10-K 1 ancb10-k20180630.htm 10-K Document

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 June 30, 2018  or
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     For the transition period from _____ to _____

Commission File Number: 001-34965
ANCHOR BANCORP
(Exact name of registrant as specified in its charter)
 
 
 
Washington
 
26-3356075
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
601 Woodland Square Loop SE, Lacey, Washington
 
98503
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant’s telephone number, including area code:
 
(360) 491-2250
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
 
Common Stock, par value $0.01 per share
 
The Nasdaq Stock Market LLC
 (Title of Class)
 
(Name of each exchange on which registered)
 
 
 
Securities registered pursuant to Section 12(g) of the Act:
 
None
 
 
 
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 Section 15(d) of the Act.    YES            NO  X 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes      X       No         

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of 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, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer [_]
Accelerated filer [_]
Emerging growth company [_]
Non-accelerated filer [_]
Smaller reporting company [X]
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES          NO    X    

As of September 13, 2018, there were issued and outstanding 2,484,030 shares of the registrant’s common stock, which are traded on the NASDAQ Global Market under the symbol “ANCB.”  The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock as of December 31, 2017, was $61.6 million.  (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)





DOCUMENTS INCORPORATED BY REFERENCE

None




ANCHOR BANCORP
2018 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS
 
 
Forward-Looking Statements
Available Information
 
 
 
General
Market Area
Lending Activities
Asset Quality
Investment Activities
Deposit Activities and Other Sources of Funds
Subsidiaries and Other Activities
Competition
Natural Disasters
Employees
Pending Merger
How We Are Regulated
Taxation
Item 1B. Unresolved Staff Comments
 
Overview
Operating Strategy
Critical Accounting Policies
Comparison of Financial Condition at June 30, 2018 and June 30, 2017
Comparison of Operating Results for the Years Ended June 30, 2018 and June 30, 2017
Comparison of Financial Condition at June 30, 2017 and June 30, 2016
Comparison of Operating Results for the Years Ended June 30, 2017 and June 30, 2016
Average Balances, Interest and Average Yields/Costs
Yields Earned and Rates Paid
Rate/Volume Analysis
 
 
(Table of Contents continued on following page)

(i)


 
 
Asset and Liability Management and Market Risk
Liquidity
Contractual Obligations
Commitments and Off-Balance Sheet Arrangements
Capital
Impact of Inflation
Recent Accounting Pronouncements
 
 
                                                                                                                   
                                                                                                                        
As used in this report, the terms, “we,” “our,” and “us,” and “Company” refer to Anchor Bancorp and its consolidated subsidiary, unless the context indicates otherwise.  When we refer to “Anchor Bank” or the “Bank” in this report, we are referring to Anchor Bank, the wholly owned subsidiary of Anchor Bancorp.

(ii)


Forward-Looking Statements
This Form 10-K, including information included or incorporated by reference, future filings by the Company on Form 10-Q, and Form 8-K, and future oral and written statements by Anchor Bancorp and its management may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, but not limited to:
the Agreement and Plan of Merger ("merger agreement") with FS Bancorp, Inc. ("FS Bancorp") may be terminated in accordance with its terms, and the merger may not be completed;
delays in closing our pending merger with FS Bancorp;
operating costs, customer and employee losses and business disruption related to the merger may be greater than expected;
we will be subject to business uncertainties and contractual restrictions while the merger is pending;
management time and effort will be diverted to completion of the proposed merger and merger-related matters;
termination of the merger agreement could negatively impact us;
the merger agreement requires us to pay a termination fee of $2.7 million under limited circumstances relating to alternative acquisition proposals;
the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
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;
fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;
secondary market conditions for loans and our ability to sell loans in the secondary market;
results of examinations of us by the Federal Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institution, Division of Banks (“DFI”) 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;
our ability to attract and retain deposits;
increases in premiums for deposit insurance;
management’s assumptions in determining the adequacy of the allowance for loan losses;
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 risks associated with the loans on our balance sheet;
staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

(iii)


disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;
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;
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 the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"), and changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including as a result of Basel III;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
our ability to pay dividends on our common stock;
adverse changes in the securities markets;
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 existing accounting issues and details of the implementation of new accounting methods, including relating to fair value accounting and loan loss reserve requirements; and
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in our filings with the Securities and Exchange Commission ("SEC"), including this Form 10-K.
These developments could have an adverse impact on our financial position and our results of operations.
Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements.

(iv)


Available Information
The Company provides a link on its investor information page at www.anchornetbank.com to the Securities and Exchange Commission’s (“SEC”) website (www.sec.gov) for purposes of providing copies of 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.  Other than an investor’s own internet access charges, these filings are available free of charge and also can be obtained by calling the SEC at 1-800-SEC-0330.  The information contained on the Company’s website is not included as part of, or incorporated by reference into, this Annual Report on Form 10-K.

(v)


PART I
Item 1.  Business
General
Anchor Bancorp, a Washington corporation, was formed for the purpose of becoming the bank holding company for Anchor Bank in connection with the Bank’s conversion from mutual to stock form, which was completed on January 25, 2011.  In connection with the mutual to stock conversion, the Bank changed its name from “Anchor Mutual Savings Bank” to “Anchor Bank.”  At June 30, 2018, we had total assets of $469.7 million, total deposits of $359.0 million and total stockholders' equity of $67.4 million.  Anchor Bancorp’s business activities generally are limited to passive investment activities and oversight of its investment in Anchor Bank.  Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to Anchor Bank.
Anchor Bancorp is a bank holding company and is subject to regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve”).  Anchor Bank is examined and regulated by the Washington State Department of Financial Institutions, Division of Banks (“DFI”) and by the Federal Deposit Insurance Corporation (“FDIC”).  Anchor Bank is required to have certain reserves set by the Federal Reserve and is a member of the Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”), which is one of the 11 regional banks in the Federal Home Loan Bank System (“FHLB System”).
Anchor Bank is a community-based savings bank primarily serving Western Washington through our nine full-service banking offices located within Grays Harbor, Thurston, Lewis, and Pierce counties, and one loan production office located in King County, Washington. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans. We offer a wide range of loan products to meet the demands of our customers, however, at June 30, 2018, 90.9% of our loans were collateralized by real estate and 52.3% of our loans were collateralized by commercial and multi-family real estate. Historically, our principal lending activity has consisted of the origination of loans secured by first mortgages on owner-occupied, one-to-four family residences and loans for the construction of one-to-four family residences, as well as consumer loans, with an emphasis on home equity loans and lines of credit. Since 1990, we have been actively offering commercial real estate loans and multi-family loans primarily in Western Washington.
The executive office of the Company is located at 601 Woodland Square Loop SE, Lacey, Washington 98503, and its telephone number is (360) 491-2250.
Recent Development-Merger Agreement with FS Bancorp, Inc.
On July 17, 2018, the Company entered into a merger agreement with FS Bancorp, Inc., a Washington corporation (“FS Bancorp”). The merger agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into FS Bancorp (the "merger") with FS Bancorp as the surviving corporation in the merger. Immediately after the effective time of the merger, FS Bancorp intends to merge Anchor Bank, a wholly-owned subsidiary of the Company, with and into 1st Security Bank of Washington, a wholly-owned subsidiary of FS Bancorp, with 1st Security Bank of Washington as the surviving institution in the bank merger. See “-Pending Merger” below for a description of the terms and conditions of the proposed transaction and “Item 1.A. Risk Factors - Risks Relating to the Pending Merger” for a description of the risks relating to the proposed transaction.
You should keep in mind that discussions in this annual report that refer to the Company's business, operations and risks in the future refer to the Company as a stand-alone entity up to the closing of the proposed Merger or if the Merger does not close, and that these considerations will be different with respect to the combined company after the closing of the Merger.

Market Area
Anchor Bank is a community-based financial institution primarily serving Western Washington including Grays Harbor, Thurston, Lewis, and Pierce counties. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2018, the median home price in our four-county market area was $271,525 an 13.3% increase compared to the quarter ended June 30, 2017. Existing home sales in our four-county primary market area for the quarter ended June 30, 2018 totaled $25.0 million, which reflected a 7.5% increase compared to the quarter ended June 30, 2017.  According to the Department of Labor, the unemployment rate in our four-county primary market area averaged 5.7% during June 2018 compared to 5.8% during June 2017. These unemployment rates are higher than the national unemployment rates of 4.0% and 4.4%, as of June 2018 and June 2017, respectively.  A continuation of the overall economic weakness in the counties in our market area could negatively impact our lending opportunities and profitability.

