TIMBERLAND BANCORP INC 10-K

Item 8. Financial Statements and Supplementary Data TIMBERLAND BANCORP, INC. AND SUBSIDIARY Index to Consolidated Financial Statements Page Report of Independent Registered Public Accounting Firm (Delap LLP, Lake Oswego, Oregon, PCAOB ID: 116 ) 68 Consolidated Balance Sheets as of September 30, 2023 and 2022 70 Consolidated Statements of Income for the Years Ended September 30, 2023, 2022 and 2021 72 Consolidated Statements of Comprehensive Income for the Years Ended September 30, 2023, 2022 and 2021 74 Consolidated Statements of Shareholders' Equity for the Years Ended September 30, 2023, 2022 and 2021 75 Consolidated Statements of Cash Flows for the Years Ended September 30, 2023, 2022 and 2021 76 Notes to Consolidated Financial Statements 78 66 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Timberland Bancorp, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Timberland Bancorp, Inc. and Subsidiary (collectively, "the Company") as of September 30, 2023 and 2022, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended September 30, 2023, and the related notes (collectively, "the financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2023 and 2022, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2023, in conformity with accounting principles generally accepted in the United States of America (U.S.). Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates. Allowance for Loan Losses Critical Audit Matter Description As described in Notes 1 and 4 to the financial statements, the Company's allowance for loan losses (ALL) is a valuation account that reflects the estimated loan losses based on known and inherent risks in the loan portfolio 67 to the extent that they are both probable and reasonable to estimate. The ALL was approximately $15,817,000 as of September 30, 2023, which consists of specific and general components in the amounts of $123,000 and $15,694,000, respectively. The specific component relates to loans that are classified as impaired. The Company measures impairment and the related asset specific allowance for impaired loans based on the difference between the recorded investment of the loan and the present value of the expected future cash flows, discounted at the original effective interest rate of the loan. However, if the loan is collateral-dependent, the Company measures impairment based upon the fair value of the underlying collateral, which the Company determines based on the current fair value of the collateral less estimated selling costs. Loans are identified as collateral-dependent if the Company believes that collateral is the sole source of repayment. The general component is based on historical losses, general economic conditions, and other qualitative risk factors – both internal and external to the Company. The historical loss ratio and valuation allowance are established for each pool of similar loans and updated periodically based on actual charge-off experience and current events. The qualitative risk factors are generally determined by evaluating, among other things: (1) lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices; (2) national and local economic trends and conditions; (3) nature and volume of the portfolio and terms of loans; (4) experience, ability, and depth of lending management and staff; (5) volume and severity of past due, classified, and nonaccrual loans, as well as other loan modifications; (6) quality of the Company's loan review system; (7) existence and effect of any concentrations of credit and changes in the level of such concentrations; (8) changes in the value of underlying collateral, and (9) other external factors such as competition and legal and regulatory requirements. The evaluation of the qualitative factor adjustments requires a significant amount of judgment by management and involves a high degree of subjectivity. We identified the ALL as a critical audit matter, as auditing the underlying qualitative factors required significant auditor judgment given that amounts determined by management rely on analysis that is highly subjective and includes significant estimation uncertainty. How the Critical Audit Matter Was Addressed in the Audit The primary audit procedures we performed to address this critical audit matter included the following, among others: a. We obtained an understanding of the relevant controls related to management’s establishment of the qualitative factors, assessment, review, and approval of the qualitative factors, and the data used in determining the qualitative factors. b. We obtained an understanding of how management developed the estimates and related assumptions, including: i. Testing completeness and accuracy of key data inputs used in forming assumptions or calculations and testing the reliability of the underlying data on which these factors are based by comparing information to source documents and external information sources, as well as evaluating the estimated correlation to potential loss. ii. Evaluating the reasonableness of the qualitative factors established by management as compared to the underlying internal or external information sources. c. We obtained an understanding of the loans excluded from the general component calculation for propriety of classification as acquired or impaired loans. /s/ Delap LLP We have served as the Company's auditors since 2010. Lake Oswego, Oregon December 11, 2023 68 Consolidated Balance Sheets (Dollars in Thousands, Except Per Share Amounts) Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 2023 2022 Assets Cash and cash equivalents: Cash and due from financial institutions $ 25,390 $ 24,808 Interest-bearing deposits in banks 103,331 291,947 Total cash and cash equivalents 128,721 316,755 Certificates of deposit (“CDs”) held for investment, at cost 15,188 22,894 Investment securities held to maturity, at amortized cost (estimated fair value $ 253,766 and $ 249,783 ) 270,218 266,608 Investment securities available for sale, at fair value 41,771 41,415 Investments in equity securities, at fair value 811 835 Federal Home Loan Bank of Des Moines (“FHLB”) stock 3,602 2,194 Other investments, at cost 3,000 3,000 Loans held for sale 400 748 Loans receivable, net of allowance for loan losses of $ 15,817 and $ 13,703 1,302,305 1,132,426 Premises and equipment, net 21,642 21,898 Accrued interest receivable 6,004 4,483 Bank owned life insurance (“BOLI”) 22,966 22,806 Goodwill 15,131 15,131 Core deposit intangible (“CDI”), net 677 948 Loan servicing rights, net 2,124 3,023 Operating lease right-of-use ("ROU") assets 1,772 1,980 Other assets 3,573 3,364 Total assets $ 1,839,905 $ 1,860,508 Liabilities and shareholders’ equity Liabilities Deposits: Non-interest-bearing demand $ 455,864 $ 530,058 Interest-bearing 1,105,071 1,102,118 Total deposits 1,560,935 1,632,176 Operating lease liabilities 1,867 2,066 FHLB borrowings 35,000 — Other liabilities and accrued expenses 9,030 7,697 Total liabilities 1,606,832 1,641,939 Commitments and contingencies (See Note 16) See Notes to Consolidated Financial Statements 69 Consolidated Balance Sheets (continued) (Dollars in Thousands, Except Per Share Amounts) Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Shareholders’ equity 2023 2022 Preferred stock, $ 0.01 par value; 1,000,000 shares authorized; none issued $ — $ — Common stock, $ 0.01 par value; 50,000,000 shares authorized; 8,105,338 shares issued and outstanding - September 30, 2023 8,221,952 shares issued and outstanding - September 30, 2022 34,771 38,751 Retained earnings 199,386 180,535 Accumulated other comprehensive loss ( 1,084 ) ( 717 ) Total shareholders’ equity 233,073 218,569 Total liabilities and shareholders’ equity $ 1,839,905 $ 1,860,508 See Notes to Consolidated Financial Statements 70 Consolidated Statements of Income (Dollars in Thousands, Except Per Share Amounts) Timberland Bancorp, Inc. and Subsidiary Years Ended September 30, 2023, 2022 and 2021 2023 2022 2021 Interest and dividend income Loans receivable and loans held for sale $ 63,154 $ 51,324 $ 52,539 Investment securities 9,384 3,488 1,195 Dividends from mutual funds, FHLB stock and other investments 270 120 111 Interest-bearing deposits in banks and CDs 7,143 3,576 1,117 Total interest and dividend income 79,951 58,508 54,962 Interest expense Deposits 11,302 2,657 3,013 FHLB borrowings 290 17 91 Total interest expense 11,592 2,674 3,104 Net interest income 68,359 55,834 51,858 Provision for loan losses 2,132 270 — Net interest income after provision for loan losses 66,227 55,564 51,858 Non-interest income Net recoveries on investment securities 9 22 20 Gain on sales of investment securities, net 95 — — Service charges on deposits 3,824 3,964 3,911 ATM and debit card interchange transaction fees 5,194 5,210 5,084 BOLI net earnings 706 613 597 Gain on sales of loans, net 244 1,510 5,904 Escrow fees 109 211 290 Valuation recovery on loan servicing rights, net — 119 110 Other, net 959 975 1,245 Total non-interest income, net 11,140 12,624 17,161 See Notes to Consolidated Financial Statements 71 Consolidated Statements of Income (continued) (Dollars in Thousands, Except Per Share Amounts) Timberland Bancorp, Inc. and Subsidiary Years Ended September 30, 2023, 2022 and 2021 2023 2022 2021 Non-interest expense Salaries and employee benefits $ 23,562 $ 20,816 $ 18,750 Premises and equipment 3,915 3,736 3,942 (Gain) loss on sales/dispositions of premises and equipment, net ( 19 ) 13 — Advertising 786 695 625 OREO and other repossessed assets, net 1 ( 17 ) ( 87 ) ATM and debit card interchange transaction fees 1,987 1,943 1,831 Postage and courier 532 577 587 Amortization of CDI 271 316 361 State and local taxes 1,219 1,062 1,088 Professional fees 2,078 1,747 1,006 Federal Deposit Insurance Corporation ("FDIC") insurance 711 506 415 Loan administration and foreclosure 503 508 471 Technology and communications 3,545 2,719 2,510 Deposit operations 1,368 1,235 1,091 Other 2,914 2,770 2,001 Total non-interest expense, net 43,373 38,626 34,591 Income before income taxes 33,994 29,562 34,428 Provision for income taxes 6,876 5,962 6,845 Net income $ 27,118 $ 23,600 $ 27,583 Net income per common share Basic $ 3.32 $ 2.84 $ 3.31 Diluted $ 3.29 $ 2.82 $ 3.27 See Notes to Consolidated Financial Statements 72 Consolidated Statements of Comprehensive Income (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiary Years Ended September 30, 2023, 2022 and 2021 2023 2022 2021 Comprehensive income Net income $ 27,118 $ 23,600 $ 27,583 Other comprehensive loss Unrealized holding loss on investment securities available for sale, net of income taxes of $( 98 ), $( 209 ), and $( 2 ), respectively ( 369 ) ( 781 ) ( 12 ) Change in OTTI on investment securities held to maturity, net of income taxes: Adjustments related to other factors for which OTTI was previously recognized, net of income taxes of $ 0 , $ 0 , and $ 1 , respectively — ( 1 ) 2 Accretion of OTTI on investment securities held to maturity, net of income taxes of $ 1 , $ 2 , and $ 2 , respectively 2 6 8 Total other comprehensive loss, net of income taxes ( 367 ) ( 776 ) ( 2 ) Total comprehensive income $ 26,751 $ 22,824 $ 27,581 See Notes to Consolidated Financial Statements 73 Consolidated Statements of Shareholders’ Equity (Dollars in Thousands, Except Per Share Amounts) Timberland Bancorp, Inc. and Subsidiary Years Ended September 30, 2023, 2022 and 2021 Common Stock Accumulated Other Comprehensive Income (Loss) Number of Shares Amount Retained Earnings Total Balance, September 30, 2020 8,310,793 $ 42,396 $ 145,173 $ 61 $ 187,630 Net income — — 27,583 — 27,583 Other comprehensive loss — — — ( 2 ) ( 2 ) Repurchase of common stock ( 19,588 ) ( 527 ) — — ( 527 ) Exercise of stock options 64,264 631 — — 631 Common stock dividends ($ 1.03 per common share) — — ( 8,589 ) — ( 8,589 ) Stock option compensation expense — 173 — — 173 Balance, September 30, 2021 8,355,469 42,673 164,167 59 206,899 Net income — — 23,600 — 23,600 Other comprehensive loss — — — ( 776 ) ( 776 ) Repurchase of common stock ( 170,237 ) ( 4,583 ) — — ( 4,583 ) Exercise of stock options 36,720 415 — — 415 Common stock dividends ($ 0.87 per common share) — — ( 7,232 ) — ( 7,232 ) Stock option compensation expense — 246 — — 246 Balance, September 30, 2022 8,221,952 38,751 180,535 ( 717 ) 218,569 Net income — — 27,118 — 27,118 Other comprehensive loss — — — ( 367 ) ( 367 ) Repurchase of common stock ( 185,399 ) ( 4,998 ) — — ( 4,998 ) Restricted stock grants 26,150 — — — — Exercise of stock options 42,635 698 — — 698 Common stock dividends ($ 1.01 per common share) — — ( 8,267 ) — ( 8,267 ) Stock option compensation expense — 320 — — 320 Balance, September 30, 2023 8,105,338 $ 34,771 $ 199,386 $ ( 1,084 ) $ 233,073 See Notes to Consolidated Financial Statements 74 Consolidated Statements of Cash Flows (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiary Years Ended September 