cash provided by (used in) investing activities
13,812
(25,166
)
See notes to unaudited consolidated financial statements
9
TIMBERLAND BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the three months ended December 31, 2018 and 2017
(Dollars in thousands)
(Unaudited)
Three Months Ended December 31,
2018
2017
Cash flows from financing activities
Net (decrease) increase in deposits
$
(5,867
)
$
38,176
Proceeds from exercise of stock options
71
61
Payment of dividends
(1,911
)
(810
)
Net cash (used in) provided by financing activities
(7,707
)
37,427
Net increase in cash and cash equivalents
12,879
18,019
Cash and cash equivalents
Beginning of period
148,864
148,188
End of period
$
161,743
$
166,207
Supplemental disclosure of cash flow information
Income taxes paid
$
—
$
—
Interest paid
901
584
Supplemental disclosure of non-cash investing activities
Loans transferred to OREO and other repossessed assets
$
91
$
163
Other comprehensive loss related to investment securities
(79
)
(12
)
Business Combination (see Note 2)
Fair value of assets acquired
$
180,825
$
—
Fair value of liabilities assumed
$
154,625
$
—
See notes to unaudited consolidated financial statements
10
Timberland Bancorp, Inc. and Subsidiary
Notes to Unaudited Consolidated Financial Statements
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation: The accompanying unaudited consolidated financial statements for the Company were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with GAAP. However, all adjustments which are, in the opinion of management, necessary for a fair presentation of the interim consolidated financial statements have been included. All such adjustments are of a normal recurring nature. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2018 (“2018 Form 10-K”). The unaudited consolidated results of operations for the three months ended December 31, 2018 are not necessarily indicative of the results that may be expected for the entire fiscal year ending September 30, 2019.
On October 1, 2018, the Company completed the acquisition of South Sound Bank, a Washington-state chartered bank, headquartered in Olympia, Washington ("South Sound Merger"). The Company acquired 100% of the outstanding common stock of South Sound Bank, and South Sound Bank was merged into the Bank. See Note 2 for additional information on the South Sound Merger.
(b) Principles of Consolidation: The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank, and the Bank’s wholly-owned subsidiary, Timberland Service Corporation. All significant inter-company transactions and balances have been eliminated in consolidation.
(c) Operating Segment: The Company has one reportable operating segment which is defined as community banking in western Washington.
(d) The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect 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 period. Actual results could differ from those estimates.
(e) Certain prior period amounts have been reclassified to conform to the December 31, 2018 presentation with no change to previously reported net income or total shareholders’ equity.
11
(2) BUSINESS COMBINATION
On October 1, 2018, the Company completed the South Sound Merger and South Sound Bank was merged into the Bank. The primary reason for the acquisition was to expand the Company's presence along Washington State's economically important I-5 corridor.
Pursuant to the terms of the merger agreement, South Sound Bank shareholders received 0.746 of a share the Company's common stock and $5.68825 in cash per share of South Sound Bank common stock. The Company issued 904,826 shares of its common stock (valued at $28.27 million based on the Company's closing stock price on September 30, 2018 of $31.24 per share) and paid $6.90 million in cash in the transaction for total consideration paid of $35.17 million.
The South Sound Merger constitutes a business combination as defined by GAAP, which establishes principles and requirements for how the acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired and liabilities assumed. The Company was considered the acquirer in this transaction. Accordingly, the preliminary estimates of fair values of the acquired assets, including the identifiable intangible assets, and the assumed liabilities in the South Sound Merger were measured and recorded as of October 1, 2018. The excess of the total consideration paid over the fair value of the net assets acquired was allocated to goodwill. The South Sound Merger resulted in $8.97 million of goodwill. The goodwill arising from the transaction consists largely of the synergies and expected economies of scale from combining the operations of the Company and South Sound Bank. This goodwill is not deductible for tax purposes.
In most instances, determining the estimated fair values of the acquired assets and assumed liabilities requires the Company to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at the appropriate rate of interest. Differences may arise between contractually required payments and the expected cash flows at the acquisition date due to items such as estimated credit losses, prepayments or early withdrawal, and other factors. One of the most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. In accordance with GAAP, there was no carry-over of South Sound Bank's previously established allowance for loan losses.