1


Grays Harbor County has a population of 72,697 and a median household income of $44,521 according to the latest 2017 information available from the U.S. Census Bureau. The economic base in Grays Harbor has been historically dependent on the timber and fishing industries. Other industries that support the economic base are tourism, manufacturing, agriculture, shipping, transportation and technology.  Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2018, the median home price in Grays Harbor County was $188,800 compared to $164,700 for the quarter ended June 30, 2017 and represents an increase of 14.6%. In addition, existing home sales in Grays Harbor County for the quarter ended June 30, 2018 increased by 12.3% from the total for the quarter ended June 30, 2017.  According to the U.S. Department of Labor, the unemployment rate in Grays Harbor County decreased to 6.2% at June 30, 2018 from 6.4% at June 30, 2017.  We have five branches (including our home office) located throughout this county.
Thurston County has a population of 280,588 and a median household income of $62,854 according to the latest 2017 information available from the U.S. Census Bureau.  Thurston County is home of Washington State’s capital (Olympia) and its economic base is largely driven by state government related employment. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2018, the median home price in Thurston County was $319,300 compared to $289,800 for the quarter ended June 30, 2017, and represents an 10.2% increase.  In addition, existing home sales in Thurston County for the quarter ended June 30, 2018 increased by 8.2% from the quarter ended June 30, 2017. According to the U.S. Department of Labor, the unemployment rate for the Thurston County area remained the same at 4.7% for June 30, 2018 and June 30, 2017.  We currently have two branches in Thurston County.  Thurston County has a stable economic base primarily attributable to the state government presence.
Lewis County has a population of 78,200 and a median household income of $44,526 according to the latest 2017 information available from the U.S. Census Bureau. The economic base in Lewis County is supported by manufacturing, retail trade, local government and industrial services. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2018, the median home price in Lewis County was $224,300 compared to $190,400 for the quarter ended June 30, 2017, and represents a 17.8% increase.  In addition, existing home sales in Lewis County for the quarter ended June 30, 2018 increased by 6.5% from the quarter ended June 30, 2017.  According to the U.S. Department of Labor, the unemployment rate in Lewis County decreased to 6.0% at June 30, 2018 from 6.1% at June 30, 2017. We have one branch located in Lewis County.
Pierce County is the second most populous county in the state and has a population of 876,764 and a median household income of $61,468 according to the latest 2017 information available from the U.S. Census Bureau. The economy in Pierce County is diversified with the presence of military related government employment (Lewis/McChord JBLM Base), transportation and shipping employment (Port of Tacoma), and aerospace related employment (Boeing).  Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2018, the median home price in Pierce County was $353,700 compared to $313,200 for the quarter ended June 30, 2017, and represents a 12.9% increase.  In addition, existing home sales in Pierce County for the quarter ended June 30, 2018 increased by 6.9% from the quarter ended June 30, 2017. According to the U.S. Department of Labor, the unemployment rate for the Pierce County area remained the same at 5.1% for June 30, 2018 and June 30, 2017. We have one branch located in Pierce County.
For a discussion regarding the competition in our primary market area, see “– Competition.”
Lending Activities
General. Historically, our principal lending activity has consisted of the origination of loans secured by first mortgages on owner-occupied, one-to-four family residences and loans for the construction of one-to-four family residences, as well as consumer loans, with an emphasis on home equity loans and lines of credit. Since 1990, we have been actively offering commercial real estate loans and multi-family loans primarily in Western Washington and beginning in 2014 increased our focus on construction lending.  A substantial portion of our loan portfolio is secured by real estate, either as primary or secondary collateral, located in our primary market area. As of June 30, 2018, the net loan portfolio totaled $392.0 million and represented 83.5% of our total assets. As of June 30, 2018, 15.6% of our total loan portfolio was comprised of one-to-four family loans, 3.1% of home equity loans and lines of credit, 37.8% of commercial real estate loans, 14.5% of multi-family real estate loans, 5.1% of commercial business loans, 23.0% of construction loans, and the remaining less than 1% various consumer loans.
As a state chartered savings bank chartered under Washington law, we are subject to 20% of total risk based capital plus reserves as our statutory lending limit to one borrower or $13.5 million at June 30, 2018.  At June 30, 2018, there were no borrowing relationships that were over the legal amount. Our ten largest credit relationships at June 30, 2018 were as follows:
Our largest single borrower relationship totaled $10.8 million and consisted of four loans secured by congregate care facilities located in Lewis, Pierce, and Grays Harbor counties;
The second largest borrower relationship is one loan for $10.6 million secured by a hotel located in Pierce County;

2


The third largest borrower relationship totaled $9.6 million and consists of one unsecured credit line and three loans secured by hospitality properties located in King and Pierce counties;
The fourth largest borrower relationship totaled $9.2 million (excluding $717,000 of available credit) and consisted of two loans secured by an airport parking lot located in King County;
The fifth largest borrower relationship is one loan for $8.6 million which is a purchased minority interest in a loan participation secured by an entertainment, hospitality and dining complex located in Lewis County;
The sixth largest borrower relationship is one loan with $8.5 million disbursed (excluding $292,000 of undisbursed loan commitment) secured by an apartment building under construction located in King County;
The seventh largest borrower relationship is one loan with $8.2 million disbursed (excluding $305,000 of undisbursed loan commitment) secured by an apartment building under construction located in Kitsap County;
The eighth largest borrower relationship is one loan for $8.1 million secured by an apartment building located in King County;
The ninth largest borrower relationship is one loan for $8.0 million secured by an apartment building located in King County; and
The tenth largest borrower relationship totaled $7.7 million (excluding $594,000 of undisbursed loan commitment) and consisted of four loans secured by one multi-family and six single family residential units, and a fifth loan secured by an additional multi-family residential structure under construction located in Pierce and Thurston counties.
All of the properties securing these loans are located in our primary market area in Grays Harbor, Thurston, Lewis, and Pierce counties or our secondary market area in other parts of Washington State.  These loans were all performing according to their repayment terms as of June 30, 2018.



















3


Loan Portfolio Analysis. The following table sets forth the composition of Anchor Bank’s loan portfolio by type of loan at the dates indicated:
 
At June 30,
 
2018
 
2017
 
2016
 
2015
 
2014
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
$
62,110

 
15.6
%
 
$
59,735

 
15.6
%
 
$
61,230

 
17.4
%
 
$
57,944

 
20.1
%
 
$
63,009

 
21.9
%
Multi-family
57,639

 
14.5

 
60,500

 
15.8

 
53,742

 
15.3

 
43,249

 
15.0

 
47,507

 
16.5

Commercial
150,050

 
37.8

 
155,525

 
40.6

 
149,527

 
42.5

 
128,306

 
44.5

 
107,828

 
37.6

Construction
85,866

 
21.6

 
49,151

 
12.8

 
21,793

 
6.2

 
11,731

 
4.1

 
19,690

 
6.9

Land loans
5,515

 
1.4

 
8,054

 
2.1

 
6,839

 
1.9

 
4,069

 
1.4

 
4,126

 
1.4

Total real estate
$
361,180

 
90.9
%
 
$
332,965

 
86.9
%
 
$
293,131

 
83.3
%
 
$
245,299

 
85.1
%
 
$
242,160

 
84.3
%
Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
12,291

 
3.1

 
13,991

 
3.6

 
16,599

 
4.7

 
17,604

 
6.1

 
20,894

 
7.3

Credit cards
2,284

 
0.6

 
2,596

 
0.7

 
2,969

 
0.8

 
3,289

 
1.1

 
3,548

 
1.2

Automobile
372

 
0.1

 
627

 
0.2

 
597

 
0.2

 
686

 
0.2

 
1,073

 
0.4

Other
960

 
0.2

 
1,524

 
0.4

 
1,933

 
0.5

 
2,347

 
0.8

 
2,838

 
1.0

Total consumer
15,907

 
4.0

 
18,738

 
4.9

 
22,098

 
6.2

 
23,926

 
8.3

 
28,353

 
9.9

Commercial business
20,329

 
5.1

 
31,603

 
8.2

 
36,848

 
10.5

 
18,987

 
6.6

 
16,737

 
5.8

Total loans
397,416

 
100.0
%
 
383,306

 
100.0
%
 
352,077

 
100.0
%
 
288,212

 
100.0
%
 
287,250

 
100.0
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred loan fees and loan premiums, net
1,002

 
 
 
1,292

 
 
 
947

 
 
 
1,047

 
 
 
1,100

 
 
Allowance for loan losses
4,370

 
 
 
4,106

 
 
 
3,779

 
 
 
3,721

 
 
 
4,624

 
 
Loans receivable, net
$
392,044

 
 
 
$
377,908

 
 
 
$
347,351

 
 
 
$
283,444

 
 
 
$
281,526

 
 


4


The following table shows the composition of Anchor Bank’s loan portfolio by fixed- and adjustable-rate loans at the dates indicated:
 
At June 30,
 
2018
 
2017
 
2016
 
2015
 
2014
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
FIXED-RATE LOANS
(Dollars in thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
$
36,667

