10-K 1 k123109330.htm ALASKA PACIFIC BANCSHARES, INC. FORM 10-K k123109330.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

        For the fiscal year ended December 31, 2009

[  ]
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:  0-26003

ALASKA PACIFIC BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
 
                                     Alaska    92-0167101 
(State or other jurisdiction of incorporation or organization)    (I.R.S. Employer Identification No.) 
     
 2094 Jordan Avenue, Juneau, Alaska 99801
(Address of principal executive offices) (Zip code)
 
Registrant’s telephone number, including area code: (907) 789-4844
     
Securities registered pursuant to Section 12(b) of the Exchange Act:  None
 
     
Securities registered pursuant to Section 12(g) of the Exchange Act:    Common Stock, par value $0.01 per share 
    (Title of Class) 
    
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes [  ]  No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange
Act. Yes [  ]  No [X]

Indicate by check mark whether the registrant (1) 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Check One.
 
Large accelerated filer [  ]      Accelerated filer [  ]      Non-accelerated filer [  ]      Smaller reporting company [X ]
 
                                                                                       
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ]  No [X]

As of March 1, 2010, there were 655,415 issued and 654,486 outstanding shares of the registrant’s Common Stock, which are traded on the over-the-counter market through the OTC “Electronic Bulletin Board” under the symbol “AKPB.” Based on the closing price of the Common Stock on June 30, 2009, the aggregate value of the Common Stock outstanding held by nonaffiliates of the registrant was  $2.1
 
 

 
million (512,035 shares at $4.05 per share). For purposes of this calculation, shares of common stock held by each executive officer and director have been excluded.
 

DOCUMENTS INCORPORATED BY REFERENCE

1.
Portions of the Proxy Statement for the 2009 Annual Meeting of Stockholders are incorporated by reference in this Form 10-K in response to Part III.


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Forward-Looking Statements

“Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: This Form 10-K contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” These forward-looking statements relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding our strategies. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs that may be impacted by deterioration in the housing and commercial real estate markets and may lead to increased losses and non-performing assets in our loan portfolio, result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; deposit flows; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; adverse changes in the securities markets; results of examinations of us and our bank subsidiary by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation, or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; the possibility that we will be unable to comply with the conditions imposed upon us in the Memorandum of Understanding entered into with the Office of Thrift Supervision, including but not limited to our ability to reduce our non-performing assets, which could result in the imposition of additional restrictions on our operations; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; computer systems on which we depend could fail or experience a security breach, or the implementation of new technologies may not be successful; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to manage loan delinquency rates; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business including changes in regulatory polices and principles, including the interpretation of regulatory capital or other rules; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services; time to lease excess space in Company-owned buildings; future legislative changes in the United States Department of Treasury Troubled Asset Relief Program Capital Purchase Program; and other risks detailed in our reports filed with the Securities and Exchange Commission. Any of the forward-looking statements that we make in this Form 10-K and in the other public statements we make may turn out to be wrong because of the inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee.  Because of these and other uncertainties, our actual future results may be materially different from those expressed in any forward- looking statements made by or on our behalf. Therefore, these factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any forward-looking statements.

As used throughout this report, the terms “we”, “our” or “us” refer to Alaska Pacific Bancshares, Inc. and our consolidated subsidiary, Alaska Pacific Bank.


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Available Information

Alaska Pacific Bancshares, Inc. posts its annual report to shareholders, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and press releases on its investor information page at www.alaskapacificbank.com.  These reports are posted as soon as reasonably practicable after they are electronically filed with the Securities and Exchange Commission (“SEC”). All of Alaska Pacific Bancshares, Inc’s SEC filings are also available free of charge at the SEC's website at www.sec.gov or by calling the SEC at 1-800-SEC-0330.

PART I

Item 1.  Business

General

            Alaska Pacific Bancshares, Inc. (“Company”), an Alaska corporation, was organized on March 19, 1999 for the purpose of becoming the holding company for Alaska Pacific Bank (“Alaska Pacific” or the “Bank”) upon the Bank’s conversion from a federal mutual to a federal stock savings bank (“Conversion”). The Conversion was completed on July 1, 1999. At December 31, 2009, the Company had total assets of $178.3 million, total deposits of $148.2 million and stockholders’ equity of $18.7 million. The Company has not engaged in any significant activity other than holding the stock of the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank.

            Alaska Pacific was founded as “Alaska Federal Savings and Loan Association of Juneau” in 1935 and changed its name to “Alaska Federal Savings Bank” in October 1993. In connection with the Conversion, Alaska Pacific changed its name from “Alaska Federal Savings Bank” to its current title. The Bank, as a federally-chartered savings institution, is regulated by the Office of Thrift Supervision (“OTS”), its primary federal regulator, and the Federal Deposit Insurance Corporation (“FDIC”), as its deposit insurer. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund administered by the FDIC. The Bank has been a member of the Federal Home Loan Bank (“FHLB”) System since 1937.

            Alaska Pacific operates as a community oriented financial institution and is devoted to serving the needs of its customers. The Bank’s business consists primarily of attracting retail deposits from the general public and using those funds to originate one-to-four-family mortgage loans, commercial business loans, consumer loans, construction loans and commercial real estate loans.

Participation in the U.S. Treasury’s Capital Purchase Program

On February 9, 2009, we received $4.8 million from the U.S. Treasury Department as part of the Treasury’s Capital Purchase Program. We issued $4.8 million in senior preferred stock, with a related warrant to purchase up to $717,150 in common stock, to the U.S. Treasury. The warrant provides the Treasury the option to purchase up to 175,772 shares of the Company’s common stock at a price of $4.08 per share at any time during the next ten years. The preferred stock pays a 5% dividend for the first five years, after which the rate will increase to 9% if the preferred shares are not redeemed by the Company. The terms and conditions of the transaction and the preferred stock conform to those provided by the U.S. Treasury. A summary of the Capital Purchase Program can be found on the Treasury’s web site at www.ustreas.gov/initiatives/eesa. The additional capital enhances our capacity to support the communities we serve through expanded lending activities and economic development. This capital will also add flexibility in considering strategic opportunities that may be available to us as the financial services industry continues to consolidate.

Memorandum of Understanding

On January 7, 2009 the OTS finalized a supervisory agreement (“MOU”) which was reviewed and approved by the Board of Directors of the Bank on December 19, 2008. The Board of Directors and management do not believe that the MOU will restrict the Bank’s business plans and that there has already been substantial
 
 
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progress made in satisfying the requirements of the MOU. While management believes the Bank is currently in compliance with the terms of the MOU, if the Bank fails to comply with these terms, the OTS could take additional enforcement action against the Bank, including the imposition of monetary penalties or the issuance of a cease and desist order requiring further corrective action. For further information regarding the terms of the MOU, see Item 1A, “Risk Factors -- Risks Related to our Business -- We are subject to the restrictions and conditions of a Memorandum of Understanding with, and other commitments we have made to, the Office of Thrift Supervision. Failure to comply with the Memorandum of Understanding could result in additional enforcement action against us, including the imposition of monetary penalties.”

In connection with the MOU, the Company’s Board of Directors has executed two resolutions to assure the OTS that the Company is committed to supporting the Bank should it be necessary, and that the Company would comply with the restrictions in the Bank’s MOU.  See Item 1A, “Risk Factors -- Risks Related to our Business -- We are subject to the restrictions and conditions of a Memorandum of Understanding with, and other commitments we have made to, the Office of Thrift Supervision. Failure to comply with the Memorandum of Understanding could result in additional enforcement action against us, including the imposition of monetary penalties.”

Market Area

Alaska Pacific’s primary markets are in the communities of Juneau, Ketchikan and Sitka, but serve the entire region of southeast Alaska considered to span the 500 miles from Yakutat in the north to Prince of Wales Island to the south. The region encompasses approximately 35,000 square miles of land distributed amongst the islands and coastline of the Alaska Panhandle. Southeast Alaska is home to approximately 69,000 residents in 14 communities, a number that, with the exception of Juneau, Ketchikan and Sitka, has shown slow but steady decline over the past nine years. While the region shares similar economic characteristics, there is some diversity and unique industries around the region.

Southeast Alaska has historically been relatively immune from the direct impact of economic problems in the “lower 48.” The region has demonstrated its stability over time missing the “booms” and avoiding the “busts” without significant swings. The region has remained relatively insulated from the deep recession experienced by many other parts of the country but has been an impact on the region. According to the State of Alaska Department of Labor, there were about 750 jobs lost in the region during 2009. The region has experienced a measurable slow down in commercial and consumer loan activity. While there has been some downward adjustment in residential real estate values, for the most part the market has remained relatively stable. Most adjustments over the past two years were directly related to small adjustments in each local market based on supply, demand and interest rates.
 
 
While avoiding most economic instability, the notable exception is tourism, with a focus in the Southeast Alaska region on cruise ship visitors. Clearly the patterns and expenditures on travel have been felt throughout the industry, and the number of cruise ships and related visitors dedicated to the various ports-of-call throughout the region are being monitored closely. Total ship visitors to the region are expected to decline. It appears that businesses engaged in this segment of the economy are making appropriate adjustments to respond to anticipated declines; and in turn municipalities can anticipate lower sales tax revenue. There are, however, two major projects in our region that we currently anticipate will have a material positive impact on the region’s employment. The Kensington Gold Mine in Juneau, and the Ketchikan Shipyard in Ketchikan, will collectively create more than 400 new, high paying jobs in the region, already giving rise to an assessment of available housing in both communities.

Alaska Pacific’s administrative headquarters and largest banking office, one full service branch and the Bank’s mortgage operation, are located in Juneau which has a population as of 2008 of 30,427. The population showed a 1% increase between 2007 and 2008. Juneau is the capital of Alaska with its primary economic resources being state and federal government, tourism, fish processing, fishing and mining. Juneau’s historically active mining industry (primarily gold and silver), which had seen decades of decline, has gained importance in the area’s economy. According to the Alaska Department of Labor, the largest employers in Juneau are the state, local and federal agencies, followed by Bartlett Regional Hospital and the University of Alaska. In terms of
 
 
 
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employment and total payroll between private and government in 2008, the private sector employed an annual average of 10,658 employees with annual wages of $373 million while government employed an annual average of 7,324 with annual wages of  $352 million. Unemployment in Juneau increased from 6.0% to 6.5% from December 2008 to December 2009, reflecting an increasing trend seen statewide. (Source: State of Alaska Department of Labor)

            Two full service offices of Alaska Pacific are located in Ketchikan (population approximately 12,993 estimated as of July 2008 by the Alaska Department of Labor). Ketchikan is an industrial center and a major port of entry in Southeast Alaska with a diverse economy. A large fishing fleet, fish processing facilities, timber and wood products manufacturing, and tourism are Ketchikan’s main economic support. The largest employers in the Ketchikan Gateway Borough include the city and state government, Ketchikan General Hospital, the Ketchikan Gateway School District, the Ketchikan Pulp Mill and the federal government.

            One full service office of Alaska Pacific is located in Sitka (population approximately 8,615 estimated as of July 2008 by the Alaska Department of Labor), located on the west coast of Baranof Island fronting the Pacific Ocean, on Sitka Sound. The primary economic sources in Sitka are fishing, fish processing, tourism, government, transportation, retail and health care services. The largest employers in Sitka include the Southeast Alaska Regional Health Corp., the Sitka Borough School District, city, state and federal governments and the Sitka Community Hospital. Other Sitka employers include the Alaska State Trooper Training Academy and numerous businesses involved in commercial and sport fishing and tourism.

         
Lending Activities

            General. At December 31, 2009, Alaska Pacific’s loan portfolio (excluding loans held for sale) amounted to $158.1 million, or 89% of total assets at that date. Alaska Pacific originates conventional mortgage loans, construction loans, commercial real estate loans, land loans, consumer loans and commercial business loans. Over 75% of Alaska Pacific’s loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area.

            Loan Portfolio Analysis. The following table sets forth the composition of Alaska Pacific’s loan portfolio (excluding loans held for sale) as of the dates indicated.
 
 
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(dollars in thousands) December 31,
  2009     2008  
   
Amount
    Percent    
Amount
    Percent  
Real estate:
                       
    Permanent:                        
One-to-four-family
  $ 33,787       21.37 %   $ 38,875       23.01 %
Multifamily
    1,736       1.10       2,575       1.52  
Commercial nonresidential
    64,453       40.77       56,019       33.15  
Total permanent
    99,976       63.24       97,469       57.68  
Land
    9,697       6.13       13,360       7.91  
Construction:
                               
One-to-four-family
    3,050       1.93       4,179       2.47  
Commercial nonresidential
    2,637       1.67       5,064       3.00  
Total construction
    5,687       3.60       9,243       5.47  
Commercial business
    19,856       12.56       24,429       14.46  
Consumer:
                               
Home equity
    16,522       10.45       18,661       11.04  
Boat
    4,287       2.71       4,060       2.40  
Automobile
    1,269       0.80       998       0.59  
Other
    814       0.51       762       0.45  
Total consumer
    22,892       14.47       24,481       14.48  
Total loans
    158,108       100.00 %     168,982       100.00 %
Less:
                               
   Allowance for loan losses
    1,786               2,688          
     Loans, net
  $ 156,322             $ 166,294          

            One-to-four-family Real Estate Lending. Historically, Alaska Pacific has concentrated its lending activities on the origination of loans secured by first mortgages on existing one-to-four-family residences located in its primary market area. At December 31, 2009, $33.8 million, or 21.4%, of Alaska Pacific’s total loan portfolio consisted of these loans. Alaska Pacific originated $47.6 million and $38.2 million of one-to-four-family residential mortgage loans during the years ended December 31, 2009 and 2008, respectively.

            Generally, Alaska Pacific’s fixed-rate one-to-four-family mortgage loans have maturities of 15 and 30 years and are fully amortizing with monthly payments sufficient to repay the total amount of the loan with interest by the end of the loan term. Generally, Alaska Pacific originates these loans under terms, conditions and documentation which permits them to be sold to U.S. Government sponsored agencies such as the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Alaska Housing Finance Corporation (“AHFC”), a state agency that provides affordable housing programs. Alaska Pacific’s fixed-rate loans customarily include “due on sale” clauses, which gives the Bank the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not paid.

            Alaska Pacific offers adjustable rate mortgage loans at rates and terms competitive with market conditions. At December 31, 2009, $3.5 million, or 10.7%, of Alaska Pacific’s one-to-four-family residential loan portfolio consisted of adjustable rate mortgage loans. Demand for conventional adjustable rate mortgage loans has been very low in the Bank’s market area, but have increased with the advent of “hybrid mortgages,” which are adjustable rate loans with the interest rate fixed for an initial period of three to five years.

            Alaska Pacific originates one-to-four-family mortgage loans under Freddie Mac, the Federal Housing Administration, the Veterans Administration, and AHFC programs. Alaska Pacific generally sells these loans in the secondary market, with servicing retained. This means that Alaska Pacific retains the right to collect principal and interest payments on the loans and forward these payments to the purchaser of the loan, maintain escrow accounts for payment of taxes and insurance and perform other loan administration functions. See “-- Loan Originations, Sales and Purchases.” Alaska Pacific also uses three larger private mortgage investors as sources for funding mortgages through correspondent lending programs.
 
 
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            Alaska Pacific requires title insurance insuring the status of its lien on all loans where real estate is the primary source of security. Alaska Pacific also requires that fire and casualty insurance, and flood insurance where appropriate, be maintained in an amount at least equal to the outstanding loan balance.

            One-to-four-family residential mortgage loans may be made up to 80% of the appraised value of the security property without private mortgage insurance. Pursuant to underwriting guidelines adopted by the Board of Directors, Alaska Pacific can lend up to 97% of the appraised value of the property securing a one-to-four-family residential loan; however, Alaska Pacific generally obtains private mortgage insurance on the portion of the principal amount that exceeds 80% of the appraised value of the security property.

            Alaska Pacific also originates loans secured by non-owner occupied residential properties that are sold to Freddie Mac.