The following table summarizes the fair value of consideration paid, the preliminary estimated fair values of assets acquired and liabilities assumed as of the acquisition date, and the resulting preliminary goodwill relating to the transaction:
12
At October 1, 2018
Book Value
Fair Value Adjustment
Estimated Fair Value
(Dollars in thousands)
Total merger consideration
$
35,170
Recognized amounts of identifiable assets acquired and liabilities assumed
Identifiable assets acquired:
Cash and cash equivalents
$
21,187
$
—
21,187
CDs held for investment
2,973
—
2,973
FHLB stock
205
—
205
Investment securities
24,913
(189
)
24,724
Loans receivable
123,627
(2,083
)
121,544
Premises and equipment
3,225
112
3,337
OREO
25
—
25
Accrued interest receivable
554
—
554
BOLI
2,629
—
2,629
CDI
—
2,483
2,483
MSRs
285
(4
)
281
Other assets
883
—
883
Total assets
180,506
319
180,825
Liabilities assumed:
Deposits
151,378
160
151,538
Other liabilities and accrued expenses
3,087
—
3,087
Total liabilities assumed
154,465
160
154,625
Total identifiable net assets acquired
$
26,041
$
159
26,200
Preliminary goodwill recognized
$
8,970
Fair values on the acquisition date are preliminary and represent management's best estimates based on available information and facts and circumstances in existence as of the filing date of this report. Fair values are subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. The Company expects to finalize the purchase price allocation by March 31, 2019 when the valuation of tax-related matters is complete.
The acquired loan portfolio was valued using Level 3 inputs (see Note 9) and included the use of present value techniques, including cash flow estimates and incorporated assumptions that the Company believes marketplace participants would use in estimating fair values. Credit discounts were included in the determination of the fair value of the loans acquired; therefore, an allowance for loan losses was 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 Company determined that PCI loans acquired in the South Sound Merger were insignificant.
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 allowance for loan losses.
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
13
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.
The operating results of the Company for the three months ended December 31, 2018 include the operating results produced by the net assets acquired in the South Sound Merger since the October 1, 2018 merger date. The table below presents the significant operating results of the acquired business since the October 1, 2018 merger date:
Three Months Ended December 31, 2018
(Dollars in thousands)
Interest income: Interest and fees on loans (1)
$
1,738
Interest income: Interest and dividends on investment securities and FHLB stock
201
Interest income: Other interest earning assets
100
Interest expense
(128
)
Provision for loan losses
—
Non-interest income
139
Non-interest expense (2)
(860
)
Net effect, pre-tax
$
1,190
(1) Includes the accretion of the fair value discount on the purchased loans of $87,000.
(2) Excludes certain compensation and employee benefits for management, and excludes certain other non-interest expenses that are impracticable to determine due to the integration of the operations for this merger. Also includes certain acquisition-related costs of $64,000 incurred by the Company.
For illustrative purposes only, the following table presents certain unaudited pro forma information for the three months ended December 31, 2018 and 2017. This unaudited estimated pro forma information was calculated as if South Sound Bank had been acquired as of the beginning of the fiscal year ended September 30, 2018. This unaudited pro forma information combines the historical results of South Sound Bank with the Company's consolidated historical results and includes certain adjustments reflecting the estimated impact of certain fair value adjustments for the respective periods. The pro forma information is not indicative of what would have occurred had the transaction occurred at the beginning of the fiscal year ended September 30, 2018. The unaudited pro forma information does not consider any changes to the provision for loan losses resulting from recording loans at fair value. Additionally, the Company expects to achieve further operating cost savings and other business synergies, including revenue growth as a result of the acquisition, which are not reflected in the pro forma amounts that follow. As a result, actual amounts would have differed from the unaudited pro forma information presented.