 
9.2
%
 
$
35,566

 
9.3
%
 
$
38,107

 
10.8
%
 
$
46,686

 
16.2
%
 
$
50,778

 
17.7
%
Multi-family
26,267

 
6.6

 
29,610

 
7.7

 
22,666

 
6.4

 
23,716

 
8.2

 
32,813

 
11.4

Commercial
24,750

 
6.2

 
19,050

 
5.0

 
14,555

 
4.1

 
25,048

 
8.7

 
34,776

 
12.1

Land loans
3,677

 
0.9

 
4,765

 
1.2

 
3,731

 
1.1

 
2,667

 
0.9

 
3,137

 
1.1

Total real estate
91,361

 
22.9

 
88,991

 
23.2

 
79,059

 
22.4

 
98,117

 
34.0

 
121,504

 
42.3

Real estate construction:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
11,890

 
3.0

 
6,604

 
1.7

 
2,498

 
0.7

 

 

 
312

 
0.1

Multi-family
10,760

 
2.7

 
2,309

 
0.6

 

 

 

 

 

 

Commercial
1,510

 
0.4

 
7,759

 
2.0

 
1,738

 
0.5

 

 

 
6,523

 
2.3

Total real estate construction
24,160

 
6.1

 
16,672

 
4.3

 
4,236

 
1.2

 

 

 
6,835

 
2.4

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
8,138

 
2.1

 
7,301

 
1.9

 
8,431

 
2.4

 
9,888

 
3.4

 
12,042

 
4.2

Automobile
372

 
0.1

 
627

 
0.2

 
597

 
0.2

 
686

 
0.2

 
1,073

 
0.4

Other
960

 
0.2

 
1,522

 
0.4

 
1,931

 
0.5

 
2,345

 
0.8

 
2,838

 
1.0

Total consumer
9,470

 
2.4

 
9,450

 
2.5

 
10,959

 
3.1

 
12,919

 
4.5

 
15,953

 
5.6

Commercial business
10,147

 
2.6

 
11,221

 
2.9

 
13,145

 
3.7

 
12,404

 
4.3

 
11,717

 
4.1

Total fixed-rate loans
$
135,138

 
34.0

 
$
126,334

 
33.0

 
$
107,399

 
30.5

 
$
123,440

 
42.8

 
$
156,009

 
54.4

ADJUSTABLE-RATE LOANS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
$
25,443

 
6.4

 
$
24,169

 
6.3

 
$
23,123

 
6.6

 
$
11,258

 
3.9

 
$
12,231

 
4.3

Multi-family
31,372

 
7.9

 
30,890

 
8.1

 
31,076

 
8.8

 
19,533

 
6.8

 
14,694

 
5.1

Commercial
125,300

 
31.5

 
136,475

 
35.6

 
134,972

 
38.3

 
103,258

 
35.8

 
73,052

 
25.4

Land loans
1,838

 
0.5

 
3,289

 
0.9

 
3,108

 
0.9

 
1,402

 
0.5

 
989

 
0.3

Total real estate
183,953

 
46.3

 
194,823

 
50.8

 
192,279

 
54.6

 
135,451

 
47.0

 
100,966

 
35.1

Real estate construction:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
16,854

 
4.2

 
10,119

 
2.6

 
9,475

 
2.7

 
2,119

 
0.7

 
2,697

 
0.9

Multi-family
34,229

 
8.6

 
19,423

 
5.1

 
1,083

 
0.3

 
9,353

 
3.2

 
3,432

 
1.2

Commercial
10,623

 
2.7

 
2,937

 
0.8

 
6,999

 
2.0

 
259

 
0.1

 
6,726

 
2.3

Total real estate construction
61,706

 
15.5

 
32,479

 
8.5

 
17,557

 
5.0

 
11,731

 
4.1

 
12,855

 
4.4


(table continued on following page)

5


 
At June 30,
 
2018
 
2017
 
2016
 
2015
 
2014
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in thousands)
Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
4,153

 
1.0

 
6,690

 
1.7

 
8,168

 
2.3

 
7,716

 
2.7

 
8,852

 
3.1

Automobile

 

 

 

 

 

 

 

 

 

Credit cards
2,284

 
0.6

 
2,596

 
0.7

 
2,969

 
0.8

 
3,289

 
1.1

 
3,548

 
1.2

Other

 

 
2

 

 
2

 

 
2

 

 

 

Total consumer
6,437

 
1.6

 
9,288

 
2.4

 
11,139

 
3.2

 
11,007

 
3.8

 
12,400

 
4.3

Commercial business
10,182

 
2.6

 
20,382

 
5.3

 
23,703

 
6.7

 
6,583

 
2.3

 
5,020

 
1.8

Total adjustable rate loans
262,278

 
66.0

 
256,972

 
67.0

 
244,678

 
69.5

 
164,772

 
57.2

 
131,241

 
45.6

Total loans
397,416

 
100.0
%
 
383,306

 
100.0
%
 
352,077

 
100.0
%
 
288,212

 
100.0
%
 
287,250

 
100.0
%
Less:
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred loan fees and loan premiums, net
1,002

 
 

 
1,292

 
 
 
947

 
 
 
1,047

 
 
 
1,100

 
 
Allowance for loan losses
4,370

 
 

 
4,106

 
 
 
3,779

 
 
 
3,721

 
 
 
4,624

 
 
Loans receivable, net
$
392,044

 
 

 
$
377,908

 
 
 
$
347,351

 
 
 
$
283,444

 
 
 
$
281,526

 
 
Commercial and Multi-Family Real Estate Lending.   As of June 30, 2018, $207.7 million, or 52.3% of our total loan portfolio was secured by commercial and multi-family real estate property located in our market area.  Of this amount, $41.3 million was identified as owner occupied commercial real estate, and the remaining $166.4 million, or 41.9% of our total loan portfolio was secured by income producing, or non-owner occupied commercial real estate. Our commercial real estate loans include loans secured by properties classified as office, hospitality, mini storage, mobile home park, congregate care, retail, education/worship, airport parking lot and other non-residential.  As of June 30, 2018, commercial real estate loans totaled $150.1 million, or 37.8% of our portfolio. Multi-family real estate totaled $57.6 million, or 14.5% of our portfolio at June 30, 2018.
Commercial real estate and multi-family loans generally are priced at a higher rate of interest than one-to-four family loans. Typically, these loans have higher loan balances, are more difficult to evaluate and monitor, and involve a greater degree of risk than one-to-four family loans. Often payments on loans secured by commercial or multi-family properties are dependent on the successful operation and management of the property; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. We generally require and obtain loan guarantees from financially capable parties based upon the review of personal financial statements. If the borrower is a corporation, we generally require and obtain personal guarantees from the corporate principals based upon a review of their personal financial statements and individual credit reports.
The average loan size in our commercial and multi-family real estate portfolio was $915,000 as of June 30, 2018.  We target individual commercial and multi-family real estate loans to small and mid-size owner occupants and investors in our market area, between $1.0 million and $6.0 million. At June 30, 2018, the largest commercial real estate loan in our portfolio was a loan of $10.6 million secured by a hotel located in Pierce County.. Our largest multi-family loan as of June 30, 2018, was an $8.0 million loan is secured by a 65 unit apartment complex located in King County.
We offer both fixed and adjustable rates on commercial and multi-family real estate loans. Loans originated on a fixed rate basis generally are originated at terms up to ten years, with amortization terms up to 30 years. A substantial amount of our commercial and multi-family real estate loans have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment. As of June 30, 2018, we had $26.3 million and $31.4 million in fixed and adjustable rate multi-family loans, respectively, and $24.7 million and $125.3 million in fixed and adjustable rate commercial real estate loans, respectively.
Commercial and multi-family real estate loans are originated with rates that generally adjust after an initial period ranging from three to ten years. Adjustable rate multi-family and commercial real estate loans are generally priced utilizing the applicable FHLB or U.S. Treasury Term Borrowing Rate plus an acceptable margin. These loans are typically amortized for up to 30 years with a prepayment penalty.  The maximum loan-to-value ratio for commercial and multi-family real estate loans is generally 75%.  We require appraisals of all properties securing commercial and multi-family real estate loans, performed by independent appraisers designated by us.  We require our commercial and multi-family real estate loan borrowers with outstanding balances in excess of $750,000, or a loan-to-value ratio in excess of 60% to submit annual financial statements and rent rolls on the subject property.  The

6


properties that fit within this profile are also inspected annually, and an inspection report and photograph are included.  We generally require a minimum pro forma debt coverage ratio of 1.20 times for loans secured by commercial and multi-family properties.
The following is an analysis of the types of collateral securing our commercial real estate and multi-family loans at June 30, 2018:
Collateral
 