            Land Lending. Alaska Pacific also originates loans secured by first mortgages on residential building lots on which the borrower proposes to construct a primary residence. These loans generally have terms of up to twelve years and can be either fixed-rate or floating rate loans.  Alaska Pacific also originates commercial land loans, which have floating rates that adjust annually. At December 31, 2009 and 2008, land loans amounted to $9.7 million and $13.4 million, respectively. The decrease in land loans was primarily attributable to the charge off of $3.0 million of land loans during 2009.

            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, Alaska Pacific may be confronted with a property value that is insufficient to assure full repayment of the loan.

            Construction Lending. At December 31, 2009, construction loans amounted to $5.7 million, or 3.6% of total loans, most of which were secured by properties located in Alaska Pacific’s primary market area. This compares with $9.2 million, or 5.5% of the total loan portfolio at December 31, 2008. The decrease is attributable to a decline in demand for construction loans, both residential and commercial.

At December 31, 2009, $5.7 million of our construction loan portfolio consisted of loans requiring interest only payments of which $2.5 million or 44% of the total construction loans were relying on the interest reserve to make this payment. As a result, construction lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor themselves to repay principal and interest.

Construction loans are made for maximum terms of nine to 18 months. Construction loans are made at fixed or adjustable rates with interest payable monthly. Alaska Pacific originates construction loans to individuals who have a contract with a builder for the construction of their residence. Alaska Pacific typically requires that permanent financing with Alaska Pacific or some other lender be in place prior to closing any construction loan to an individual. Alaska Pacific generally underwrites these loans, which typically convert to a fully amortizing adjustable- or fixed-rate loan at the end of the construction term, according to the underwriting standards for a permanent loan.

            Construction loans to builders, or speculative loans, are typically made with a maximum loan-to-value ratio of the lesser of 80% of the cost of construction or 75% of the appraised value. Construction loans made to home builders are termed “speculative” because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing with either Alaska Pacific or another lender for the finished home. The home buyer may be identified either during or after the construction period, with the risk that the builder will have to service the debt on the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until the home buyer is identified.

            Prior to making a commitment to fund a construction loan, Alaska Pacific requires an appraisal of the property by an independent state-licensed and qualified appraiser approved by the Board of Directors. Alaska
 
 
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Pacific’s staff also reviews and inspects projects prior to any disbursement of funds during the term of the construction loan. The review consists of examining the percentage of funds expended compared to the percentage of work completed and examining interest reserves compared to work left to finish the project.

            Although construction lending affords Alaska Pacific the opportunity to achieve higher interest rates and fees with shorter terms to maturity than one-to-four-family mortgage lending, construction lending is generally considered to involve a higher degree of risk than one-to-four-family mortgage lending. It is more difficult to evaluate construction loans than permanent loans. At the time the loan is made, the value of the collateral securing the loan must be estimated based on the projected selling price at the time the residence is completed, typically six to 12 months later, and on estimated building and other costs (including interest costs). However, appraisers will use both market and income valuation approaches in addition to cost to establish value. Changes in the demand for new housing in the area and higher-than-anticipated building costs may cause actual results to vary significantly from those estimated. Accordingly, Alaska Pacific may be confronted, at the time the residence is completed, with a loan balance exceeding the value of the collateral. 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 new housing. The fact that in-process homes are difficult to sell and typically must be completed in order to be successfully sold also complicates the process of working out problem construction loans. This may require Alaska Pacific to advance additional funds and/or contract with another builder to complete the residence. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished home.

            Alaska Pacific has attempted to minimize the foregoing risks by, among other things, limiting its construction lending, and especially speculative loans, to a small number of well-known local builders. One-to-four-family construction loans generally range in size from $100,000 to $600,000, while commercial nonresidential and multifamily construction loans have generally ranged from $500,000 to $2.5 million. At December 31, 2009, the largest construction loan was approximately $1.9 million for a multi-use real estate project located in Alaska, which was performing in accordance with its terms.

            Multifamily and Commercial Real Estate Lending. The multifamily residential loan portfolio consists primarily of loans secured by small apartment buildings and the commercial real estate loan portfolio consists primarily of loans secured by retail, office, warehouse, mini-storage facilities and other improved commercial properties. These loans generally range in size from $100,000 to $2.5 million and at December 31, 2009 the largest loan totaled $2.7 million and was performing in accordance with its terms. At December 31, 2009, Alaska Pacific had $1.7 million of multifamily residential and $64.5 million of commercial real estate loans, or 1.1% and 40.8%, respectively, of the total loan portfolio at this date. Multifamily and commercial real estate loans are generally underwritten with loan-to-value ratios of up to 75% of the lesser of the appraised value or the purchase price of the property. These loans generally are made at interest rates based on the prime rate for 15 to 20 year terms, with adjustment periods of one, three or five years and an adjustment rate equal to the prime rate plus a negotiated margin of 1% to 3%. In addition, many of these loans have interest rate floors ranging from 5.75% to 6.25%. Alaska Pacific is increasingly using interest rate floors in the current low interest rate environment to protect or enhance yield. While a majority of Alaska Pacific’s multifamily and commercial real estate loans are secured by properties located within Alaska Pacific’s primary market area, others are secured by properties elsewhere in Alaska as well as Washington, Oregon, Utah, Colorado, California, and Idaho.

            Alaska Pacific is also an approved lender under the AHFC Multifamily Participation Program, which was introduced in 1998. The AHFC Multifamily Participation Program provides for up to 80% of the loan amount, which allows Alaska Pacific to pursue larger lending opportunities while mitigating its risk.

            From time to time, Alaska Pacific purchases participations in multifamily and commercial real estate loans from other banks in Alaska and the Pacific Northwest, generally ranging from $500,000 to $2.5 million. Such loans are on similar terms and are subject to the same underwriting standards as loans originated by Alaska Pacific. Alaska Pacific lending policy limits participation loans by geographic region, loan type and lead lender concentrations.  Additionally, the Board of Directors must approve all participation loans. Alaska Pacific monitors
 
 
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participation loans by maintaining consistent communication with lead lenders, receipt of status updates on each credit and by review of annual financial statements of the borrowers.

            Multifamily residential and commercial real estate lending entails significant additional risks as compared with single-family residential property lending. Multifamily residential and commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience on these loans typically is dependent on the successful operation of the real estate project. Supply and demand conditions in the market for office, retail and residential space can significantly affect these risks, and, as such, may be subject to a greater extent to adverse conditions in the economy generally. Alaska Pacific reviews all commercial real estate loans in excess of $500,000 on an annual basis to ensure that the loan meets current underwriting standards.

Future growth of commercial real estate loans is restricted by regulation which generally limits such loans, under Alaska Pacific’s federal thrift charter, to 400% of total capital for regulatory purposes, or approximately $74.0 million at December 31, 2009.

            Commercial Business Lending. At December 31, 2009, commercial business loans amounted to $19.9 million, or 12.6% of total loans. Future growth of commercial business loans is restricted by regulation which generally limits such loans, under Alaska Pacific’s federal thrift charter, to 20% of total assets, or approximately $36 million at December 31, 2009.

            Alaska Pacific originates commercial business loans to small sized businesses in its primary market area. Commercial business loans are generally made to finance the purchase of seasonal inventory needs, new or used equipment, and for short-term working capital. Security for these loans generally includes equipment, boats, accounts receivable and inventory, although commercial business loans are sometimes granted on an unsecured basis. Commercial business loans are made for terms of seven years or less, depending on the purpose of the loan and the collateral, with operating lines of credit made for one year or less renewed annually at an interest rate based on the prime rate, usually adding a margin of between one half and three percentage points. Such loans generally are originated in principal amounts between $100,000 and $1 million. At December 31, 2009, the largest commercial business loan for $2.0 million was secured by equipment and inventory and was performing in accordance with terms.

            Alaska Pacific originates guaranteed loans through the Small Business Administration, the U.S. Department of Agriculture and the Alaska Industrial Development and Export Authority. Alaska Pacific has also worked with local municipal agencies, such as the Juneau Economic Development Council and the cities of Sitka and Ketchikan in exploring participation or guaranty programs in each of these cities. Generally in these programs, Alaska Pacific receives guarantees of between 75% and 90% of the loan amount. In addition, Alaska Pacific has retained portions of commercial business loans originated through participation programs with economic development agencies such as the Alaska Industrial Development and Export Authority, often retaining portions of as little as 10%.

            Alaska Pacific also makes commercial business loans secured by commercial charter boats and commercial fishing boats. These loans have 10 to 15 year terms with an interest rate that adjusts based on the prime interest rate. In connection with the loans on these boats, Alaska Pacific receives a ship’s preferred marine mortgage to protect its interest in the collateral. Alaska Pacific has also granted a flooring line to one boat dealer for the purchase of boats and other related marine equipment.

            Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential, commercial and multifamily 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 often have equipment, inventory, accounts receivable or other business assets as collateral, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other conditions.
 
 
-10-

 
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.

            Consumer Lending. At December 31, 2009, consumer loans totaled $22.9 million, or 14.5% of total loans.  Consumer loans generally have shorter terms to maturity or repricing and higher interest rates than long-term, fixed-rate mortgage loans. In addition to home equity, boat loans and automobile loans, Alaska Pacific’s consumer loans consist of loans secured by land, airplanes, deposit accounts, and unsecured loans for personal or household purposes.

            The largest category of Alaska Pacific’s consumer loan portfolio is home equity loans that are made on the security of residences. At December 31, 2009, home equity loans totaled $16.5 million, or 10.5% of the total loan portfolio, compared to $18.7 million, or 11.0% of the total loan portfolio at December 31, 2008. Home equity loans generally do not exceed 95% of the appraised value of the residence or 100% of the tax assessment including the outstanding principal of the first mortgage. Closed-end loans are generally fixed-rate and have terms of up to 25 years requiring monthly payments of principal and interest. Home equity lines of credit generally have adjustable interest rates. These rates are graduated based on credit scores. Recently, with the slowdown in price appreciation or actual declines in values, homeowner’s equity in some high loan to value (LTV) home equity loans may have declined. However, Alaska has not experienced the rapid declines in home prices experienced by many parts of the country where home prices rose much faster.

            At December 31, 2009, consumer boat loans amounted to $4.3 million, or 2.7%, of the total loan portfolio compared to $4.1 million, or 2.4% of the total loan portfolio at December 31, 2008. Alaska Pacific offers boat loans with maturities of between five and 20 years, which generally range in principal amounts from $15,000 to $350,000 and are secured by new and used boats. Alaska Pacific makes boat loans of less than $100,000 at fixed rates of interest and loans over $100,000 are made at an interest rate that is adjustable based on the prime lending rate. Alaska Pacific generally makes boat loans on new boats of up to 90% of the value and 85% on used boats, but in certain instances it will loan up to 100% of the value depending on the borrower’s credit score.

            At December 31, 2009, automobile loans amounted to $1.3 million, or 0.8%, of the total loan portfolio compared to $998,000, or 0.6% of the total loan portfolio at December 31, 2008. Alaska Pacific offers automobile loans with maturities of up to seven years with fixed rates of interest.

            Other consumer loans include loans collateralized by deposit accounts and other types of collateral, and by unsecured loans to qualified individuals. These loans amounted to $814,000, or 0.5%, of total loans at December 31, 2009, compared to $762,000, or 0.5% of total loans at December 31, 2008.

            Alaska Pacific also requires title, fire and casualty insurance on secured consumer loans. The only title exception is for home equity loans under $50,000 where a property profile, obtained from a title company, indicates there are no liens or encumbrances not previously disclosed.

            Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles or boats and particularly used automobiles. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans. These loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of these loans such as Alaska Pacific, and a borrower may be able to assert against this assignee claims and defenses that it has against the seller of the underlying collateral.
 
 
-11-


            Loan Maturity and Repricing. The following table sets forth certain information at December 31, 2009 regarding the dollar amount of loans maturing in Alaska Pacific’s portfolio based on their contractual terms to final maturity, but does not include scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of undisbursed loan proceeds and unearned discounts, and do not include loans held for sale.

   
After
After
After
     
After 1 Year
(in thousands)
December 31, 2009
Within
1 Year
1 Year
Through
3 Years
3 Years
Through
5 Years
5 Years
Through
10 Years
Beyond
10 Years
Total
 
Fixed
Rates
Adjust-
able
Rates
Real estate:
                 
Permanent:
                 
One-to-four-
  family
$ 886
$   751
$452
$ 5,855
$25,843
$33,787
 
$29,840
$  3,061
Multifamily
-
-
-
693
1043
1,736
 
693
1,043
Commercial
  nonresidential
415
3,154
4,013
5,911
50,960
64,453
 
3,540
60,498
Land
2,566
4,133
1,641
607
750
9,697
 
2,222
4,909
Construction:
                 
One-to-four-
  family
2,654
396
-
-
-
3,050
 
-
396
Commercial
  nonresidential
2,408
229
-
-
-
2,637
 
-
229
Commercial
  business
4,362
2,517
2,009
5,149
5,819
19,856
 
1,688
13,806
Consumer:
                 
Home equity
71
270
583
3,631
11,967
16,522
 
11,938
4,513
Boat
1
98
199
1,264
2,725
4,287
 
3,761
525
Automobile
19
279
484
487
-
1,269
 
1,250
-
Other
73
78
112
47
504
814
 
448
294
Net Loans
$13,455
$11,905
   $9,493
 $23,644
$99,611
$158,108
 
$55,379
$89,274

            Loan Solicitation and Processing. Alaska Pacific obtains its loan applicants from walk-in traffic, which is generated through media advertising and referrals from existing customers, from on-line loan applications through its web site, and through officer business development calls and activities. Local real estate agents refer a portion of Alaska Pacific’s mortgage loan applicants, and dealers refer some consumer loans, such as boat loans. Alaska Pacific requires title insurance on all of its mortgage loans. All mortgage loans require fire and extended coverage on appurtenant structures and flood insurance, if applicable.

            Loan approval authority varies based on loan type. The Chief Executive Officer, the Chief Credit Officer, and the Chief Lending Officer each has authority to approve all residential mortgage loans up to and including $300,000 that are originated for Alaska Pacific’s portfolio, and up to the agency limit if the loan is to be sold in the secondary market; multifamily and commercial real estate loans up to and including $300,000; commercial business loans up to and including $300,000 ($100,000 if unsecured); and consumer loans up to and including $300,000 ($100,000 if unsecured). Alaska Pacific’s Senior Loan Committee, consisting of the Chief Executive Officer, Chief Credit Officer, Chief Lending Officer and a senior lending officer, must approve loans in excess of these amounts up to and including $750,000. The Directors’ Loan Committee must approve all loans in excess of the Senior Loan Committee’s approval authority up to 75% of Alaska Pacific’s legal lending limit. The Board of Directors must approve all loans in excess of the Directors’ Loan Committee’s approval authority.

            Upon receipt of a loan application from a prospective borrower, a credit report and other data are obtained to verify specific information relating to the loan applicant’s employment, income and credit standing. An independent appraiser approved by Alaska Pacific and licensed or certified by the State of Alaska undertakes an
 
 
-12-

 
appraisal of any real estate offered as collateral. Alaska Pacific promptly notifies applicants of the decision. Interest rates are subject to change if the approved loan is not closed within the time of the commitment.

            Alaska Pacific has an automated underwriting system for consumer loans, enabling expedited approval of consumer loans at any branch location. This system also enables processing of online loan applications from customers. In addition, Alaska Pacific has a system for online loan applications for mortgage loans.
 
            Pursuant to OTS regulations, loans to one borrower cannot exceed 15% of Alaska Pacific’s unimpaired capital and surplus. At December 31, 2009, the loans-to-one-borrower limitation for Alaska Pacific was $2.9 million, and Alaska Pacific had no loans in excess of this limitation except where guaranteed by a government agency or approved prior to December 31, 2009, at a time when the Bank's legal lending limit was higher.
 
            Loan Originations, Sales and Purchases. Alaska Pacific’s lending activities include the origination of one-to-four-family residential mortgage loans, construction and land loans, loans to businesses, commercial real estate, multi-family and consumer loans.
 
    Alaska Pacific generally sells loans without recourse and with servicing retained except in its correspondent lending programs. Correspondent lending involves the sale of one-to-four-family mortgages to private (non-government sponsored enterprises or GSE) institutional investors, usually with servicing rights released. By retaining the servicing, Alaska Pacific receives fees for performing the traditional services of processing payments, accounting for loan funds, and collecting and paying real estate taxes, hazard insurance and other loan-related items, such as private mortgage insurance. At December 31, 2009, Alaska Pacific’s servicing portfolio was $119.6 million. For the year ended December 31, 2009, loan servicing fees totaled $295,000 before amortization of servicing rights.

