What changed in this filing

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Item 1A. Risk Factors

2021-12-08 compared with 2020-12-09 · 143 added, 98 removed, 342 unchanged (41% of the section changed)

Risk Factors Summary

We assume and manage a certain degree of risk in order to conduct our business strategy.

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This report is qualified in its entirety by these risk factors.

The most significant risks include the following:

Risks Related to the COVID-19 Pandemic and Associated Economic Slowdown

• The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our financial results and those of our customers.

The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.

Risks Related to Economic Conditions

• Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.

Risks Related to our Lending Activities

• Our real estate construction and land loans expose us to significant risks.

• Our emphasis on commercial real estate lending may expose us to increased lending risks.

• The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.

• 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 business may be adversely affected by credit risk associated with residential property.

• Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

• If our non-performing assets increase, our earnings will be adversely affected.

Risk Related to our Business Strategy

• We may be adversely affected by risks associated with completed and potential acquisitions.

Risk Related to Market Interest Rates

• Changes in interest rates may reduce our net interest income and may result in higher defaults in a rising rate environment.

• Our investment securities portfolio may be negatively impacted by fluctuations in market value and interest rates and result in losses.

• An increase in interest rates, change in the programs offered by Freddie Mac or our ability to qualify for their programs may reduce our mortgage revenues, which would negatively impact our non-interest income.

Risks Related to Laws and Regulations

• We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations that could increase our costs of operations.

• Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.

Risks Related to Cybersecurity, Third Parties and Technology

• The financial services market is undergoing rapid technological changes, and if we are unable to stay current with those changes, we may not be able to effectively compete.

• We are subject to certain risks in connection with our use of technology.

• Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.

• Managing reputational risk is important to attracting and maintaining customers, investors and employees.

• We rely on other companies to provide key components of our business infrastructure.

Risks Related to Accounting Matters

• We may experience future goodwill impairment, which could reduce our earnings.

• We may experience decreases in the fair value of our loan servicing rights, which could reduce our earnings.

• The required accounting treatment of loans we acquire through acquisitions including purchase credit impaired loans could result in higher net interest margins and interest income in current periods and lower net interest margins and interest income in future periods.

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

Other Risks Related to Our Business

• Ineffective liquidity management could adversely affect our financial results and condition.

• Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.

• Our framework for managing risks may not be effective in mitigating risk and loss to us.

• We are dependent on key personnel, and the loss of one or more of those key personnel may materially and adversely affect our prospects.

• We will be required to transition from the use of the LIBOR interest rate index in the future.

• Societal responses to climate change could adversely affect our business and performance, including indirectly through impacts on our customers.

Risks Related to the COVID-19 Pandemic and Associated Economic Slowdown

The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our financial results and those of our customers.

The COVID-19 pandemic has significantly adversely affected our operations and the way we provide banking services to businesses and individuals, many of whom are currently under some level of government restrictions.

The COVID-19 pandemic has adversely impacted our ability to conduct business, our financial results and those of our customers.

During our fiscal year ended September 30, 2021, the COVID-19 pandemic significantly adversely affected our operations and the way we provided banking services to businesses and individuals during government issued modified stay-at-home orders.

As an essential business, we continue to provide banking and financial services to our customers with drive-thru access available at the majority of our branch locations and in-person services available by appointment.

We have also opened several branch lobbies with modified access.

We have re-opened branch lobbies with modified access.

In addition, we continue to provide access to banking and financial services through online banking, ATMs and by telephone.

If the COVID-19 pandemic worsens it could limit or disrupt our ability to provide banking and financial services to our customers.

As the government issued orders were lifted during the latter part of fiscal year 2021 and vaccinations were becoming available, businesses were able to reopen, but mask and social distancing measures slowed the pace of an economic rebound.

We continue to monitor the impact of the new variants of COVID-19 which has prompted many health officials and municipalities to reinstate mask mandates and reconsider lifting pandemic restrictions.

If the COVID-19 pandemic again worsens it could limit or disrupt our ability to provide banking and financial services to our customers.

A number of our employees currently are working remotely to enable us to continue to provide banking services to our customers.

Heightened cybersecurity, information security and operational risks may result from these remote work-from-home arrangements.

We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic.

We also rely upon our third-party vendors to conduct business and to process, record and monitor transactions.

If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers.

We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the continued pandemic impacted by the new variants.