30, 2023, 2022 and 2021 2023 2022 2021 Cash flows from operating activities Net income $ 27,118 $ 23,600 $ 27,583 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,381 1,367 1,563 Deferred income taxes ( 291 ) ( 177 ) 275 Amortization of CDI 271 316 361 Accretion of discount on purchased loans ( 75 ) ( 182 ) ( 340 ) Stock option compensation expense 320 246 173 Gain on sales of investment securities, net ( 95 ) — — Net recoveries on investment securities ( 9 ) ( 22 ) ( 20 ) Change in fair value of investments in equity securities 24 120 22 Gain on sales of OREO and other repossessed assets, net — ( 2 ) ( 92 ) Amortization (accretion) of discounts and premiums on securities ( 1,223 ) ( 39 ) 118 Gain on sales of loans, net ( 244 ) ( 1,510 ) ( 5,904 ) (Gain) loss on sales/dispositions of premises and equipment, net ( 19 ) 13 — Provision for loan losses 2,132 270 — Loans originated for sale ( 10,946 ) ( 55,136 ) ( 133,006 ) Proceeds from sales of loans 11,538 59,115 140,202 Amortization of loan servicing rights 1,012 1,156 1,111 Valuation adjustment on loan servicing rights, net — ( 119 ) ( 110 ) BOLI net earnings ( 627 ) ( 613 ) ( 597 ) BOLI death benefit in excess of cash surrender value ( 79 ) — — Increase (decrease) in deferred loan origination fees 921 ( 822 ) ( 1,293 ) Net change in accrued interest receivable and other assets, and other liabilities and accrued expenses ( 112 ) ( 1,081 ) ( 411 ) Net cash provided by operating activities 30,997 26,500 29,635 Cash flows from investing activities Net decrease in CDs held for investment 7,706 5,588 37,063 Purchase of investment securities held to maturity ( 15,602 ) ( 208,778 ) ( 53,049 ) Purchase of investment securities available for sale ( 16,994 ) — ( 18,698 ) Proceeds from maturities and prepayments of investment securities held to maturity 13,123 11,661 12,004 Proceeds from maturities and prepayments of investment securities available for sale 7,442 20,448 13,162 Proceeds from sales of investment securities available for sale 8,927 — — Purchase of FHLB stock ( 1,408 ) ( 91 ) ( 181 ) (Increase) decrease in loans receivable, net ( 172,857 ) ( 163,238 ) 47,054 Purchase of premises and equipment ( 1,106 ) ( 911 ) ( 895 ) Proceeds from sales of OREO and other repossessed assets — 159 985 Proceeds from death benefit on BOLI 546 — — Net cash provided by (used in) investing activities ( 170,223 ) ( 335,162 ) 37,445 See Notes to Consolidated Financial Statements 75 Consolidated Statements of Cash Flows (continued) (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiary Years Ended September 30, 2023, 2022 and 2021 2023 2022 2021 Cash flows from financing activities Net (decrease) increase in deposits $ ( 71,241 ) $ 61,621 $ 212,149 Proceeds from (repayment of) FHLB borrowings 35,000 ( 5,000 ) ( 5,000 ) Proceeds from exercise of stock options 698 415 631 Repurchase of common stock ( 4,998 ) ( 4,583 ) ( 527 ) Payment of dividends ( 8,267 ) ( 7,232 ) ( 8,589 ) Net cash (used in) provided by financing activities ( 48,808 ) 45,221 198,664 Net increase (decrease) in cash and cash equivalents ( 188,034 ) ( 263,441 ) 265,744 Cash and cash equivalents Beginning of year 316,755 580,196 314,452 End of year $ 128,721 $ 316,755 $ 580,196 Supplemental disclosure of cash flow information Income taxes paid $ 6,989 $ 5,450 $ 5,965 Interest paid 10,303 2,700 3,244 Supplemental disclosure of non-cash investing and financing activities Other comprehensive loss related to investment securities $ ( 367 ) $ ( 776 ) $ ( 2 ) Operating lease liabilities arising from recording of ROU assets 72 — — See Notes to Consolidated Financial Statements 76 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 1 - Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of Timberland Bancorp, Inc. (“Timberland Bancorp”), its wholly owned subsidiary, Timberland Bank (the “Bank”), and the Bank’s wholly owned subsidiary, Timberland Service Corp. (collectively, the "Company”). All significant intercompany transactions and balances have been eliminated in consolidation. Nature of Operations Timberland Bancorp is a bank holding company which operates primarily through its subsidiary, the Bank. The Bank was established in 1915 and, through its 23 branches located in Grays Harbor, Pierce, Thurston, Kitsap, King and Lewis counties in Washington State, attracts deposits from the general public and uses those funds, along with other borrowings, primarily to provide residential real estate, construction, commercial real estate, commercial business and consumer loans to borrowers primarily in western Washington. Consolidated Financial Statement Presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S.") (“GAAP”) and prevailing practices within the banking industry. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, as of the date of the consolidated balance sheets, and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, the determination of any OTTI in the fair value of investment securities, the valuation of loan servicing rights, the valuation of assets acquired and liabilities assumed in acquisitions and the valuation of goodwill for potential impairment. Certain prior year amounts have been reclassified to conform to the 2023 fiscal year presentation with no change to previously reported net income or shareholders’ equity. Segment Reporting The Company has one reportable operating segment which is defined as community banking in western Washington under the operating name “Timberland Bank.” Cash and Cash Equivalents and Cash Flows The Company considers amounts included in the consolidated balance sheets’ captions “Cash and due from financial institutions” and “Interest-bearing deposits in banks,” all of which mature within ninety days, to be cash equivalents for purposes of reporting cash flows. Interest-bearing deposits in banks as of September 30, 2023 and 2022 included deposits with the Federal Reserve Bank of San Francisco ("FRB") of $ 84,500,000 and $ 215,637,000 , respectively. The Company also maintains balances in correspondent bank accounts which, at times, may exceed the FDIC insurance limit of $250,000 per correspondent bank. Management believes that its risk of loss associated with such balances is minimal due to the financial strength of the FRB and the correspondent banks. CDs Held for Investment CDs held for investment include amounts invested with other FDIC-insured financial institutions for a stated interest rate and with a fixed maturity date. Such CDs generally have maturities of 12 to 60 months from the date of purchase by the Company. Early withdrawal penalties may apply; however, the Company intends to hold these CDs to maturity. The Company generally limits its purchases of CDs to a maximum of $250,000 (the FDIC insurance coverage limit) with any single financial institution. 77 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Investment Securities Investments in debt securities are classified upon acquisition as held to maturity or available for sale. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost. Investments in debt securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss), net of income tax effects. Premiums and discounts are amortized to interest income using the interest method over the contractual lives of the securities. Gains and losses on sales of investment securities are recognized on the trade date and determined using the specific identification method. In estimating whether there are any OTTI losses, management considers (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) the impact of changes in market interest rates and (4) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value. Declines in the fair value of individual debt securities available for sale that are deemed to be other than temporary are recognized in earnings when identified. The fair value of the debt security then becomes the new cost basis. For individual debt securities that are held to maturity which the Company does not intend to sell, and it is not more likely than not that the Company will be required to sell before recovery of its amortized cost basis, the other than temporary decline in the fair value of the debt security related to: (1) credit loss is recognized in earnings and (2) market or other factors is recognized in other comprehensive income (loss). Credit loss is recorded if the present value of expected future cash flows is less than the amortized cost. For individual debt securities which the Company intends to sell or more likely than not will not recover all of its amortized cost, the OTTI is recognized in earnings equal to the entire difference between the debt security’s cost basis and its fair value at the consolidated balance sheet date. For individual debt securities for which credit loss has been recognized in earnings, interest accruals and amortization and accretion of premiums and discounts are suspended when the credit loss is recognized. Interest received after accruals have been suspended is recognized on a cash basis. Investments in Equity Securities Investments in equity securities are stated at fair value. Changes in the fair value of investments in equity securities are recorded in other non-interest income. FHLB Stock The Bank, as a member of the FHLB, is required to maintain an investment in capital stock of the FHLB in an amount equal to 0.12 % of the Bank's total assets, with a maximum of $10 million and a minimum of $10,000, plus 4.00 % of any borrowings from the FHLB. On December 15, 2023, the capital stock requirements will change to 0.06% of the Bank's total assets, with no change in the maximum and minimum, plus 4.50% of any borrowings from the FHLB. No ready market exists for this stock, and it has no quoted market value. However, redemption of FHLB stock has historically been at par value. The Company's investment in FHLB stock is carried at cost, which approximates fair value. The Company evaluates its FHLB stock for impairment as needed. The Company's determination of whether this investment is impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared with the capital stock amount and the length of time that any decline has persisted; (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB; (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB; and (4) the liquidity position of the FHLB. Based on its evaluation, the Company determined that there was no impairment of FHLB stock at September 30, 2023 and 2022. Other Investments The Bank invests in the Solomon Hess SBA Loan Fund LLC - a private investment fund - to help satisfy compliance with the Bank's Community Reinvestment Act ("CRA") investment test requirements. Shares in this fund are not publicly traded and, therefore, have no readily determinable fair value. The Bank's investment in the fund is recorded at cost. An investor can have its investment in the fund redeemed for the balance of its capital account at any quarter-end with a 60 day notice to the fund. 78 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Loans Held for Sale Mortgage loans and commercial business loans originated and intended for sale in the secondary market are stated in the aggregate at the lower of cost or estimated fair value. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Gains or losses on sales of loans are recognized at the time of sale. The gain or loss is the difference between the net sales proceeds and the recorded value of the loans, including any remaining unamortized deferred loan origination fees. Loans Receivable Loans are stated at the amount of unpaid principal, reduced by the undisbursed portion of construction loans in process, net deferred loan origination fees and the allowance for loan losses. Interest on loans is accrued daily based on the principal amount outstanding. Generally, the accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to make payments as they become due or when they are past due 90 days as to either principal or interest (based on contractual terms), unless the loan is well secured and in the process of collection. In determining whether a borrower may be able to make payments as they become due, management considers circumstances such as the financial strength of the borrower, the estimated collateral value, reasons for the delays in payments, payment record, the amounts past due and the number of days past due. All interest accrued but not collected for loans that are placed on non-accrual status or charged off is reversed against interest income. Subsequent collections on a cash basis are applied proportionately to past due principal and interest, unless collectability of principal is in doubt, in which case all payments are applied to principal. Loans are returned to accrual status when the loan is deemed current, and the collectability of principal and interest is no longer doubtful, or, in the case of one- to four-family loans, when the loan is less than 90 days delinquent. The categories of non-accrual loans and impaired loans overlap, although they are not identical. The Company charges fees for originating loans. These fees, net of certain loan origination costs, are deferred and amortized to income on the level-yield basis over the loan term. If the loan is repaid prior to maturity, the remaining unamortized deferred loan origination fee is recognized in income at the time of repayment. Acquired Loans Purchased loans, including loans acquired in business combinations, are recorded at their estimated fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit-impaired ("PCI") or purchased non-credit-impaired. PCI loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. The excess of the cash flows expected to be collected over a PCI loan's carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the PCI loan using the effective yield method. The excess of the undiscounted contractual balances due over the cash flows expected to be collected is considered to be the nonaccretable difference. The nonaccretable difference represents the Company's estimate of the credit losses expected to occur and would be considered in determining the estimated fair value of the loans as of the acquisition date. Subsequent to the acquisition date, any increases in expected cash flows over those expected at the purchase date in excess of fair value are adjusted through a change to the accretable yield on a prospective basis. Any subsequent decreases in expected cash flows attributable to credit deterioration are recognized by recording an allowance for loan losses. PCI loans were insignificant as of September 30, 2023 and 2022. For purchased non-credit-impaired loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the life of the loans. Any subsequent deterioration in credit quality is recognized by recording an allowance for loan losses. Troubled Debt Restructured Loans A troubled debt restructured loan ("TDR") is a loan for which the Company, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. Examples of such concessions 79 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 include, but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market rates; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-amortizations, extensions, deferrals and renewals. TDRs are considered impaired and are individually evaluated for impairment. TDRs are classified as non-accrual (and considered to be non-performing) unless they have been performing in accordance with modified terms for a period of at least six months. Allowance for Loan Losses The allowance for loan losses is maintained at a level sufficient to provide for probable losses inherent in the loan portfolio. The allowance is provided based upon management's comprehensive analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the amount and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and a detailed analysis of individual loans for which full collectability may not be assured. The detailed analysis includes methods to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific and general components. The specific component relates to loans that are deemed impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value less selling costs (if applicable), or observable market price of the impaired loan is lower than the recorded value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. The Company's historical loss experience is determined by evaluating the average net charge-offs over the most recent economic cycle, but not to exceed six years. Qualitative factors are determined by loan type and allow management to adjust reserve levels to reflect the current general economic environment and portfolio performance trends including recent charge-off trends. Allowances are provided based on management’s continuing evaluation of the pertinent factors underlying the quality of the loan portfolio, including changes in the size and composition of the loan portfolio, actual loan loss experience, current economic conditions, collateral values, geographic concentrations, seasoning of the loan portfolio, specific industry conditions, the duration of the current business cycle, and regulatory requirements and expectations. When determining the appropriate historical loss and qualitative factors, management took into consideration the impact of the COVID-19 pandemic on such factors as the national and state unemployment rates and related trends, the amount and timing of financial assistance provided by the government, consumer spending levels and trends, industries significantly impacted by the COVID-19 pandemic, and the Company's COVID-19 loan modification program. The appropriateness of the allowance for loan losses is estimated based upon these factors and trends identified by management at the time that the consolidated financial statements are prepared. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts (principal and interest) when due according to the contractual terms of the loan agreement. Smaller balance homogeneous loans, such as residential mortgage loans and consumer loans, may be collectively evaluated for impairment. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when, as an alternative, the current estimated fair value of the collateral (reduced by estimated costs to sell, if applicable) or observable market price is used. The valuation of real estate collateral is subjective in nature and may be adjusted in future periods because of changes in economic conditions. Management considers third-party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling real estate, in determining the estimated fair value of particular properties. In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes and any related adjustments are generally recorded at the time such information is received. When the estimated net realizable value of the impaired loan is less than the recorded investment in the loan (including accrued interest and net deferred loan origination fees or costs), impairment is recognized by creating or adjusting an allocation of the allowance for loan losses, and uncollected accrued interest is reversed against interest income. If the ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance. A provision for (recapture of) loan losses is charged (credited) to operations and is added to (deducted from) the allowance for loan losses based on a quarterly comprehensive analysis of the loan portfolio. The allowance for loan losses is allocated to certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan portfolio. While management has allocated the allowance for loan losses to various loan portfolio segments, the allowance is general in nature and is available for the loan portfolio in its entirety. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. These factors may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. If real estate values decline and as updated appraisals are received on collateral for impaired loans, the Company may need to increase the 80 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 allowance for loan losses as appropriate. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations. Premises and Equipment Premises and equipment are recorded at cost. Depreciation is computed using the straight-line method over the following estimated useful lives: buildings and improvements - five to forty years; and furniture and equipment - three to seven years. The cost of maintenance and repairs is charged to expense as incurred. Gains and losses on dispositions are reflected in current earnings. Impairment of Long-Lived Assets Long-lived assets, consisting of premises and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the recorded amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the recorded amount of an asset to undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the recorded amount of the assets exceeds the discounted recovery amount or estimated fair value of the assets. No events or changes in circumstances have occurred during the years ended September 30, 2023 or 2022 that would cause management to re-evaluate the recoverability of the Company’s long-lived assets. OREO and Other Repossessed Assets OREO and other repossessed assets consist of properties or assets acquired through or in lieu of foreclosure, and are recorded initially at the estimated fair value of the properties less estimated costs of disposal, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. When the property is acquired, any excess of the loan balance over the estimated net realizable value is charged to the allowance for loan losses. The valuation of real estate is subjective in nature and may be adjusted in future periods because of changes in economic conditions. Management considers third-party appraisals, as well as independent fair market value assessments from realtors or persons involved in selling real estate, in determining the estimated fair values of particular properties. In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes and any related adjustments are generally recorded at the time such information is received. Costs relating to development and improvement of the properties or assets are capitalized, while costs relating to holding the properties or assets are expensed. BOLI BOLI policies are recorded at their cash surrender value less applicable cash surrender charges. Income from BOLI is recognized when earned. Goodwill Goodwill is initially recorded when the purchase price paid in a business combination exceeds the estimated fair value of the net identified tangible and intangible assets acquired and liabilities assumed. Goodwill is presumed to have an indefinite useful life and is analyzed annually for impairment. The Company performs an annual review during the third quarter of each fiscal year, or more frequently if indicators of potential impairment exist, to determine if the recorded goodwill is impaired. For purposes of goodwill impairment testing, the services offered through the Bank and its subsidiary are managed as one strategic unit and represent the Company's only reporting unit. The annual goodwill impairment test begins with a qualitative assessment of whether it is "more likely than not" that the reporting unit's fair value is less than its carrying amount. If an entity concludes that it is not "more likely than not" that the fair value of a reporting unit is less than its carrying amount, it need not perform a two-step impairment test. If the Company's qualitative assessment concluded that it is "more likely than not" that the fair value of its reporting unit is less than its carrying amount, it must perform the two-step impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized, if any. The first step of the goodwill impairment test compares the estimated fair 81 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 value of the reporting unit with its carrying amount, or the book value, including goodwill. If the estimated fair value of the reporting unit equals or exceeds its book value, goodwill is considered not impaired, and the second step of the impairment test is unnecessary. The second step, if necessary, measures the amount of goodwill impairment loss to be recognized. The reporting unit must determine fair value for all assets and liabilities, excluding goodwill. The net of the assigned fair value of assets and liabilities is then compared to the book value of the reporting unit, and any excess book value becomes the implied fair value of goodwill. If the carrying amount of the goodwill exceeds the newly calculated implied fair value of goodwill, an impairment loss is recognized in the amount required to write-down the goodwill to the implied fair value. Management's qualitative assessment takes into consideration macroeconomic conditions, industry and market considerations, cost or margin factors, financial performance and the share price of the Company's common stock. The Company performed its fiscal year 2023 goodwill impairment test during the quarter ended June 30, 2023 with the assistance of an independent third-party firm specializing in goodwill impairment valuations for financial institutions. Based on this assessment, the Company determined that it is not "more likely than not" that the Company's fair value is less than its carrying amount, and, therefore, goodwill was determined not to be impaired at May 31, 2023. A significant amount of judgment is involved in determining if an indicator of goodwill impairment has occurred. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in the Company's stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse assessment or action by a regulator; and unanticipated competition. Any change in these indicators could have a significant negative impact on the Company's financial condition, impact the goodwill impairment analysis or cause the Company to perform a goodwill impairment analysis more frequently than once per year. As of September 30, 2023, management believes that there were no events or changes in the circumstances since May 31, 2023 that would indicate a potential impairment of goodwill. No assurances can be given, however, that the Company will not record an impairment loss on goodwill in the future. If adverse economic conditions or decreases in the Company's stock price and market capitalization were deemed to be other than temporary, it may significantly affect the fair value of the Company's goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on the Company's results of operation and financial condition. CDI CDI represents the future economic benefit of the potential cost savings from acquiring core deposits as part of a business combination compared to the cost of alternative funding sources. CDI is amortized to non-interest expense using an accelerated method based on an estimated runoff of related deposits over a period of ten years. CDI is evaluated for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable, with any changes in estimated useful life accounted for prospectively over the revised remaining life. Loan Servicing Rights The Company holds rights to service (1) loans that it has originated and sold to the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and (2) the guaranteed portion of U.S. Small Business Administration ("SBA") loans sold in the secondary market. Loan servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold with the servicing rights retained. Loan servicing rights are amortized to servicing income on loans sold approximately in proportion to and over the period of estimated net servicing income. The value of loan servicing rights at the date of the sale of loans is estimated based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and expected prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the loan servicing assets to those estimated at the time that the loan servicing assets were originated. Fair values are estimated using expected future discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the loan servicing rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized loan servicing rights based on product type and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the loan servicing rights exceeds their fair value. Impairment, if deemed temporary, is recognized through a valuation allowance to the extent that fair value is less than the recorded amount. 82 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Operating Leases The Company has only identified leases classified as operating leases. Operating leases are recorded as ROU assets and ROU liabilities within operating lease assets and operating lease liabilities, respectively, in the consolidated balance sheet. ROU assets represent the Company's right to use an underlying asset for the lease term and ROU liabilities represent the Company's obligation to make lease payments arising from the lease. Operating lease ROU assets and ROU liabilities are recognized at the lease agreement commencement date based on the present value of lease payments over the lease term. The lease term incorporates options to extend the lease when it is reasonably certain that the Company will exercise that option. As the Company's leases typically do not provide an implicit rate; the Company uses the weighted average discount rate to estimate the present value of future lease payments in calculating the value of the ROU asset. The operating lease ROU assets is further reduced by any lease pre-payments made and lease incentives. The leases may contain various provisions for increases in rental rates based either on changes in the published Consumer Price Index or a predetermined escalation schedule and such variable lease payments are recognized as lease expense as they are incurred. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company excludes operating leases with a term of twelve months or less from being capitalized as ROU assets and ROU liabilities. Transfers of Financial Assets Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Income Taxes The Company files a consolidated federal and various state income tax returns. The Bank provides for income taxes separately and remits to (receives from) Timberland Bancorp amounts currently due (receivable). Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements. These temporary differences will result in differences between income for tax purposes and income for financial reporting purposes in future years. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established to reduce the net recorded amount of deferred tax assets if it is determined to be more likely than not that all or some portion of the potential deferred tax asset will not be realized. With respect to accounting for uncertainty in incomes taxes, a tax provision is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized upon examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters as income tax expense. The Company is no longer subject to U.S. federal income tax examination by tax authorities for years ended on or before September 30, 2019. Advertising Costs for advertising and marketing are expensed as incurred. Stock-Based Compensation The Company measures compensation cost for all stock-based awards based on the grant-date fair value of the stock-based awards and recognizes compensation cost over the service period of stock-based awards. The fair value of stock options is 83 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 determined using the Black-Scholes valuation model. Stock option forfeitures are accounted for as they occur. The fair value of restricted stock is determined based on the grant date fair value of the Company's common stock. Net Income Per Common Share Basic net income per common share is computed by dividing net income to common shareholders by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Nonvested shares of restricted stock are included in the computation of basic earnings per share because the holder has voting rights and shares in non-forfeitable dividends during the vesting period. Diluted net income per common share is computed by dividing net income to common shareholders by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method at the average share price for the Company's common stock during the period. Common stock equivalents arise from the assumed conversion of outstanding stock options. Related Party Transactions The Chairman of the Board of the Bank and Timberland Bancorp passed away during the year ended September 30, 2023. He was a member of the law firm that provides general counsel to the Company. Legal and other fees paid to this law firm during the period of time he served on the Board for years ended September 30, 2023, 2022 and 2021 totaled $ 24,000 , $ 48,000 and $ 67,000 , respectively. Recent Accounting Pronouncements In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments , as amended by ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10 and ASU 2019-11. ASU 2016-13 replaces the existing incurred losses methodology with a current expected losses methodology with respect to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held to maturity investment securities and off-balance sheet commitments. In addition, ASU 2016-13 requires credit losses relating to available for sale debt securities to be recorded through an allowance for credit losses rather than as a reduction of the carrying amount. ASU 2016-13 also changes the accounting for PCI debt securities and loans. ASU 2016-13 retains many of the current disclosure requirements in GAAP and expands certain disclosure requirements. As a "smaller reporting company" filer with the U.S. Securities and Exchange Commission, ASU 2016-13 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company adopted ASU 2016-13 as of October 1, 2023 in accordance with the required implementation date and recorded the impact of adoption to retained earnings, net of deferred income taxes, as required by the standard. The adjustment recorded at adoption was not significant to the overall allowance for credit losses or shareholders' equity as compared to September 30, 2023 and consisted of adjustments to the allowance for credit losses on loans as well as an adjustment to the Company's reserve for unfunded loan commitments. Subsequent to adoption, the Company will record adjustments to its allowance for credit losses and reserves for unfunded loan commitments through the provision for credit losses in the consolidated statement of income. The Company also recorded an immaterial allowance for credit losses on investment securities at the date of adoption. The majority of investment securities held are treasury or government agency-backed securities, which have minimal risk. In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. This ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity has to perform procedures to determine the fair value of its assets and liabilities (including unrecognized assets and liabilities) at the impairment testing date following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity would then recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized would not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity would consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU 2017-04 is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2022. The adoption ASU 2017-04 is not expected to a have a material impact on the Company's future consolidated financial statements. 84 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU applies to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate ("LIBOR") or other rate references expected to be discontinued because of reference rate reform. The ASU permits an entity to make necessary modifications to eligible contracts or transactions without requiring contract remeasurement or reassessment of a previous accounting determination. This ASU is effective for all entities as of March 12, 2020 through December 31, 2024. The Company has adopted ASU 2020-04 as of June 30, 2023. The adoption of ASU 2020-04 did not have a material impact on the Company's consolidated financial statements. In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU eliminates the accounting guidance for TDRs for creditors, requires new disclosures for creditors for certain loan refinancings and restructurings when a borrower is experiencing financial difficulty, and requires public business entities to include current-period gross write-offs in the vintage disclosure tables. The amendments in this ASU are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company adopted ASU 2022-02 in conjunction with ASU 2016-13 as of October 1, 2023. The adoption of ASU 2022-02 did not have a material impact on the consolidated financial statements. Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Company's financial position, results of operations or cash flows. Note 2 - Restricted Assets Federal Reserve regulations require that the Bank maintain certain minimum reserve balances on hand or on deposit with the FRB, based on a percentage of transaction account deposits. In response to the COVID-19 pandemic, the Federal Reserve reduced the reserve requirement ratio to zero percent, effective March 26, 2020. Currently, the FRB has not announced plans to re-impose a reserve requirement; however, the FRB may adjust reserve requirement ratios at its sole discretion. 