            The value of the loans that are serviced for others is significantly affected by interest rates. In general, during periods of falling interest rates, mortgage loans prepay at faster rates and the value of the mortgage servicing declines. Conversely, during periods of rising interest rates, the value of the servicing rights generally increases as a result of slower rates of prepayment. Alaska Pacific may be required to recognize a decrease in value by taking a charge against earnings, which would cause its profits to decrease.

             In addition, Alaska Pacific retains certain amounts in escrow for the benefit of investors. Alaska Pacific is able to invest these funds but is not required to pay interest on them. At December 31, 2009, these escrow balances totaled $751,000.
 
 
-13-


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

 (in thousands) Year ended December 31,
    2009
 
    2008
 
Loans originated:
       
  Real estate:
       
Permanent:
       
  One-to-four-family
$47,598
 
$38,167
 
  Multifamily
-
 
880
 
  Commercial nonresidential
10,551
 
29,642
 
Land
874
 
1,304
 
Construction:
       
  One-to-four-family
4,203
 
1,598
 
  Multifamily
1,505
 
-
 
  Commercial nonresidential
851
 
1,490
 
Commercial business
11,439
 
14,743
 
Consumer:
       
  Home equity
2,430
 
4,187
 
  Boat
1,238
 
971
 
  Automobile
719
 
435
 
  Other
2,697
 
3,523
 
        Total loans originated
84,105
 
96,940
 
Loans purchased
647
 
893
 
Loans sold
(39,309
(17,713
Foreclosed loans
(3,508
(742
Principal repayments and other changes
(55,340
(76,236
Net increase (decrease) in loans and loans held for sale
$  (13,405
$  3,142
 

The increase in loans sold relates to an increase in one-to-four-family loans sold primarily to Freddie Mac without recourse.

A portion of Alaska Pacific’s originations in 2009 and 2008 represent refinancing of loans originally made by Alaska Pacific and other lenders.

                Loan Commitments. Occasionally, Alaska Pacific issues, without charge, commitments for fixed- and adjustable-rate single-family residential mortgage loans conditioned upon the occurrence of certain events. These commitments are made in writing on specified terms and conditions and are honored for up to 60 days. Commercial commitments issued by Alaska Pacific include commitments for fixed-term loans as well as business lines of credit; letters of credit are not offered. At December 31, 2009, Alaska Pacific had $15.0 million of outstanding net loan commitments, including unused portions on commercial business lines of credit and undisbursed funds on construction loans. For additional information on loan commitments, see Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.

                Loan Origination and Other Fees. Alaska Pacific often receives loan origination fees and discount “points.”  Loan fees and points are a percentage of the principal amount of the loan that are charged to the borrower for funding the loan. The amount of fees and points charged by Alaska Pacific varies, though the range generally is between one half and two points. Accounting standards require fees received (net of 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 associated with loans that are prepaid are recognized as income at the time of prepayment. Alaska Pacific had $567,000 of net deferred loan fees at December 31, 2009.

                Nonperforming Assets and Delinquencies. Alaska Pacific utilizes one loan collector that is a Bank employee to monitor the loan portfolio and communicate with customers concerning past due payments. The size of the portfolio and historically low delinquency rates allow one individual to manage consumer, commercial and residential loans, including those loans serviced for other investors. When a borrower fails to make a required
 
 
-14-

 
payment, Alaska Pacific institutes collection procedures. The process for monitoring consumer, commercial and residential loans is the same for each type of loan until foreclosure or repossession of the collateral. Depending on the value or nature of the collateral, the loan servicing manager, senior lender or senior management directs any further action in consultation with the Bank’s legal counsel.

            Customers who miss a payment are mailed a computer-generated notice 15 days after the payment due date. If the customer does not pay promptly, the collector telephones the customer 20 days after the payment due date. After 30 days, the collector sends a letter, which begins the demand process. Follow-up contacts are made between the 30th and 60th day, after which the collector sends a demand letter that specifies the action Alaska Pacific will take and the deadline for resolving the delinquency. While most delinquencies are cured promptly, the collector initiates foreclosure or repossession, according to the terms of the security instrument and applicable law, if the deadline in the 60-day letter is not met.

            Residential loans have a highly structured process for foreclosure. In addition to Alaska Pacific’s residential loan portfolio, Alaska Pacific services real estate loans for other investors who in turn have their own requirements that must be followed. Alaska Pacific evaluates consumer and commercial business loans individually depending on the nature and value of the collateral.

            Alaska Pacific places all loans that are past due 90 days or more on nonaccrual status and all previously accrued interest income is reversed. Alaska Pacific charges off consumer loans when it is determined they are no longer collectible.

            Alaska Pacific’s Board of Directors is informed monthly as to the status of all mortgage, commercial and consumer loans that are delinquent 30 days or more, the status on all loans currently in foreclosure, and the status of all foreclosed and repossessed property owned by Alaska Pacific.

            The following table sets forth information with respect to Alaska Pacific’s nonperforming assets at the dates indicated. It is the policy of Alaska Pacific to cease accruing interest on loans 90 days or more past due.

(dollars in thousands) December 31,
2009
 
2008
 
Loans accounted for on a nonaccrual basis:
       
Consumer
$   78
 
$   22
 
Commercial business
   236
 
   410
 
Real Estate
2,541
 
5,639
 
Total
2,855
 
6,071
 
Accruing loans which are contractually past due 90
   days or more
-
 
-
 
       Total of nonaccrual and 90 days past due loans
2,855
 
6,071
 
         
Repossessed assets
2,598
 
408
 
       Total nonperforming assets
$   5,453
 
$   6,479
 
         
Nonaccrual and 90 days or more past due loans as a
   percentage of loans
1.81
3.59
         
Nonaccrual and 90 days or more past due loans as a
   percentage of total assets
1.60
3.18
         
Nonperforming assets as a percentage of total assets
3.06
3.39

As of December 31, 2009 and 2008, approximately $789,000 and $665,000, respectively, of interest would have been recorded if these loans had been current according to their original terms and had been outstanding throughout the year.
 
 
-15-

 
            Other Real Estate Owned and Repossessed Assets. Alaska Pacific classifies real estate acquired as a result of foreclosure and other repossessed collateral as repossessed assets until sold. When Alaska Pacific acquires collateral, it is recorded at the lower of its cost, which is the unpaid principal balance of the related loan plus acquisition costs, or fair value. Subsequent to acquisition, the property is carried at the lower of the acquisition amount or fair value. At December 31, 2009, Alaska Pacific held repossessed assets of $2.6 million, which consisted of other real estate owned and repossessed consumer assets.

            Asset Classification. The OTS has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis.  In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets:  substandard, doubtful and loss. Substandard assets must have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations have also created a special mention category, described as assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management’s close attention. If an asset or portion thereof is classified loss, the loss amount is charged off.

            Alaska Pacific monitors its asset quality through the use of an Asset Classification Committee, which is comprised of senior lenders and executive officers. The Committee meets monthly to review the loan portfolio, with specific attention given to assets with an identified weakness, as well as reviewing the local, state and national economic trends and the adequacy of the allowance for loan losses.

            At December 31, 2009 and 2008, the aggregate amounts of Alaska Pacific’s classified, special mention and repossessed assets (as determined by Alaska Pacific), were as follows:

(in thousands) December 31,
    2009
    2008
Doubtful
$450
$1,055
Substandard assets
4,892
6,936
Special mention
3,623
1,865
Other real estate owned and repossessed assets
2,598
408
   Total classified loans and repossessed assets
$11,563
$10,364

At December 31, 2009 total classified loans totaled $5.3 million compared to $8.0 million at December 31, 2008.

Impaired Loans. Loans with balances totaling $5.3 million at December 31, 2009 and $10.7 million at December 31, 2008 were considered to be impaired. The $5.4 million decrease in impaired loans consisted of loans no longer classified as impaired or charged off offset with additional loans. The total number of impaired loans was 15 and 23 as of December 31, 2009 and 2008, respectively. Total estimated impairments of $514,000 and $875,000, respectively, were recognized on impaired loans in evaluating the adequacy of the allowance for loan losses at December 31, 2009 and 2008.

-16 -
 
 

 


The following table reflects loan balances considered to be impaired by asset type at December 31, 2009 and 2008.

(in thousands) December 31,
    2009
    2008
Residential real estate
$ 541
$      66
Commercial real estate
909
2,612
Land
3,263
5,898
Construction - residential
180
180
Construction - commercial
209
250
Consumer
212
15
Commercial business
28
1,664
   Total impaired loans
$5,342
$ 10,685

At December 31, 2009, 77% of classified loans totaling $4.1 million included loans to three borrowers. Loans to one of these borrowers were for a residential land development project affected by the downturn in the housing market located outside of Alaska. Additional information regarding these three borrowers, by market area as of December 31, 2009 is provided in the following table:

     
December 31,
2009
Loan Type
Description
Market Area
(in thousands)
Land
Residential land development project
Washington
                  $1,321
Land
Commercial land
Alaska
                   1,942
Commercial Real Estate
Commercial real estate
Alaska
                      845
   Total –Impaired loans of three largest credit relationships
 
                  $4,108

Potential Problem Loans. Potential problem loans are loans that do not yet meet the criteria for placement on non-accrual status, but where known information about the possible credit problems of the borrowers causes management to have serious concerns as to the ability of the borrower to comply with present loan repayment terms, and may result in the future inclusion of such loans in the non-accrual loan category. At December 31, 2009, Alaska Pacific had $3.6 million of loans that were identified as potential problems consisting primarily of permanent commercial non-residential loans secured by real estate located outside of Alaska.

Allowance for Loan Losses. Alaska Pacific maintains an allowance for loan losses sufficient to absorb losses inherent in the loan portfolio. Alaska Pacific has established a systematic methodology to ensure that the allowance is adequate. The Asset Classification Policy requires an ongoing quarterly assessment of the probable estimated losses in the portfolios. The Asset Classification Committee reviews the following information:

·  
All loans classified during the previous analysis. Current information as to payment history or actions taken to correct the deficiency are reviewed, and if justified, the loan is no longer classified. If conditions have not improved, the loan classification is reviewed to ensure that the appropriate action is being taken to mitigate loss.

·  
Growth and composition of the portfolio. The Committee considers changes in composition of loan portfolio and the relative risk of these loan portfolios in assessing the adequacy of the allowance.

·  
Historical loan losses. The Committee reviews Alaska Pacific’s historical loan losses and historical industry losses in considering losses inherent in the loan portfolio.

·  
Past due loans. The Committee reviews loans that are past due 30 days or more, taking into consideration the borrower, nature of the collateral and its value, the circumstances that have caused the delinquency, and the likelihood of the borrower correcting the conditions that have resulted in the
 
 
-17-


  
delinquent status. The Committee may recommend more aggressive collection activity, inspection of the collateral, or no change in its classification.
 
·  
Reports from Alaska Pacific’s managers and analysis of potential problem loans. Lending managers may be aware of a borrower’s circumstances that have not yet resulted in any past due payments but has the potential for problems in the future. Each lending manager reviews their respective lending unit’s loans and identifies any that may have developing weaknesses. This “self identification” process is an important component of maintaining credit quality, as each lender is accountable for monitoring as well as originating loans.

·  
Current economic conditions. Alaska Pacific takes into consideration economic conditions in its market area, the state’s economy, and national economic factors that could influence the quality of the loan portfolio in general. The unique, isolated geography of Alaska Pacific’s market area of Southeast Alaska requires that each community’s economic activity be reviewed. The Bank also reviews out of market economic data associated with participation loans and their respective markets.

·  
Trends in Alaska Pacific’s delinquencies. Alaska Pacific’s market area has seasonal trends and as a result, the portfolio tends to have similar fluctuations. Prior period statistics are reviewed and evaluated to determine if the current conditions exceed expected trends.

            The amount that is to be added to allowance for loan losses is based upon a variety of factors. An important component is a loss percentage set for each major category of loan that is based upon Alaska Pacific’s past loss experience. In certain instances, Alaska Pacific’s own loss experience has been minimal, and the related loss factor is modified based on consideration of published national loan loss data. The loss percentages are also influenced by economic factors as well as management experience.

            Each individual loan, previously classified by management or newly classified during the quarterly review, is evaluated for loss potential, and any specific estimates of impairment are added to the overall required reserve amount. As a result of the size of the institution, the size of the portfolio, and the relatively small number of classified loans, most members of the asset classification committee are often directly familiar with the borrower, the collateral or the circumstances giving rise to the concerns. For the remaining portion of the portfolio, comprised of “pass” loans, the loss percentages discussed above are applied to each loan category.

            The calculated amount is compared to the actual amount recorded in the allowance at the end of each quarter and a determination is made as to whether the allowance is adequate or needs to be increased. Management increases the amount of the allowance for loan losses by charges to income and decreases it by loans charged off (net of recoveries).

             Alaska Pacific’s loan categories that it considers in evaluating risk may be broadly described as residential, commercial and consumer. The following comments represent management’s view of the risks inherent in several component portfolio categories.

·  
One-to-four-family Residential - Alaska Pacific’s market area is comprised primarily of a population with above-average incomes and market conditions that have, over the long term, supported a stable or increasing market value of real estate. Absent an overall economic downturn in the economy, experience in this portfolio indicates that losses are minimal provided the property is reasonably maintained, and marketing time to resell the property is relatively short.

·  
Multifamily Residential - There have been minimal losses taken in this segment of the portfolio, however, the rental market is very susceptible to the effects of an economic downturn. While Alaska Pacific monitors loan-to-value ratios, the conditions that would create a default and foreclosure would carry through to a new owner, which may require that Alaska Pacific discount the property or hold it until conditions improve.
 
 
-18-


 
·  
Commercial Real Estate - As with multifamily loans, the classification of commercial real estate loans closely corresponds to economic conditions which will limit the income potential and marketability of the property, resulting in higher risk than a loan secured by a single-family residence.

·  
Construction Loans (Residential and Commercial) - There are a variety of risks in construction lending, increased in Alaska by a short building season, difficult building sites and construction delays attributable to delivery of materials. While Alaska Pacific has established construction loan policies and underwriting guidelines designed to mitigate the risk, there is still a higher risk of loss with these loans.

·  
Commercial Business Loans - These types of loans carry the highest degree of risk, relying on the ongoing success of the business to repay the loan. Collateral for commercial credits is often difficult to secure, and even more difficult to liquidate in the event of a default.

·  
Consumer Loans - The consumer loan portfolio has a wide range of factors, determined primarily by the nature of the collateral and the credit history and capacity of the borrower. These loans tend to be smaller in principal amount and secured by second deeds of trust on homes, automobiles, and pleasure boats. Loans for automobiles and pleasure boats generally experience higher than average wear in the Alaskan environment and hold a higher degree of risk of loss in the event of repossession.

            The allowance for loan losses represents management's best estimate of incurred credit losses inherent in the Company's loan portfolio as of December 31, 2009. Although management believes that it uses the best information available to make these determinations, future adjustments to the allowance for loan losses 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 Alaska Pacific believes it has established its existing allowance for loan losses in accordance with generally accepted accounting principles, there can be no assurance that regulators, in reviewing Alaska Pacific’s loan portfolio, will not request Alaska Pacific to increase significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses will be adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect Alaska Pacific’s financial condition and results of operations.  In addition, the determination of the amount of the Company's allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
 
 
-19-


            The following table sets forth an analysis of the changes in the allowance for loan losses for the periods indicated.

