LOANS AND ALLOWANCE FOR CREDIT LOSSES

3 Months Ended

Jun. 30, 2023

LOANS AND ALLOWANCE FOR CREDIT LOSSES

LOANS AND ALLOWANCE FOR CREDIT LOSSES

6.      LOANS AND ALLOWANCE FOR CREDIT LOSSES

Loans receivable are reported net of deferred loan fees and discounts, and inclusive of premiums. At June 30, 2023, deferred loan fees totaled $4.3 million compared to $4.4 million at March 31, 2023. Loans receivable discounts and premiums totaled $1.4 million and $2.1 million, respectively, at both June 30, 2023 and March 31, 2023. Loans receivable, excluding loans held for sale, consisted of the following at the dates indicated (in thousands):

	June 30,		March 31,
	2023		2023
Commercial and construction
Commercial business	$	244,725	$	232,868
Commercial real estate		556,639		564,496
Land		6,367		6,437
Multi-family		54,340		55,836
Real estate construction		43,940		47,762
Total commercial and construction		906,011		907,399
Consumer
Real estate one-to-four family		96,607		99,673
Other installment		1,789		1,784
Total consumer		98,396		101,457
Total loans		1,004,407		1,008,856
Less: Allowance for loan losses		15,343		15,309
Loans receivable, net	$	989,064	$	993,547

The Company considers its loan portfolio to have very little exposure to sub-prime mortgage loans since the Company has not historically engaged in this type of lending. At June 30, 2023, loans carried at $592.0 million were pledged as collateral to the Federal Home Loan Bank of Des Moines (“FHLB”) and Federal Reserve Bank of San Francisco (“FRB”) pursuant to borrowing agreements.

Substantially all of the Company’s business activity is with customers located in the states of Washington and Oregon. Loans and extensions of credit outstanding at one time to one borrower are generally limited by federal regulation to 15% of the Bank’s shareholders’ equity, excluding accumulated other comprehensive income (loss). As of June 30, 2023 and March 31, 2023, the Bank had no loans to any one borrower in excess of the regulatory limit.

Credit quality indicators: The Company monitors credit risk in its loan portfolio using a risk rating system (on a scale of one to nine) for all commercial (non-consumer) loans. The risk rating system is a measure of the credit risk of the borrower based on their historical, current and anticipated future financial characteristics. The Company assigns a risk rating to each commercial loan at origination and subsequently updates these ratings, as necessary, so that the risk rating continues to reflect the appropriate risk characteristics of the loan. Application of appropriate risk ratings is key to management of loan portfolio risk. In determining the appropriate risk rating, the Company considers the following factors: delinquency, payment history, quality of management, liquidity, leverage, earnings trends, alternative funding sources, geographic risk, industry risk, cash flow adequacy, account practices, asset protection and extraordinary risks. Consumer loans, including custom construction loans, are not assigned a risk rating but rather are grouped into homogeneous pools with similar risk characteristics. When a consumer loan is delinquent 90 days, it is placed on non-accrual status and assigned a substandard risk rating. Loss factors are assigned to each risk rating and homogeneous pool based on historical loss experience for similar loans. This historical loss experience is adjusted for qualitative factors that are likely to cause the estimated credit losses to differ from the Company’s historical loss experience. The Company uses these loss factors to estimate the general component of its allowance for credit losses.

Pass – These loans have a risk rating between 1 and 4 and are to borrowers that meet normal credit standards. Any deficiencies in satisfactory asset quality, liquidity, debt servicing capacity and coverage are offset by strengths in other areas. The borrower currently has the capacity to perform according to the loan terms. Any concerns about risk factors such as stability of margins, stability of cash flows, liquidity, dependence on a single product/supplier/customer, depth of management, etc. are offset by strengths in other areas. Typically, these loans are secured by the operating assets of the borrower and/or real estate. The borrower’s management is considered competent. The borrower has the ability to repay the debt in the normal course of business.

Watch – These loans have a risk rating of 5 and are included in the “pass” rating. However, there would typically be some reason for additional management oversight, such as the borrower’s recent financial setbacks and/or deteriorating financial position, industry concerns and failure to perform on other borrowing obligations. Loans with this rating are monitored closely in an effort to correct deficiencies.

Special mention – These loans have a risk rating of 6 and are rated in accordance with regulatory guidelines. These loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the credit position at some future date. These loans pose elevated risk but their weakness does not yet justify a “substandard” classification.

Substandard – These loans have a risk rating of 7 and are rated in accordance with regulatory guidelines, for which the accrual of interest may or may not be discontinued. By definition under regulatory guidelines, a “substandard” loan has defined weaknesses which make payment default or principal exposure likely but not yet certain. Repayment of such loans is likely to be dependent upon collateral liquidation, a secondary source of repayment, or an event outside of the normal course of business.