Amount
 
Percent of
Total
 
 
(Dollars in thousands)
Multi-family
 
$
57,639

 
27.7
%
Office
 
16,381

 
7.9

Hospitality
 
30,251

 
14.6

Mini storage
 
24,258

 
11.7

Mobile home park
 
6,006

 
2.9

Congregate care
 
13,452

 
6.5

Retail
 
26,899

 
13.0

Education/Worship
 
9,636

 
4.6

Airport parking lot
 
4,403

 
2.1

Other non-residential
 
18,764

 
9.0

Total
 
$
207,689

 
100.0
%
If we foreclose on a multi-family or commercial real estate loan, our holding period for the collateral typically is longer than for one-to-four family mortgage loans because there are fewer potential purchasers of the collateral. Additionally, as a result of our increasing emphasis on this type of lending, a portion of our multi-family and commercial real estate loan portfolio is relatively unseasoned and has not been subjected to unfavorable economic conditions. As a result, we may not have enough payment history with which to judge future collectability or to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our historical experience, which could adversely affect our future performance. Further, our multi-family and commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we make any errors in judgment in the collectability of our commercial real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. At June 30, 2018, there were no commercial or multi-family real estate loans that were on nonaccrual status.  Commercial real estate loan charge offs for the years ended June 30, 2018 and 2017 were $200,000 and $110,000, respectively. There were no multi-family loans charged-off for the years ended June 30, 2018 and 2017.
One-to-Four Family Real Estate Lending. As of June 30, 2018, $62.1 million, or 15.6%, of our total loan portfolio consisted of permanent loans secured by one-to-four family residences. We originate both fixed rate and adjustable rate loans in our residential lending program and use Federal Home Loan Mortgage Corporation ("Freddie Mac") underwriting guidelines.  None of our residential loan products allow for negative amortization of principal.  We typically base our decision on whether to sell or retain secondary market quality loans on the rate and fees for each loan, market conditions and liquidity needs.  Although we have sold the majority of our residential loans over the last two years, we do not sell all qualified loans on the secondary market as we hold in our portfolio many residential loans that may not meet all of Freddie Mac's guidelines yet meet our investment and liquidity objectives.  
At June 30, 2018, $36.7 million of this loan portfolio consisted of fixed rate loans which were 59.0% of our total one-to-four family portfolio and 9.2% of our total loans at that date. Specifically, we offer fixed rate, residential mortgages from 10 to 30 year terms and we use Freddie Mac daily pricing to set our pricing.  Borrowers have a variety of buy-down options with each loan and most mortgages have a duration of less than ten years.  The average loan duration is a function of several factors, including real estate supply and demand, current interest rates, expected future rates and interest rates payable on outstanding loans.
Additionally, we offer a full range of adjustable rate mortgage products.  These loans offer three, five or seven year fixed-rate terms with annual adjustments thereafter.  The annual adjustments are limited to increases or decreases of no more than two percent and carry a typical lifetime cap of five percent above the original rate.  At this time, we hold these adjustable rate mortgages in our portfolio.  Similar to fixed rate loans, borrower demand for adjustable rate mortgage loans is a function of the current rate environment, the expectations of future interest rates and the difference between the initial interest rates and fees charged for each type of loan. The relative amount of fixed rate mortgage loans and adjustable rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment.

7


While adjustable rate mortgages in our loan portfolio help us reduce our exposure to changes in interest rates, it is possible that, during periods of rising interest rates, the risk of default on adjustable rate mortgage loans may increase as a result of annual repricing and the subsequent higher payment to the borrower.  In some rate environments, adjustable rate mortgages may be offered at initial rates of interest below a comparable fixed rate and could result in a higher risk of default or delinquency. Another consideration is that although adjustable rate mortgage loans allow us to decrease the sensitivity of our asset base as a result of changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Our historical experience with adjustable rate mortgages has been very favorable.  We do not, however, offer adjustable rate mortgages with initial teaser rates.  At June 30, 2018, $25.4 million of our permanent one-to-four family mortgage loans were adjustable rate loans which were 41.0% of our total one-to-four family loan portfolio and 6.4% of our total loans at that date.
Regardless of the type of loan, we underwrite our residential loans based on Freddie Mac's Loan Prospector guidelines.  This underwriting considers a variety of factors such as credit history, debt to income, property type, loan-to-value, and occupancy, to name a few.  Generally, we use the same Freddie Mac criteria for establishing maximum loan-to-values and also consider whether a transaction is a purchase, rate and term refinance, or cash-out refinance. For loans above 80% loan-to-value, we typically require private mortgage insurance in order to reduce our risk exposure should the loan default.  Regardless of the loan-to-value, our one-to-four family loans are appraised by independent fee appraisers that have been approved by us and generally carry no prepayment restrictions. We also require title insurance, hazard insurance, and if necessary, flood insurance in an amount not less than the current regulatory requirements.
We also have additional products designed to make home ownership available to qualified low to moderate income borrowers. The underwriting guidelines for these programs are usually more flexible in the areas of credit or work history.  For example, some segments of the low to moderate income population have non-traditional credit histories and pay cash for many of their consumer purchases.  They may also work in seasonal industries that do not offer a standard work schedule or salary.  Loans such as Freddie Mac's “Homestart Program” are designed to meet this market's needs and often require a borrower to show a history of saving and budgeting. These types of programs also provide education on the costs and benefits of homeownership.  We plan on continuing to offer these and other programs which reach out to qualifying borrowers in all the markets we serve.
Anchor Bank does not actively engage in subprime lending, either through advertising, marketing, underwriting and/or risk selection, and has no established program to originate or purchase subprime loans to be held in its portfolio.  Residential mortgage loans identified as subprime, with FICO scores of less than 660, were originated and managed in the ordinary course of business, and totaled $4.1 million at June 30, 2018, representing 1.0% of total loans, 6.6% of one-to-four family mortgage loans, and 6.5% of Tier 1 Capital.  Our weighted average seasoning for these loans (the number of months since the funding date of the loans) was 93 months as of June 30, 2018. Our one-to-four family mortgage loans identified as subprime based on the borrower’s FICO score at time the loan was originated do not represent a material part of our lending activity.  Accordingly, these loans are identified as “exclusions” as defined pursuant to regulatory guidance issued by the FDIC in Financial Institutions Letter FIL-9-2001 on subprime lending. At June 30, 2018, $507,000 of one-to-four family loans were in nonaccrual status. No one-to-four family loans were charged off during the year ended June 30, 2018 compared to $21,000 of one-to-four family loans that were charged-off during the year ended June 30, 2017.

Mortgage reform rules mandated by the Dodd-Frank Act became effective in January 2014, requiring lenders to make a reasonable, good faith determination of a borrower’s ability to repay any consumer closed-end credit transaction secured by a dwelling and to limit prepayment penalties. Increased risks of legal challenge, private right of action and regulatory enforcement are presented by these rules. Anchor Bank does not originate loans that do not meet the regulatory definition of a qualified mortgage.
Construction and Land Loans.  We have been an active originator of real estate construction loans in our market area since 1990. At June 30, 2018, our construction loans totaled $85.9 million or 21.6% of the total loan portfolio, an increase of $36.7 million or 74.7% since June 30, 2017. Our construction loans are for the construction of multi-family and for the construction of one-to-four family residences.
We generally provide an interest reserve for funds on builder construction loans that have been advanced.  Interest reserves are a means by which a lender builds in, as a part of the loan approval and as a component of the cost of the project, the amount of the monthly interest required to service the debt during the construction period of the loan.  
At June 30, 2018, our construction loan portfolio contained 16 loans totaling $36.3 million which had been previously extended or renewed due to a delay in the permitting process. Our entire construction loan portfolio at June 30, 2018 consisted of 70 loans requiring interest only payments, 40 of which totaled $26.1 million and were relying on the interest reserve to make this payment. At June 30, 2018, no construction loans were delinquent. No construction loans were charged-off during the years ended June 30, 2018 and 2017.


8


At the dates indicated, the composition of our construction portfolio was as follows:
 
At June 30,
 
2018
 
2017
 
2016
 
(In thousands)
One-to-four family:
 
 
 
 
 
Speculative
$
27,054

 
$
15,416

 
$
11,220

Permanent

 

 

Custom
1,690

 
1,306

 
753

Land acquisition and development loans
4,276

 
3,870

 
156

Multi-family
44,989

 
21,732

 
1,083

Commercial real estate:
 
 
 
 
 
