What changed in this filing

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Item 1A. Risk Factors

2022-12-09 compared with 2021-12-08 · 89 added, 163 removed, 322 unchanged (44% 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 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 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.

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 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 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 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 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, 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.

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 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.

If the COVID-19 pandemic were to materially adversely affect Timberland Bank’s regulatory capital levels or liquidity, it may result in Timberland Bank being unable to pay dividends to us, which may result in our not being able to pay dividends on our common stock at the same rate or at all.

Even after the COVID-19 pandemic subsides, the U.S.

economy will likely require some time to recover from its effects, the length of which is unknown.

and during which we may experience a recession.

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.

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.

Substantially all of our loans are to businesses and individuals in the state of Washington.

A decline in the economies of our local market areas of Grays Harbor, Pierce, Thurston, King, Kitsap and Lewis counties in which we operate, and which we consider to be our primary market areas, could have a material adverse effect on our business, financial condition, results of operations and prospects.

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.

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:

A return of recessionary conditions or adverse economic conditions in our local market areas of Grays Harbor, Pierce, Thurston, King, Kitsap and Lewis counties Washington, which we consider to be our primary market area, may reduce our rate of growth, affect our customers' ability to repay loans and adversely impact our business, financial condition, and results of operations.

General economic conditions, including inflation, unemployment and money supply fluctuations, also may adversely affect our profitability.

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

Changes in agreements or relationships between the United States and other countries may also affect these businesses.

A deterioration in economic conditions in the market areas we serve as a result of inflation, a recession, the effects of COVID-19 variants 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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• the sale of foreclosed assets may slow;

• demand for our products and services may decline possibly resulting in a decrease in our total loans or assets;

• demand for our products and services may decline possibly resulting in a decrease in our total loans, total deposits, or assets;

• collateral for loans made may decline in value, exposing us to increased risk loans, reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans;

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Many of the loans in our portfolio are secured by real estate.

Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower's ability to repay the loan and the value of the collateral securing the loan.

Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively

affect the borrower's ability to repay the loan and the value of the collateral securing the loan.

Real estate values are affected by various other factors, including changes in general or regional economic conditions, government rules or policies and natural disasters such as fires and earthquakes.

If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected.

Inflation can have an adverse impact on our business and on our customers.

Inflation risk is the risk that the value of assets or income from investments will be worth less in the future as inflation decreases the value of money.

The annual inflation rate in the United States increased to 8.2% in September 2022.

As a result, the Federal Reserve has continued to increase the target federal funds rate, by 300 basis points to date in 2022, and has indicated its intention to continue to increase interest rates in an effort to combat inflation.

As inflation increases, the value of our investment securities, particularly those with longer maturities, would decrease, although this effect can be less pronounced for floating rate instruments.

In addition, inflation increases the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our non-interest expenses.

Furthermore, our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.

The economic impact of the COVID-19 pandemic could continue to affect our financial condition and results of operations.

The COVID-19 pandemic caused significant economic dislocation in the United States and internationally, resulting in a slow-down in economic activity, increased unemployment levels, and disruptions in global supply chains and financial markets.

The pandemic and related government actions to curb its spread also resulted in closures of many organizations and the institution of social distancing requirements in many states and communities.

Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry and the retail industry.

In response to the pandemic, various state governments and federal agencies required lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees).

Federal banking agencies encouraged financial institutions to prudently work with affected borrowers and legislation provided relief from reporting loan classifications due to modifications related to the COVID-19 outbreak.

The spread of the coronavirus also caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences.

Given the ongoing dynamic nature of variants of COVID-19, it is difficult to predict the full impact of the COVID-19 pandemic outbreak on our business.

As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to a number of risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, results of operations, ability to execute our growth strategy, and ability to pay dividends.