Unaudited Pro Forma Three Months Ended December 31,
2018
2017
(Dollars in thousands except per share data)
Total revenues (net interest income plus non-interest income)
$
15,610
$
14,362
Net income
5,666
3,789
Basic net income per common share
0.68
0.46
Diluted net income per common share
0.67
0.45
During the three months ended December 31, 2018 and 2017, the Company incurred acquisition-related expenses of $64,000 and $41,000, respectively, related to the South Sound Merger, which are included in professional fees in the accompanying consolidated statement of income. South Sound Bank incurred acquisition-related expenses of $2,000 for the three months ended December 31, 2017 related to the South Sound Merger. These acquisition-related expenses incurred by the Company and South Sound Bank are not included in the unaudited pro forma information presented for the three months ended December 31, 2018 and 2017. The Company incurred acquisition-related expenses of $616,000 for the fiscal year ended September 30, 2018 related to the South Sound Merger, which were included in professional fees.
The Company expects to incur additional acquisition-related expenses of approximately $580,000 over the next two quarters. These expenses are related to the conversion of South Sound Bank's current core processing and ancillary information technology systems to the Company's new core processing system.
14
(3) INVESTMENT SECURITIES
Held to maturity and available for sale investment securities have been classified according to management’s intent and were as follows as of December 31, 2018 and September 30, 2018 (dollars in thousands):
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
December 31, 2018
Held to maturity
Mortgage-backed securities ("MBS"):
U.S. government agencies
$
20,551
$
90
$
(25
)
$
20,616
Private label residential
424
527
(2
)
949
U.S. Treasury and U.S government agency securities
10,975
—
(68
)
10,907
Total
$
31,950
$
617
$
(95
)
$
32,472
Available for sale
MBS: U.S. government agencies
$
2,299
$
8
$
(110
)
$
2,197
Total
$
2,299
$
8
$
(110
)
$
2,197
September 30, 2018
Held to maturity
MBS:
U.S. government agencies
$
1,385
$
8
$
(21
)
$
1,372
Private label residential
460
552
(2
)
1,010
U.S. Treasury and U.S. government agency securities
10,965
—
(83
)
10,882
Total
$
12,810
$
560
$
(106
)
$
13,264
Available for sale
MBS: U.S. government agencies
$
231
$
7
$
(1
)
$
237
Total
$
231
$
7
$
(1
)
$
237
15
Held to maturity and available for sale investment securities with unrealized losses were as follows as of December 31, 2018 (dollars in thousands):
Less Than 12 Months
12 Months or Longer
Total
Estimated
Fair
Value
Gross
Unrealized
Losses
Quantity
Estimated
Fair
Value
Gross
Unrealized
Losses
Quantity
Estimated
Fair
Value
Gross
Unrealized
Losses
Held to maturity
MBS:
U.S. government agencies
$
1,443
$
(10
)
7
$
960
$
(15
)
6
$
2,403
$
(25
)
Private label residential
—
—
—
45
(2
)
7
45
(2
)
U.S. Treasury and U.S. government agency securities
4,970
(7
)
1
5,936
(61
)
2
10,906
(68
)
Total
$
6,413
$
(17
)
8
$
6,941
$
(78
)
15
$
13,354
$
(95
)
Available for sale
MBS: U.S. government agencies
$
2,004
$
(110
)
7
$
—
$
—
—
$
2,004
$
(110
)
Total
$
2,004
$
(110
)
7
$
—
$
—
—
$
2,004
$
(110
)
Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2018 (dollars in thousands):
Less Than 12 Months
12 Months or Longer
Total
Estimated
Fair
Value
Gross
Unrealized Losses
Quantity
Estimated
Fair
Value
Gross
Unrealized Losses
Quantity
Estimated
Fair
Value
Gross
Unrealized Losses
Held to maturity
MBS:
U.S. government agencies
$
954
$
(20
)
2
$
64
$
(1
)
5
$
1,018
$
(21
)
Private label residential
—
—
—
50
(2
)
8
50
(2
)
U.S. Treasury and U.S. government agency securities
7,946
(22
)
2
2,935
(61
)
1
10,881
(83
)
Total
$
8,900
$
(42
)
4
$
3,049
$
(64
)
14
$
11,949
$
(106
)
Available for sale
MBS:
U.S. government agencies
$
34
$
(1
)
1
$
—
$
—
—
$
34
$
(1
)
Total
$
34
$
(1
)
1
$
—
$
—
—
$
34
$
(1
)
The Company has evaluated the investment securities in the above tables and has determined that the decline in their value is temporary. The unrealized losses are primarily due to changes in market interest rates and spreads in the market for mortgage-related products. The fair value of these securities is expected to recover as the securities approach their maturity dates and/or as the pricing spreads narrow on mortgage-related securities. The Company has the ability and the intent to hold the investments until the market value recovers. Furthermore, as of December 31, 2018, management does not have the intent to sell any of the securities classified as available for sale where the estimated fair value is below the recorded value and believes that it is more likely than not that the Company will not have to sell such securities before a recovery of cost (or recorded value if previously written down).