(dollars in thousands) Year ended December 31,
2009
 
2008
 
Allowance at beginning of period
$2,688
 
$1,783
 
Provision for loan losses
2,947
 
5,034
 
Charge-offs:
       
Real estate
(3,090
(2,853
Commercial business
(760
(1,319
Consumer:
       
Boat
(25
-
 
Other
-
 
(10
Total charge-offs
(3,875
(4,182
Recoveries:
       
Commercial business
26
 
49
 
Consumer:
       
Home Equity
-
 
2
 
Automobile
-
 
2
 
Total recoveries
26
 
53
 
Net charge-offs
(3,849
(4,129
Balance at end of period
$1,786
 
$2,688
 
         
Allowance for loan losses as a percentage of loans
   outstanding at the end of the period
1.13
1.59
         
Net charge-offs as a percentage of average loans
   outstanding during the period
2.32
2.36
         
Allowance for loan losses as a percentage of
   nonperforming loans at end of period
62.56
41.49



-20 -
 
 

 


            The following table sets forth the breakdown of the allowance for loan losses by loan category for the dates indicated.

December 31,
2009
2008
(dollars in thousands)
Amount
As a % of
Outstanding
Loans in
Category
% of Loans
in
Category
to Total
Loans
Amount
As a % of
Outstanding
Loans in
Category
% of
Loans in
Category
to Total
Loans
Real estate:
           
Permanent:
           
One-to-four-family
$  56
   0.16%
    21.40%
$  23
   0.06%
    23.01%
Multifamily
13
0.75
  1.10
7
0.27
  1.52
Commercial non-residential
444
0.69
 40.78
899
1.60
33.15
Land
56
0.57
  6.14
409
3.06
  7.91
Construction:
           
One-to-four-family
144
4.66
  1.95
5
0.12
  2.47
Multifamily
-
    -
      -
-
     -
      -
Commercial nonresidential
236
8.82
  1.69
256
5.06
  3.00
Commercial
615
3.09
12.53
1,049
4.29
14.46
Consumer:
           
Home equity
114
0.69
10.40
15
0.08
11.04
Boat
87
2.03
  2.70
23
0.57
  2.40
Automobile
2
0.16
  0.80
1
0.10
  0.59
Other
19
2.34
  0.51
1
0.13
  0.45
Total allowance for loan losses
$1,786
    1.13%
    100.00%
$2,688
    1.59%
   100.00%

Investment Activities

            Federal law permits Alaska Pacific to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the FHLB of Seattle, certificates of deposit of federally insured institutions, certain bankers’ acceptances and federal funds. Subject to various restrictions, Alaska Pacific may also invest a portion of its assets in commercial paper and corporate debt securities. Alaska Pacific must also maintain an investment in FHLB stock as a condition of membership in the FHLB of Seattle.

            Investment securities provide liquidity for funding loan originations and deposit withdrawals and enable Alaska Pacific to improve the match between the maturities and repricing of its interest-rate sensitive assets and liabilities. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources and Regulation” herein.

            Alaska Pacific’s Asset Liability Management Committee determines appropriate investments in accordance with the Board of Directors’ approved investment policies and procedures. Alaska Pacific’s policies generally limit investments to U.S. Government and agency securities and mortgage-backed securities issued and guaranteed by Freddie Mac, the Federal National Mortgage Association (“Fannie Mae”) and the Government National Mortgage Association (“Ginnie Mae”). Alaska Pacific’s policies provide that investment purchases be ratified at monthly Board of Directors meetings. Certain considerations, which include the interest rate, yield, settlement date and maturity of the investment, Alaska Pacific’s liquidity position, and anticipated cash needs and sources (which in turn include outstanding commitments, upcoming maturities, estimated deposits and anticipated loan amortization and repayments) affect the making of investments. The effect that the proposed investment would have on Alaska Pacific’s credit and interest rate risk, and risk-based capital is also considered. From time to time, investment levels may be increased or decreased depending upon the yields on investment alternatives and upon management’s judgment as to the attractiveness of the yields then available in relation to other opportunities
 
 
-21-

 
and its expectation of the level of yield that will be available in the future, as well as management’s projections as to the short-term demand for funds to be used in Alaska Pacific’s loan origination and other activities.

            The following table sets forth the composition of Alaska Pacific’s investment and mortgage-backed securities portfolios at the dates indicated.

December 31,
2009
 
2008
 
(dollars in thousands)
     Fair
     Value
     Amortized
     Cost
     Percent
     of
      Portfolio
 
     Fair
     Value
     Amortized
     Cost
   Percent
   of
     Portfolio
 
Mortgage-backed securities:
               
Fannie Mae
$1,930
$1,890
74.5
$2,394
$2,405
74.4
Freddie Mac
254
263
10.4
364
376
11.6
 
Ginnie Mae
330
292
11.5
387
353
11.0
 
U.S. agencies and corporations:
               
Small Business Administration
   pools
92
91
3.6
98
99
3.0
 
Total investment securities
   available for sale
$2,606
$2,536
100.0
$3,243
$3,233
100.0
 
    While management has no specific plans to sell any security, the entire portfolio has been designated as “available-for-sale” at December 31, 2009 and 2008, to allow flexibility in managing the portfolio.

            At December 31, 2009, the portfolio of U.S. Government and agency securities had an aggregate estimated fair value of $92,000 and the portfolio of mortgage-backed securities had an estimated fair value of $2.5 million.

            At December 31, 2009, mortgage-backed securities consisted of Freddie Mac, Fannie Mae and Ginnie Mae issues with an amortized cost of $2.4 million. The mortgage-backed securities portfolio had coupon rates ranging from 2.5% to 9.0% and had a weighted average yield of 4.6% at December 31, 2009.

            Mortgage-backed securities, which also are known as mortgage participation certificates or pass-through certificates, typically represent interests in pools of single-family or multifamily mortgages in which payments of both principal and interest on the securities are generally made monthly. The principal and interest payments on these mortgages are passed from the mortgage originators, through intermediaries, generally U.S. Government agencies and government sponsored enterprises, that pool and resell the participation interests in the form of securities, to investors such as Alaska Pacific. These U.S. Government agencies and government-sponsored enterprises, which guarantee the payment of principal and interest to investors, primarily include the Freddie Mac, Fannie Mae and the Ginnie Mae. Mortgage-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgages that have loans with interest rates that fall within a specific range and have varying maturities. Mortgage-backed securities generally yield less than the loans that underlie these securities because of the cost of payment guarantees and credit enhancements. In addition, mortgage-backed securities are usually more liquid than individual mortgage loans and may be used to collateralize certain liabilities and obligations of Alaska Pacific. These types of securities also permit Alaska Pacific to optimize its regulatory capital because they have low risk weighting.

            The actual maturity of a mortgage-backed security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and may result in a loss of any premiums paid and thereby reduce the net yield on these securities. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of declining mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the
 
 
-22-

 
prepayment of the underlying mortgages and the related security. Under these circumstances, Alaska Pacific may be subject to reinvestment risk because, to the extent that Alaska Pacific’s mortgage-backed securities amortize or prepay faster than anticipated, Alaska Pacific may not be able to reinvest the proceeds of these repayments and prepayments at a comparable rate.

            The table below sets forth certain information regarding the carrying value, weighted average yields and maturities or periods to repricing of Alaska Pacific’s investment and mortgage-backed securities at December 31, 2009.

(dollars in thousands) as of
December 31, 2009
Amortized
Cost
Weighted
Average
Yield
Weighted
Average
Maturity (Yrs)
Mortgage Backed Securities
$2,445
4.56%
8.32
US Agency
91
3.98%
9.42


            Alaska Pacific’s investment policy permits investment in “off balance sheet” derivative instruments such as “forwards,” “futures,” “options” and “swaps” used as hedges; however, Alaska Pacific has not utilized such instruments.

As a member of the FHLB of Seattle, the Bank is required to own capital stock in the FHLB of Seattle. The minimum amount of stock held is based on percentages specified by the FHLB of Seattle outstanding advances.  The carrying value of FHLB of Seattle stock totaled $1.8 million at December 31, 2009. The redemption of any excess stock held by the Bank is at the discretion of the FHLB of Seattle, and under present policies may take up to five years. The yield on the FHLB of Seattle stock is normally paid through stock dividends that are subject to the discretion of the board of directors of the FHLB of Seattle. However, the FHLB of Seattle suspended the payment of dividends during the fourth quarter of 2004 until the third quarter of 2006. The FHLB of Seattle resumed the payment of dividends in the fourth quarter of 2006, with the announcement of a $0.10 per share cash dividend. In 2007, the FHLB of Seattle paid a cumulative $0.60 per share cash dividend with Alaska Pacific receiving $12,000 in dividends.

In 2008, the FHLB of Seattle paid a cumulative $0.95 per share in cash dividends. Based on the FHLB of Seattle's third-quarter 2008 results, the FHB of Seattle announced they would not pay a dividend for the third quarter. Subsequent to December 31, 2008, the FHLB of Seattle announced that it was below its regulatory risk-based capital requirement and it is now precluded from paying dividends or repurchasing its capital stock. The FHLB of Seattle is not anticipated to resume dividend payments until their financial results improve. The FHLB of Seattle has not indicated when dividend payments may resume.

Alaska Pacific had no securities (other than U.S. Government and agency securities and mutual funds which invest exclusively in such securities), which had an aggregate book value in excess of 10% of shareholders’ equity at December 31, 2009.

Deposit Activities and Other Sources of Funds

                General. Deposits and loan repayments are the major sources of Alaska Pacific’s funds for lending and other investment purposes.  Scheduled loan repayments are a relatively stable source of funds, while general interest rates and money market conditions significantly influence deposit inflows and outflows and loan prepayments. Alaska Pacific may use borrowings on a short-term basis to compensate for reductions in the availability of funds from other sources. Alaska Pacific may also use borrowings on a longer-term basis for general business purposes.

                Deposit Accounts. Alaska Pacific attracts deposits from within its primary market area through the offering of a broad selection of deposits as set forth in the following table. In determining the terms of its deposit accounts, Alaska Pacific considers current market interest rates, profitability to Alaska Pacific, matching deposit
 
 
-23-

 
and loan products and its customer preferences and concerns. Alaska Pacific’s deposit mix and pricing is generally reviewed weekly. Deposits from municipalities and other public entities were $4.8 million at December 31, 2009.

            Alaska Pacific had $1.7 million of brokered deposits at December 31, 2009 issued through the Certificate of Deposit Account Registry Service (“CDARS”). CDARS deposits range in maturities from one month to three years, and carry interest rates that are generally higher than locally obtained time deposits. As a result, Alaska Pacific utilizes these deposits as an alternative supplemental funding source in addition to advances from the FHLB of Seattle.

            In the unlikely event Alaska Pacific is liquidated, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to the Corporation, as the sole stockholder of the Bank. Substantially all of the Bank’s depositors are residents of the State of Alaska.

The following table sets forth information concerning Alaska Pacific’s time deposits and other interest-bearing deposits at December 31, 2009.

Weighted
Average
Interest
Rate
Original
Term
Category
Amount
(in thou-
sands)
Minimum
Balance
Percentage
of Total
Deposits
 
0.00%
N/A
Noninterest-bearing
$27,416
$   100
18.50
0.11   
N/A
Interest-bearing demand
32,474
100
21.91
 
0.43  
N/A
Money market deposit accounts
28,982
100
19.55
 
0.15   
N/A
Savings accounts
19,170
100
12.93
 
             
   
Certificates of Deposit
       
0.24   
Seven days
Fixed-rate
302
2,000
0.20
 
0.20   
One month
Fixed-rate
11
2,000
0.01
 
0.40  
Two months
Fixed-rate
96
2,000
0.07
 
0.56   
Three months
Fixed-rate
2,254
2,000
1.52
 
0.82   
Six months
Fixed-rate
3,722
2,000
2.51
 
1.34   
Nine months
Fixed-rate
1,185
2,000
0.80
 
1.68   
One year
Fixed-rate
9,091
2,000
6.13
 
2.00   
15 months
Fixed-rate
3,055
2,000
2.06
 
2.94   
18 months
Fixed-rate
5,961
2,000
4.02
 
2.82   
Two years
Fixed-rate
2,355
2,000
1.59
 
3.02   
Three years
Fixed-rate
499
2,000
0.34
 
3.89   
Four years
Fixed-rate
240
2,000
0.16
 
3.95   
Five years
Fixed-rate
2,669
2,000
1.80
 
1.04   
Various specials
Fixed-rate
748
5,000
0.51
 
2.32   
Gold minor one
   year
Fixed-rate
1,958
500
1.32
 
8.00   
Deferred Comp
   one year
Fixed-rate
1,223
2,000
0.83
 
 
2.39   
1.00   
CDARS -
   various
One year
 
Fixed-rate
Variable-rate
 
1,705
1,157
2,000
2,000
1.15
0.78
 
1.74   
2-1/2 years
Variable-rate
1,944
2,000
1.31
 
0.74%
 
               TOTAL
$148,217
 
100.00

            

-24-
 
 

 

            The following table sets forth the balances and changes in dollar amounts of deposits in the various types of accounts offered by Alaska Pacific at the dates indicated.

(dollars in thousands) December 31,
2009
     
2008
 
 
        Amount
        Percent of
         Total
 
         Increase
         (Decrease)
 
        Amount
         Percent of
        Total
 
Noninterest-bearing demand accounts
$27,416
18.50
$  1,709
 
$  25,707
15.85
Interest-bearing demand accounts
32,474
21.91
 
1,432
 
31,042
19.14
 
Money market deposit accounts
28,982
19.55
 
(4,090
33,072
20.39
 
Savings accounts
19,170
12.93
 
1,634
 
17,536
10.81
 
Fixed-rate certificates which mature:
               
Within 1 year
20,590
13.90
 
(22,237
42,827
24.62
 
After 1 year, but within 2 years
11,371
7.67
 
5,457
 
5,914
2.48
 
After 2 years, but within 5 years
3,408
2.30
 
320
 
3,088
2.62
 
Variable-rate certificates which
    mature:
               
Within 1 year
2,862
1.93
 
1,060
 
1,802
1.34
 
After 1 year, but within 2 years
-
-
 
(625
625
0.55
 
After 2 years, but within 5 years
1,944
1.31
 
1,382
 
562
0.33
 
Total
$148,217
100.00
$(13,958
$162,175
100.00

         
Time Deposits Maturities and Weighted Average Rates

            The following table sets forth the amount, maturities and weighted average rates of time deposits at December 31, 2009.

 
(In thousands) Year
ending December 31,
 
Weighted
Average
Interest Rate
2010
$23,452
1.82%
2011
11,371
3.15%
2012
2,443
2.50%
2013
240
3.23%
2014 and thereafter
2,669
2.20%
 
$40,175
 

Deposit Activities and Other Sources of Funds

            The following table sets forth the deposit activities of Alaska Pacific for the periods indicated.

 (in thousands) Year ended December 31,
       2009
 
       2008
Beginning balance
$162,175
 
$149,367
       
Net deposits before interest credited
(15,327
10,223
Interest credited
1,369
 
2,585
Net increase (decrease) in deposits
(13,958
12,808
       
Ending balance
$148,217
 
$162,175

            Borrowings. Deposits and loan repayments are the primary source of funds for Alaska Pacific’s lending and investment activities. However, Alaska Pacific may rely upon advances from the FHLB of Seattle to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Seattle
 
 
-25-

 
functions as a central reserve bank providing credit for thrift institutions and many other member financial institutions. The FHLB of Seattle requires Alaska Pacific, as a member, to own capital stock in the FHLB of Seattle and authorizes it to apply for advances on the security of this stock and certain of its mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. At December 31, 2009, Alaska Pacific had a borrowing capacity of approximately $44.8 million with the FHLB of Seattle, of which $35.0 million was unused compared with $47.7 million and $20.4 million, respectively, at December 31, 2008. At December 31, 2009, Alaska Pacific had $9.8 million outstanding on the line of credit.
 
            The following table sets forth certain information regarding Alaska Pacific’s advances from the FHLB of Seattle at the end of and during the periods indicated:

(dollars in thousands) Year ended December 31,
       2009
 
       2008
 
Advances:
       
Maximum amount of borrowings outstanding
   during the year at any month end
$23,624
 
$23,681
 
Average outstanding during the year
12,156
 
14,611
 
Balance outstanding at end of year
9,834
 
10,320
 
         
Approximate weighted average rate paid:
       
Average during the year
4.06
5.00
At end of year
3.05
 
5.63
 


REGULATION

General

            The Bank, as a federally-chartered savings institution, is subject to federal regulation and oversight by the OTS extending to all aspects of its operations. The Bank also is subject to regulation and examination by the FDIC, which insures the deposits of The Bank to the maximum extent permitted by law, and requirements established by the Federal Reserve Board. Federally chartered savings institutions are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and the FDIC. The investment and lending authority of savings institutions are prescribed by federal laws and regulations, and these institutions are prohibited from engaging in any activities not permitted by the laws and regulations. This regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting stockholders. Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”), which granted significant authority to the U.S. Department of the Treasury (the “Treasury”) to invest in financial institutions, guarantee debt, buy troubled assets and take other action designed to stabilize financial markets.