85 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 3 - Investment Securities Held to maturity and available for sale investment securities were as follows as of September 30, 2023 and 2022 (dollars in thousands): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value September 30, 2023 Held to Maturity U.S. Treasury and U.S. government agency securities $ 171,626 $ — $ ( 10,088 ) $ 161,538 Mortgage-backed securities ("MBS"): U.S. government agencies 52,294 — ( 3,950 ) 48,344 Private label residential 44,011 295 ( 2,611 ) 41,695 Taxable municipal securities 1,787 — ( 47 ) 1,740 Bank issued trust preferred securities 500 — ( 51 ) 449 Total $ 270,218 $ 295 $ ( 16,747 ) $ 253,766 Available for Sale MBS: U.S. government agencies $ 43,132 $ — $ ( 1,361 ) $ 41,771 Total $ 43,132 $ — $ ( 1,361 ) $ 41,771 September 30, 2022 Held to Maturity U.S. Treasury and U.S. government agency securities $ 170,676 $ 11 $ ( 12,109 ) $ 158,578 MBS: U.S. government agencies 43,995 4 ( 2,486 ) 41,513 Private label residential 49,335 245 ( 2,392 ) 47,188 Taxable municipal securities 2,102 — (67) 2,035 Bank issued trust preferred securities 500 — ( 31 ) 469 Total $ 266,608 $ 260 $ ( 17,085 ) $ 249,783 Available for Sale MBS: U.S. government agencies $ 42,309 $ — $ ( 894 ) $ 41,415 Total $ 42,309 $ — $ ( 894 ) $ 41,415 86 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2023 (dollars in thousands): Less Than 12 Months 12 Months or Longer Total Estimated Fair Value Gross Unrealized Losses Qty Estimated Fair Value Gross Unrealized Losses Qty Estimated Fair Value Gross Unrealized Losses Held to Maturity U.S. Treasury and U.S. government agency securities $ 9,455 $ ( 129 ) 1 $ 152,082 $ ( 9,959 ) 26 $ 161,537 $ ( 10,088 ) MBS: U.S. government agencies 16,432 ( 549 ) 13 31,703 ( 3,401 ) 51 48,135 ( 3,950 ) Private label residential 1,288 ( 2 ) 1 38,205 ( 2,609 ) 32 39,493 ( 2,611 ) Taxable municipal securities — — — 1,740 ( 47 ) 1 1,740 ( 47 ) Bank issued trust preferred securities — — — 449 ( 51 ) 1 449 ( 51 ) Total $ 27,175 $ ( 680 ) 15 $ 224,179 $ ( 16,067 ) 111 $ 251,354 $ ( 16,747 ) Available for Sale MBS: U.S. government agencies $ 10,635 $ ( 308 ) 3 $ 30,809 $ ( 1,053 ) 27 $ 41,444 $ ( 1,361 ) Total $ 10,635 $ ( 308 ) 3 $ 30,809 $ ( 1,053 ) 27 $ 41,444 $ ( 1,361 ) Held to maturity and available for sale investment securities with unrealized losses were as follows as of September 30, 2022 (dollars in thousands): Less Than 12 Months 12 Months or Longer Total Estimated Fair Value Gross Unrealized Losses Qty Estimated Fair Value Gross Unrealized Losses Qty Estimated Fair Value Gross Unrealized Losses Held to Maturity U.S. Treasury and U.S. government agency securities $ 115,504 $ ( 7,224 ) 17 $ 33,638 $ ( 4,885 ) 9 $ 149,142 $ ( 12,109 ) MBS: U.S. government agencies 35,896 ( 1,449 ) 54 5,306 ( 1,037 ) 5 41,202 ( 2,486 ) Private label residential 35,447 ( 2,166 ) 27 8,708 ( 226 ) 6 44,155 ( 2,392 ) Taxable municipal securities 2,035 (67) 1 — — — 2,035 (67) Bank issued trust preferred securities 469 ( 31 ) 1 — — — 469 ( 31 ) Total $ 189,351 $ ( 10,937 ) 100 $ 47,652 $ ( 6,148 ) 20 $ 237,003 $ ( 17,085 ) Available for Sale MBS: U.S. government agencies $ 25,170 $ ( 292 ) 16 $ 15,705 $ ( 602 ) 13 $ 40,875 $ ( 894 ) Total $ 25,170 $ ( 292 ) 16 $ 15,705 $ ( 602 ) 13 $ 40,875 $ ( 894 ) 87 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The Company has evaluated the investment securities in the above tables and has determined that the decline in their fair value is temporary. The unrealized losses are primarily due to changes in market interest rates and spreads in the market for mortgage-related products. The fair value of these securities is expected to recover as the securities approach their maturity dates and/or as the pricing spreads narrow on mortgage-related securities. The Company has the ability and the intent to hold the investments until the fair value of these securities recovers. The Company bifurcates OTTI into (1) amounts related to credit losses which are recognized through earnings and (2) amounts related to all other factors which are recognized as a component of other comprehensive income (loss). To determine the component of the gross OTTI related to credit losses, the Company compared the amortized cost basis of the OTTI security to the present value of its revised expected cash flows, discounted using its pre-impairment yield. The revised expected cash flow estimates for individual securities are based primarily on an analysis of default rates, prepayment speeds and third-party analytic reports. Significant judgment by management is required in this analysis that includes, but is not limited to, assumptions regarding the collectability of principal and interest, net of related expenses, on the underlying loans. The following table presents a summary of the significant inputs utilized to measure management’s estimates of the credit loss component on OTTI securities as of September 30, 2023, 2022 and 2021: Range Weighted Minimum Maximum Average September 30, 2023 Constant prepayment rate 6.00 % 15.00 % 8.26 % Collateral default rate — % 26.71 % 11.28 % Loss severity rate — % 5.73 % 1.55 % September 30, 2022 Constant prepayment rate 6.00 % 15.00 % 12.98 % Collateral default rate 0.58 % 25.64 % 9.96 % Loss severity rate — % 8.19 % 3.36 % September 30, 2021 Constant prepayment rate 6.00 % 15.00 % 10.20 % Collateral default rate 1.47 % 17.55 % 12.19 % Loss severity rate — % 12.96 % 4.55 % The following table presents a roll forward of the credit loss component of held to maturity and available for sale debt securities that have been written down for OTTI with the credit loss component recognized in earnings for the years ended September 30, 2023, 2022 and 2021 (dollars in thousands): 2023 2022 2021 Balance, beginning of year $ 836 $ 853 $ 885 Additions: Additional increases to the amount related to credit losses for which OTTI was previously recognized — — 2 Subtractions: Net realized gain (losses) previously recorded as credit losses ( 11 ) 1 ( 12 ) Recovery of prior credit loss ( 9 ) ( 18 ) ( 22 ) Balance, end of year $ 816 $ 836 $ 853 88 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 During the year ended September 30, 2023, the Company recorded a $ 11,000 net realized loss on 14 held to maturity investment securities, all of which had been recognized previously as a credit loss. During the year ended September 30, 2022, the Company recorded a $ 1,000 net realized gain on 16 held to maturity investment securities, all of which had been recognized previously as a credit loss. During the year ended September 30, 2021, the Company recorded a $ 12,000 net realized loss on 19 held to maturity investment securities, all of which had been recognized previously as a credit loss. During the year ended September 30, 2023, the Company recorded a $95,000 realized gain on sale of two available for sale investment securities. There were no realized gains or losses on available for sale investment securities for the years ended September 30, 2022 and 2021. The recorded amount of investment securities pledged as collateral for public fund deposits, federal treasury tax and loan deposits and FHLB collateral totaled $ 201,817,000 and $ 133,824,000 at September 30, 2023 and 2022, respectively. The contractual maturities of debt securities at September 30, 2023 are as follows (dollars in thousands). Expected maturities may differ from scheduled maturities due to the prepayment of principal or call provisions. Held to Maturity Available for Sale Amortized Cost Estimated Fair Value Amortized Cost Estimated Fair Value Due within one year $ 83,614 $ 82,258 $ 388 $ 385 Due after one year to five years 105,308 96,743 2,608 2,590 Due after five years to ten years 10,510 9,428 6,689 6,642 Due after ten years 70,786 65,337 33,447 32,154 Total $ 270,218 $ 253,766 $ 43,132 $ 41,771 89 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 4 - Loans Receivable and Allowance for Loan Losses Loans receivable by portfolio segment consisted of the following at September 30, 2023 and 2022 (dollars in thousands): 2023 2022 Mortgage loans: One- to four-family $ 253,227 $ 176,116 Multi-family 127,176 95,025 Commercial 568,265 536,650 Construction – custom and owner/builder 129,699 119,240 Construction – speculative one- to four-family 17,099 12,254 Construction – commercial 51,064 40,364 Construction – multi-family 57,140 64,480 Construction – land development 18,841 19,280 Land 26,726 26,854 Total mortgage loans 1,249,237 1,090,263 Consumer loans: Home equity and second mortgage 38,281 35,187 Other 2,772 2,128 Total consumer loans 41,053 37,315 Commercial loans: Commercial business 135,802 125,039 SBA Paycheck Protection Program ("PPP") 466 1,001 Total commercial loans 136,268 126,040 Total loans receivable 1,426,558 1,253,618 Less: Undisbursed portion of construction loans in process 103,194 103,168 Deferred loan origination fees, net 5,242 4,321 Allowance for loan losses 15,817 13,703 124,253 121,192 Loans receivable, net $ 1,302,305 $ 1,132,426 Loans receivable at September 30, 2023 and 2022 are reported net of unamortized discounts totaling $ 192,000 and $ 267,000 , respectively. Significant Concentrations of Credit Risk Most of the Company’s lending activity is with customers located in the state of Washington and involves real estate. At September 30, 2023, the Company had $ 1,287,518,000 (including $ 103,194,000 of undisbursed construction loans in process) in loans secured by real estate, which represented 90.3 % of total loans receivable. The real estate loan portfolio is primarily secured by one- to four-family properties, multi-family properties, land, and a variety of commercial real estate property types. At September 30, 2023, there were no concentrations of real estate loans to a specific industry or secured by a specific collateral type that equaled or exceeded 20 % of the Company’s total loan portfolio, other than loans secured by one-to four-family properties. The ultimate collectability of a substantial portion of the loan portfolio is susceptible to changes in economic and market conditions in the region and the impact of those changes on the real estate market. The Company typically originates real estate loans with loan-to-value ratios of no greater than 85 %. Collateral and/or guarantees are required for all loans. 90 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Related Party Loans Certain related parties of the Company, principally Bank directors and officers, are loan customers of the Bank in the ordinary course of business. Such related party loans were performing according to their repayment terms at September 30, 2023 and 2022. Activity in related party loans during the years ended September 30, 2023, 2022 and 2021 was as follows (dollars in thousands): 2023 2022 2021 Balance, beginning of year $ 50 $ 466 $ 248 New loans or borrowings 61 40 316 Repayments and reclassifications ( 9 ) ( 456 ) ( 98 ) Balance, end of year $ 102 $ 50 $ 466 Loan Segment Risk Characteristics The Company believes that its loan classes are the same as its loan segments. One- To Four-Family Residential Lending: The Company originates both fixed-rate and adjustable-rate loans secured by one- to four-family residences. A portion of the fixed-rate one- to four-family loans are sold in the secondary market for asset/liability management purposes and to generate non-interest income. The Company’s lending policies generally limit the maximum loan-to-value on one- to four-family loans to 85 % of the lesser of the appraised value or the purchase price. However, the Company usually obtains private mortgage insurance on the portion of the principal amount that exceeds 80 % of the appraised value of the property. Multi-Family Lending : The Company originates loans secured by multi-family dwelling units (more than four units). Multi-family lending generally affords the Company an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by multi-family properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or economy. The Company attempts to minimize these risks by scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Commercial Mortgage Lending : The Company originates commercial real estate loans secured by properties such as office buildings, retail/wholesale facilities, motels, restaurants, mini-storage facilities and other commercial properties. Commercial real estate lending generally affords the Company an opportunity to receive interest at higher rates than those available from one- to four-family residential lending. However, loans secured by such properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial properties are often dependent on the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or economy. The Company attempts to mitigate these risks by generally limiting the maximum loan-to-value ratio to 80 % and scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Construction Lending : The Company currently originates the following types of construction loans: custom construction loans, owner/builder construction loans, speculative construction loans, commercial real estate construction loans, multi-family construction loans and land development loans. Construction lending affords the Company the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does its single-family permanent mortgage lending. Construction lending, however, is generally considered to involve a higher degree of risk than one- to four family residential lending because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost of the project. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimated cost of construction proves to be inaccurate, the Company may be required to advance funds beyond the amount originally committed to complete the project. If the estimate of value upon completion proves to be inaccurate, the Company may be confronted with a project whose value is insufficient to assure full repayment, and the Company may incur a loss. Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to construct homes for which no purchaser has been 91 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 identified carry more risk, because the payoff for the loan depends on the builder’s ability to sell the property prior to the time that the construction loan is due. The Company attempts to mitigate these risks by adhering to its underwriting policies, disbursement procedures and monitoring practices. Construction Lending – Custom and Owner/Builder: Custom construction and owner/builder construction loans are originated to home owners and are typically refinanced into permanent loans at the completion of construction. Construction Lending – Speculative One- To Four-Family: Speculative one-to four-family construction loans are made to home builders and are termed “speculative”, because the home builder does not have, at the time of the loan origination, a signed contract with a home buyer who has a commitment for permanent financing with the Company or another lender for the finished home. The home buyer may be identified either during or after the construction period. Construction Lending – Commercial: Commercial construction loans are originated to construct properties such as office buildings, hotels, retail rental space and mini-storage facilities. Construction Lending – Multi-Family: Multi-family construction loans are originated to construct apartment buildings and condominium projects. Construction Lending – Land Development: Land development loans are originated to real estate developers for the purpose of developing residential subdivisions. The Company is currently originating land development loans on a limited basis. Land Lending : The Company originates loans for the acquisition of land upon which the purchaser can then build or make improvements necessary to build or to sell as improved lots. Loans secured by undeveloped land or improved lots involve greater risks than one- to four-family residential mortgage loans because these loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in the event of default or foreclosure, the Company may be confronted with a property value which is insufficient to assure full repayment. The Company attempts to minimize this risk by generally limiting the maximum loan-to-value ratio on land loans to 65 %. Consumer Lending – Home Equity and Second Mortgage: The Company originates home equity lines of credit and second mortgage loans. Home equity lines of credit and second mortgage loans have a greater credit risk than one- to four-family residential mortgage loans because they are secured by mortgages subordinated to the existing first mortgage on the property, which may or may not be held by the Company. The Company attempts to mitigate these risks by adhering to its underwriting policies in evaluating the collateral and the credit-worthiness of the borrower. Consumer Lending – Other: The Company originates other consumer loans, which include automobile loans, boat loans, motorcycle loans, recreational vehicle loans, savings account loans and unsecured loans. Other consumer loans generally have shorter terms to maturity than mortgage loans. Other consumer loans generally involve a greater degree of risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The Company attempts to mitigate these risks by adhering to its underwriting policies in evaluating the credit-worthiness of the borrower. Commercial Business Lending: The Company originates commercial business loans which, excluding SBA PPP loans, are generally secured by business equipment, accounts receivable, inventory and/or other property. The Company also generally obtains personal guarantees from the business owners based on a review of personal financial statements. Commercial business lending generally involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable and/or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment, because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use. Accordingly, the repayment of a commercial business loan depends primarily on the credit-worthiness of the borrower (and any guarantors), while the liquidation of collateral is a secondary and potentially insufficient source of repayment. The Company attempts to mitigate these risks by adhering to its underwriting policies in evaluating the management of the business and the credit-worthiness of the borrowers and the guarantors. 92 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 SBA PPP: The Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") authorized the SBA to temporarily guarantee loans under the PPP. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020 through the program's initial conclusion in August 2020. The Consolidated Appropriations Act, 2021 ("CAA 2021"), which was signed into law on December 27, 2020, renewed and extended the PPP until May 31, 2021. As a result, the Company began originating PPP loans again in January 2021. The SBA guarantees 100% of PPP loans made to eligible borrowers, and the entire amount of the borrower's PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA. PPP loans have: (1) an interest rate of 1%, (2) a two-year loan term to maturity for loans approved by the SBA prior to June 5, 2020 (unless the borrower and the Company mutually agree to extend the term of the loan to five years) and a five-year maturity for loans approved thereafter; and (3) principal and interest payments deferred for at least six months from the date of disbursement. The PPP ended on May 31, 2021. Allowance for Loan Losses The following table sets forth information for the year ended September 30, 2023 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands): Beginning Allowance Provision for (Recapture of) Loan Losses Charge- offs Recoveries Ending Allowance Mortgage loans: One- to four-family $ 1,658 $ 759 $ — $ — $ 2,417 Multi-family 855 301 — — 1,156 Commercial 6,682 527 — — 7,209 Construction – custom and owner/builder 675 75 — — 750 Construction – speculative one- to four-family 130 18 — — 148 Construction – commercial 343 ( 27 ) — — 316 Construction – multi-family 447 155 — — 602 Construction – land development 233 41 — — 274 Land 397 9 — — 406 Consumer loans: Home equity and second mortgage 440 79 — — 519 Other 42 14 ( 4 ) 1 53 Commercial business loans 1,801 181 ( 15 ) — 1,967 Total $ 13,703 $ 2,132 $ ( 19 ) $ 1 $ 15,817 93 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table sets forth information for the year ended September 30, 2022 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands): Beginning Allowance Provision for (Recapture of) Loan Losses Charge- offs Recoveries Ending Allowance Mortgage loans: One- to four-family $ 1,154 $ 504 $ — $ — $ 1,658 Multi-family 765 90 — — 855 Commercial 6,813 ( 131 ) — — 6,682 Construction – custom and owner/builder 644 31 — — 675 Construction – speculative one- to four-family 188 ( 58 ) — — 130 Construction – commercial 784 ( 441 ) — — 343 Construction – multi-family 436 11 — — 447 Construction – land development 124 109 — — 233 Land 470 ( 73 ) — — 397 Consumer loans: Home equity and second mortgage 528 ( 88 ) — — 440 Other 50 1 ( 10 ) 1 42 Commercial business loans 1,513 315 ( 49 ) 22 1,801 Total $ 13,469 $ 270 $ ( 59 ) $ 23 $ 13,703 The following table sets forth information for the year ended September 30, 2021 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands): Beginning Allowance Provision for (Recapture of) Loan Losses Charge- offs Recoveries Ending Allowance Mortgage loans: One- to four-family $ 1,163 $ ( 9 ) $ — $ — $ 1,154 Multi-family 718 47 — — 765 Commercial 7,144 ( 331 ) — — 6,813 Construction – custom and owner/builder 832 ( 188 ) — — 644 Construction – speculative one- to four-family 158 30 — — 188 Construction – commercial 420 364 — — 784 Construction – multi-family 238 198 — — 436 Construction – land development 133 ( 9 ) — — 124 Land 572 ( 147 ) — 45 470 Consumer loans: Home equity and second mortgage 593 ( 65 ) — — 528 Other 71 ( 24 ) ( 1 ) 4 50 Commercial business loans 1,372 134 ( 2 ) 9 1,513 Total $ 13,414 $ — $ ( 3 ) $ 58 $ 13,469 94 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table presents information on loans evaluated individually and collectively for impairment in the allowance for loan losses by portfolio segment at September 30, 2023 (dollars in thousands): Allowance for Loan Losses Recorded Investment in Loans Individually Evaluated for Impairment Collectively Evaluated for Impairment Total Individually Evaluated for Impairment Collectively Evaluated for Impairment Total Mortgage loans: One- to four-family $ — $ 2,417 $ 2,417 $ 368 $ 252,859 $ 253,227 Multi-family — 1,156 1,156 — 127,176 127,176 Commercial — 7,209 7,209 2,973 565,292 568,265 Construction – custom and owner/ builder — 750 750 — 73,239 73,239 Construction – speculative one- to four-family — 148 148 — 9,361 9,361 Construction – commercial — 316 316 — 26,030 26,030 Construction – multi-family — 602 602 — 45,890 45,890 Construction – land development — 274 274 — 16,129 16,129 Land — 406 406 — 26,726 26,726 Consumer loans: Home equity and second mortgage — 519 519 382 37,899 38,281 Other — 53 53 — 2,772 2,772 Commercial business loans 123 1,844 1,967 286 135,516 135,802 SBA PPP loans — — — — 466 466 Total $ 123 $ 15,694 $ 15,817 $ 4,009 $ 1,319,355 $ 1,323,364 95 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table presents information on loans evaluated individually and collectively for impairment in the allowance for loan losses by portfolio segment at September 30, 2022 (dollars in thousands): Allowance for Loan Losses Recorded Investment in Loans Individually Evaluated for Impairment Collectively Evaluated for Impairment Total Individually Evaluated for Impairment Collectively Evaluated for Impairment Total Mortgage loans: One- to four-family $ — $ 1,658 $ 1,658 $ 388 $ 175,728 $ 176,116 Multi-family — 855 855 — 95,025 95,025 Commercial — 6,682 6,682 2,988 533,662 536,650 Construction – custom and owner/ builder — 675 675 — 67,091 67,091 Construction – speculative one- to four-family — 130 130 — 8,364 8,364 Construction – commercial — 343 343 — 29,059 29,059 Construction – multi-family — 447 447 — 34,354 34,354 Construction – land development — 233 233 — 13,582 13,582 Land — 397 397 450 26,404 26,854 Consumer loans: Home equity and second mortgage — 440 440 394 34,793 35,187 Other — 42 42 3 2,125 2,128 Commercial business loans 127 1,674 1,801 309 124,730 125,039 SBA PPP loans — — — — 1,001 1,001 Total $ 127 $ 13,576 $ 13,703 $ 4,532 $ 1,145,918 $ 1,150,450 96 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2023 (dollars in thousands): 30-59 Days Past Due 60-89 Days Past Due Non- Accrual(1) Past Due 90 Days or More and Still Accruing Total Past Due Current Total Loans Mortgage loans: One- to four-family $ — $ — $ 368 $ — $ 368 $ 252,859 $ 253,227 Multi-family — — — — — 127,176 127,176 Commercial — — 683 — 683 567,582 568,265 Construction – custom and owner/ builder 151 — — — 151 73,088 73,239 Construction – speculative one- to four-family — — — — — 9,361 9,361 Construction – commercial — — — — — 26,030 26,030 Construction – multi-family — — — — — 45,890 45,890 Construction – land development — — — — — 16,129 16,129 Land — — — — — 26,726 26,726 Consumer loans: Home equity and second mortgage — — 177 — 177 38,104 38,281 Other — — — — — 2,772 2,772 Commercial business loans — — 286 — 286 135,516 135,802 SBA PPP loans — — — — — 466 466 Total $ 151 $ — $ 1,514 $ — $ 1,665 $ 1,321,699 $ 1,323,364 __________________ (1) Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual. 97 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2022 (dollars in thousands): 30-59 Days Past Due 60-89 Days Past Due Non- Accrual(1) Past Due 90 Days or More and Still Accruing Total Past Due Current Total Loans Mortgage loans: One- to four-family $ — $ — $ 388 $ — $ 388 $ 175,728 $ 176,116 Multi-family — — — — — 95,025 95,025 Commercial — — 657 — 657 535,993 536,650 Construction – custom and owner/ builder — — — — — 67,091 67,091 Construction – speculative one- to four-family — — — — — 8,364 8,364 Construction – commercial — — — — — 29,059 29,059 Construction – multi-family — — — — — 34,354 34,354 Construction – land development — — — — — 13,582 13,582 Land — — 450 — 450 26,404 26,854 Consumer loans: Home equity and second mortgage 37 — 252 — 289 34,898 35,187 Other — — 3 — 3 2,125 2,128 Commercial business loans — — 309 — 309 124,730 125,039 SBA PPP loans — — — — — 1,001 1,001 Total $ 37 $ — $ 2,059 $ — $ 2,096 $ 1,148,354 $ 1,150,450 ___________________ (1) Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual. Credit Quality Indicators The Company uses credit risk grades which reflect the Company’s assessment of a loan’s risk or loss potential. The Company categorizes loans into risk grade categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors such as the estimated fair value of the collateral. The Company uses the following definitions for credit risk ratings as part of the on-going monitoring of the credit quality of its loan portfolio: Pass: Pass loans are defined as those loans that meet acceptable quality underwriting standards. Watch: Watch loans are defined as those loans that still exhibit acceptable quality but have some concerns that justify greater attention. If these concerns are not corrected, a potential for further adverse categorization exists. These concerns could relate to a specific condition peculiar to the borrower, its industry segment or the general economic environment. Special Mention: Special mention loans are defined as those loans deemed by management to have some potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the payment prospects of the loan. Substandard : Substandard loans are defined as those loans that are inadequately protected by the current net worth and paying capacity of the obligor, or of the collateral pledged. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. If the weakness or weaknesses are not corrected, there is the distinct possibility that some loss will be sustained. 98 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Doubtful: Loans in this classification have the weaknesses of substandard loans with the additional characteristic that the weaknesses make the collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. At September 30, 2023 and 2022, there were no loans classified as doubtful. Loss: Loans in this classification are considered uncollectible and of such little value that continuance as an asset is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this loan even though partial recovery may be realized in the future. At September 30, 2023 and 2022, there were no loans classified as loss. The following table presents an analysis of loans by credit quality indicator and portfolio segment at September 30, 2023 (dollars in thousands): Loan Grades Pass Watch Special Mention Substandard Total Mortgage loans: One- to four-family $ 252,859 $ — $ — $ 368 $ 253,227 Multi-family 127,176 — — — 127,176 Commercial 551,669 11,143 — 5,453 568,265 Construction – custom and owner / builder 68,181 5,058 — — 73,239 Construction – speculative one- to four-family 9,361 — — — 9,361 Construction – commercial 25,063 967 — — 26,030 Construction – multi-family 45,890 — — — 45,890 Construction – land development 16,129 — — — 16,129 Land 26,226 500 — — 26,726 Consumer loans: Home equity and second mortgage 37,982 34 — 265 38,281 Other 2,716 56 — — 2,772 Commercial business loans 135,502 — — 300 135,802 SBA PPP loans 466 — — — 466 Total $ 1,299,220 $ 17,758 $ — $ 6,386 $ 1,323,364 99 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table presents an analysis of loans by credit quality indicator and portfolio segment at September 30, 2022 (dollars in thousands): Loan Grades Pass Watch Special Mention Substandard Total Mortgage loans: One- to four-family $ 175,687 $ 38 $ — $ 391 $ 176,116 Multi-family 95,025 — — — 95,025 Commercial 522,741 7,940 237 5,732 536,650 Construction – custom and owner / builder 65,249 1,842 — — 67,091 Construction – speculative one- to four-family 8,364 — — — 8,364 Construction – commercial 29,059 — — — 29,059 Construction – multi-family 34,354 — — — 34,354 Construction – land development 13,557 — — 25 13,582 Land 25,882 522 — 450 26,854 Consumer loans: Home equity and second mortgage 34,709 19 — 459 35,187 Other 2,063 62 — 3 2,128 Commercial business loans 124,712 — — 327 125,039 SBA PPP loans 1,001 — — — 1,001 Total $ 1,132,403 $ 10,423 $ 237 $ 7,387 $ 1,150,450 100 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table is a summary of information related to impaired loans by portfolio segment as of and for the year ended September 30, 2023 (dollars in thousands): September 30, 2023 For the Year Ended September 30, 2023 Recorded Investment Unpaid Principal Balance (Loan Balance Plus Charge Off) Related Allowance Average Recorded Investment Interest Income Recognized Cash Basis Interest Income Recognized With no related allowance recorded: Mortgage loans: One- to four-family $ 368 $ 412 $ — $ 378 $ 29 $ 29 Commercial 2,973 2,973 — 2,987 167 129 Land — — — 297 5 4 Consumer loans: Home equity and second mortgage 382 382 — 390 12 10 Other — — — 1 — — Commercial business loans 41 90 — 49 — — Subtotal 3,764 3,857 — 4,102 213 172 With an allowance recorded: Consumer loans: Commercial business loans 245 245 123 247 — — Subtotal 245 245 123 247 — — Total: Mortgage loans: One- to four-family 368 412 — 378 29 29 Commercial 2,973 2,973 — 2,987 167 129 Land — — — 297 5 4 Consumer loans: Home equity and second mortgage 382 382 — 390 12 10 Other — — — 1 — — Commercial business loans 286 335 123 296 — — Total $ 4,009 $ 4,102 $ 123 $ 4,349 $ 213 $ 172 101 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table is a summary of information related to impaired loans by portfolio segment as of and for the year ended September 30, 2022 (dollars in thousands): September 30, 2022 For the Year Ended September 30, 2022 Recorded Investment Unpaid Principal Balance (Loan Balance Plus Charge Off) Related Allowance Average Recorded Investment Interest Income Recognized Cash Basis Interest Income Recognized With no related allowance recorded: Mortgage loans: One- to four-family $ 388 $ 432 $ — $ 470 $ 31 $ 31 Commercial 2,988 2,988 — 3,041 152 123 Land 450 450 — 492 — — Consumer loans: Home equity and second mortgage 394 394 — 436 6 5 Other 3 3 — 7 — — Commercial business loans 59 108 — 121 — — Subtotal 4,282 4,375 — 4,567 189 159 With an allowance recorded: Consumer loans: Home equity and second mortgage — — — 145 — — Commercial business loans 250 250 127 268 — — Subtotal 250 250 127 413 — — Total: Mortgage loans: One- to four-family 388 432 — 470 31 31 Commercial 2,988 2,988 — 3,041 152 123 Land 450 450 — 492 — — Consumer loans: Home equity and second mortgage 394 394 — 581 6 5 Other 3 3 — 7 — — Commercial business loans 309 358 127 389 — — Total $ 4,532 $ 4,625 $ 127 $ 4,980 $ 189 $ 159 102 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table is a summary of information related to impaired loans by portfolio segment as of and for the year ended September 30, 2021 (dollars in thousands): September 30, 2021 For the Year Ended September 30, 2021 Recorded Investment Unpaid Principal Balance (Loan Balance Plus Charge Off) Related Allowance Average Recorded Investment Interest Income Recognized Cash Basis Interest Income Recognized With no related allowance recorded: Mortgage loans: One- to four-family $ 407 $ 450 $ — $ 655 $ 58 $ 52 Commercial 3,143 3,143 — 3,039 159 127 Land 321 321 — 292 2 2 Consumer loans: Home equity and second mortgage 516 516 — 552 1 1 Other 17 17 — 12 — — Commercial business loans 164 168 — 200 — — Subtotal 4,568 4,615 — 4,750 220 182 With an allowance recorded: Mortgage loans: One- to four-family — — — 97 — — Land 362 362 76 72 — — Commercial business loans 294 294 171 285 — — Subtotal 656 656 247 454 — — Total: Mortgage loans: One- to four-family 407 450 — 752 58 52 Commercial 3,143 3,143 — 3,039 159 127 Land 683 683 76 364 2 2 Consumer loans: Home equity and second mortgage 516 516 — 552 1 1 Other 17 17 — 12 — — Commercial business loans 458 462 171 485 — — Total $ 5,224 $ 5,271 $ 247 $ 5,204 $ 220 $ 182 103 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The Company had $ 2,495,000 and $ 2,615,000 in TDRs included in impaired loans at September 30, 2023 and 2022, respectively, and no commitments to lend additional funds on these loans at either such date. None of the allowance for loan losses was allocated to TDRs at September 30, 2023 and 2022. The following tables set forth information with respect to the Company’s TDRs by interest accrual status as of September 30, 2023 and 2022 (dollars in thousands): 2023 Accruing Non-Accrual Total Mortgage loans: Commercial $ 2,290 $ — $ 2,290 Consumer loans: Home equity and second mortgage 205 — 205 Total $ 2,495 $ — $ 2,495 2022 Accruing Non-Accrual Total Mortgage loans: Commercial $ 2,330 $ — $ 2,330 Land — 88 88 Consumer loans: Home equity and second mortgage 142 55 197 Total $ 2,472 $ 143 $ 2,615 There were no new TDRs during the years ended September 30, 2023 and 2021. There was one new TDR during the year ended September 30, 2022. The following table sets forth information with respect to the Company's TDRs, by portfolio segment, added during the year ended September 30, 2022: 2022 Number of Contracts Pre-Modification Outstanding Recorded Investment Post- Modification Outstanding Recorded Investment End of Period Balance Home equity and second mortgage loans (1) 1 $ 136 $ 145 $ 142 Total 1 $ 136 $ 145 $ 142 (1) Modification resulted in an extension of maturity and deferral of accrued interest. There were no TDRs for which there was a payment default within the first 12 months of modification during the years ended September 30, 2023, 2022 or 2021. Note 5 - Premises and Equipment Premises and equipment consisted of the following at September 30, 2023 and 2022 (dollars in thousands): 2023 2022 Land $ 5,404 $ 5,404 Buildings and improvements 25,178 24,764 Furniture and equipment 10,715 10,152 Property held for future expansion 116 129 Construction and purchases in progress 177 152 41,590 40,601 Less accumulated depreciation 19,948 18,703 Premises and equipment, net $ 21,642 $ 21,898 104 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 6 – OREO and Other Repossessed Assets The following table presents the activity related to OREO and other repossessed assets for the years ended September 30, 2023 and 2022 (dollars in thousands): 2023 2022 Amount Number Amount Number Balance, beginning of year $ — 2 $ 157 3 Sales — — ( 157 ) ( 1 ) Balance, end of year $ — 2 $ — 2 At September 30, 2023 and 2022, OREO and other repossessed assets consisted of two OREO properties in Washington with no book value. The Company did not record a net gain or loss on sale of OREO for the year ended September 30, 2023. For the years ended September 30, 2022 and 2021 the company recorded net gains on sales of OREO and other repossessed assets of $ 2,000 , and $ 92,000 , respectively. Gains and losses on sales of OREO and other repossessed assets are recorded in the OREO and other repossessed assets, net category in non-interest expense in the accompanying consolidated statements of income. At September 30, 2023, and 2022 there were no foreclosed residential real estate properties held in OREO as a result of obtaining physical possession, and there were no one- to four-family properties in the process of foreclosure. Note 7 - Goodwill and CDI Goodwill There were no changes to the recorded amount of goodwill for both years ended September 30, 2023 and 2022. CDI The CDI amortization expense totaled $ 271,000 , $ 316,000 and $ 361,000 for the years ended September 30, 2023, 2022 and 2021, respectively. Amortization expense for the CDI for fiscal years ending subsequent to September 30, 2023 is estimated to be as follows (dollars in thousands): 2024 $ 226 2025 181 2026 135 2027 90 2028 45 Total $ 677 Note 8 - Loan Servicing Rights The Company services one- to four-family mortgage loans for Freddie Mac and also provides servicing for secondary market purchasers of the guaranteed portion of SBA loans; such loans are not included in the accompanying consolidated balance sheets. The principal amount of loans serviced for Freddie Mac at September 30, 2023, 2022 and 2021 was $ 384,619,000 , $ 406,727,000 and $ 419,675,000 , respectively. The guaranteed principal amount of SBA loans serviced for others at September 30, 2023, 2022 and 2021 was $ 1,882,000 , $ 3,560,000 and $ 6,761,000 , respectively. 