These risks include, but are not limited to, changes in demand for our products and services;

increased loan losses or other impairments in our loan portfolios and increases in our allowance for loan losses;

a decline in collateral for our loans, especially real estate;

unanticipated unavailability of employees;

increased cyber security risks as employees work remotely;

a prolonged weakness in economic conditions resulting in a reduction of future projected earnings could necessitate a valuation allowance against our current outstanding deferred tax assets;

a triggering event leading to impairment testing on our goodwill or core deposit and customer relationships intangibles, which could result in an impairment charge;

and increased costs as the Company and our regulators, customers and vendors adapt to evolving pandemic conditions.

Risks Related to our Lending Activities

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Changes in demand for new housing and higher than anticipated building costs may cause actual results to vary significantly from those estimated.

For these reasons, this type of lending also typically involves higher loan principal amounts and may be concentrated with a small number of builders.

For these reasons, this type of lending also typically

involves higher loan principal amounts and may be concentrated with a small number of builders.

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.

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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.

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.

This 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.

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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As a result of these characteristics, if we foreclose on a commercial real estate loan, our holding period for the collateral typically is longer than for one- to four-family residential mortgage loans because there are fewer potential purchasers of the collateral.

Accordingly, charge-offs on commercial real estate loans may be larger as a percentage of the total principal outstanding than those incurred with our residential or consumer loan portfolios.

Accordingly, charge-offs on commercial real

estate loans may be larger as a percentage of the total principal outstanding than those incurred with our residential or consumer loan portfolios.

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

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We have concluded that we have a concentration in commercial real estate lending because our balance in commercial real estate loans (including owner-occupied loans) at September 30, 2022 represents more than 300% of total capital.

While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.

While we believe that we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.

Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.

At September 30, 2021, we had $74.58 million, or 6.9%, of total loans in commercial business loans (excluding SBA PPP loans).

At September 30, 2022, we had $126.04 million, or 10.1%, of total loans in commercial business loans.

Commercial business lending involves risks that are different from those associated with residential and commercial real estate lending.

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Further, a significant amount of our home equity lines of credit consist of second mortgage loans.

For those home equity lines secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.

repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.

For these reasons, we may experience higher rates of delinquencies, default and losses on our residential loans.

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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 standard, referred to as 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.

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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.

In addition to the non-performing loans, there were $2.37 million in loans classified as performing troubled debt restructurings at September 30, 2021.

In addition to the non-performing loans, there were $2.47 million in loans classified as performing TDRs at September 30, 2022.

Risk Related to our Business Strategy

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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.

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

Since March 2022, in response to inflation, the Federal Open

Market Committee ("FOMC") of the Federal Reserve has increased the target range for the federal funds rate by 300 basis, including 150 basis points during the third calendar quarter of 2022, to a range of 3.00% to 3.25% as of September 30, 2022.

As it seeks to control inflation without creating a recession, the FOMC has indicated further increases are to be expected this year.

If the FOMC further increased the targeted federal funds rates, overall interest rates will likely continue to rise, which will positively impact our net interest income but may negatively impact both the housing market by reducing refinancing activity and new home purchases and the U.S.

In addition, inflationary pressures will increase our operational costs and 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.

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

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

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.

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.

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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Decreases in the fair value of investment securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders' equity.

Stockholders' equity, specifically accumulated other comprehensive income (loss) ("AOCI"), is increased or decreased by the amount of change in the estimated fair value of our securities available for sale, net of deferred income taxes.

Increases in interest rates generally decrease the fair value of securities available for sale, which adversely impacts stockholders' equity.

Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition, liquidity and results of operations.

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Quantitative and Qualitative Disclosures About Market Risk" for additional information about our interest rate risk management.

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

Our investment securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income (loss) and/or earnings.

Fluctuations in market value may be caused by changes in market interest rates, lower market prices for investment securities and limited investor demand.

Our held to maturity and available for sale investment securities are evaluated for other-than-temporary-impairment ("OTTI").

If this evaluation shows impairment to the actual or projected cash flows associated with one or more investment securities, a potential loss to earnings may occur.

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.

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 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.

We may incur losses on our securities portfolio as a result of changes in interest rates.

Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities.

These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets.

Any of these factors, among others, could cause other-than-temporary impairments ("OTTI") and realized and/or unrealized losses in future periods and declines in AOCI.