We rely upon our third-party vendors to help us conduct aspects of our business and to process, record and monitor transactions.

If any of these vendors are unable to continue to provide us with their services, it could also negatively impact our ability to serve our customers.

Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic.

There is a pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic.

As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on credit quality, revenues and asset values.

To date, the COVID-19 pandemic has resulted in changes in the demand for certain loan types, including government sponsored programs such as the Paycheck Protection Program ("PPP") through August 2020, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments.

Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including a continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected.

To date, the COVID-19 pandemic has resulted in changes in the demand for certain loan types, including government sponsored programs such as the Paycheck Protection Program ("PPP") through May 2021, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments.

Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including a

continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected.

Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as their revenues decline precipitously, especially in businesses related to travel, hospitality, leisure and physical personal services.

Businesses may ultimately not reopen as there is a significant level of uncertainty

regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.

The impact of the pandemic is expected to continue to adversely affect us during the 2021 fiscal year and possibly longer as the ability of many of our customers to make loan payments has been significantly affected.

Although the Company makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact the pandemic will have on the credit quality of our loan portfolio.

Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.

The impact of the pandemic may continue to adversely affect us during our 2022 fiscal year and possibly longer, as loan demand, market interest rates, and the ability of some customers to make timely loan payments has been significantly affected.

Although the Company makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates involve significant judgment and are made in the context of continued uncertainty as to the impact the pandemic will have on the credit quality of our loan portfolio.

Consistent with guidance provided by banking regulators, we have modified loans by providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic.

Notwithstanding these modifications, not all of these borrowers may be able to resume making full payments on their loans once the COVID-19 pandemic is resolved.

Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans as the COVID-19 pandemic subsides.

Any increases in the allowance for credit losses will result in a decrease in net income, and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.

The SBA PPP loans made by the Bank are guaranteed by the SBA and, if used by the borrower for authorized purposes, may be fully forgiven.

However, in the event of a loss resulting from a default on a SBA PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded or serviced by the Bank, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from the Bank.

As of September 30, 2021, we hold and service SBA PPP loans with an aggregate balance of $40.92 million.

These SBA PPP loans are subject to the provisions of the CARES Act and to complex and evolving rules and guidance issued by the SBA and other government agencies.

We expect that the great majority of our SBA PPP borrowers will seek full or partial forgiveness of their loan obligations.

We have credit risk on SBA PPP loans if the SBA determines that there is a deficiency in the manner in which we originated, funded or serviced loans, including any issue with the eligibility of a borrower to receive a SBA PPP loan.

We could face additional risks in our administrative capabilities to service our SBA PPP loans, and risk with respect to the determination of loan forgiveness, depending on the final procedures for determining loan forgiveness.

In the event of a loss resulting from a default on a SBA PPP loan and a determination by the SBA that there was a deficiency in the manner in which we originated, funded or serviced a SBA PPP loan, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty or, if the SBA has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill.

If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges.

Any impairment charge could have a material adverse effect on our results of operations and financial condition.

If adverse economic conditions or our stock price and market capitalization decreases as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges.

Any impairment charge could have a material adverse effect on our financial condition and results of operations.

We are an entity separate and distinct from our principal subsidiary, Timberland Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary.

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and during which we may experience a recession.

As a result, we anticipate our business may be materially and adversely affected during this recovery.

As a result, we anticipate that our business may be materially and adversely affected during this recovery.

To the extent the effects of the COVID-19 pandemic adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in this section.

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Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade, and it is not known how the recent changes in tariffs being imposed on international trade may also affect these businesses.

While real estate values and unemployment rates have recently improved, a deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:

Deterioration in economic conditions in the market areas we serve as a result of COVID-19 or other factors could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:

• loan delinquencies, problem assets and foreclosures may increase;

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At September 30, 2021, construction loans totaled $233.21 million, or 21.5% of our total loan portfolio, of which $179.04 million were for residential real estate projects, $43.37 million for commercial real estate projects and $10.80 million for land development projects.

This compares to total construction loans of $223.53 million, or 22.5% of our total loan portfolio at September 30, 2019, or a decrease of 1.8% during the past year.

This compares to total construction loans of $219.50 million, or 19.4% of our total loan portfolio at September 30, 2020, or an increase of 6.3% during the past year.

Approximately $109.15 million of our residential construction loans at September 30, 2021 were made to finance the construction of owner-occupied homes and are structured to be converted to permanent loans at the end of the construction phase.