            The OTS regularly examines the Bank and prepares reports for the consideration of the Bank’s Board of Directors on any deficiencies that it may find in the Bank’s operations. The FDIC also has the authority to examine the Bank in its roles as the administrator of the Deposit Insurance Fund. The Bank’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters such as the ownership of savings accounts and the form and content of the Bank’s mortgage requirements. Any change in these regulations, whether by the FDIC, the OTS or Congress, could have a material adverse impact on the Bank and its operations.

-26-
 
 

 

Regulation and Supervision of Savings Institutions

            Office of Thrift Supervision. The OTS has extensive authority over the operations of savings institutions. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. All savings institutions are subject to a semi-annual assessment, based upon the institution’s total assets, to fund the operations of the OTS. The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and the Corporation. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required.

            In addition, the investment, lending and branching authority of the Bank is prescribed by federal laws and it is prohibited from engaging in any activities not permitted by these laws. For example, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal institutions in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings institutions are also generally authorized to branch nationwide. The Bank is in compliance with the noted restrictions.
 
    The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of  $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 2009, the Bank's lending limit under this restriction was $2.9 million and, at that date, the Bank had no loans to one borrower exceeding this amount except where guaranteed by a government agency or approved prior to December 31, 2009 at a time when the Bank's legal lending limit was higher.
 
    The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits.  Any institution that fails to comply with these standards must submit a compliance plan.

            All savings institutions are required to pay assessments to the OTS to fund the agency’s operations. The general assessments, paid on a semi-annual basis, are determined based on the institution’s total assets, including consolidated subsidiaries. The Bank’s OTS assessment for the year ended December 31, 2009 was $107,000.

            FHLB System. The Bank is a member of the FHLB of Seattle, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing.
 
    As a member, the Bank is required to purchase and maintain stock in the FHLB of Seattle. At December 31, 2009, the Bank had $1.8 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB stock until such dividends were suspended during the fourth quarter of 2004 until the third quarter of 2006. The FHLB of Seattle resumed the payment of dividends in the fourth quarter of 2006, with the announcement of a $0.10 per share cash dividend. In 2007, the FHLB of Seattle paid a cumulative $0.60 per share cash dividend with Alaska Pacific receiving $12,000 in dividends.
 
    In 2008, the Federal Home Loan Bank of Seattle paid a cumulative $0.95 per share in cash dividends and Alaska Pacific received $16,000 in dividends. Based on the FHLB of Seattle's third-quarter 2008 results, the FHLB of Seattle announced they would not pay a dividend for the third quarter. Subsequent to December 31,
 
 
-27-

 
2008, the FHLB of Seattle announced that it was below its regulatory risk-based capital requirement and it is now precluded from paying dividends or repurchasing its capital stock. The FHLB of Seattle is not anticipated to resume dividend payments until their financial results improve. The FHLB of Seattle has not indicated when dividend payments may resume.
 
    Under federal law, the Federal Home Loan Banks are required to provide funds for the resolution of troubled savings institutions and to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank’s FHLB stock may result in a corresponding reduction in the Bank’s capital.
 
    Federal Deposit Insurance Corporation. The FDIC is an independent federal agency that insures the deposits, up to applicable limits, of depository institutions. As insurer of the Bank’s deposits, the FDIC has supervisory and enforcement authority over Alaska Pacific.
 
    The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund, or DIF, which is administered by the FDIC. The FDIC insures deposits up to the applicable limits and this insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by institutions insured by the FDIC. It also may prohibit any institution insured by the FDIC from engaging in any activity determined by regulation or order to pose a serious risk to the institution and the DIF. The FDIC also has the authority to initiate enforcement actions and may terminate the deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
 
    The FDIC assesses deposit insurance premiums on all FDIC-insured institutions quarterly based on annualized rates for one of four risk categories. Each institution is assigned to one of four risk categories based on its capital, supervisory ratings and other factors. Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risks to the DIF. Under the FDIC’s risk-based assessment rules, effective April 1, 2009, the initial base assessment rates prior to adjustments range from 12 to 16 basis points for Risk Category I, and are 22 basis points for Risk Category II, 32 basis points for Risk Category III, and 45 basis points for Risk Category IV. Initial base assessment rates are subject to adjustments based on an institution’s unsecured debt, secured liabilities and brokered deposits, such that the total base assessment rates after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV.  Rates increase uniformly by three basis points effective January 1, 2011.
 
    In addition to the regular quarterly assessments, due to losses and projected losses attributed to failed institutions, the FDIC imposed on every insured institution a special assessment of five basis points on the amount of each depository institution’s assets reduced by the amount of its Tier 1 capital (not to exceed 10 basis points of its assessment base for regularly quarterly premiums) as of June 30, 2009, which was collected on September 30, 2009.
 
    As a result of a decline in the reserve ratio (the ratio of the DIF to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the DIF, the FDIC adopted a rule requiring each insured institution to prepay on December 30, 2009 the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the regular quarterly assessment for the third quarter which was due on December 30, 2009). The prepaid amount is recorded as an asset with a zero risk weight and the institution will continue to record quarterly expenses for deposit insurance. For purposes of calculating the prepaid amount, assessments were measured at the institution’s assessment rate as of September 30, 2009, with a uniform increase of 3 basis points effective January 1, 2011, and were based on the institution’s assessment base for the third quarter of 2009, with growth assumed quarterly at annual rate of 5%. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash or receive a rebate of prepaid amounts not exhausted after collection of assessments due on June 30, 2013, as applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future. The rule includes a process for exemption from the
 
 
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prepayment for institutions whose safety and soundness would be affected adversely. Alaska Pacific prepaid $1.3 million in FDIC assessments during the fourth quarter of 2009 and the balance of the prepaid assessment was $1.2 million at December 31, 2009.
 
    The FDIC estimates that the reserve ratio (the ratio of the net worth of the DIF to estimated insured deposits) will reach the designated reserve ratio of 1.15% by 2017 as required by statute.
 
    Federally insured institutions are required to pay a Financing Corporation assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. For the quarterly period ended December 31, 2009, the Financing Corporation assessment equaled 1.02 basis points for each $100 in domestic deposits. These assessments, which may be revised based upon the level of DIF deposits, will continue until the bonds mature in the years 2017 through 2019. For 2009, Alaska Pacific incurred $16,000 in FICO assessments.
 
    The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the deposit insurance of Alaska Pacific.

            Capital Requirements. Federally insured savings institutions, such as Alaska Pacific Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings institutions. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis.

            The capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders’ equity and retained income, and certain noncumulative perpetual preferred stock and related income. In addition, all intangible assets must be deducted from tangible capital for calculating compliance with the requirement. At December 31, 2009, the Bank had tangible capital of $17.2 million, or 9.70% of adjusted total assets, which is $14.6 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date.

            The capital standards also require core capital equal to at least 4% of adjusted total assets unless an institution’s supervisory condition is such to allow it to maintain a 3.0% ratio. Core capital generally consists of tangible capital plus certain intangible assets, including a limited amount of purchased credit card relationships. At December 31, 2009, the Bank had core capital equal to $17.2 million, or 9.70% of adjusted total assets, which is $10.1 million above the minimum requirement of 4% in effect on that date.

            The OTS also requires savings institutions to have core capital equal to 4% of risk-weighted assets ("Tier 1 risk-based"). At December 31, 2009, the Bank had Tier 1 risk-based capital of $18.5 million, or 12.84% of risk-weighted assets, which is $7.0 million above the minimum on that date. The OTS risk-based requirement requires savings institutions to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is also authorized to require a savings institution to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities.
 
 
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            In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, are multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to- four family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by Fannie Mae or Freddie Mac.

            On December 31, 2009, the Bank had total risk-based capital of $18.5 million and risk-weighted assets of $144.0 million, or total capital of 12.84% of risk-weighted assets. This amount was $7.0 million above the 8% requirement in effect on that date.
 
    The Bank currently is operating under the restrictions imposed by an MOU issued by the OTS on January 7, 2009.  Among other restrictions, the MOU requires the Bank to: (a) submit a business plan that sets forth a plan for maintaining Tier 1 (Core) Leverage Ratio of 8% and a minimum Total Risk-Based Capital Ratio of 12% and provides a detailed financial forecast including capital ratios, earnings and liquidity and containing comprehensive business line goals and objectives; and (b) remain in compliance with the minimum capital ratios contained in the business plan. As of December 31, 2009, the Bank’s Tier-1 (Core) Leverage Ratio was 9.70% (1.70% over the new required minimum) and Risk-Based Capital Ratio was 12.84%, (0.84% over the new required minimum). Management believes that the Bank is currently in compliance with the terms of the MOU. For further information regarding the MOU, see Item 1A, “Risk Factors -- Risks Related to our Business -- We are subject to the restrictions and conditions of a Memorandum of Understanding with, and other commitments we have made to, the Office of Thrift Supervision. Failure to comply with the Memorandum of Understanding could result in additional enforcement action against us, including the imposition of monetary penalties.”

            The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against savings institutions that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an “undercapitalized institution,” which is an institution with less than either a 4.0% core capital ratio, a 4.0% Tier 1 risk-based capital ratio, or an 8.0% risk-based capital ratio. Any such institution must submit a capital restoration plan and until the plan is approved by the OTS, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions that are applicable to significantly undercapitalized institutions. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized institution must agree that it will enter into a limited capital maintenance guarantee with respect to the institution’s achievement of its capital requirements.

            Any savings institution that fails to comply with its capital plan or has Tier 1 risk-based or core capital ratios of less than 3.0% or a risk-based capital ratio of less than 6.0% and is considered “significantly undercapitalized” will be made subject to one or more additional specified actions and operating restrictions which may cover all aspects of its operations and may include a forced merger or acquisition of the institution. An institution that becomes “critically undercapitalized” because it has a tangible capital ratio of 2.0% or less is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized institutions. In addition, the OTS must appoint a receiver, or conservator with the concurrence of the FDIC, for a savings institution, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized institution is also subject to the general enforcement authority of the OTS and the FDIC, including the appointment of a conservator or a receiver.

            The OTS is also generally authorized to reclassify an institution into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on its operations and profitability.
 
    Emergency Economic Stabilization Act of 2008. In October 2008, the EESA was enacted. The EESA authorizes the U.S. Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (“TARP”). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to
 
 
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encourage financial institutions to increase their lending to customers and to each other. Under the TARP Capital Purchase Program (“CPP”), the Treasury may purchase debt or equity securities from participating institutions. The TARP also allows direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications. The Company completed its TARP CPP transaction in the first quarter of fiscal 2009, receiving $4.8 million in funding on February 6, 2009. For additional information regarding the TARP CPP transaction, see “Participation in the U.S. Treasury Capital Purchase Program.”
 
    EESA also included additional provisions directed at bolstering the economy, which we were able to participate in, such as the temporary increase in FDIC insurance coverage of deposit accounts, which increased from $100,000 to $250,000 through December 31, 2013.
 
    Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings; and (viii) compensation, fees and benefits (“Guidelines”).  The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OTS determines that the Bank fails to meet any standard prescribed by the Guidelines, the OTS may require the Bank to submit an acceptable plan to achieve compliance with the standard. OTS regulations establish deadlines for the submission and review of such safety and soundness compliance plans. Management of the Bank is not aware of any conditions relating to these safety and soundness standards which would require submission of a plan of compliance.
 
    Temporary Liquidity Guaranty Program. Following a systemic risk determination, the FDIC established as Temporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008.  Under the interim rule for the TLGP, there are two parts to the program: the Debt Guarantee Program (“DGP”) and the Transaction Account Guarantee Program (“TAGP”).  Eligible entities generally are participants unless they exercised opt out rights on or before December 5, 2008.
 
    For the DGP, eligible entities are generally US bank holding companies, savings and loan holding companies, and FDIC-insured institutions. Under the DGP, the FDIC guarantees new senior unsecured debt, and with special approval certain convertible debt of an eligible entity issued not later than October 31, 2009. The guarantee is effective through the earlier of the maturity date or June 30, 2012 (for debt issued before April 1, 2009) or December 31, 2012 (for debt issued on or after April 1, 2009). The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009, or for certain institutions, 2% of liabilities as of September 30, 2008. The nonrefundable DGP fee ranges from 50 to 100 basis points (annualized), depending on maturity, for covered debt outstanding during the period until the earlier of maturity or June 30, 2012, with various surcharges of 10 to 50 basis points applicable to debt with a maturity of one year or more issued on or after April 1, 2009. Generally, eligible debt of a participating entity becomes covered when and as issued until the coverage limit is reached, except that under some circumstances, participating entities can issue nonguaranteed debt. Various features of the program require applications and approvals.  The Bank and the Company do not participate in the DGP.
 
    For the TAGP, eligible entities are FDIC-insured institutions. Under the TAGP, the FDIC provides unlimited deposit insurance coverage for noninterest-bearing transaction accounts (typically business checking accounts), NOW accounts bearing interest at 0.5% or less, and certain funds swept into noninterest-bearing savings accounts. Other NOW accounts and money market deposit accounts are not covered. TAGP coverage lasts until December 31, 2009 and, unless the participant has opted out of the extension period, during the extension period of January 1, 2010 through June 30, 2010. Participating institutions pay fees of 10 basis points (annualized) on the balance of each covered account in excess of $250,000 during the period through December 31, 2009. During the extension period, such fees are 15 basis points for institutions in Risk Category I, 20 basis points for those in Risk Category II and 25 basis points for those in Risk Categories III and IV (Risk Categories are those assigned for deposit insurance purposes). The Bank participates in the TAGP.
 
 
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    The American Recovery and Reinvestment Act of 2009. On February 17, 2009, President Obama signed The American Recovery and Reinvestment Act of 2009 (“ARRA”) into law. The ARRA is intended to revive the U.S. economy by creating millions of new jobs and stemming home foreclosures. For financial institutions that have received or will receive financial assistance under TARP or related programs, the ARRA significantly rewrites the original executive compensation and corporate governance provisions of Section 111 of the EESA.  Among the most important changes instituted by the ARRA are new limits on the ability of TARP recipients to pay incentive compensation to up to 20 of the next most highly-compensated employees in addition to the “senior executive officers,” a restriction on termination of employment payments to senior executive officers and the five next most highly-compensated employees and a requirement that TARP recipients implement “say on pay” shareholder votes. For additional information regarding the effects of the ARRA on the Company’s senior executive officers as a result of the Company’s participation in TARP, see “Risk Factors – Risks Related to our Business—Risks specific to our participation in TARP.”
 
    Qualified Thrift Lender Test. All savings institutions, including Alaska Pacific, are required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 month period on a rolling basis.  As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code (“Code”). Under either test, such assets primarily consist of residential housing related loans and investments. At December 31, 2009, the Bank met the test, with a ratio of 71.82%.
 
    Any savings institution that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL within one year of failure and thereafter remains a QTL. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings institution and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such an institution has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies.  See “ - Savings and Loan Holding Company Regulations.”
 
    Limitations on Capital Distributions. OTS regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as Alaska Pacific, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS. The Bank may pay dividends to the Company in accordance with this general authority; however, it must also comply with the MOU and provide notice to, and obtain a non-objection from, the OTS prior to declaring a dividend.
 
    Savings institutions proposing to make any capital distribution need not submit written notice to the OTS prior to such distribution unless they are a subsidiary of a holding company or would not remain well-capitalized following the distribution. Savings institutions that do not, or would not meet their current minimum capital requirements following a proposed capital distribution or propose to exceed these net income limitations, must obtain OTS approval prior to making such distribution. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. See “- Capital Requirements.”
 
    Liquidity. All savings institutions, including the Bank, are required to maintain sufficient liquidity to ensure a safe and sound operation.
 