Construction
7,857

 
6,827

 
8,581

Total construction (1)
$
85,866

 
$
49,151

 
$
21,793

(1) 
Loans in process for these loans at June 30, 2018, 2017 and 2016 were $28.6 million, $61.6 million and $37.9 million, respectively.
For the year ended June 30, 2018, we originated 54 builder construction loans to fund the construction of one-to-four family properties totaling $41.6 million, as compared to 27 builder construction loans for $26.6 million during the year ended June 30, 2017, and 28 builder construction loans for $25.0 million during the year ended June 30, 2016. We originate construction and site development loans to experienced contractors and builders in our market area primarily to finance the construction of single-family homes and subdivisions, which homes typically have an average price ranging from $200,000 to $500,000.  All builders were qualified using the same standards as other commercial loan credits, requiring minimum debt service coverage ratios and established cash reserves to carry projects through construction completion and sale of the project. The maximum loan-to-value limit on both pre-sold and speculative projects is generally up to 75% of the appraised market value or sales price upon completion of the project. Development plans are required from builders prior to making the loan. We also require that builders maintain adequate insurance coverage. Maturity dates for residential construction loans are largely a function of the estimated construction period of the project, and generally do not exceed 18 months for residential subdivision development loans at the time of origination. Our residential construction loans typically have adjustable rates of interest based on The Wall Street Journal prime rate and during the term of construction, the accumulated interest is added to the principal of the loan through an interest reserve. Construction loan proceeds are disbursed periodically in increments as construction progresses and based on inspections by our approved inspectors.  At June 30, 2018, our largest builder relationship consisted of three loans for $5.7 million, including $2.5 million which was undisbursed.
We also make construction loans for commercial development projects. These projects include multi-family, apartment, retail, office/warehouse and office buildings. These loans generally have an interest-only phase during construction, rely on an interest reserve to fund interest payments and generally convert to permanent financing when construction is completed. Disbursement of funds is at our sole discretion and is based on the progress of the construction. The maximum loan-to-value limit applicable to these loans is generally 75% of the appraised post-construction value.  Additional analysis and underwriting of these loans typically results in lower loan-to-value ratios based on the debt service coverage analysis, including our interest rate and vacancy stress testing.  Our target minimum debt coverage ratio is 1.20 for loans on these projects.  At June 30, 2018, our portfolio of construction loans for commercial and multi-family projects included 16 loans totaling $57.1 million, and there was an additional $10.5 million undisbursed.  These loan commitments range in size from $659,000 to $8.8 million with an average disbursed balance of $3.6 million. These loans were for the construction of ten multi-family complexes, one office, one industrial facility and four land developments, all of which are located in Washington. Monitoring construction progress and managing advances during construction are risks not present when lending on complete commercial properties. In order to mitigate these risks the Bank requires the use of an approved third-party construction process monitoring firm for inspections, progress reports and construction budget oversight and utilizes construction loan management software to assist in assuring that advances are consistent with the progress that has been confirmed.
Properties which are the subject of a construction loan are monitored for progress through our construction loan administration department, and include monthly site inspections, inspection reports and photographs provided by a qualified staff inspector or a licensed and bonded third party inspection service contracted by and for us.  If we make a determination that there is deterioration, or if the loan becomes nonperforming, we halt any disbursement of those funds identified for use in paying interest and bill the borrower directly for interest payments.  Construction loans with interest reserves are underwritten similarly to construction loans without interest reserves.

9


We also originate land loans which are typically made to individual consumers to buy a lot or parcel of land for the future construction of the buyer’s primary residence and are included in “land loans”.  At June 30, 2018, our land loans totaled $5.5 million or 1.4% of the total loan portfolio, none of which were on nonaccrual status.

Our construction and land loans are based upon estimates of costs in relation to values associated with the completed project. Construction and land lending involves additional risks when compared with permanent residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Changes in the demand, such as for new housing and higher than anticipated building costs may cause actual results to vary significantly from those estimated. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor. This type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. In addition, generally during the term of a construction loan, no payment from the borrower is generally required since the accumulated interest is added to the principal of the loan through an interest reserve. 

Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction and assume the market risk of selling the project at a future market price, which may or may not enable us to fully recover unpaid loan funds and associated construction and liquidation costs. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers' borrowing costs, thereby reducing the overall demand for the project. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk to us than construction loans to individuals on their personal residences because there is the added risk associated with identifying an end-purchaser for the finished project.

Land loans also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral.  These risks can be significantly impacted by the supply and demand conditions.  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.
Consumer Lending.  We offer a variety of consumer loans, including home equity loans and lines of credit, automobile loans, credit cards and personal lines of credit. At June 30, 2018, the largest component of the consumer loan portfolio consisted of home equity loans and lines of credit, which totaled $12.3 million, or 3.1%, of the total loan portfolio.  Our home equity loans are risk priced using credit score, loan-to-value and overall credit quality of the applicant.  Home equity loans and lines of credit are made for a variety of purposes including improvement of residential properties. The majority of these loans are secured by a second deed of trust on owner-occupied primary single family residential property. Our home equity lines of credit include a maximum total term of 30 years, including an initial period of 10 years with interest-only payments and a variable rate of interest tied to the Prime Rate, plus a margin (the "draw" period), followed by 20 years of principal and interest payments under a level amortization schedule and an interest rate that is fixed for the 20 years at the fully indexed accrual rate as of the time of variable-to-fixed rate conversion. Our home equity loans are closed-end loans with a term of 20 years and have level amortization with regular monthly payments of principal and interest. The interest rate is risk based and reflects both credit and collateral risk. Both our home equity lines and home equity loans are available up to 95% of the combined loan to value ratio as determined by the Bank.
Our credit card portfolio includes both VISA and MasterCard brands, and totaled $2.3 million, or 0.6% of the total loan portfolio at June 30, 2018.  We have been offering credit cards for more than 20 years and all of our credit cards have interest rates and credit limits determined by the creditworthiness of the borrower.  We use credit bureau scores in addition to other criteria such as income in our underwriting decision process on these loans.
Our automobile loan portfolio totaled $372,000 or 0.1% of the total loan portfolio at June 30, 2018.  We offer several options for vehicle purchase or refinance with a maximum term of 84 months for newer vehicles and 72 months for older vehicles.  As with home equity loans, our vehicle and recreational vehicle loans are risk priced based on creditworthiness, loan term and loan-to-value.  We currently access a Carfax Vehicle Report to ensure that the collateral being loaned against is acceptable and to protect borrowers from a “lemon” or other undesirable histories. Other consumer loans, consisting primarily of unsecured personal lines of credit totaled $960,000 or 0.2% of our total loan portfolio at June 30, 2018.

10


Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as 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 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 that can be recovered on these loans.  These risks are not as prevalent with respect to our consumer loan portfolio because a large percentage of the portfolio consists of home equity lines of credit that are underwritten in a manner such that they result in credit risk that is substantially similar to one-to-four family mortgage loans.  Nevertheless, home equity lines of credit have greater credit risk than one-to-four family mortgage loans because they are secured by mortgages subordinated to the existing first mortgage on the property, which we may or may not hold and do not have private mortgage insurance coverage.  At June 30, 2018, $207,000 of consumer loans were on nonaccrual status.  Consumer loans of $52,000 were charged off during the year ended June 30, 2018 compared to $193,000 of consumer loans that were charged-off during the year ended June 30, 2017.
Commercial Business Lending.  These loans are primarily originated as conventional loans to business borrowers, which include lines of credit, term loans and letters of credit.  These loans are typically secured by collateral and are used for general business purposes, including working capital financing, equipment financing, capital investment and general investments.  Loan terms vary from one to seven years.  The interest rates on such loans are generally floating rates indexed to The Wall Street Journal prime rate.  Inherent with our extension of business credit is the business deposit relationship which frequently includes multiple accounts and related services from which we realize low cost deposits plus service and ancillary fee income.
Commercial business loans typically have shorter maturity terms and higher interest spreads than real estate loans, but generally involve more credit risk because of the type and nature of the collateral. We are focusing our efforts on small- to medium-sized, privately-held companies with local or regional businesses that operate in our market area. Our commercial business lending policy includes credit file documentation and analysis of the borrower's background, capacity to repay the loan, the adequacy of the borrower's capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower's past, present and future cash flows is also an important aspect of our credit analysis. We generally obtain personal guarantees on our commercial business loans.  At June 30, 2018, commercial business loans totaled $20.3 million or 5.1% of our loan portfolio and was comprised of 118 loans in 56 different business classifications as identified by the North American Industrial Classification System.  The largest commercial business relationship at June 30, 2018 consisted of one loan for $4.8 million which is an operating line collateralized by an airport parking facility located in King County, Washington. The largest commercial business relationship at June 30, 2017 consisted of one loan for $9.0 million which is a purchased minority interest in a line of credit to provide warehouse lending to a financial services company which is collateralized by an assignment of financial notes receivable on residential housing secured by properties located in Washington, Oregon and Utah.
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. Our commercial business loans are originated primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral consists of accounts receivable, inventory or equipment. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.  For the years ended June 30, 2018 and 2017 there were no commercial business loan charge-offs. At June 30, 2018, there was one $222,000 commercial business loan on nonaccrual status.
Loan Maturity and Repricing.  The following table sets forth certain information at June 30, 2018 regarding the dollar amount of loans maturing in our portfolio based on their contractual terms to maturity, but does not include scheduled payments or potential prepayments.  Demand loans, loans having no stated schedule of repayments and no stated maturity, are reported as due in one year or less.  Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses.