In general, construction lending involves additional risks because funds are advanced upon estimates of costs in relation to values associated with the completed project.

Construction 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 complete 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.

Because of the uncertainties inherent in estimating construction costs, as well as the market value of the complete project and the effects of governmental regulations 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 demand for new housing and higher than anticipated building costs may cause actual results to vary significantly from those estimated.

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A downturn in housing, or the real estate market, could increase delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure.

Some of the builders we deal with have more than one loan outstanding with us.

Some of the builders who are our customers have more than one loan outstanding with us.

Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.

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At September 30, 2021, land loans totaled $19.94 million, or 1.8% of our total loan portfolio.

Loans on land under development or held for future construction as well as land loans made to individuals for the future construction of a residence also pose additional risk because the length of time from financing to completion of a

development project is significantly longer than for a traditional construction loan, which makes them more susceptible to declines in real estate values, declines in overall economic conditions which may delay the development of the land and changes in the political landscape that could affect the permitted and intended use of the land being financed, and the potential illiquid nature of the collateral.

them more susceptible to declines in real estate values, declines in overall economic conditions which may delay the development of the land and changes in the political landscape that could affect the permitted and intended use of the land being financed, and the potential illiquid nature of the collateral.

In addition, during this long period of time from financing to completion, the collateral often does not generate any cash flow to support the debt service.

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Management also recognizes that significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our allowance may be insufficient to absorb losses without significant additional provisions.

Further, the Financial Accounting Standards Board has adopted a new accounting standard that will be effective for our fiscal year beginning October 1, 2023.

Further, the FASB has adopted a new accounting standard that will be effective for our fiscal year beginning October 1, 2023.

This standard, referred to as Current Expected Credit Loss ("CECL") will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for credit losses.

This will change the current method of providing allowances for credit losses that are probable.

We anticipate that our allowance for loan losses will increase as a result of the implementation of CECL, however, until our evaluation is complete, the magnitude of the increase will be unknown.

We anticipate that our allowance for loan losses will increase as a result of the implementation of CECL;

however, until our evaluation is complete, the magnitude of the increase will be unknown.

Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may also require an increase in the allowance for loan losses.

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• There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance costs related to our OREO.

• The resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity.

• The resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activities.

If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our non-performing assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our financial condition and results of operations.

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Although our business strategy emphasizes organic expansion, we continue, from time to time in the ordinary course of business, to engage in preliminary discussions with potential acquisition targets.

There can be no assurance that, in the future, we will successfully identify suitable acquisition candidates,

complete acquisitions and successfully integrate acquired operations into our existing operations or expand into new markets.

There can be no assurance that, in the future, we will successfully identify suitable acquisition candidates, complete acquisitions and successfully integrate acquired operations into our existing operations or expand into new markets.

The consummation of any future acquisitions may dilute shareholder value or may have an adverse effect upon our operating results while the operations of the acquired business are being integrated into our operations.

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If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;

• Higher than expected deposit attrition;

• We could experience higher than expected deposit attrition;

• The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful.

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We may also experience greater than anticipated customer losses even if the integration process is successful;

• To the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill.

• To the extent that our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill.

As discussed below, we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operation and financial condition;

• We expect our net income will increase following an acquisition;

• We expect that our net income will increase following an acquisition;

however, we also expect our general and administrative expenses to increase, which could result to an increase in our efficiency ratio.

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Risk Related to Market Interest Rates

Fluctuating interest rates can adversely affect our profitability

Changes in interest rates may reduce our net interest income and may result in higher defaults in a rising rate environment.

Our earnings and cash flows are largely dependent upon our net interest income.

Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board.

After steadily increasing the target federal funds rate in 2018 and 2017, the Federal Reserve Board in 2019 decreased the target federal funds rate by 75 basis points, and in response to the COVID-19 pandemic in March 2020, an additional 150 basis point decrease to a range of 0.00% to 0.25% as of March 31, 2020.

The Federal Reserve Board could make additional changes during 2020 subject to economic conditions.

In response to the COVID-19 pandemic, the Federal Reserve decreased the target federal funds rate by 150 basis points to a range of 0.00% to 0.25%.

If the Federal Reserve Board increases the Fed Funds rate, overall interest rates will likely rise, which may negatively impact both the housing markets by reducing refinancing activity and new home purchases and the U.S.