Doubtful – These loans have a risk rating of 8 and are rated in accordance with regulatory guidelines. Such loans are placed on non-accrual status and repayment may be dependent upon collateral which has value that is difficult to determine or upon some near-term event which lacks certainty.

Loss – These loans have a risk rating of 9 and are rated in accordance with regulatory guidelines. Such loans are charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

The following table sets forth the Company’s loan portfolio at June 30, 2023 by risk attribute and year of origination as well as current period gross charge-offs:

	Term Loans Amortized Cost Basis by Origination Fiscal Year
															Total
													Revolving		Loans
	2024		2023		2022		2021		2020		Prior		Loans		Receivable
Commercial business
Risk rating
Pass	$	4,314	$	63,317	$	89,900	$	34,254	$	18,736	$	16,061	$	13,122	$	239,704
Special Mention		—		102		—		—		681		455		3,673		4,911
Substandard		—		—		—		—		—		110		—		110
Total commercial business	$	4,314	$	63,419	$	89,900	$	34,254	$	19,417	$	16,626	$	16,795	$	244,725
Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial real estate
Risk rating
Pass	$	1,564	$	65,785	$	144,067	$	91,666	$	54,754	$	178,736	$	—	$	536,572
Special Mention		—		—		—		—		—		19,139		—		19,139
Substandard		—		—		—		—		—		928		—		928
Total commercial real estate	$	1,564	$	65,785	$	144,067	$	91,666	$	54,754	$	198,803	$	—	$	556,639
Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Land
Risk rating
Pass	$	—	$	2,402	$	1,407	$	1,856	$	119	$	486	$	—	$	6,270
Special Mention		—		97		—		—		—		—		—		97
Total land	$	—	$	2,499	$	1,407	$	1,856	$	119	$	486	$	—	$	6,367
Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Multi-family
Risk rating
Pass	$	398	$	3,474	$	32,575	$	5,474	$	9,324	$	2,996	$	—	$	54,241
Special Mention		—		—		—		—		35		33		—		68
Substandard		—		—		—		—		—		31		—		31
Total multi-family	$	398	$	3,474	$	32,575	$	5,474	$	9,359	$	3,060	$	—	$	54,340
Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

	Term Loans Amortized Cost Basis by Origination Fiscal Year
															Total
													Revolving		Loans
	2024		2023		2022		2021		2020		Prior		Loans		Receivable
Real estate construction
Risk rating
Pass	$	1,687	$	22,592	$	19,214	$	—	$	—	$	—	$	124	$	43,617
Special Mention		—		323		—		—		—		—		—		323
Total real estate construction	$	1,687	$	22,915	$	19,214	$	—	$	—	$	—	$	124	$	43,940
Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Real estate one-to-four family
Risk rating
Pass	$	4	$	—	$	62,576	$	4,255	$	4,512	$	15,946	$	9,273	$	96,566
Substandard		—		—		—		—		—		41		—		41
Total real estate one-to-four family	$	4	$	—	$	62,576	$	4,255	$	4,512	$	15,987	$	9,273	$	96,607
Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Other installment
Risk rating
Pass	$	141	$	709	$	293	$	125	$	58	$	34	$	429	$	1,789
Total other installment	$	141	$	709	$	293	$	125	$	58	$	34	$	429	$	1,789
Current period gross write-offs	$	—	$	11	$	—	$	—	$	—	$	—	$	—	$	11
Total loans receivable, gross
Risk rating
Pass	$	8,108	$	158,279	$	350,032	$	137,630	$	87,503	$	214,259	$	22,948	$	978,759
Special Mention		—		522		—		—		716		19,627		3,673		24,538
Substandard		—		—		—		—		—		1,110		—		1,110
Total loans receivable, gross	$	8,108	$	158,801	$	350,032	$	137,630	$	88,219	$	234,996	$	26,621	$	1,004,407
Total current period gross write-offs	$	—	$	11	$	—	$	—	$	—	$	—	$	—	$	11

Allowance for Credit Losses - The Company adopted the new accounting standard for the allowance for credit losses, commonly referred to as the current expected credit losses (“CECL”) methodology, as of April 1, 2023. All disclosures as of and for the three months ended June 30, 2023 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 11, New Accounting Pronouncements. As a result of implementing this new accounting standard, there was a one-time adjustment to the fiscal year 2024 opening allowance balance of $42,000. The Company elected not to measure an allowance for credit losses for accrued interest receivable and instead elected to reverse interest income on loans or securities 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 allowance for credit losses is an estimate of the expected credit losses on financial assets measured at amortized cost. The allowance for credit losses is evaluated and calculated on a collective basis for those loans which share similar risk characteristics and whether it needs to evaluate the allowance on an individual loan basis. The Company estimates the expected credit losses over the loans’ contractual terms, adjusted for expected prepayments. The allowance for credit losses calculation is calculated for loan segments utilizing loan level information and relevant information from internal and external sources related to past events and current conditions. In addition, the Company incorporates a reasonable and supportable forecast. The individual component relates to loans that are considered impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows or collateral value (less estimated selling costs, if applicable) of the impaired loan is lower than the carrying value of that loan.