11


 
Within
One Year
 
After
One Year
Through
3 Years
 
After
3 Years
Through
5 Years
 
After
5 Years
Through
10 Years
 
Beyond
10 Years
 
Total
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family
$
6,817

 
$
1,991

 
$
4,349

 
$
16,861

 
$
32,092

 
$
62,110

Multi-family
4,184

 
1,111

 
2,245

 
21,425

 
28,674

 
57,639

Commercial
6,205

 
4,313

 
31,263

 
105,176

 
3,093

 
150,050

Construction
83,909

 
1,957

 

 

 

 
85,866

Land loans
2,063

 
1,010

 
1,845

 
147

 
450

 
5,515

Total real estate
103,178

 
10,382

 
39,702

 
143,609

 
64,309

 
361,180

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity
1,753

 
150

 
760

 
2,699

 
6,929

 
12,291

Credit cards
2,284

 

 

 

 

 
2,284

Automobile
1

 
77

 
182

 
112

 

 
372

Other
190

 
118

 
210

 
114

 
328

 
960

Total consumer
4,228

 
345

 
1,152

 
2,925

 
7,257

 
15,907

Commercial business
4,736

 
8,689

 
3,877

 
3,027

 

 
20,329

Total
$
112,142

 
$
19,416

 
$
44,731

 
$
149,561

 
$
71,566

 
$
397,416

The following table sets forth the dollar amount of all loans due after June 30, 2019, which have fixed interest rates and have floating or adjustable interest rates:
 
Fixed
Rates
 
Floating or
Adjustable Rates
 
Total
 
(In thousands)
Real estate:
 
 
 
 
 
One-to-four family
$
33,994

 
$
21,299

 
$
55,293

Multi-family
22,083

 
31,372

 
53,455

Commercial
22,851

 
120,994

 
143,845

Construction
826

 
1,131

 
1,957

Land loans
3,076

 
376

 
3,452

Total real estate
82,830

 
175,172

 
258,002

 
 
 
 
 
 
Consumer:
 
 
 
 
 
Home equity
8,118

 
2,420

 
10,538

Automobile
371

 

 
371

Other
770

 

 
770

Total consumer
9,259

 
2,420

 
11,679

 
 
 
 
 
 
Commercial business
9,240

 
6,353

 
15,593

Total
$
101,329

 
$
183,945

 
$
285,274

Loan Solicitation and Processing.  Loan originations are obtained from a variety of sources, including direct mail and telephone solicitation, trade and business organization participation.  Our management and staff are also involved in a wide variety of professional, charitable, service and social organizations within the communities in which we operate, and our branch managers, loan representatives and business bankers solicit referrals from existing clients and new prospects.  We also originate and cross sell loans and services to our existing customer base as well as our walk-in/call-in/internet traffic as a result of our long standing community presence and broad based advertising efforts.  Loan processing and underwriting, closing and funding are determined

12


by the type of loan. Consumer loans, including conforming one-to-four family mortgage loans are processed, underwritten, documented and funded through our centralized processing and underwriting center located in Lacey, Washington.  Commercial business loans, including commercial and multi-family real estate loans and any non-conforming one-to-four family mortgage loans are processed and underwritten in one of our two Business Banking Center offices located in Lacey and Aberdeen, Washington. Our consumer and residential loan underwriters have specific approval authority, and requests that exceed such authority are referred to the appropriate supervisory level.
Depending upon the size of the loan request and the total borrower credit relationship with us, loan decisions may include the Executive Loan Committee, Senior Loan Committee, and/or Board of Directors.  The Executive Loan Committee is currently comprised of the President/Chief Executive Officer, Chief Financial Officer, Chief Lending Officer, Chief Credit Officer, Credit Administrator, Business Banking Manager, Note Department Manager, and Senior Data Manager. The Senior Loan Committee is a Board committee, comprised of three board members. Credit relationships up to $4.0 million may be approved by the Executive Loan Committee.  Loans or aggregated credit relationships which exceed $4.0 million must be approved by Senior Loan Committee, with an authority limit of $6.0 million, or by the Board of Directors.
Commercial and multi-family real estate loans can be approved up to $250,000 by the Chief Financial Officer, up to $500,000 by either the Senior Data Manager or Commercial Loan Administrator, and up to $750,000 by the Special Assets/Construction Manager.  These loans can be approved up to $1.0 million by either the President/Chief Executive Officer, Chief Lending Officer or Chief Credit Officer, and up to $2.0 million with the combination of both President/Chief Executive Officer, Chief Lending Officer or Chief Credit Officer.  Our Executive Loan Committee is authorized to approve loans to one borrower or a group of related borrowers up to $4.0 million.  Loans over $4.0 million must be approved by the Senior Loan Committee with a limit of $6.0 million, or the Board of Directors.
Loan Originations, Servicing, Purchases and Sales.  During the years ended June 30, 2018 and 2017, our combined total loan originations were $72.6 million and $110.7 million, respectively. For the years ended June 30, 2018 and 2017, we had no loan purchases.
One-to-four family loans are generally originated in accordance with the guidelines established by Freddie Mac, with the exception of our special community development loans under the Community Reinvestment Act. We utilize the Freddie Mac Loan Prospector, an automated loan system to underwrite the majority of our residential first mortgage loans (excluding community development loans). The remaining loans are underwritten by designated real estate loan underwriters internally in accordance with standards as provided by our Board-approved loan policy.
We actively sell the majority of our residential fixed rate first mortgage loans to the secondary market at the time of origination. During the years ended June 30, 2018 and 2017, we sold $9.5 million and $8.9 million, respectively, in one-to-four family whole loans to the secondary market. Our secondary market relationship is with Freddie Mac. We generally retain the servicing on the loans we sell into the secondary market.  Loans are generally sold on a non-recourse basis. As of June 30, 2018 and 2017, our residential loan servicing portfolio was $73.8 million and $74.8 million, respectively.
In order to achieve our loan growth objectives and/or improve earnings, we may purchase loans, either individually, through participations, or in bulk. During the year ended June 30, 2016, we purchased $22.8 million in multi-family loans. The loan purchase consisted of 12 multi-family projects in King and Pierce counties. We have also participated with other lenders on commercial real estate loans located in Washington, whereby we receive a portion of a loan originated by another lender who retains the servicing and customer relationship of the loan and may, depending on the terms of the agreement, retain a portion of the interest as a servicing fee. During 2016 we participated in $9.9 million of commercial real estate loans and $15.8 million of commercial business loans, including the $9.0 million purchased minority interest in a line of credit to provide warehouse lending, discussed above. Purchased loans, loan pools, and participations are underwritten by our credit administration department, evaluated for credit risk, and approved by the appropriate loan committee(s) prior to purchase, according to our lending authority guidelines.







13


The following table shows total loans originated, purchased, sold and repaid during the periods indicated:
 
Year Ended June 30,
 
2018
 
2017
 
2016
Loans originated:
(In thousands)
Real estate:
 
 
 
 
 
One-to-four family
$
25,350

 
$
24,060

 
$
22,280

Multi-family
1,984

 
12,427

 
3,043

Commercial
15,274

 
34,645

 
32,758

Construction
21,784

 
29,380

 
19,997

Land loans
1,633

 
3,224

 
4,122

Total real estate
66,025

 
103,736

 
82,200

Consumer:
 
 
 
 
 
Home equity
3,560

 
2,291

 
2,616

Credit cards

 

 
191

Automobile
80

 
314

 
432

Other
167

 
226

 

Total consumer
3,807

 
2,831

 
3,239

 
 
 
 
 
 
Commercial business
2,759

 
4,173

 
7,389

Total loans originated
72,591

 
110,740

 
92,828

 
 
 
 
 
 
Participation loans purchased:
 
 
 
 
 
Commercial real estate

 

 
9,889

Commercial business

 

 
15,845

 

 

 
25,734

Loans purchased:
 
 
 
 
 
Multi-family

 

 
22,840

Total loans purchased

 

 
22,840

 
 
 
 
 
 
Loans sold:
 
 
 
 
 
One-to-four family
9,523

 
8,867

 
7,724

Participation loans

 
4,000

 
1,763

Total loans sold
9,523

 
12,867

 
9,487

 
 
 
 
 
 
Principal repayments
45,289

 
60,308

 
64,946

Loans securitized
1,105

 
3,536

 

Transfer to real estate owned
1,992

 
954

 
852

Decrease in other items, net
(448
)
 
(967
)
 
(346
)
Loans held for sale
98

 
1,551

 
1,864

Net increase in loans receivable, net
$
14,136

 
$
30,557

 
$
63,907

Loan Origination and Other Fees.  In some instances, we receive loan origination fees on real estate related products.  Loan fees generally represent a percentage of the principal amount of the loan that is paid by the borrower. Accounting standards require that certain fees received, net of certain origination costs, be deferred and amortized over the contractual life of the loan. Net deferred fees or costs associated with loans that are prepaid or sold are recognized as income at the time of prepayment. We had