In addition, deflationary pressures, while possibly lowering our operational costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans which could negatively affect our financial performance.

In addition, inflationary pressures will increase our operational costs and could have a significant negative effect on our borrowers, especially our business borrowers.

We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities.

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Changes in interest rates (up or down) could adversely affect our net interest margin and, as a result, our net interest income.

Although the yield we earn on our assets and our funding costs tends to move in the same direction in response to changes in

interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract.

Although the yield we earn on our assets and our funding costs tends to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract.

Changes in the slope of the "yield curve," or the spread between short-term and long-term interest rates, could also reduce our net interest margin.

Normally the yield curve is upward sloping, meaning short-term rates are lower than long-term rates.

Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.

liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.

Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs.

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Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results.

In this regard, because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the recent 150 basis point reductions in the targeted federal funds rate, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected.

For further discussion of how changes in interest rates could impact us, see "Part II, Item 7A.

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Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale investment securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates.

We increase or decrease our shareholders' equity by the amount of change in the estimated fair value of the available-for-sale investment securities, net of income taxes.

Shareholders' equity is increased or decreased by the amount of change in the estimated fair value of the available-for-sale investment securities, net of income taxes.

There can be no assurance that the declines in market value, including as a result of the COVID-19 pandemic, will not result in OTTI of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.

During the year ended September 30, 2020, we recognized a $120,000 recovery of OTTI charges on private label mortgage backed securities we hold for investment.

During the year ended September 30, 2019, we recognized a $59,000 recovery of OTTI charges on private label mortgage backed securities we hold for investment.

During the year ended September 30, 2018, we recognized a $68,000 recovery of OTTI charges on private label mortgage backed securities we hold for investment.

At September 30, 2020, our remaining private label mortgage backed securities portfolio totaled $229,000 of which $209,000 was on non-accrual status.

The valuation of our investment securities also is influenced by additional external market and other factors, including implementation of Securities and Exchange Commission and Financial Accounting Standards Board guidance on fair value accounting, default rates on residential mortgage securities and rating agency actions.

Accordingly, there can be no assurance

that future declines in the market value of our private label mortgage backed securities or other investment securities will not result in additional OTTI of these assets and lead to accounting charges that could have an adverse effect on our results of operations.

During the years ended September 30, 2021, 2020 and 2019, we recognized a $20,000, $120,000 and $59,000 recovery of OTTI charges on private label mortgage-backed securities we hold for investment, respectively.

At September 30, 2021, our remaining private label mortgage-backed securities portfolio totaled $13.93 million of which $159,000 was on non-accrual status.

The valuation of our investment securities also is influenced by additional external market and other factors, including implementation of SEC and FASB guidance on fair value accounting, default rates on residential mortgage securities and rating agency actions.

Accordingly, there can be no assurance that future declines in the market value of our private label mortgage-backed securities or other investment securities will not result in additional OTTI of these assets and lead to accounting charges that could have an adverse effect on our results of operations.

An increase in interest rates, change in the programs offered by Freddie Mac or our ability to qualify for their programs may reduce our mortgage revenues, which would negatively impact our non-interest income.

The sale of residential mortgage loans to Freddie Mac provides a significant portion of our non-interest income.

Any future changes in their program, our eligibility to participate in such program, the criteria for loans to be accepted or laws that significantly affect the activity of Freddie Mac could, in turn, materially adversely affect our results of operations if we could not find other purchasers.

Any future changes in their program, our eligibility to participate in such program, the criteria for loans to be accepted or laws that

significantly affect the activity of Freddie Mac could, in turn, materially adversely affect our results of operations if we could not find other purchasers.

Mortgage banking is generally considered a volatile source of income because it depends largely on the level of loan volume which, in turn, depends largely on prevailing market interest rates.

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These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.

Any new regulations or legislation, change in existing regulation or oversight, whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability.

Any new regulations or legislation, change in existing regulations or oversight, whether a change in regulatory policy or a change in a regulator's interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory compliance and of doing business and adversely affect our profitability.

In this regard, the U.S.

Department of the Treasury's Financial Crimes Enforcement Network ("FinCEN"), published guidelines in 2014 for financial institutions servicing marijuana businesses that are legal under state law.

These guidelines allow us to work with marijuana-related businesses that are operating in accordance with state laws and regulations, so long as we comply with required regulatory oversight of their accounts with us.