16
The Company bifurcates 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 default rates, prepayment speeds and third-party analytic reports. Significant judgment by management is required in this analysis that includes, but is not limited to, assumptions regarding the collectability of principal and interest, net of related expenses, on the underlying loans.
The following table presents a summary of the significant inputs utilized to measure management’s estimates of the credit loss component on OTTI securities as of December 31, 2018 and 2017:
Range
Weighted
Minimum
Maximum
Average
December 31, 2018
Constant prepayment rate
6.00
%
15.00
%
13.56
%
Collateral default rate
—
%
11.94
%
5.72
%
Loss severity rate
—
%
77.00
%
46.97
%
December 31, 2017
Constant prepayment rate
6.00
%
15.00
%
9.91
%
Collateral default rate
—
%
11.08
%
4.77
%
Loss severity rate
—
%
62.00
%
37.32
%
The following table presents the OTTI recoveries (losses) for the three months ended December 31, 2018 and 2017 (dollars in thousands):
Three Months Ended December 31, 2018
Three Months Ended December 31, 2017
Held To
Maturity
Available
For Sale
Held To
Maturity
Available
For Sale
Total recoveries
$
11
$
—
$
27
$
—
Adjustment for portion of OTTI transferred from
other comprehensive income (loss) before income taxes (1)
—
—
(5
)
—
Net recoveries recognized in earnings (2)
$
11
$
—
$
22
$
—
_________________
(1) Represents OTTI related to all other factors.
(2) Represents OTTI related to credit losses.
17
The following table presents a roll forward of the credit loss component of held to maturity and available for sale debt securities that have been written down for OTTI with the credit loss component recognized in earnings for the three months ended December 31, 2018 and 2017 (dollars in thousands):
Three Months Ended December 31,
2018
2017
Beginning balance of credit loss
$
1,153
$
1,301
Additions:
Additional increases to the amount
related to credit loss for which OTTI
was previously recognized
1
6
Subtractions:
Realized losses previously recorded
as credit losses
(20
)
(22
)
Recovery of prior credit loss
(12
)
(26
)
Ending balance of credit loss
$
1,122
$
1,259
During the three months ended December 31, 2018, the Company recorded a $20,000 net realized loss (as a result of investment securities being deemed worthless) on 15 held to maturity investment securities, all of which had been recognized previously as a credit loss. During the three months ended December 31, 2017, the Company recorded a $22,000 net realized loss (as a result of investment securities being deemed worthless) on 12 held to maturity investment securities, all of which had been recognized previously as a credit loss.
The recorded amount of investment securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits, FHLB collateral and other non-profit organization deposits totaled $14.94 million and $12.10 million at December 31, 2018 and September 30, 2018, respectively.
The contractual maturities of debt securities at December 31, 2018 were as follows (dollars in thousands). Expected maturities may differ from scheduled maturities due to the prepayment of principal or call provisions.
Held to Maturity
Available for Sale
Amortized
Cost
Estimated
Fair
Value
Amortized
Cost
Estimated
Fair
Value
Due within one year
$
7,978
$
7,960
$
—
$
—
Due after one year to five years
7,192
7,142
—
—
Due after five years to ten years
969
974
447
434
Due after ten years
15,811
16,396
1,852
1,763
Total
$
31,950
$
32,472
$
2,299
$
2,197
(4) GOODWILL AND CDI
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
18
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 share price of the Company's common stock. 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, 2018.
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 December 31, 2018, management believes that there have been no events or changes in the circumstances since May 31, 2018 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.
The following table presents the change in the carrying amount of goodwill for the period indicated (dollars in thousands).