The process for determining whether impairment of a security is other-than-temporary impaired usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security to assess the probability of receiving all contractual principal and interest payments on the security.

There can be no assurance that the declines in market value will not result in other-than-temporary impairments of these assets, and lead to accounting charges that could have a material adverse effect on our business, financial condition and 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.

The sale of residential mortgage loans to Freddie Mac has historically provided 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.

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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Certain significant federal and state banking regulations that affect us are described in this report under the heading "Item 1.

Business-How We Are Regulated".

These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures.

Business-How We Are Regulated." These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures.

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

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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.

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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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.

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

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

The Board of Directors oversees the risk management process, including the risk of cybersecurity, and engages with management on cybersecurity issues.

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however, it would have no impact on our liquidity, operations or regulatory capital.

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

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).

At September 30, 2022, our loan servicing rights totaled $3.02 million.

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.

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.

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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.

Under GAAP, we are required to record loans acquired through acquisitions, including purchase credit impaired loans, at fair value.

Estimating the fair value of such loans requires management to make estimates based on available information and facts and circumstances on the acquisition date.

Actual performance could differ from management’s initial estimates.

If these loans outperform our original fair value estimates, the difference between our original estimate and the actual performance of the loan (the “discount”) is accreted into net interest income.

Thus, our net interest margins may initially increase due to the discount accretion.

We expect the yields on our loans to decline as our acquired loan portfolio pays down or matures and the discount decreases, and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans.

This could result in higher net interest margins and interest income in current periods and lower net interest margins and lower 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.

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If our valuation process is incorrect or if the property declines in value after foreclosure, the fair value of our OREO may not be sufficient to recover our NBV in such assets, resulting in the need for a valuation allowance.

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

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

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

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

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.

We rely on customer deposits and at times, borrowings from the FHLB, borrowings from the FRB and other borrowings to fund our operations.

At September 30, 2021, we had $5.00 million in outstanding FHLB borrowings and an additional $465.02 million of available borrowing capacity through the FHLB and the FRB.

Deposit flows and the prepayment of loans and mortgage-related securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and the competition for deposits and loans in the markets we serve.

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.

Liquidity is essential to our business.

We rely on a number of different sources in order to meet our potential liquidity demands.

Our primary sources of liquidity are increases in deposit accounts, cash flows from loan payments and our securities portfolio.

Borrowings also provide us with a source of funds to meet liquidity demands.

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

Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives.

Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms.

If additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected.

Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our income may not increase proportionately to cover our costs.

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 in which our loans and deposits are concentrated, negative operating results, or adverse regulatory action against us.

Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry or deterioration in credit markets.

Any decline in available funding in amounts adequate to finance our activities or on terms which are acceptable could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which

could, in turn, have a material adverse effect on our business, financial condition and results of operations.

Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity” of this Form 10-K.

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.

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Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel.

In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our President, and certain other employees.

In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our Chief Executive Officer (who is retiring in January 2023) and certain other employees.

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.

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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 continued availability of the LIBOR index is not guaranteed after 2022 and by June 2023, LIBOR is scheduled to be eliminated entirely.

We cannot 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.

At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight repurchase agreements, which are expected to be based on the Secured Overnight Financing Rate ("SOFR").

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 to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings.

The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor rate to the designated rate would be selected.

If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the substitute index or indices for the calculation of interest rates to be selected.

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.

We will transition to

SOFR as a substitute for LIBOR in June of 2023.

As of September 30, 2022, there were $2.92 million of loans in our portfolio tied to LIBOR.

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

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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.

For example, residential or commercial construction projects may be impacted as builders may incur additional expenses to comply with possible standards of increasing green space or reducing emissions.

Possible requirements may lengthen the required time to complete construction projects.

If requirements are not satisfied, conversion of the loan from the construction phase to the permanent phase may be significantly delayed.

Among the impacts to us could be a drop in demand for our products and services, particularly in certain industry sectors as well as possibly having a negative impact on our cash flow.

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

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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