TIMBERLAND BANCORP INC annual report, FY2018

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Business context and reporting period

Timberland Bancorp, Inc. is a Washington bank holding company operating Timberland Bank, a community bank serving six western Washington counties through 22 branches. This Form 10-K covers the fiscal year ended September 30, 2018; amounts are consolidated unless noted. The South Sound Bank acquisition closed October 1, 2018, so its assets, liabilities, and operating results are excluded from fiscal 2018.

Financial performance and condition

  • Profitability: Net income was $16.72 million, up 18.0% from $14.17 million. Diluted EPS rose to $2.22 from $1.92. Return on average assets was 1.70%, return on average equity 14.27%, and the efficiency ratio improved to 56.55% from 57.92%.
  • Interest income and margins: Net interest income increased 11.1% to $39.06 million; net interest margin expanded to 4.23% from 4.07%. Interest and dividend income was $41.83 million and interest expense was $2.78 million.
  • Other income and expenses: Non-interest income was $12.54 million, up 1.4%; non-interest expense increased 6.0% to $29.18 million, including $616,000 of South Sound acquisition costs. No loan-loss provision or recapture was recorded in 2018, compared with a $1.25 million recapture in 2017.
  • Cash flow: Operating activities provided $21.45 million; investing activities used $68.27 million; financing activities provided $47.50 million. Cash and cash equivalents increased $676,000 to $148.86 million.
  • Balance sheet and liquidity: Total assets rose 7.0% to $1.02 billion; net loans increased 5.1% to $725.39 million; deposits rose 6.2% to $889.51 million; and shareholders’ equity increased 12.3% to $124.66 million. Cash, investment certificates, and securities totaled $226.12 million. The regulatory liquidity ratio was 24.3%.
  • Funding and capital: No FHLB borrowings were outstanding at year-end. Available borrowing capacity was $279.49 million from the FHLB and $76.70 million from the Federal Reserve, subject to collateral and facility terms. The Bank was “well capitalized,” with a 16.74% CET1 ratio and 11.73% leverage ratio. The annual common dividend was $0.60 per share.
  • Credit quality: Non-accrual loans declined to $1.32 million from $1.91 million; non-performing assets fell to $3.64 million, or 0.36% of assets, from $5.75 million, or 0.60%. The allowance was $9.53 million, 1.30% of loans. Potential problem loans totaled $5.0 million, and accruing troubled debt restructurings were $2.96 million.

Material changes versus the prior period

  • Loan growth was led by commercial real estate and construction lending; commercial real estate loans were $345.11 million, or 42.0% of loans, and construction loans were $188.36 million, or 22.9%.
  • Deposit growth was strongest in non-interest-bearing demand accounts, which increased $27.31 million. Interest expense declined as the Bank had repaid its FHLB borrowings, although deposit costs rose as market rates increased.
  • The allowance for loan losses was broadly stable, while non-performing loans, special-mention loans, and OREO declined. Net charge-offs were $23,000, compared with net recoveries of $977,000 in 2017.
  • The federal tax rate reduction lowered the fiscal 2018 effective tax rate to 25.4% from 33.3%. A one-time $548,000 deferred-tax remeasurement charge partially offset the tax benefit.

Outlook, commentary, and risks

  • Management’s stated strategy is to expand in existing markets, grow higher-yielding commercial real estate, construction, and business lending, build core deposits, manage problem assets, and control expenses. The filing gives no quantified earnings or growth guidance.
  • On October 1, 2018, the Company acquired South Sound Bank for total consideration of $35.17 million, comprising 904,826 Timberland shares and $6.90 million in cash. South Sound had $178.33 million in assets, $121.35 million in net loans, and $151.43 million in deposits at September 30. Integration, customer and employee retention, costs, and realization of expected benefits are identified risks; purchase accounting was not complete when the filing was prepared.
  • Credit risk is concentrated in Washington real estate: 94.3% of loans were secured by real estate. The Company identified a commercial real estate concentration under regulatory guidance. Construction, speculative projects, commercial property values, and borrower cash flows are key exposures.
  • Interest-rate modeling estimated that an immediate 100-basis-point increase would raise projected net interest income 4.2%, while a 100-basis-point decrease would lower it 7.7%. These are model estimates, not forecasts; deposit costs, repricing limits, and actual borrower behavior could produce different results.
  • Other notable risks include competition for deposits and loans, cybersecurity and third-party service disruptions, regulatory and compliance changes, and servicing accounts for state-legal marijuana businesses. Such businesses represented 2.5% of deposits at year-end.
  • The Tax Act produced a blended 24.5% federal rate for fiscal 2018; management expected a 21.0% federal rate thereafter. The Company anticipated that CECL adoption, expected for fiscal 2021, could increase the loan-loss allowance, but the amount was not yet known.
  • The auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective. The filing reports no pending legal proceeding expected to have a material adverse effect.

Important facts for investors to verify

  1. Review post-acquisition results, integration costs, purchase accounting, goodwill, and whether expected cost savings and revenue benefits are achieved.
  2. Track commercial real estate and construction concentrations, loan growth, delinquencies, potential problem loans, collateral values, and allowance adequacy.
  3. Monitor deposit pricing and retention, uninsured or brokered funding, borrowing availability, and the effect of rate changes on net interest margin and liquidity.
  4. Separate recurring earnings from the fiscal 2018 tax-rate benefit and the $548,000 deferred-tax remeasurement charge; assess future profitability at the 21% federal rate.
  5. Confirm the eventual CECL transition impact and any material changes in capital, credit quality, or dividends.