When available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged against the allowance for credit losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan 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 allowance for credit losses is based on ongoing, quarterly 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 current business cycle, a detailed analysis of impaired loans and other factors as deemed appropriate. 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 allowance for credit losses and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

The following tables summarize the allocation of the allowance for credit losses, as well as the activity in the allowance for credit losses attributed to various segments in the loan portfolio, as of and for the three months ended June 30, 2023 and the allocation and activity of the loans and allowance for loan losses attributed to the various segments in the loan portfolio for the three months ended June 30, 2022 (in thousands):

Three months ended	Commercial		Commercial				Multi-		Real Estate
June 30, 2023	Business		Real Estate		Land		Family		Construction		Consumer		Unallocated		Total
Beginning balance	$	3,123	$	8,894	$	93	$	798	$	764	$	1,127	$	510	$	15,309
Impact of adopting CECL (ASU 2016-13)		1,884		(1,494)		40		(492)		131		483		(510)		42
Provision for (recapture of) credit losses		208		(195)		(10)		(13)		(65)		75		—		—
Charge-offs		—		—		—		—		—		(11)		—		(11)
Recoveries		—		—		—		—		—		3		—		3
Ending balance	$	5,215	$	7,205	$	123	$	293	$	830	$	1,677	$	—	$	15,343
Three months ended
June 30, 2022
Beginning balance	$	2,422	$	9,037	$	168	$	845	$	393	$	943	$	715	$	14,523
Provision for (recapture of) loan losses		73		(495)		(19)		17		125		257		42		—
Charge-offs		—		—		—		—		—		(6)		—		(6)
Recoveries		—		—		—		—		—		42		—		42
Ending balance	$	2,495	$	8,542	$	149	$	862	$	518	$	1,236	$	757	$	14,559

The following table presents an analysis of loans receivable and the allowance for loan losses, based on impairment methodology as of March 31, 2023 (in thousands):

	Allowance for Loan Losses						Recorded Investment in Loans
	Individually		Collectively				Individually		Collectively
	Evaluated		Evaluated				Evaluated		Evaluated
	for		for				for		for
March 31, 2023	Impairment		Impairment		Total		Impairment		Impairment		Total
Commercial business	$	—	$	3,123	$	3,123	$	79	$	232,789	$	232,868
Commercial real estate		—		8,894		8,894		100		564,396		564,496
Land		—		93		93		—		6,437		6,437
Multi-family		—		798		798		—		55,836		55,836
Real estate construction		—		764		764		—		47,762		47,762
Consumer		6		1,121		1,127		450		101,007		101,457
Unallocated		—		510		510		—		—		—
Total	$	6	$	15,303	$	15,309	$	629	$	1,008,227	$	1,008,856

Non-accrual loans: Loans are reviewed regularly and it is the Company’s general policy that a loan is past due when it is 30 to 89 days delinquent. In general, when a loan is 90 days delinquent or when collection of principal or interest appears doubtful, it is placed on non-accrual status, at which time the accrual of interest ceases and a reserve for unrecoverable accrued interest is established and charged against operations. As a general practice, payments received on non-accrual loans are applied to reduce the outstanding principal balance on a cost recovery method. Also, as a general practice, a loan is not removed from non-accrual status until all delinquent principal, interest and late fees have been brought current and the borrower has demonstrated a history of performance based upon the contractual terms of the note. A history of repayment performance generally would be a minimum of nine months. Interest income foregone on non-accrual loans was $3,000 for both of the three months ended June 30, 2023 and 2022.

The following tables present an analysis of loans by aging category at the dates indicated (in thousands):

							Total
			90 Days				Past
			and				Due and				Total
	30-89 Days		Greater				Non-				Loans
June 30, 2023	Past Due		Past Due		Non-accrual		accrual		Current		Receivable
Commercial business	$	270	$	797	$	92	$	1,159	$	243,566	$	244,725
Commercial real estate		—		—		95		95		556,544		556,639
Land		—		—		—		—		6,367		6,367
Multi-family		—		—		—		—		54,340		54,340
Real estate construction		—		—		—		—		43,940		43,940
Consumer		—		—		41		41		98,355		98,396
Total	$	270	$	797	$	228	$	1,295	$	1,003,112	$	1,004,407
March 31, 2023
Commercial business	$	1,967	$	1,569	$	97	$	3,633	$	229,235	$	232,868
Commercial real estate		—		—		100		100		564,396		564,496
Land		—		—		—		—		6,437		6,437
Multi-family		—		—		—		—		55,836		55,836
Real estate construction		—		—		—		—		47,762		47,762
Consumer		11		—		86		97		101,360		101,457
Total	$	1,978	$	1,569	$	283	$	3,830	$	1,005,026	$	1,008,856