14


$1.1 million of net deferred loan fees and costs as of June 30, 2018 compared to $1.6 million and $1.5 million at June 30, 2017 and 2016, respectively.
Asset Quality
The objective of our loan review process is to determine risk levels and exposure to loss. The depth of review varies by asset types, depending on the nature of those assets. While certain assets may represent a substantial investment and warrant individual reviews, other assets may have less risk because the asset size is small, the risk is spread over a large number of obligors or the obligations are well collateralized and further analysis of individual assets would expand the review process without measurable advantage to risk assessment. Asset types with these characteristics may be reviewed as a total portfolio on the basis of risk indicators such as delinquency (consumer and residential real estate loans) or credit rating. A formal review process is conducted on individual assets that represent greater potential risk. A formal review process is a total re-evaluation of the risks associated with the asset and is documented by completing an asset review report. Certain real estate-related assets must be evaluated in terms of their fair market value or net realizable value in order to determine the likelihood of loss exposure and, consequently, the adequacy of valuation allowances.
We define a loan as being impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due under the contractual terms of the loan agreement. Large groups of smaller balance homogeneous loans such as consumer secured loans, residential mortgage loans and consumer unsecured loans are collectively evaluated for potential loss. All other loans are evaluated for impairment on an individual basis.
We generally assess late fees or penalty charges on delinquent loans of five percent of the monthly payment amount due. Substantially all fixed rate and adjustable rate mortgage loan payments are due on the first day of the month; however, the borrower is given a 15-day grace period to make the loan payment. When a mortgage loan borrower fails to make a required payment when it is due, we institute collection procedures. The first notice is mailed to the borrower on the 16th day requesting payment and assessing a late charge. Attempts to contact the borrower by telephone generally begin upon the 30th day of delinquency. If a satisfactory response is not obtained, continual follow-up contacts are attempted until the loan has been brought current. Before the 90th day of delinquency, attempts to interview the borrower are made to establish the cause of the delinquency, whether the cause is temporary, the attitude of the borrower toward the debt and a mutually satisfactory arrangement for curing the default.
When a consumer loan borrower fails to make a required payment on a consumer loan by the payment due date, we institute the same collection procedures as for our mortgage loan borrowers.
The Board of Directors is informed monthly as to the number and dollar amount of mortgage and consumer loans that are delinquent by more than 30 days, and is given information regarding classified assets.
If the borrower is chronically delinquent and all reasonable means of obtaining payments have been exercised, we will seek to recover the collateral securing the loan according to the terms of the security instrument and applicable law.  In the event of an unsecured loan, we will either seek legal action against the borrower or refer the loan to an outside collection agency.












15


Nonperforming Assets.  The following table sets forth information with respect to our nonperforming assets and restructured loans for the periods indicated:
 
At June 30,
 
2018
 
2017
 
2016
 
2015
 
2014
Loans accounted for on a nonaccrual basis:
(Dollars in thousands)
Real estate:
 
 
 
 
 
 
 
 
 
One-to-four family
$
507

 
$
1,170

 
$
1,539

 
$
1,263

 
$
2,101

Multi-family

 

 

 

 
158

Commercial

 
1,992

 
319

 

 
2,070

Construction

 

 

 

 

Land loans

 

 

 

 
150

Total real estate
507

 
3,162

 
1,858

 
1,263

 
4,479

Consumer:
 
 
 
 
 
 
 
 
 
Home equity
207

 
242

 
16

 

 

Credit cards

 

 

 

 

Automobile

 

 

 

 

Other

 

 
1

 
31

 

Total consumer
207

 
242

 
17

 
31

 

Commercial business
222

 
300

 
97

 
711

 
235

Total
936

 
3,704

 
1,972

 
2,005

 
4,714

Accruing loans which are contractually past due 90 days or more:
 
 
 
 
 
 
 
 
 
Consumer:
 
 
 
 
 
 
 
 
 
Credit cards

 

 

 
6

 

Total consumer

 

 

 
6

 

Commercial business

 

 

 

 

Total of nonaccrual and 90 days past due loans

936

 
3,704

 
1,972

 
2,011

 
4,714

Real estate owned
737

 
867

 
373

 
797

 
5,067

Repossessed automobiles

 

 
46

 

 
59

Total nonperforming assets
$
1,673

 
$
4,571

 
$
2,391

 
$
2,808

 
$
9,840

Troubled debt restructured loans (1)
$
3,051

 
$
4,320

 
$
8,755

 
$
9,827

 
$
11,261

Allowance for loan loss as a percent of
  nonperforming loans
466.9
%
 
110.8
%
 
191.6
%
 
185.0
%
 
98.1
%
Classified assets included in nonperforming
   assets
$
936

 
$
3,704

 
$
1,972

 
$
2,011

 
$
4,714

Nonaccrual and 90 days or more past due loans as percentage of total loans
0.2
%
 
1.0
%
 
0.6
%
 
0.7
%
 
1.6
%
Nonaccrual and 90 days or more past due loans as a percentage of total assets
0.2
%
 
0.8
%
 
0.5
%
 
0.5
%
 
1.2
%
Nonperforming assets as a percentage of
    total assets
0.4
%
 
1.0
%
 
0.6
%
 
0.7
%
 
2.5
%
Nonaccrued interest (2)
$
69

 
$
117

 
$
126

 
$
140

 
$
323

(1)    There were $108,000 of restructured loans included in nonperforming assets as of June 30, 2018.
(2) Represents foregone interest on nonaccrual loans.







16


Real Estate Owned and Other Repossessed Assets.  As of June 30, 2018, the Company had two real estate owned ("REO") properties with an aggregate book value of $737,000 compared to three properties with an aggregate book value of $867,000 at June 30, 2017.  At June 30, 2018, the largest of the REO properties was a residential real estate property with an aggregate book value of $647,000 located in Lewis County, Washington.
Restructured Loans. According to generally accepted accounting principles, we are required to account for certain loan modifications or restructurings as “troubled debt restructurings.” Our policy is to track and report all loans modified to terms not generally available in the market, except for those outside of the materiality threshold established for such tracking and reporting. In general, the modification or restructuring of a debt is considered a troubled debt restructuring if we, for economic or legal reasons related to a borrower's financial difficulties, grant a concession to the borrower that we would not otherwise consider.  We will modify the loan when upon completion of the residence the home is rented instead of sold, or when the borrower can continue to make interest payments and is unable to repay the loan until the property is sold as a result of current market conditions. In connection with a loan modification, we may lower the interest rate, extend the maturity date and require monthly payments when monthly payments are not otherwise required. We may also require additional collateral. All loans which are extended with rates and/or terms below market are identified as impaired loans and an appropriate allowance is established pursuant to generally accepted accounting principles.  Loans which are placed in nonaccrual status and subsequently modified are not returned to accruing status until there has been at least six months of consecutive satisfactory performance.  As of June 30, 2018, there were 22 loans with aggregate net principal balances of $3.1 million that we have identified as “troubled debt restructures.”  In connection with these loans, a valuation allowance in the form of charged-off principal equal to $145,000 has been taken.  Of these 22 loans, one $108,000 loan was not performing according to the modified repayment terms at June 30, 2018, and was classified as nonaccrual.
The existence of a guarantor is an important factor that we consider in every deteriorating credit relationship and in our determination as to whether or not to restructure the loan.  Additional factors we consider include the cooperation we receive from the borrower and/or guarantor as determined by the timeliness and quality of their direct and indirect communication, including providing us with current financial information; their willingness to develop new, and report on, previously identified risk mitigation strategies; and whether we receive additional collateral.  The financial ability of the borrower and/or guarantor is determined through a review and analysis of personal and business financial statements, tax return filings, liquidity verifications, personal and business credit reports, rent rolls, and direct reference checks.  The type of financial statements required of a borrower and/or guarantor varies based upon the credit risk and our aggregate credit exposure as it relates to the borrower and any guarantor. Reviewed financial statements are required for commercial business loans greater than $1.5 million and for commercial real estate loans greater than $5.0 million, with the level of outside independent accounting review decreasing as our risk exposure decreases.  We conduct reviews of the financial condition of borrowers and guarantors at least annually for credits of $750,000 or more, and for aggregate relationships of $1.5 million or more.
At both the time of loan origination and when considering a restructuring of a loan, we also assess the guarantor's character and reputation. This assessment is made by reviewing the duration of time such guarantor has been providing credit guarantees, the aggregate of the contingent liabilities of such guarantor as it relates to guarantees of additional debt provided to other lenders, and the results of direct reference checks.  Cooperative and communicative borrowers and/or guarantors may create opportunities for restructuring a loan, however, this cooperation does not affect the amount of the allowance for loan losses recorded or the timing of charging off the loan.
Classified Assets.  Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful or loss.  An asset is considered substandard if it is inadequately protected by the current net worth and repayment capacity of the borrower or of any collateral pledged.  Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent and approved by senior management or the Classified Asset Committee to address the risk specifically or we may allow the loss to be charged-off against the general loan allowance. General loan allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets. When an insured institution classifies problem assets as a loss, it is required to charge off such assets in the period in which they are deemed uncollectible.  Assets that do not currently expose us to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are considered either watch or special mention assets.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by our regulators, which can order the establishment of additional loss allowances.