These guidelines allow us to work with marijuana-related businesses that are operating in accordance with state laws and regulations, as long as we comply with required regulatory oversight of their accounts with us.

In addition, legislation is currently pending in Congress that would allow banks and financial institutions to serve marijuana businesses in states where it is legal without any risk of federal prosecution.

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The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities.

If such activities are detected, financial institutions are obligated to file suspicious activity reports with FinCEN.

These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts.

Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.

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While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.

Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

Any of these results could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

Risks Related to Cybersecurity, Third-Parties and Technology

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The financial services market, including banking services, is undergoing rapid changes with frequent introductions of new technology-driven products and services.

Our future success will depend, in part, on our ability to keep pace with the technological changes and to use technology to satisfy and grow customer demand for our products and services and to create additional efficiencies in our operations.

additional efficiencies in our operations.

We expect that we will need to make substantial investments in our technology and information systems to compete effectively and to stay current with technological changes.

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If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties.

We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured or not fully covered through any insurance maintained by us.

We could also suffer significant reputational damage.

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Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely.

We may not be insured against all types of losses as a result

of third-party failures and insurance coverage may be inadequate to cover all losses, resulting from breaches, systems failures or other disruptions.

If any of our third party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all.

We cannot assure that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third-parties on which we rely.

We may not be insured against all types of losses as a result of third-party failures and insurance coverage may be inadequate to cover all losses, resulting from breaches, systems failures or other disruptions.

If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure that we could negotiate terms that are as favorable to us or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all.

Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability.

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The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations.

We also could be adversely affected to the extent such an agreement is not renewed by a third party vendor or is renewed on terms less favorable to us.

We also could be adversely affected to the extent that such an agreement is not renewed by a third-party vendor or is renewed on terms less favorable to us.

Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors' performance, including aspects which they delegate to third-parties.

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The acquisition of South Sound Bank on October 1, 2018 substantially increased our goodwill.

We may experience decreases in the fair value of our servicing rights, which could reduce our earnings.

Servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold with servicing rights retained.

At September 30, 2020, our servicing rights totaled $3.10 million (including a valuation allowance of $229,000).

Servicing rights are amortized to servicing income on loans sold over the period of estimated net servicing income.

The estimated fair value of servicing rights at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans.

On a quarterly basis, we evaluate the fair value of servicing rights for impairment by comparing actual cash flows and estimated cash flows from the servicing assets to those estimated at the time servicing assets were originated.

Our methodology for estimating the fair value of servicing rights is highly sensitive to changes in assumptions, such as prepayment speeds.

The effect of changes in market interest rates on estimated rates of loan prepayments represents the predominant risk characteristic underlying the servicing rights portfolio.

For example, a decrease in interest rates typically increases the prepayment speeds of servicing rights and therefore decreases the fair value of the servicing rights.

Future decreases in interest rates could decrease the fair value of our servicing rights below their recorded amount, which would decrease our earnings.

We may experience decreases in the fair value of our loan servicing rights, which could reduce our earnings.

Loan servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold with servicing rights retained.

At September 30, 2021, our loan servicing rights totaled $3.48 million (including a valuation allowance of $119,000).

Loan servicing rights are amortized to servicing income on loans sold over the period of estimated net servicing income.

The estimated fair value of loan servicing rights at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans.

On a quarterly basis, we evaluate the fair value of loan servicing rights

for impairment by comparing actual cash flows and estimated cash flows from the loan servicing assets to those estimated at the time loan servicing assets were originated.

Our methodology for estimating the fair value of loan servicing rights is highly sensitive to changes in assumptions, such as prepayment speeds.

The effect of changes in market interest rates on estimated rates of loan prepayments represents the predominant risk characteristic underlying the loan servicing rights portfolio.

For example, a decrease in interest rates typically increases the prepayment speeds of loan servicing rights and therefore decreases the fair value of the loan servicing rights.

Future decreases in interest rates could decrease the fair value of our loan servicing rights below their recorded amount, which would decrease our earnings.

The required accounting treatment of loans we acquire through acquisitions including purchase credit impaired loans could result in higher net interest margins and interest income in current periods and lower net interest margins and interest income in future periods.

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In addition, bank regulators periodically review our OREO and may require us to recognize further valuation allowances.

Significant charge-offs to our OREO may have a material adverse effect on our financial condition and results of operations.