Included in the 30-89 days past due and 90 days and greater past due loans at June 30, 2023 are $930,000 of fully guaranteed SBA or United States Department of Agriculture (“USDA”) loans. These government guaranteed loans are classified as pass rated loans and are not considered to be either nonaccrual, classified or impaired loans because based on the guarantee, the Company expects to receive all principal and interest according to the contractual terms of the loan agreement and there are no well-defined weaknesses or risk of loss. For additional information, see Management’s Discussion and Analysis of Financial Condition and Results of Operations – Comparison of Financial Condition at June 30, 2023 and March 31, 2023 – Asset Quality, discussed below. As a result, these loans were omitted from the required calculation of the allowance for credit losses. Interest income foregone on non-accrual loans was $3,000 and $14,000 for the three months ended June 30, 2023 and the year ended March 31, 2023, respectively.

The following table presents an analysis of loans by credit quality indicators as of March 31, 2023 (in thousands):

											Total
			Special								Loans
March 31, 2023	Pass		Mention		Substandard		Doubtful		Loss		Receivable
Commercial business	$	231,384	$	1,367	$	117	$	—	$	—	$	232,868
Commercial real estate		544,426		17,626		2,444		—		—		564,496
Land		6,437		—		—		—		—		6,437
Multi-family		55,694		142		—		—		—		55,836
Real estate construction		47,762		—		—		—		—		47,762
Consumer		101,371		—		86		—		—		101,457
Total	$	987,074	$	19,135	$	2,647	$	—	$	—	$	1,008,856

Impaired loans and Allowance for Loan Losses: Prior to the implementation of Financial Instruments – Credit Losses (ASU 2016-13) on April 1, 2023, a loan was considered impaired when based on current information and circumstances, the Company determines it was probable that it would be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Factors considered in determining impairment included, but were not limited to, the financial condition of the borrower, the value of the underlying collateral and the status of the economy. Impaired loans were comprised of TDR loans that were performing under their restructured terms. Two of the impaired loans were on non-accrual status.  

At June 30, 2023, the Company had $187,000 of nonaccrual loans with no ACL and $41,000 of nonaccrual loans with ACL of $1,000. The amortized cost of collateral dependent loans as of June 30, 2023, were $74,000 and $95,000 for commercial business and commercial real estate, respectively.

The following tables present the total and average recorded investment in impaired loans at the dates and for the periods indicated (in thousands):

	Recorded		Recorded
	Investment		Investment
	with		with						Related
	No Specific		Specific		Total		Unpaid		Specific
March 31, 2023	Valuation		Valuation		Recorded		Principal		Valuation
	Allowance		Allowance		Investment		Balance		Allowance
Commercial business	$	79	$	—	$	79	$	127	$	—
Commercial real estate		100		—		100		162		—
Consumer		355		95		450		442		6
Total	$	534	$	95	$	629	$	731	$	6

	Three months ended
	June 30, 2022
			Interest
			Recognized
	Average		on
	Recorded		Impaired
	Investment		Loans
Commercial business	$	98	$	—
Commercial real estate		119		—
Consumer		491		6
Total	$	708	$	6

The cash basis interest income on impaired loans was not materially different than the interest recognized on impaired loans as shown in the above table.

Troubled debt restructurings (“TDRs”): On April 1, 2023, the Company adopted ASU No. 2022-02, Financial Instruments – Credit Losses (ASU 2016-13). The ASU eliminated the accounting guidance for TDR loans for creditors, while 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 three months ended June 30, 2023. At June 30, 2022, the Company had $698,000 of TDRs, all of which were paying as agreed. There were no new TDRs for the three months ended June 30, 2022.

In accordance with the Company’s policy guidelines, unsecured loans are generally charged-off when no payments have been received for three consecutive months unless an alternative action plan is in effect. Consumer installment loans delinquent nine months or more that have not received at least 75% of their required monthly payment in the last 90 days are charged-off. In addition, loans discharged in bankruptcy proceedings are charged-off. Loans under bankruptcy protection with no payments received for four consecutive months are charged-off. The outstanding balance of a secured loan that is in excess of the net realizable value is generally charged-off if no payments are received for four to five consecutive months. However, charge-offs are postponed if alternative proposals to restructure, obtain additional guarantors, obtain additional assets as collateral or a potential sale of the underlying collateral would result in full repayment of the outstanding loan balance. Once any other potential sources of repayment are exhausted, the impaired portion of the loan is charged-off. Regardless of whether a loan is unsecured or collateralized, once an amount is determined to be a confirmed loan loss it is promptly charged off.