    Activities of Associations and Their Subsidiaries. When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings institution must notify the FDIC and the OTS 30 days in advance and provide the information each agency may,
 
 
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by regulation, require. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders.
 
    The OTS may determine that the continuation by a savings institution of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIA. Based upon that determination, the FDIC or the OTS has the authority to order the savings institution to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly.
 
    Transactions with Affiliates. The Bank's authority to engage in transactions with "affiliates" is limited by OTS regulations and by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board's Regulation W. The term "affiliates" for these purposes generally means any company that controls or is under common control with an institution. The Corporation and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from an institution. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
 
    The Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans to its executive officers and directors. However, there is a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank's authority to extend credit to executive officers, directors and 10% stockholders ("insiders"), as well as entities that such person’s control is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.
 
    Federal Reserve System. The Federal Reserve Board requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. Negotiable order of withdrawal (NOW) accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to the reserve requirements, as are any non-personal time deposits at a savings bank. As of December 31, 2009, the Bank’s deposit with the Federal Reserve Bank and vault cash exceeded its reserve requirements.

            Community Reinvestment Act. Under the Community Reinvestment Act, every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the OTS, in connection with the examination of the Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. Due to the heightened attention being given to the Community Reinvestment Act in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank was examined in 2004 for Community Reinvestment Act compliance and received a rating of satisfactory in its latest examination.
 
 
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    Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), a federal statute, generally imposes strict liability on all prior and present “owners and operators” of sites containing hazardous waste. However, Congress asked to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan.
 
    To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.
 
    Privacy Standards. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA"), which was enacted in 1999, modernized the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. The Bank is subject to OTS regulations implementing the privacy protection provisions of the GLBA. These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter.
 
    Anti-Money Laundering and Customer Identification. Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on October 26, 2001 in response to the terrorist events of September 11, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. In 2006, Congress re-enacted certain expiring provisions of the USA Patriot Act.

Regulation and Supervision of the Company
 
    General. The Company is a unitary savings and loan holding company subject to regulatory oversight of the OTS. Accordingly, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution.
 
    In connection with the MOU, the Company’s Board of Directors executed two resolutions to assure the OTS that the Company is committed to supporting the Bank should it be necessary, and that the Company would comply with the restrictions in the Bank’s MOU. See Item 1A, “Risk Factors -- Risks Related to our Business --We are subject to the restrictions and conditions of a Memorandum of Understanding with, and other commitments we have made to, the Office of Thrift Supervision. Failure to comply with the Memorandum of Understanding could result in additional enforcement action against us, including the imposition of monetary penalties.”
 
    Activities Restrictions. The Company and its non-savings institution subsidiaries are subject to statutory and regulatory restrictions on their business activities specified by federal regulations, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987, and non-banking activities permissible for bank holding companies pursuant to the Bank Holding Company Act of 1956 or authorized for financial holding companies pursuant to the GLBA.
 
    If the Bank fails the qualified thrift lender test, the Company must, within one year of that failure, register as, and will become subject to, the restrictions applicable to bank holding companies. See "- Regulation and Supervision of Savings Institutions - Qualified Thrift Lender Test."
 
 
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    Dividend Payments and Common Stock Repurchases. As an Alaska corporation, the Company is subject to restrictions on the payment of dividends under Alaska law. In addition, as a savings and loan holding company, the Company’s ability to declare and pay dividends is dependent on certain federal regulatory considerations. The Company is an entity separate and distinct from its principal subsidiary, Alaska Pacific Bank, and derives substantially all of its revenue in the form of dividends from this subsidiary. Accordingly, the Company is, and will be, dependent upon dividends from the Bank to pay the principal of and interest on its indebtedness, to satisfy its other cash needs and to pay dividends on its common stock. The Bank’s ability to pay dividends is subject to their ability to earn net income and to meet certain regulatory requirements. See “—Regulation and Supervision of Savings Institutions - Limitations on Capital Distributions” and Item 1A, “Risk Factors - Risks Related to our Business -- There are regulatory and contractual limitations that may limit or prevent us from paying dividends on the common stock and we may limit or eliminate our dividends to shareholders.”
 
    As a result of our participation in the TARP CPP, we are subject to certain limitations regarding the payment of dividends on and the repurchase of our common stock. Without the consent of the U.S. Treasury, we may not increase the cash dividend on our common stock or, pay any dividends on our common stock unless we are current in our dividend payments to the U.S. Treasury on the Series A Preferred Stock. In addition and subject to limited exceptions, with the consent of the U.S. Treasury, we also may not redeem, repurchase or otherwise acquire shares of our common stock or preferred stock other than the Series A Preferred Stock or trust preferred securities. For additional information, see “Risk Factors - Risks Related to our Business -- Risks specific to our participation in TARP -- The securities purchase agreement between us and Treasury limits our ability to pay dividends on and repurchase our common stock.”
 
    Mergers and Acquisitions. The Company must obtain approval from the OTS before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Company to acquire control of a savings institution, the OTS would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the insurance funds, the convenience and the needs of the community and competitive factors.
 
    Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with the recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the Securities and Exchange Commission (“SEC”), under the Securities Exchange Act of 1934 (“Exchange Act”), including the Company.

            The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.


TAXATION

Federal Taxation

            General. The Company and the Bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other Companies with some exceptions, including particularly the Bank’s reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company.
 
 
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            Bad Debt Reserve. Historically, savings institutions such as the Bank which met certain definitional tests primarily related to their assets and the nature of their business (“qualifying thrift”) were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. The Bank’s deductions with respect to “qualifying real property loans,” which are generally loans secured by certain interest in real property, were computed using an amount based on the Bank’s actual loss experience, or a percentage equal to 8% of the Bank’s taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the non-qualifying reserve. Due to the Bank’s loss experience, the Bank generally recognized a bad debt deduction equal to 8% of taxable income.

            The thrift bad debt rules were revised by Congress in 1996. The new rules eliminated the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also required that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Bank has no post-1987 reserves subject to recapture. For taxable years beginning after December 31, 1995, the Bank’s bad debt deduction will be determined under the experience method using a formula based on actual bad debt experience over a period of years. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders.

            Distributions. To the extent that the Bank makes “nondividend distributions” to the Company, such distributions will be considered to result in distributions from the balance of its bad debt reserve as of December 31, 1987 (or a lesser amount if the Bank’s loan portfolio decreased since December 31, 1987) and then from the supplemental reserve for losses on loans (“Excess Distributions”), and an amount based on the Excess Distributions will be included in the Bank’s taxable income. Nondividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Bank’s current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank’s bad debt reserve. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if, after the Conversion, the Bank makes a “nondividend distribution,” then approximately one and one-half times the Excess Distribution would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state and local taxes). See “Regulation” for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve.

            Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income (“AMTI”) at a rate of 20%. The excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Bank’s adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on Companies, including the Bank, whether or not an Alternative Minimum Tax is paid.

            Dividends-Received Deduction. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of Companies. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated Companies with which the Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank owns more than 20% of the stock of a Company distributing a dividend, then 80% of any dividends received may be deducted.

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State Taxation

            The Alaska state income tax rate applicable to the Bank is based on a graduated tax rate schedule, with a maximum rate of 9.4% on income over $90,000. There have not been any audits of the Bank’s state tax returns during the past five years.

Audits

            The Company’s income tax returns have not been audited by federal or state authorities within the last five years. For additional information regarding income taxes, see Note 13 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Subsidiary Activities

            As of December 31, 2009, Alaska Pacific did not own any active subsidiaries.

Executive Officers

The following table sets forth certain information with respect to the executive officers of the Company and the Bank are as follows:

 
Age at
December 31,
Position
Name
2009
Company
Bank
Craig E. Dahl
60
Director, President
Director, President
   
and Chief Executive Officer
and Chief Executive Officer
       
Julie M. Pierce
38
Senior Vice President, Chief
Senior Vice President and
   
Financial Officer and Secretary
Chief Financial Officer
       
John E. Robertson
62
--
Senior Vice President and
     
Chief Credit Officer
       
Christopher P. Bourque
58
--
Senior Vice President and
     
Chief Operating Officer
       
Leslie Dahl
50
--
Senior Vice President and
     
Chief Lending Officer

            The following is a description of the principal occupation and employment of the executive officers of the Company and the Bank during at least the past five years:

            Craig E. Dahl joined the Bank in 1992 and has served as President and Chief Executive Officer of the Bank since 1996 and as President and Chief Executive Officer of the Company since its formation in 1999.  Prior to joining the Bank, he was President of the B.M. Behrends Bank in Juneau, Alaska. Mr. Dahl and Leslie Dahl, the Bank’s Senior Vice President and Chief Lending Officer, are married to each other.

            Julie M. Pierce joined the Bank in September 2007. Ms. Pierce previously held the positions of Assistant State and State Comptroller for the State of Alaska from 2005 until 2007, Director of Finance for Sealaska Heritage Institute from 2004 until 2005, and Chief Financial Officer for True North Federal Credit Union from 1999 until 2004.

            John E. Robertson joined the Bank in December 2002. Mr. Robertson previously held the position of Group Vice President/Senior Relationship Banker at ABN Amro Bank from 1995 until 2002.
 
 
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            Christopher P. Bourque joined the Bank in June 2003 and has served as Senior Vice President and Chief Operating Officer since April 2006. Mr. Bourque previously held the position of Senior Vice President of Operations at  Mount McKinley Bank in Fairbanks, Alaska from 1992 until 2000.

            Leslie Dahl joined the Bank in February 2000 and has served as Senior Vice President and Chief Lending Officer since April 2006. Ms. Dahl has 30 years of commercial lending experience. Ms. Dahl and Craig E. Dahl, the Company’s and the Bank’s President and Chief Executive Officer, are married to each other.

Personnel

            As of December 31, 2009, the Bank had 62 full-time and four part-time employees, none of whom are represented by a collective bargaining unit. The Bank believes its relationship with its employees is good.

Competition

            Alaska Pacific faces strong competition in its primary market area for the attraction of deposits (its primary source of lendable funds) and in the origination of loans. Its most direct competition for deposits has historically come from commercial banks and credit unions operating in its primary market area. The Bank competes with four commercial banks (including one Southeast Alaska based community bank, two giant super-regional banks and one statewide regional bank) and six credit unions in its primary market area. Particularly in times of high interest rates, Alaska Pacific has faced additional significant competition for investors’ funds from short-term money market securities, other corporate and government securities and credit unions. The Bank’s competition for loans also comes from mortgage bankers and Internet-based marketers. This competition for deposits and the origination of loans may limit Alaska Pacific’s future growth.

            Alaska Pacific’s market share is approximately 12.0% of deposits in Southeast Alaska, however, this calculation does not include deposits held by credit unions. If state-wide credit unions were included in this calculation as well as “non-bank” competitors such as brokerage firms and money market mutual funds, Alaska Pacific’s share would be somewhat less. Alaska Pacific’s largest competitor is Wells Fargo, with a market share of approximately 49.8%. Wells Fargo acquired the former National Bank of Alaska in 2000, and Alaska Pacific has achieved some success in drawing customers away from Wells Fargo, especially small businesses, through a targeted calling effort and a marketing emphasis on the advantages of banking locally.


Item 1A – Risk Factors

An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements. This report is qualified in its entirety by these risk factors.


Risks Related to our Business

Our business is subject to general economic risks that could adversely impact our results of operations and financial condition.

We are subject to the restrictions and conditions of a Memorandum of Understanding with, and other commitments we have made to, the Office of Thrift Supervision. Failure to comply with the
 
 
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Memorandum of Understanding could result in additional enforcement action against us, including the imposition of monetary penalties.

On January 7, 2009 the Office of Thrift Supervision finalized a supervisory agreement (a memorandum of understanding or “MOU”) which was reviewed and approved by the Board of Directors of Alaska Pacific Bank on December 19, 2008.  The MOU  specifically requires the Bank to: (a) submit a business plan that sets forth a plan for maintaining Tier 1 (Core) Leverage Ratio of 8% and a minimum Total Risk-Based Capital Ratio of 12% and provides a detailed financial forecast including  capital ratios, earnings and liquidity and containing comprehensive business line goals and objectives; (b) remain in compliance with the minimum capital ratios contained in the business plan; (b) provide notice to and obtain a non-objection from the  OTS  prior to the Bank declaring a dividend; (c) maintain an adequate Allowance for Loan and Lease Losses (ALLL); (d) engage an independent consultant to conduct a loan review of the Bank’s purchased loan participations  current nonperforming loans and any new loans that are  in excess of $500,000 and that were originated since the last review; and (e)  develop a written comprehensive plan, that is acceptable to the OTS, to reduce classified assets.

The Board of Directors and management of the Bank do not believe that the MOU will constrain the Bank’s   business plans and that there has already been substantial progress made in satisfying the requirements of the MOU. Management believes that the primary reason that the OTS requested the Bank enter into an MOU with the OTS was specific participation loans that give rise to the high level of classified assets.  An independent loan review was conducted in March 2009. As of December 31, 2009, the Bank’s Tier-1 (Core) Leverage Ratio was 9.70% (1.70% over the new required minimum) and Risk-Based Capital Ratio was 12.84%, (0.84% more than the new required minimum). While we believe we are currently in compliance with the terms of the MOU, if we fail to comply with these terms, the Office of Thrift Supervision could take additional enforcement action against us, including the imposition of monetary penalties or the issuance of a cease and desist order requiring further corrective action.

In March 2009, subsequent to the MOU, the Company’s Board of Directors executed two resolutions to assure the Office of Thrift Supervision that the Company was committed to supporting the Bank should it be necessary, and that the Company would comply with the restrictions in the Bank’s MOU. The first resolution was required by the OTS of all OTS regulated holding companies. The resolution, referred to as a “Source of Strength” resolution, ensures that the Company is prepared to contribute additional capital to the Bank should it become necessary.  The second resolution states that the Company would issue dividends only upon the “nonobjection” of the OTS, would maintain sufficient cash and cash flow so that Company’s activities would not be paid for by the Bank, and that the Company would not issue debt without the nonobjection of the OTS.

Our business may continue to be adversely affected by downturns in the national economy and the states where our out of market area loans are located.

Since the latter half of 2007, depressed economic conditions have prevailed in portions of the United States outside of our primary area of Southeast Alaska, including areas where the Bank has participation loans, specifically in the States of Washington, Oregon, Idaho, California and Colorado. We provide banking and financial services to customers located in our primary market of Southeast Alaska, which up to this point in time and based upon its geographic location and diverse resource-based economy has not experienced the serious problems as those of markets in the lower-48 states. If there were to be a further decline of the economic conditions in our primary market, this could have an adverse effect on our business, financial condition, results of operations and prospects.

A further deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:

·  
an increase in loan delinquencies problem assets and foreclosures;
 
·  
the slowing of sales of foreclosed assets;
 
 
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·  
a decline in demand for our products and services;
 
·  
a continuing decline in the value of collateral for loans may in turn reduce customers’ borrowing power, and the value of assets and collateral associated with existing loans; and
 
·  
a decrease in the amount of our low cost or non-interest bearing deposits.
 

We may be required to make further increases in our provisions for loan losses and to charge off additional loans in the future, which could adversely affect our results of operations.

Although our provision for loan losses decreased during the year ended December 31, 2009, we may be required to make further increases as a result of any further decline in the economy. The decrease in the provision for loan losses reflected the decrease in our non performing loans and assets during 2009. In comparison, during the year ended December 31, 2008, we experienced increasing loan delinquencies and credit losses and we substantially increased our provision for loan losses, which adversely affected our results of operations. With the exception of residential construction and land development loans, non performing loans and assets generally reflect unique operating difficulties for individual borrowers rather than a weakness in the overall economy of our primary market area. In addition, our portfolio is concentrated in construction and land loans and commercial and multifamily loans, all of which have a higher risk of loss than residential mortgage loans. As a result, we may be required to make further increases in our provision for loan losses and to charge off additional loans in the future, which could adversely affect our results of operations.

Our emphasis on commercial real estate lending may expose us to increased lending risks.
 
Our current business strategy is focused on the expansion of commercial real estate lending. This type of lending activity, while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. A downturn in 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.
 