Significant charge-offs to our OREO may have an adverse effect on our financial condition and results of operations.

Other Risks Related to Our Business

Ineffective liquidity management could adversely affect our financial results and condition.

Effective liquidity management is essential to our business.

We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress.

Effective liquidity management is essential for the operation of our business.

We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances causing industry or general financial market stress.

An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity.

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Further, changes to the FHLB's underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity.

Although we have historically been able to replace maturing deposits and borrowings if desired, we may not be able to replace such funds in the

future if, among other things, our financial condition, the financial condition of the FHLB or FRB, or market conditions change.

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry.

Additional factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Washington markets where our deposits are concentrated or adverse regulatory action against us.

Although we have historically been able to replace maturing deposits and borrowings if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB or FRB, or market conditions change.

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry.

Additional factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Washington markets where our loans and deposits are concentrated or adverse regulatory action against us.

Our access to deposits may also be affected by the liquidity needs of our depositors.

In particular, a majority of our liabilities are checking accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by

comparison, a substantial majority of our assets are loans, which cannot be called or sold in the same time frame.

Although we have historically been able to replace maturing deposits and borrowings as necessary, we might not be able to replace such funds in the future, especially if a large number of our depositors seek to withdraw their accounts, regardless of the reason.

A failure to maintain adequate liquidity could materially and adversely affect our business, results of operations, or financial condition.

Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates.

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In addition, our success has been and continues to be highly dependent upon the services of our directors, and we may not be able to identify and attract suitable candidates to replace such directors.

Uncertainty relating to the London Interbank Offered Rate ("LIBOR") calculation process and potential phasing out of LIBOR may adversely affect our results of operations.

On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021.

The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021.

It is impossible to predict whether and to what extent banks will continue to provide

LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally.

The Federal Reserve Board, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S.

financial institutions, is considering replacing the U.S.

dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities ("SOFR").

SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members.

Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR).

SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions.

Whether or not SOFR attains traction as a LIBOR replacement tool remains in question, although transactions using SOFR have been completed including by Fannie Mae.

Both Fannie Mae and Freddie Mac have recently announced that they will cease accepting adjustable rate mortgages tied to LIBOR by the end of 2020 and will soon begin accepting mortgages based on SOFR.

Continued uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and securities in our portfolio.

If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may experience significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.

We will be required to transition from the use of the LIBOR interest rate index in the future.

Some of our loans are indexed to LIBOR to calculate the loan interest rate.

LIBOR will be discontinued on December 31, 2021.

Although we expect that the capital and debt markets will cease to use LIBOR as a benchmark in the near future and the administrator of LIBOR has announced its intention to extend the publication of most tenors of LIBOR for U.S.

dollars through June 30, 2023, we cannot predict whether or when LIBOR will actually cease to be available, whether the Secured Overnight Funding Rate, or SOFR, will become the market benchmark in its place or what impact such a transition may have on our business, financial condition and results of operations.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR.

Regulators, industry groups and certain committees (e.g.

the Alternative Reference Rates Committee) have published recommended fallback language for LIBOR-linked financial instruments, identified recommended alternatives for the LIBOR, such as SOFR, and proposed implementations of the recommended alternatives in floating-rate financial instruments.

At this time, it is not possible to predict whether these specific recommendations and proposals will be broadly accepted.

The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers may result in our incurring significant expenses in implementing the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations.

Societal responses to climate change could adversely affect our business and performance, including indirectly through impacts on our customers.

Concerns over the long-term impacts of climate change have led and will continue to lead to governmental efforts around the world to mitigate those impacts.

Consumers and businesses also may change their behavior on their own as a result of these concerns.

We and our customers will need to respond to new laws and regulations as well as consumer and business preferences resulting from climate change concerns.

We and our customers may face cost increases, asset value reductions and operating process changes.

The impact on our customers will likely vary depending on their specific attributes, including reliance on or role in carbon intensive activities.

Among the impacts to us could be a drop in demand for our products and services, particularly in certain industry sectors.

In addition, we could face reductions in creditworthiness on the part of some customers or in the value of assets securing loans.

Our efforts to take these risks into account in making lending and other decisions, including by increasing our business with climate-friendly companies, may not be effective in protecting us from the negative impact of new laws and regulations or changes in consumer or business behavior.

Unresolved Staff Comments

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 1A. Risk Factors