17


In connection with the filing of periodic reports with the FDIC classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations. On the basis of our review of our loans, as of June 30, 2018 and 2017, we had classified loans of $936,000 and $3.7 million comprised entirely of loans classified as substandard.  The total amount classified represented 1.4% of equity capital and 0.2% of assets at June 30, 2018.
The aggregate amounts of our classified loans at the date indicated (as determined by management), were as follows:
 
At June 30,
 
2018
 
2017
 
(In thousands)
Classified Loans:
 
 
 
Substandard
$
936

 
$
3,721

Doubtful

 

Loss

 

Total
$
936

 
$
3,721

Our $936,000 of substandard loans at June 30, 2018, consisted of $714,000 of real estate secured loans and $222,000 of commercial business loans. Of the $714,000 of substandard loans which were real estate secured, $507,000 were one-to-four family and $207,000 were home equity loans, secured by property located in Washington.  
Potential Problem Loans.  Potential problem loans are loans that do not yet meet the criteria for identification as classified assets graded as substandard or doubtful, but where known information about the borrower causes management to have serious concerns about the ability of the borrower to comply with present loan repayment terms and may result in the loan being included as a classified asset for future periods.  At June 30, 2018, we had $3.6 million, or 0.9% of our net loans that were identified as potential problem loans compared to $7.0 million or 1.8% of our net loans at June 30, 2017.
The largest potential problem loan at June 30, 2018 was a term loan of $573,000 secured by commercial real estate in Oregon representing 15.8% of our potential problem loans.  The commercial real estate property securing this loan is located in Western Oregon and the loan was in compliance with its repayment terms at June 30, 2018.
Allowance for Loan Losses.  Management recognizes that loan losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our Chief Credit Officer assesses the allowance for loan and lease losses on a monthly basis and reports to the Board of Directors no less than quarterly.  The assessment includes analysis of several different factors, including delinquency, charge-off rates and the changing risk profile of our loan portfolio, as well as local economic conditions such as unemployment rates, bankruptcies and vacancy rates of business and residential properties.
We believe that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period and requires management to make assumptions about probable losses inherent in the loan portfolio. The impact of a sudden large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings.
Our methodology for analyzing the allowance for loan losses consists of two components: general and specific allowances.  The formula allowance is determined by applying an estimated loss percentage to various groups of loans.  The loss percentages are generally based on various historical measures such as the amount and type of classified loans, past due ratios and loss experience, which could affect the collectability of the respective loan types.
The specific allowance component is created when management believes that the collectability of a specific large loan, such as a real estate, multi-family or commercial real estate loan, has been impaired and a loss is probable.
The allowance is increased by the provision for loan losses, which is charged against current period earnings and decreased by the amount of actual loan charge-offs, net of recoveries.
We had a $405,000 provision for loan losses for the year ended June 30, 2018 compared to a $310,000 provision for loan losses at June 30, 2017, primarily reflecting loan growth.  The specific risks that are considered in our analysis for determining the provision for loan losses include an automatic elevation in risk grade and corresponding reserve requirement based on loan payment and payment delinquencies, including debt to the borrower and related entities under loans to one borrower guidelines; and a

18


qualitative analysis of the economic and portfolio trends.  We also continually monitor the market conditions reported at national, regional, and local levels including those from the FDIC, Case-Shiller, and Realtor Boards.
The calculation of the allowance for loan losses includes an incremental component, a qualitative component, and specific reserve amount as a result of impairment analysis.  The total allowance for loan losses was $4.4 million and $4.1 million at June 30, 2018 and 2017, respectively.  Of the total allowance at June 30, 2018, specific reserves decreased to $191,000 and general reserves increased to $4.2 million from specific reserves of $198,000 and general reserves of $3.9 million, respectively, at June 30, 2017. The level of the allowance is based on estimates, and the ultimate losses may vary from the estimates.  Management will continue to review the adequacy of the allowance for loan losses and make adjustments to the provision for loan losses based on loan growth, economic conditions, charge-offs and portfolio composition.
Levels and trends with respect to delinquent, nonperforming and impaired loans have improved during the year ended June 30, 2018.  At June 30, 2018 and June 30, 2017, our total delinquent loans, including loans 30 or more days past due, were $1.9 million and $4.1 million, respectively, which included nonperforming loans of $936,000 and $3.7 million at the end of each year.  The decrease in total delinquent loans was primarily the result of a $2.0 million commercial real estate loan becoming a real estate owned property that was subsequently sold during the year ended June 30, 2018. Net charge-offs (recoveries) during the years ended June 30, 2018 and June 30, 2017 were $141,000 and $(17,000), respectively.
Management identifies a loan as impaired when the source of repayment of the loan is recognized as being in jeopardy, such that economic or other changes have affected the borrower to the extent that it may not be able to meet repayment terms, and that resources available to the borrower, including the liquidation of collateral, may be insufficient.  Impairment is measured on a loan-by-loan basis for each loan based upon its source or sources of repayment. For collateral dependent loans management utilizes the valuation from an appraisal obtained generally within the last six months in establishing the allowance for loan losses, unless additional information known to management results in management applying a downward adjustment to the valuation. Appraisals are updated subsequent to the time of origination when management identifies a loan as impaired or potentially being impaired, as indicated by the borrower’s payment and loan covenant performance, an analysis of the borrower’s financial condition, property tax and/or assessment delinquency, increases in deferred maintenance or other information known to management.  When the results of the impairment analysis indicate a potential loss, the loan is classified as substandard and a specific reserve is established for such loan in the amount determined.  Further, the specific reserve amount is adjusted to reflect any further deterioration in the value of the collateral that may occur prior to liquidation or reinstatement.  The impairment analysis takes into consideration the primary, secondary, and tertiary sources of repayment, whether impairment is likely to be temporary in nature or liquidation is anticipated.
A loan is considered impaired when we have determined that we may be unable to collect payments of principal and/or interest when due under the terms of the loan. In the process of identifying loans as impaired, management takes into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered by management on a case by case basis, after taking into consideration the totality of circumstances surrounding the loans and the borrowers, including payment history and amounts of any payment shortfall, length and reason for delay, and likelihood of return to stable performance.
Impairment is measured on a loan by loan basis for all loans in the portfolio except for the smaller groups of homogeneous consumer loans in the portfolio.
As of June 30, 2018 and 2017, we had impaired loans of $4.0 million and $8.5 million, respectively.  Included within the impaired loan totals are loans identified as troubled debt restructures.  


19


The following table summarizes the distribution of the allowance for loan losses by loan category at the dates indicated:

 
At June 30,
 
2018
 
2017
 
2016
 
2015
 
2014
 
Loan
Balance
 
Amount
 by Loan Category
 
Percent of
Loans
in Loan
Category to
total
Loans
 
Loan
Balance
 
Amount
 by Loan Category
 
Percent of
Loans
in Loan
Category to
total
Loans
 
Loan
Balance
 
Amount
 by Loan Category
 
Percent of
Loans
in Loan
Category to
total
Loans
 
Loan
Balance
 
Amount
 by Loan Category
 
Percent of
Loans
in Loan
Category to
total
Loans
 
Loan
Balance
 
Amount
 by Loan Category
 
Percent of
Loans
in Loan
Category to
total
Loans
 
(Dollars in thousands)
Real estate:
 
One-to-four family
$
62,110

 
$
339

 
15.6
%
 
$
59,735

 
$
495

 
15.6
%
 
$
61,230

 
$
798

 
17.4
%
 
$
57,944

 
$
1,113

 
20.1
%
 
$
63,009

 
$
1,550

 
21.9
%
Multi-family
57,639

 
585

 
14.5

 
60,501

 
690

 
15.8

 
53,742

 
454

 
15.3

 
43,249

 
95

 
15.0

 
47,507

 
229

 
16.5

Commercial
150,050

 
1,478

 
37.8

 
155,525

 
1,456

 
40.6

 
149,527

 
1,333

 
42.5

 
128,306

 
262

 
44.5

 
107,828

 
682

 
37.6

Construction
85,866

 
1,280

 
21.6

 
49,151

 
651

 
12.8

 
21,793

 
271

 
6.2

 
11,731

 
247

 
4.1

 
19,690

 
190

 
6.9

Land loans
5,515

 
83

 
1.4

 
8,054

 
120

 
2.1

 
6,839

 
75

 
1.9

 
4,069

 
75

 
1.4

 
4,126

 
74

 
1.4

Total real estate
361,180

 
3,765

 
90.9

 
332,966

 
3,412

 
86.9

 
293,131

 
2,931

 
83.3

 
245,299

 
1,792

 
85.1

 
242,160

 
2,725

 
84.3

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
12,291

 
218

 
3.1

 
13,991

 
251

 
3.7

 
16,599

 
369

 
4.7

 
17,604

 
189

 
6.1

 
20,894

 
290

 
7.3