At December 31, 2009, we had $1.7 million of multifamily residential and $64.5 million of commercial real estate loans, representing 1.1% and 40.8%, respectively, of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multi-family mortgage loans also expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate.
 
A secondary market for most types of commercial real estate loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a commercial or multi-family real estate loan, our holding period for the collateral typically is longer than for one-to-four family residential mortgage loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial and multi-family real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
 
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
 
The FDIC, the Federal Reserve and the Office of Thrift Supervision have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending
 
 
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should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors (i) total reported loans for construction, land development, and other land represent 100% or more of total capital, or (ii) total reported loans secured by multifamily and non-farm residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. We have concluded that we have a concentration in commercial real estate lending under the foregoing standards because our $64.5 million balance in commercial real estate loans at December 31, 2009 represents 300% or more of total capital. While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
 
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
 
At December 31, 2009, we had $19.9 million or 12.6% of total loans in commercial business loans. Commercial lending 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 being viewed as the primary source of repayment in the event of borrower default. Our commercial loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers' cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower.
 
Our business may be adversely affected by credit risk associated with residential property.
 
At December 31, 2009, $33.8 million, or 21.4% of our total loan portfolio, was secured by one-to-four single-family mortgage loans and home equity lines of credit. This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in the housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans. Continued declines in the housing market and the economy and the associated increases in unemployment may result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or lack of growth or a decrease in deposits. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity, and damage our financial condition and business operations.

High loan-to-value ratios on a portion of our residential mortgage loan portfolio exposes us to greater risk of loss.
 
Many of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because either we originated upon purchase a first mortgage with an 80% loan-to-value ratio, have originated a home equity loan with a combined loan-to-value ratio of up to 90% or because of the decline in home values in our market areas. Residential loans with high loan-to-value ratios will be more
 
 
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sensitive to declining property values than those with lower combined loan-to-value ratios and, therefore, may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers may be unable to repay their loans in full from the sale. As a result, these loans may experience higher rates of delinquencies, defaults and losses.
 
We may have continuing losses and continuing variation in our quarterly results.

We had net losses of $2.2 million for the year ended December 31, 2009 and $2.3 million for the year ended December 31, 2008. These losses primarily resulted from our high level of non-performing assets and the resultant increased provision for loan losses. We may continue to experience further losses as a result of these factors.  In addition, several factors affecting our business can cause significant variations in our quarterly results of operations. In particular, variations in the volume of our loan originations and sales, the differences between our costs of funds and the average interest rates of originated or purchased loans, changes in our provision for loan losses and non-performing assets can result in significant increases or decreases in our revenues from quarter to quarter.

Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
 
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
 
 
 
the cash flow of the borrower and/or the project being financed;
 
 
 
 
changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
     
 
the duration of the loan;
     
 
the credit history of a particular borrower; and
     
 
changes in economic and industry conditions.
 
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:
 
our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management’s expectations of future events; and
 
 
 
 
our specific reserve, based on our evaluation of nonperforming loans and their underlying collateral.
 
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and the loss and delinquency experience, and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. Our allowance for loan losses was 1.13% of total loans held for investment and 62.6% of nonperforming loans at December 31, 2009. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan
 
 
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losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and our capital.

If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.

We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as other real estate owned (“OREO”), and at certain other times during the assets holding period. Our net book value in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s net book value over its fair value. If our valuation process is incorrect, the fair value of our investments in real estate may not be sufficient to recover our net book value  in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations.

In addition, bank regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs, as required by such regulators, may have a material adverse effect on our financial condition and results of operations.

We may suffer losses in our loan portfolio despite our underwriting practices.

We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan losses.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and advances from the FHLB of Seattle (“FHLB”), the Federal Reserve Bank of San Francisco ("FRB") and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or FRB, or market conditions change. Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general - such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in our primary market area of Southeast Alaska where our loans are concentrated or adverse regulatory action against us.
 
Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected. In addition, the Bank may not incur additional debt without the prior written non-objective of the OTS. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs.
 
 
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Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.

We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future. Nonetheless, we may at some point need to raise additional capital to support continued growth.
 
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition and liquidity, results of operations and prospects.

There are regulatory and contractual limitations that may limit or prevent us from paying dividends on the common stock and we may limit or eliminate our dividends to shareholders.

As an Alaska corporation, under Alaska law we are subject to restrictions on the payment of dividends. In addition, as a savings and loan holding company, Alaska Pacific’s ability to declare and pay dividends is dependent on certain federal regulatory considerations. Alaska Pacific is an entity separate and distinct from its principal subsidiary, Alaska Pacific Bank, and derives substantially all of its revenue in the form of dividends from this subsidiary. Accordingly, Alaska Pacific is and will be dependent upon dividends from Alaska Pacific Bank to pay the principal of and interest on its indebtedness, to satisfy its other cash needs and to pay dividends on its common stock. Alaska Pacific Bank’s ability to pay dividends is subject to their ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to Alaska Pacific, it may not be able to pay its obligations or pay dividends on Alaska Pacific’s common stock. See “Regulation - Regulation and Supervision of Savings Institutions - Limitations on Capital Distributions” and Note 3 of the Notes to Consolidated Financial Statements. Also, Alaska Pacific’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.

Alaska Pacific is also subject to certain regulatory restrictions that could prohibit it from declaring or paying dividends or making liquidation payments on its common stock. See “Regulation - Regulation and Supervision of the Company - Dividend Payments and Common Stock Repurchases” above. In addition, the securities purchase agreement between us and Treasury limits our ability to pay dividends on and repurchase our common stock. The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) November 21, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) increase the cash dividend on our common stock or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock other than the Series A Preferred Stock or trust preferred securities. In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock.

Our board of directors regularly reviews our dividend policy in light of current economic conditions for financial institutions as well as our capital needs and any applicable contractual restrictions. On a quarterly basis, the board of directors determines whether a dividend will be paid and in what amount, if any.

We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations, including changes that may restrict our ability to foreclose on single-family home loans and offer overdraft protection.

We are subject to extensive examination, supervision and comprehensive regulation by the OTS and the FDIC. Banking regulations are primarily intended to protect depositors' funds, federal deposit insurance funds, and the banking system as a whole, and not holders of our common stock. These regulations affect our lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes.
 
 
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Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

New legislation proposed by Congress may give bankruptcy courts the power to reduce the increasing number of home foreclosures by giving bankruptcy judges the authority to restructure mortgages and reduce a borrower’s payments. Property owners would be allowed to keep their property while working out their debts. Other similar bills placing additional temporary moratoriums on foreclosure sales or otherwise modifying foreclosure procedures to the benefit of borrowers and the detriment of lenders may be enacted by either Congress or the States of Alaska, Washington, Oregon, Idaho, Utah and Colorado in the future. These laws may further restrict our collection efforts on one-to-four single-family loans. Additional legislation proposed or under consideration in Congress would give current debit and credit card holders the chance to opt out of an overdraft protection program and limit overdraft fees which could result in additional operational costs and a reduction in our non-interest income.
 
Our investment in Federal Home Loan Bank stock may be impaired.

At December 31, 2009, we owned $1.8 million of stock of the Federal Home Loan Bank of Seattle, or FHLB.  As a condition of membership at the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the Capital Plan of the FHLB. Our FHLB stock has a par value of $100, is carried at cost, and it is subject to recoverability testing per SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The FHLB recently announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (the "FHFA"), its primary regulator, as of December 31, 2008, and that it would suspend future dividends and the repurchase and redemption of outstanding common stock. As a result, the FHLB has not paid a dividend since the fourth quarter of 2008. The FHLB has communicated that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market risk of the FHLB's private-label mortgage-backed securities in the current market environment and that it has enough capital to cover the risks reflected in its balance sheet. As a result, we have not recorded an other-than-temporary impairment on our investment in FHLB stock. However, continued deterioration in the FHLB's financial position may result in impairment in the value of those securities. We will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.

Continued weak or worsening credit availability could limit our ability to replace deposits and fund loan demand, which could adversely affect our earnings and capital levels.

Continued weak or worsening credit availability and the inability to obtain adequate funding to replace deposits and fund continued loan growth may negatively affect asset growth and, consequently, our earnings capability and capital levels. In addition to any deposit growth, maturity of investment securities and loan payments, we rely from time to time on advances from the FHLB to fund loans and replace deposits. If the economy does not improve or continues to deteriorate, this additional funding source could be negatively affected, which could limit the funds available to us. Our liquidity position could be significantly constrained if we are unable to access funds from the FHLB.

The maturity and repricing characteristics of our assets and liabilities are mismatched and subject us to interest rate risk which could adversely affect our net earnings and economic value.

-45-
 
 

 


Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities. Significant changes in market interest rates or errors or misjudgments in our interest rate risk management procedures could have a material adverse effect on our net earnings and economic value. We currently believe that declining interest rates will adversely affect our near-term net earnings.

Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on our earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of our assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting our financial performance.

We believe that the greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for our rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets. Additional interest rate risk results from mismatched repricing indices and formulae (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to us.

Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income and net market value of equity resulting from those movements under different rate environments. We update and prepare our simulation modeling at least quarterly for review by senior management and our directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net market value of our equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used and, as a result, our interest rate risk management strategies may prove to be inadequate.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Market Risk and Asset/Liability Management” for additional information concerning interest rate risk.

If external funds were not available, this could adversely impact our growth and prospects.

We rely on deposits and advances from the FHLB of Seattle and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we might not be able to replace such funds in the future if our financial condition or the financial condition of the FHLB of Seattle or market conditions were to change. While we consider such sources of funds adequate for our liquidity needs, we may be compelled or elect to seek additional sources of financing in the future. Likewise, we may seek additional debt in the future to achieve our long-term business objectives, in connection with future acquisitions or for other reasons. Additional borrowings, if sought, may not be available to us or, if available, may not be on reasonable terms. If additional financing sources are unavailable or not available on reasonable terms, our financial condition, results of operations and future prospects could be materially adversely affected.

Increases in deposit insurance premiums and special FDIC assessments will hurt our earnings.
 
Beginning in late 2008, the economic environment caused higher levels of bank failures, which dramatically increased FDIC resolution costs and led to a significant reduction in the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. The base assessment rate was increased by seven basis points (seven cents for every $100 of deposits) for the first quarter of 2009. Effective April 1, 2009, initial base assessment rates were changed to range
 
 
-46-

 
from 12 basis points to 45 basis points across all risk categories with possible adjustments to these rates based on certain debt-related components. These increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions due to recent bank and savings association failures. The emergency assessment amounts to five basis points on each institution’s assets minus Tier 1 capital as of June 30, 2009, subject to a maximum equal to 10 basis points times the institution’s assessment base. Our FDIC deposit insurance expense for fiscal the year ended December 31, 2009 was $387,000, including the special assessment of $84,000 paid at the end of September 2009. Any additional emergency special assessment imposed by the FDIC will negatively impact our earnings.
 
The loss of key members of our senior management team could adversely affect our business.

We believe that our success depends largely on the efforts and abilities of our senior management. Their experience and industry contacts significantly benefit us. The competition for qualified personnel in the financial services industry is intense, and the loss of any of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business. In addition, the American Recovery and Reinvestment Act has imposed significant limitations on executive compensation for recipients, such as us, of funds under the TARP Capital Purchase Program, which may make it more difficult for us to retain and recruit key personnel.

Our real estate lending also exposes us to the risk of environmental liabilities.
 
In the course of our business, we may foreclose and take title to real estate, and we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
 
Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

We rely on dividends from Alaska Pacific Bank for most of our revenue.

Alaska Pacific is a separate and distinct legal entity from Alaska Pacific Bank. We receive substantially all of our revenue from dividends from Alaska Pacific Bank. These dividends are the principal source of funds to pay dividends on our common stock. Various federal laws and regulations limit the amount of dividends that Alaska Pacific Bank may pay to Alaska Pacific. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to Alaska Pacific, we may not be able to pay obligations or pay dividends on Alaska Pacific’s common stock. The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations. See Item 1, “Business-Regulation.”
 
 
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If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in our financial reporting, which could adversely affect our business, the trading price of our stock and our ability to attract additional deposits.

In connection with the enactment of the Sarbanes-Oxley Act of 2002 (“Act”) and the implementation of the rules and regulations promulgated by the SEC, we document and evaluate our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Act. This requires us to prepare an annual management report on our internal control over financial reporting, including among other matters, management’s assessment of the effectiveness of internal control over financial reporting and an attestation report by our independent auditors addressing these assessments. If we fail to identify and correct any significant deficiencies in the design or operating effectiveness of our internal control over financial reporting or fail to prevent fraud, current and potential shareholders and depositors could lose confidence in our internal controls and financial reporting, which could adversely affect our business, financial condition and results of operations, the trading price of our stock and our ability to attract and retain deposits.

Item 1B. Unresolved Staff Comments.

Not applicable.

-48-
 
 

 


Item 2.  Properties

 
The following table sets forth certain information regarding Alaska Pacific’s offices at December 31, 2009.

Location
Year
Opened
Square
Footage
Deposits
(in thousands)
       
Main Office:
     
       
Nugget Mall Office (1)
1984
16,000
$72,538
2094 Jordan Avenue
     
Juneau, Alaska 99801
     
       
Branch Offices:
     
       
301 N. Franklin Street
1960
6,268
30,683
Juneau, Alaska  99801
     
       
410 Mission Street (2)
1974
2,300
14,665
Ketchikan, Alaska  99901
     
       
2442 Tongass Avenue (3)
1997
1,550
7,001
Ketchikan, Alaska 99901
     
       
315 Lincoln Street (4)
1978
2,032
23,330
Sitka, Alaska  99835
     
       
Alaska Pacific Mortgage (5)
     
       
2092 Jordan Avenue, Suite 595
2003
2,500
Non-depository
Juneau, Alaska 99801
     
_____________
(1)  
Lease expires in January 2019, with one 10-year option to renew.
(2)  
Lease expires in February 2013, with option to renew for five-year term.
(3)  
Lease expires in November 2010, with two 6-month options to renew.
(4)  
Lease expires in December 2013, with option to renew for five-year term.
(5)  
Lease expires in October 2013

            Alaska Pacific maintains 11 automated teller machines including six in the Juneau area, two in the Sitka area, two in the Ketchikan area, and one in Hoonah. At December 31, 2009, the net book value of Alaska Pacific’s properties and its fixtures, furniture and equipment was $2.8 million.

Item 3.  Legal Proceedings

            Periodically, there have been various claims and lawsuits involving the Bank, mainly as a defendant, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business. The Bank is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Bank.

Item 4.  [Reserved]
 

 
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PART II

Item 5.   Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

            The Company’s common stock is traded on the over-the-counter market through the OTC “Electronic Bulletin Board” under the symbol “AKPB.”  As of December 31, 2009, there were approximately 367 stockholders of record and 654,486 shares outstanding. Generally, if the Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the OTS regulations. However, an institution that has converted to the stock form of ownership may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account which was established in connection with the institution’s mutual-to-stock conversion.
 
The Bank is restricted by the amount of dividends it may pay to the Company. It is generally limited to the net income of the current fiscal year and that of the two previous fiscal years, less dividends already paid during those periods. Based on this calculation, at December 31, 2009, none of the Bank’s retained earnings were available for dividends to the Company. However, payment of dividends may be further restricted by the OTS if such payment would reduce the Bank’s capital ratios below required minimums or would otherwise be considered to adversely affect the safety and soundness of the institution.
 
The Bank currently is operating under the restrictions imposed by an MOU issued by the OTS on January 7, 2009.  Among other restrictions, the MOU requires the Bank to: (a) submit a business plan that sets forth a plan for maintaining Tier 1 (Core) Leverage Ratio of 8% and a minimum Total Risk-Based Capital Ratio of 12% and provides a detailed financial forecast including capital ratios, earnings and liquidity and containing comprehensive business line goals and objectives; and (b) remain in compliance with the minimum capital ratios contained in the business plan. As of December 31, 2009, the Bank’s Tier-1 (Core) Leverage Ratio was 9.70% (1.70% over the new required minimum) and Risk-Based Capital Ratio was 12.84%, (0.84% more than the new required minimum). Management believes that the Bank is currently in compliance with the terms of the MOU. For further information regarding the MOU, see Item 1A, “Risk Factors -- Risks Related to our Business -- We are subject to the restrictions and conditions of a Memorandum of Understanding with, and other commitments we have made to, the Office of Thrift Supervision. Failure to comply with the Memorandum of Understanding could result in additional enforcement action against us, including the imposition of monetary penalties.”
 