Three Months Ended December 31,
2018
Balance at the beginning of the period
$
5,650
Addition as a result of the South Sound Merger (see Note 2)
8,970
Balance at the end of the period
$
14,620
The following table presents the change in CDI for the period indicated (dollars in thousands).
Three Months Ended December 31,
2018
Balance at the beginning of the period
$
—
Addition as a result of the South Sound Merger (see Note 2)
2,483
Amortization
(109
)
Balance at the end of the period
$
2,374
19
(5) LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable by portfolio segment consisted of the following at December 31, 2018 and September 30, 2018 (dollars in thousands):
December 31, 2018
September 30, 2018
Amount
Percent
Amount
Percent
Mortgage loans:
One- to four-family (1)
$
130,219
13.4
%
$
115,941
14.1
%
Multi-family
72,076
7.4
61,928
7.5
Commercial
426,144
43.9
345,113
42.0
Construction - custom and owner/builder
119,214
12.3
119,555
14.6
Construction - speculative one- to four-family
17,934
1.9
15,433
1.9
Construction - commercial
42,416
4.4
39,590
4.8
Construction - multi-family
25,645
2.6
10,740
1.3
Construction - land development
10,578
1.1
3,040
0.4
Land
22,734
2.3
25,546
3.1
Total mortgage loans
866,960
89.3
736,886
89.8
Consumer loans:
Home equity and second mortgage
40,468
4.2
37,341
4.5
Other
4,443
0.5
3,515
0.5
Total consumer loans
44,911
4.7
40,856
5.0
Commercial business loans
58,202
6.0
43,053
5.2
Total loans receivable
970,073
100.0
%
820,795
100.0
%
Less:
Undisbursed portion of construction
loans in process
100,595
83,237
Deferred loan origination fees, net
2,875
2,637
Allowance for loan losses
9,533
9,530
113,003
95,404
Loans receivable, net
$
857,070
$
725,391
_____________________________
(1) Does not include one- to four-family loans held for sale totaling $2,988 and $1,785 at December 31, 2018 and September 30, 2018, respectively.
20
Allowance for Loan Losses
The following tables set forth information for the three months ended December 31, 2018 and 2017 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):
Three Months Ended December 31, 2018
Beginning
Allowance
Provision for
(Recapture of) Loan Losses
Charge-
offs
Recoveries
Ending
Allowance
Mortgage loans:
One- to four-family
$
1,086
$
73
$
—
$
—
$
1,159
Multi-family
433
16
—
—
449
Commercial
4,248
(9
)
—
—
4,239
Construction – custom and owner/builder
671
(28
)
—
—
643
Construction – speculative one- to four-family
178
28
—
—
206
Construction – commercial
563
(177
)
—
—
386
Construction – multi-family
135
74
—
—
209
Construction – land development
49
94
—
—
143
Land
844
(91
)
—
4
757
Consumer loans:
Home equity and second mortgage
649
17
—
—
666
Other
117
(15
)
(2
)
1
101
Commercial business loans
557
18
—
—
575
Total
$
9,530
$
—
$
(2
)
$
5
$
9,533
Three Months Ended December 31, 2017
Beginning
Allowance
Provision for
(Recapture of) Loan Losses
Charge-
offs
Recoveries
Ending
Allowance
Mortgage loans:
One- to four-family
$
1,082
$
43
$
—
$
—
$
1,125
Multi-family
447
(17
)
—
—
430
Commercial
4,184
(91
)
—
—
4,093
Construction – custom and owner/builder
699
89
—
—
788
Construction – speculative one- to four-family
128
(61
)
—
8
75
Construction – commercial
303
93
—
—
396
Construction – multi-family
173
55
—
—
228
Land
918
(142
)
—
4
780
Consumer loans:
Home equity and second mortgage
983
(25
)
—
—
958
Other
121
8
(1
)
1
129
Commercial business loans
515
48
—
—
563
Total
$
9,553
$
—
$
(1
)
$
13
$
9,565
21
The following tables present information on the loans evaluated individually and collectively for impairment in the allowance for loan losses by portfolio segment at December 31, 2018 and September 30, 2018 (dollars in thousands):