The Company received $4.8 million from the U.S. Treasury Department on February 9, 2009 as part of the Treasury’s Capital Purchase program. The securities purchase agreement between us and Treasury limits our ability to pay dividends on and repurchase our common stock. The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) November 21, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) increase the cash dividend on our common stock or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock other than the Series A Preferred Stock or trust preferred securities. In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock. These restrictions, together with the potentially dilutive impact of the warrant described in the next risk factor, could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our Board of Directors. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce or eliminate our common stock dividend in the future.  

 

-50-

 

 
The following table sets forth market price information of the Company’s stock for 2009 and 2008.
 
 
Market Price
 
Years Ended December 31,
High
Low
Dividends
       
2009:
     
First Quarter
$5.00  
$3.60   
$0.00  
Second Quarter
4.50
3.55
0.00
Third Quarter
5.90
4.01
0.00
Fourth Quarter
5.80
4.25
0.00
       
       
2008:
     
First Quarter
$23.00  
$19.40  
$0.10  
Second Quarter
22.50
18.25
0.10
Third Quarter
20.10
13.00
0.00
Fourth Quarter
15.00
  2.75
0.00


Equity Compensation Plan Information

The equity compensation plan information presented under subparagraph (d) in Part III, Item 11 of this Form 10-K is incorporated herein by reference.

Issuer Purchases of Equity Securities

During the fourth quarter of the year ended December 31, 2009, the Company had no purchases of its Common Stock.

Item 6.   Selected Financial Data

Not Applicable

Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
General
 
The following discussion is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The Company is not engaged in any significant business activity other than holding the stock of the Bank. Accordingly, the information in this discussion applies primarily to the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying notes included in Item 8 of this annual report. In the following discussion, except as otherwise noted, references to “2009” or “2008” indicate the year ended December 31, 2009 or 2008, respectively.
 
The Bank’s results of operations depend primarily on its net interest income, which is the difference between the income earned on its interest-earning assets, consisting of loans and investments, and the cost of its interest-bearing liabilities, consisting of deposits and FHLB borrowings. Among other things, fee income, provisions for loan losses, operating expenses and income tax provisions also affect the Bank’s net income. General economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the attendant actions of the regulatory authorities also significantly affect the Bank’s results of operations.
 
 
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Operating Strategy
 
The Company’s strategy is to operate a community-oriented financial institution devoted to serving the needs of its customers. The Company’s business consists primarily of attracting retail deposits from the general public and using those funds to originate residential real estate loans, land, construction, commercial real estate loans, commercial business loans, and a variety of consumer loans.
 
Financial Condition
 
Total assets were $178.3 million at December 31, 2009, compared with $190.9 million at December 31, 2008. The $12.5 million decrease was primarily the result of a decline in loans.
 
Loans decreased $10.9 million, or 6.5%, to $158.1 million at December 31, 2009 from $169.0 million at December 31, 2008. The decrease is largely attributable to a decrease in one-to-four family mortgage loans and commercial business loans offset with an increase in commercial real estate loans.

Total commercial real estate loans increased 15.2% to $64.5 million, or 40.8% of the portfolio at December 31, 2009, from $56.0 million, or 33.2% of the portfolio at December 31, 2008. Land loans decreased 27.6% to $9.7 million, or 6.1% of the portfolio at December 31, 2009, from $13.4 million, or 7.9% of the portfolio at December 31, 2008. Total commercial business loans decreased 18.4% to $19.9 million, or 12.6% of the portfolio at December 31, 2009, from $24.4 million, or 14.5% of the portfolio at December 31, 2008.
 
Production of one-to-four-family mortgage loans continued to grow in 2009. Originations totaled $47.6 million in 2009, a 24.6% increase over the $38.2 million originated in 2008. Most of these loans were sold in the secondary market and, as a result, total one-to-four-family mortgages declined to 21.4% of the loan portfolio at December 31, 2009, compared with 23.0% of the loan portfolio at December 31, 2008.
 
Cash and cash equivalents decreased $2.5 million to $6.9 million at December 31, 2009, compared to $9.4 million at December 31, 2008.
 
Available-for-sale securities decreased $600,000 to $2.6 million at December 31, 2009, compared to $3.2 million at December 31, 2008. The decrease was the result of normal principal reductions on mortgage-backed securities.
 
Premises and equipment was $2.8 million at December 31, 2009, a $300,000 decrease from $3.1 million at the end of 2008.
 
Total deposits decreased 8.6% to $148.2 million at December 31, 2009 from $162.2 million at December 31, 2008. Money market accounts decreased a total of $4.1 million to $29.0 million at December 31, 2009 compared to $33.1 million a year ago. During the same period, however, regular savings increased $1.6 million and non-interest bearing demand increased $1.7 million. Certificates of deposit decreased $14.6 million to $40.2 million at December 31, 2009.
 
At December 31, 2009 and 2008, $1.7 million and $2.1 million, respectively, of the certificates of deposit were brokered CDs obtained through the Certificate of Deposit Account Registry Service (“CDARS”). These deposits carry interest rates that are generally higher than locally obtained CDs, but which are generally lower than FHLB advances. Total CDs made by a public entity under a CD program for qualified Alaskan financial institutions amounted to $15 million at December 31, 2008. We had no CDs under this program at December 31, 2009.

 FHLB advances decreased $500,000 to $9.8 million at December 31, 2009 from $10.3 million at December 31, 2008.
 
 
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Results of Operations
 
Net Loss. For the year ended December 31, 2009, the Company reported a net loss of $2.2 million, or $(3.76) per diluted share, after recording a $2.9 million provision for loan losses and $905,000 provision for deferred income tax benefit. This compares to a net loss of $2.3 million, or $(3.54) per diluted share, after recording a $5.0 million provision for loan losses, for 2008. The loss in 2009 is primarily attributable to an increase in provision for loan loss and a decrease in net interest income. For purposes of comparison, pre-tax income may be separated into major components as follows:
 
         
Income
Increase
 
(in thousands) Year ended December 31,
         2009
 
  2008
 
(Decrease)
 
Net interest income
$8,322
 
$8,760
 
$(438
Gain on sale of loans
712
 
251
 
461
 
Other noninterest income
1,172
 
1,091
 
81
 
Net revenues
10,206
 
10,102
 
104
 
Noninterest expense
(9,432
(8,791
(641
Subtotal
774
 
1,311
 
(537
Provision for loan losses
(2,947
(5,034
2,087
 
Income (loss) before income tax
$(2,173
$(3,723
$1,550
 

 
Net Interest Income. Net interest income decreased $500,000, or 5.7%, to $8.3 million in 2009 from $8.8 million in 2008. The decrease is due to a combination of factors, including nonaccrual loans and decline in averages balances. See the tables in “Average Balances, Interest and Average Yields/Cost” and in “Rate/Volume Analysis” elsewhere in this discussion. The net interest margin on average earning assets was 4.86% for 2009 compared with 4.76% in 2008 reflecting the decrease in interest earning assets offset with a more rapid decline in cost of funds than yield on earning assets as a result of the rapid drop in interest rates. Nonaccrual loans were $2.9 million and $6.1 million at December 31, 2009 and 2008, respectively. As of December 31, 2009 and 2008, $789,000 and $665,000, respectively, of interest would have been recorded if these loans had been current according to their original terms and had been outstanding throughout the year.
 
Average loans (including held for sale) decreased $8.9 million, or 5.1%, to $165.8 million in 2009 from $174.7 million in 2008. The net interest margin on average interest-earning assets increased 100 basis points to 4.86% in 2009 from 4.76% in 2008.
 
Noninterest Income. The gain on sale of loans increased $461,000 to $712,000 in 2009 from $251,000 in 2008 as a result of a decline in brokered loan income and gain on sale of loans origination fees/costs.
 
Excluding mortgage banking income, noninterest income increased $81,000, or 7.4%, to $1.2 million in 2009 compared with $1.1 million in 2008. The increase is primarily in document preparation fee income. Additionally, non-recurring income of $56,000 was recognized in 2008 from the cash proceeds received on shares redeemed associated with the Company’s ownership in VISA and VISA’s initial public offering and business combination.

 
Noninterest Expense. Noninterest expense increased $641,000, or 7.3%, to $9.4 million in 2009 from $8.8 million in 2008. The net increase in expense is attributable to higher repossessed asset expense and an increase in FDIC assessments.
 
 
Income Tax. During the fourth quarter of 2009, the Company recorded a valuation allowance of $905,000 against its net deferred tax asset of $1.3 million due to uncertainty about the Company’s ability to generate sufficient taxable income in the near term; the valuation allowance of $905,000 had the effect of increasing the provision for income taxes in 2009.  There was no prior valuation allowance recorded.  The Company will not be able to recognize the tax benefits on future losses until it can show that it is more likely than not that it will generate enough taxable income in future periods to realize the benefits of its deferred tax asset and loss carryforwards.  Management believes it is more likely than not that these tax benefits will be realized which would result in a reversal of the deferred tax valuation allowance.
 
 
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Provision and Allowance for Loan Losses
 
Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered by management to be adequate to provide for known and inherent risks in the loan portfolio, including management's continuing analysis of factors underlying the quality of the loan portfolio.
 
The provision for loan losses decreased $2.1 million to $2.9 million for 2009 from $5.0 million for  2008. The provision for both years was considered appropriate in order for the allowance for loan losses to reflect management's best estimate of losses inherent in the loan portfolio. The allowance for loan losses decreased $900,000, or 33.3%, to $1.8 million at December 31, 2009 from $2.7 million at December 31, 2008. The provision and the resulting allowance are reflective of numerous factors, including the following:
 
·  
Loan losses. Net loan charge offs were $3.8 million (2.4% of total loans) in 2009 compared with $4.1 million (2.4% of total loans) in 2008.
 
·  
Growth and composition of the portfolio. Total loans decreased $10.9 million to $158.1 million at December 31, 2009 compared with $169.0 million at December 31, 2008. The decline reflects gradual changes in the loan portfolio composition away from single-family mortgages, moving to a greater proportion of commercial real estate. Management considered the higher relative risk of these loans in assessing the adequacy of the allowance.
 
·  
Management analysis of loans. As part of an assessment of the adequacy of the allowance, management performed a detailed review of individual loans for which full collectibility may not be assured. Loans judged to be impaired amounted to $5.3 million (3.4% of total loans) at December 31, 2009, compared with $10.7 million (6.3% of total loans) at December 31, 2008. A specific allowance for estimated impairments of $514,000 and $875,000, respectively, was established for these loans.
 
·  
Past-due Loans. At December 31, 2009, 2.2% of all loan balances were past due 30 days or more, compared with 6.1% at December 31, 2008.
 
·  
Nonperforming and classified loans. Nonaccrual loans were $2.9 million (1.8% of total loans) at December 31, 2009, compared with $6.1 million (3.6% of total loans) at December 31, 2008. Loans classified as “substandard” or “doubtful” were $5.3 million (3.4% of total loans) at December 31, 2009 compared with $8.0 million (4.7% of total loans) at December 31, 2008.
 
·  
Economic conditions. Management considered known economic conditions in each of the geographic areas in which the Bank makes loans. For the last several years, Southeast Alaska’s economy has been relatively “flat” but stable, and management knows of no current economic conditions that warrant expectations of significant decline in the Bank’s markets. However, uncertainties in both the national and local economies have been considered in assessing the allowance.
 
The Company’s accounting for the allowance for loan losses is its most critical accounting process and is also the most subjective. While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen market conditions and other events might result in adjustment to the allowance if circumstances differ substantially from the assumptions used in making the final determination. One or more of these events could have a significant effect on net income, and the effect could be both material and adverse.
 
For further information on the Bank’s accounting for the allowance for loan losses as well as how loan impairment is determined, see Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
 

 

-54-
 
 

 

Average Balances, Interest and Average Yields/Cost
 
The earnings of the Company depend largely on the spread between the yield on interest-earning assets, which consist primarily of loans and investments, and the cost of interest-bearing liabilities, which consist primarily of deposit accounts and borrowings, as well as the relative size of the Company’s interest-earning assets and interest-bearing liabilities.
 
The following table sets forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin, and ratio of average interest-earning assets to average interest-bearing liabilities. Average balances are generally daily averages for the period.
 
 (dollars in thousands)
Year ended December 31,
   
2009
       
2008
   
 
Average
Balance
 
Interest
Average Yield/ Cost
 
Average
Balance
 
Interest
Average Yield/ Cost
 
Interest-earning assets:
                   
Loans (1)
$165,807
 
$10,053
6.06
$174,655
 
$11,838
6.78
Investment securities (1)
4,721
 
126
2.67
 
5,336
 
195
3.65
 
Interest-earning deposits in banks
818
 
5
0.61
 
3,984
 
42
1.05
 
Total interest-earning assets
171,346
 
10,184
5.94
 
183,975
 
12,075
6.56
 
Allowance for loan losses
(2,349
     
(3,077
     
Cash and due from banks
6,924
       
6,940
       
Other assets
8,709
       
6,942
       
Total assets
$184,630
       
$194,780
       
                     
Interest-bearing liabilities:
                   
Deposits:
                   
Interest-bearing demand
$  31,161
 
$   54
0.17
$  29,192
 
$   93
0.32
Money market
30,295
 
218
0.72
 
29,687
 
545
1.84
 
Savings
18,243
 
47
0.26
 
16,682
 
64
0.38
 
Certificates of deposit
40,933
 
1,050
2.57
 
53,721
 
1,883
3.51
 
Total interest-bearing deposits
120,632
 
1,369
1.13
 
129,282
 
2,585
2.00
 
Borrowings
12,156
 
493
4.06
 
14,611
 
730
5.00
 
Total interest-bearing liabilities
132,788
 
1,862
1.40
 
143,893
 
3,315
2.30
 
Noninterest-bearing demand deposits
27,720
       
27,447
       
Mortgage escrows
1,227
       
1,261
       
Other liabilities
3,430
       
4,393
       
Shareholders’ equity
19,465
       
17,786
       
Total liabilities and shareholders’ equity
$184,630
       
$194,780
       
                     
Net interest income
   
$8,322
       
$8,760
   
                     
Interest rate spread
     
4.54
     
4.26
                     
Net interest margin:
                   
On average interest-earning assets
     
4.86
     
4.76
On average total assets
     
4.51
       
4.50
 
                     
Ratio of average interest-earning assets to average interest-bearing liabilities
129.04
     
127.86
     

 
 (1)  Average loans include nonperforming loans and loans held for sale. Interest income does not include interest on nonaccrual loans. Average investment
       securities includes FHLB stock.

 
 
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Rate/Volume Analysis
 
The following table sets forth the effects of changing rates and volumes on net interest income of the Company. Information is provided with respect to effects on interest income attributable to changes in volume, which are changes in volume multiplied by prior rate; effects on interest income attributable to changes in rate, which are changes in rate multiplied by prior volume; and changes in rate/volume, which is a change in rate multiplied by change in volume.
 

(in thousands)
Year ended December 31, 2009 compared with year ended 2008
 
Rate
   
Volume
   
Rate/
Volume
   
Total
 
Interest-earning assets:
                       
Loans
  $ (1,249 )   $ (600 )   $ 64     $ (1,785 )
Investment securities
    (53 )     (22 )     6       (69 )
Interest-earning deposits in banks
    (18 )     (33 )     14       (37 )
Total net change in interest income
    (1,320 )     (655 )     84       (1,891 )
                                 
Interest-bearing liabilities:
                               
Interest-bearing demand accounts
    (42 )     6       (3 )     (39 )
Money market accounts
    (331 )     11       (7 )     (327 )
Savings accounts
    (21 )     6       (2 )     (17 )
Certificates of deposit
    (505 )     (448 )     120       (833 )
Borrowings
    (137 )     (123 )     23       (237 )
Total net change in interest expense
    (1,036 )     (548 )     131       (1,453 )
                                 
Net change in net interest income
  $ (284 )   $ (107 )   $ (47 )   $ (438 )

 
 
 
 
 
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