105 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following is an analysis of the changes in Freddie Mac loan servicing rights for the years ended September 30, 2023, 2022 and 2021 (dollars in thousands): 2023 2022 2021 Balance, beginning of year $ 3,020 $ 3,438 $ 2,980 Additions 113 578 1,388 Amortization ( 1,009 ) ( 1,115 ) ( 1,022 ) Valuation recovery — 119 92 Balance, end of year $ 2,124 $ 3,020 $ 3,438 At September 30, 2023, 2022 and 2021, the estimated fair value of Freddie Mac servicing rights totaled $ 5,469,000 , $ 5,547,000 and $ 3,656,000 , respectively. The Freddie Mac servicing rights' fair values at September 30, 2023, 2022 and 2021 were estimated using discounted cash flow analyses with an average discount rates of 9.50 %, 9.50 % and 9.00 %, and average conditional prepayment rates of 6.23 %, 6.31 % and 12.71 %, respectively . At September 30, 2023 and 2022, there was no valuation allowance. At September 30, 2021, there was a valuation allowance of $92,000, respectively. The following is an analysis of the changes in SBA loan servicing rights for the years ended September 30, 2023, 2022 and 2021 (dollars in thousands): 2023 2022 2021 Balance, beginning of year $ 3 $ 44 $ 115 Amortization ( 3 ) ( 41 ) ( 89 ) Valuation recovery — — 18 Balance, end of year $ — $ 3 $ 44 At September 30, 2023 and 2022, SBA servicing rights were insignificant. At September 30, 2021, the estimated fair value of SBA servicing rights totaled $ 99,000 . The SBA servicing rights' fair values at September 30, 2021 were estimated using discounted cash flow analyses with an average discount rate of 15.00 % and average conditional prepayment rates of 17.85 % . There was no valuation allowance on SBA servicing rights at September 30, 2023, 2022 and 2021. Note 9 - Leases At September 30, 2023, the Company has operating leases for two retail bank branch offices and an administrative office. The Company's leases have remaining lease terms of two to eight years , which include options to extend the leases for up to five years . Lease extensions are not certain, and the Company evaluates each lease based on the specific circumstances for the location to determine the probability of exercising the extensions in the calculation of ROU assets and liabilities. The components of lease cost (included in the premises and equipment expense category in the consolidated statements of income) are as follows for the years ended September 30, 2023, 2022 and 2021 (dollars in thousands): Lease cost: 2023 2022 2021 Operating lease cost $ 354 $ 371 $ 395 Short-term lease cost — — — Total lease cost $ 354 $ 371 $ 395 106 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table provides supplemental information related to operating leases at or for the years ended September 30, 2023, 2022 and 2021 (dollars in thousands): 2023 2022 2021 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 316 $ 342 $ 327 Weighted average remaining lease term-operating leases 6.69 yrs 7.67 yrs 8.44 yrs Weighted average discount rate-operating leases 2.33 % 2.25 % 2.24 % The Company's leases typically do not contain a discount rate implicit in the lease contracts. As an alternative, the weighted average discount rate is used to estimate the present value of future lease payments in calculating the value of the ROU asset. Maturities of operating lease liabilities at September 30, 2023 for the five fiscal years ending subsequent to September 30, 2023 and thereafter, are as follows (dollars in thousands): 2024 $ 333 2025 336 2026 304 2027 232 2028 219 Thereafter 600 Total lease payments 2,024 Less imputed interest 157 Total $ 1,867 Note 10 - Deposits Deposits consisted of the following at September 30, 2023 and 2022 (dollars in thousands): 2023 2022 Non-interest-bearing demand $ 455,864 $ 530,058 NOW checking 386,730 447,779 Savings 228,366 283,219 Money market 189,875 248,536 Certificates of deposit 300,100 122,584 Total $ 1,560,935 $ 1,632,176 Individual certificates of deposit in amounts of $250,000 or greater totaled $ 91,714,000 and $ 21,830,000 at September 30, 2023 and 2022, respectively. The Company had brokered deposits totaling $ 38,165,000 at September 30, 2023. The Company had no brokered deposits at September 30, 2022. The Company had reciprocal deposits totaling $70,764,000 and $4,617,000 at September 30, 2023 and 2022, respectively. 107 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Scheduled maturities of certificates of deposit for fiscal years ending subsequent to September 30, 2023 are as follows (dollars in thousands): 2024 $ 251,737 2025 18,320 2026 8,685 2027 12,883 2028 8,461 Thereafter 14 Total $ 300,100 Interest expense on deposits by account type was as follows for the years ended September 30, 2023, 2022 and 2021 (dollars in thousands): 2023 2022 2021 NOW checking $ 3,561 $ 650 $ 605 Savings 415 230 201 Money market 1,601 767 560 Certificates of deposit 5,725 1,010 1,647 Total $ 11,302 $ 2,657 $ 3,013 Note 11 – FHLB Borrowings and Other Borrowings The Bank has long- and short-term borrowing lines with the FHLB with total credit on the lines up to 45 % of the Bank’s total assets, limited by available collateral. At September 30, 2023, the Bank had a borrowing capacity of $ 533,989,000 . The Bank had $ 15,000,000 long-term and $20,000,000 short-term FHLB borrowings outstanding at September 30, 2023. The long term borrowings consisted of two borrowings, with scheduled maturities in May 2026, and each bears interest at 3.95%. The short-term borrowings consist of three borrowings, which mature at various dates during the 2024 fiscal year and bear interest at rates ranging from 5.52% to 5.57%. The Bank had no FHLB borrowings outstanding at September 30, 2022. Under the Advances, Pledge and Security Agreement entered into with the FHLB ("FHLB Borrowing Agreement"), virtually all of the Bank’s assets, not otherwise encumbered, are pledged as collateral for borrowings under the FHLB Borrowing Agreement. The Bank also maintains two short-term borrowing lines with the FRB, with total credit based on eligible collateral: Borrower-in-custody ("BIC") and Bank Term Funding Program ("BTFP"). At September 30, 2023, the Bank had a borrowing capacity on the BIC line of $ 146,257,000 , with no outstanding borrowings at September 30, 2023 and 2022. At September 30, 2023, the Bank had a borrowing capacity on the BTFP line of $57,000,000, with no outstanding borrowings at September 30, 2023. The Bank has a short-term $ 50,000,000 overnight borrowing line with Pacific Coast Bankers' Bank. The borrowing line may be reduced or withdrawn at any time. The Bank had no outstanding borrowings on this line at both September 30, 2023 and 2022. Note 12 - Other Liabilities and Accrued Expenses Other liabilities and accrued expenses were comprised of the following at September 30, 2023 and 2022 (dollars in thousands): 2023 2022 Accrued deferred compensation, profit sharing plans and bonuses payable $ 2,641 $ 2,790 Accrued interest payable on deposits 1,397 108 Accounts payable and accrued expenses - other 4,992 4,799 Total other liabilities and accrued expenses $ 9,030 $ 7,697 108 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 13 - Income Taxes The components of the provision for income taxes for the years ended September 30, 2023, 2022 and 2021 were as follows (dollars in thousands): 2023 2022 2021 Current: Federal $ 7,167 $ 6,139 $ 6,570 Deferred ( 291 ) ( 177 ) 275 Provision for income taxes $ 6,876 $ 5,962 $ 6,845 At September 30, 2023, the Company had income tax receivable of $ 107,000 , which is included in other assets in the accompanying consolidated balance sheets. At September 30, 2022, the Company had an income tax payable of $ 332,000 , which is included in other liabilities and accrued expenses in the accompanying consolidated balance sheets. The components of the Company’s deferred tax assets and liabilities at September 30, 2023 and 2022 were as follows (dollars in thousands): 2023 2022 Deferred Tax Assets Allowance for loan losses $ 3,322 $ 2,878 Allowance for OREO losses 5 5 OTTI credit impairment on investment securities 50 62 Accrued interest on loans 58 63 Deferred compensation and bonuses 217 260 Reserve for loan commitments 70 64 Operating lease liabilities 392 434 Net unrealized losses on investment securities and investments in equity securities 288 190 Other 85 66 Total deferred tax assets 4,487 4,022 2023 2022 Deferred Tax Liabilities Goodwill 1,187 1,187 Loan servicing rights 446 635 Depreciation 906 757 Loan fees/costs 983 771 Prepaid expenses 172 175 Purchase accounting adjustment 159 208 Operating lease ROU assets 372 416 Total deferred tax liabilities 4,225 4,149 Net deferred tax assets (liabilities) $ 262 $ ( 127 ) Deferred tax assets are included in other assets, and deferred tax liabilities are included in other liabilities and accrued expenses in the accompanying consolidated balance sheets. No valuation allowance for deferred tax assets was recorded as of September 30, 2023 and 2022, as management believes that it is more likely than not that all of the deferred tax assets will be realized based on management's expectations of future taxable income. The provision for income taxes for the years ended September 30, 2023, 2022 and 2021 differs from that computed at the federal statutory corporate tax rate as follows (dollars in thousands): 109 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 2023 2022 2021 Expected federal income tax provision at statutory rate $ 7,139 $ 6,208 $ 7,230 BOLI income ( 148 ) ( 129 ) ( 125 ) Dividends on Employee Stock Ownership Plan ("ESOP") stock ( 71 ) ( 70 ) ( 88 ) Stock options tax effect ( 66 ) ( 34 ) ( 167 ) Other, net 22 ( 13 ) ( 5 ) Provision for income taxes $ 6,876 $ 5,962 $ 6,845 Note 14 - Employee Stock Ownership and 401(k) Plan The Timberland Bank Employee Stock Ownership and 401(k) Plan (“KSOP”) is comprised of two components, the ESOP and the 401(k) Plan. The KSOP benefits employees with at least one year of service who are 18 years of age or older. The Bank may fund the ESOP with contributions of cash or stock, which are made at the discretion of the Board, and may fund the 401(k) Plan with contributions of cash. Employee vesting occurs over six years . ESOP In January 1998, the ESOP borrowed $ 7,930,000 from the Company to purchase 1,058,000 shares of common stock of the Company. The loan was repaid primarily from the Bank’s contributions to the ESOP and was fully repaid by March 31, 2019. As of September 30, 2023, an aggregate of 740,906 ESOP shares, which were previously released for allocation to participants, had been distributed to participants. Total shares held by the ESOP as of September 30, 2023, 2022 and 2021 were 317,094 , 372,559 and 397,626 , respectively. There was no compensation expense recognized for the ESOP for the years ended September 30, 2023, 2022 and 2021. 401(k) Plan Eligible employees may contribute a portion of their wages to the 401(k) Plan up to the maximum established under the Internal Revenue Code. Contributions by the Bank are at the discretion of the Board except for a safe harbor contribution of 3 % of eligible employees' wages, which is mandatory according to the plan document. Bank contributions totaled $ 1,039,000 , $ 942,000 and $ 931,000 for the years ended September 30, 2023, 2022 and 2021, respectively. Note 15 - Stock Compensation Plans The Company has two active stock compensation plans: the 2014 Equity Incentive plan and the 2019 Equity Incentive Plan. Under the Company's 2014 Equity Incentive Plan, the Company is able to grant options and awards of restricted stock (with or without performance measures) for up to 352,366 shares of common stock to employees, officers, directors and directors emeriti. Under the Company's 2019 Equity Incentive Plan, the Company is able to grant options and awards of restricted stock (with or without performance measures) for up to 350,000 shares of common stock, of which 300,000 shares are reserved to be awarded to employees and officers and 50,000 shares are reserved to be awarded to directors and directors emeriti. Shares issued may be purchased in the open market or may be issued from authorized and unissued shares. The exercise price of each option equals the fair market value of the Company’s common stock on the date of grant. Generally, options and restricted stock vest in equal annual installments commencing on the first anniversary of the grant date. Stock options generally vest over a five year period from the date of the grant with a maximum contractual term of ten years from the date of the grant. Restricted stock grants generally vest over a three or five year term from the date of grant. At September 30, 2023, there were 5,036 and 176,050 shares of common stock available under the 2014 and 2019 Equity Incentive Plans, respectively. Stock option activity for the years ended September 30, 2023, 2022 and 2021 is summarized as follows: 110 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Number of Shares Weighted Average Exercise Price Outstanding September 30, 2020 395,349 $ 18.45 Options granted 81,000 28.06 Options exercised ( 64,264 ) 9.81 Options forfeited ( 5,270 ) 26.91 Outstanding September 30, 2021 406,815 21.62 Options granted 74,000 27.40 Options exercised ( 36,720 ) 11.31 Options forfeited ( 22,170 ) 26.01 Outstanding September 30, 2022 421,925 23.30 Options granted 1,000 33.40 Options exercised ( 42,635 ) 16.38 Options forfeited ( 11,140 ) 27.26 Outstanding September 30, 2023 369,150 $ 24.00 The aggregate intrinsic value of options exercised during the years ended September 30, 2023, 2022 and 2021 was $ 632,000 , $ 605,000 and $ 1,143,000 , respectively. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the weighted average assumptions noted in the following table. The risk-free interest rate is based on the rate of a U.S. Treasury security with a similar term as the expected life of the stock option at the particular grant date. The expected life is based on historical data, vesting terms and estimated exercise dates. The expected dividend yield is based on the most recent quarterly dividend on an annualized basis in effect at the time that the options were granted, adjusted, if appropriate, for management's expectations regarding future dividends. The expected volatility is based on historical volatility of the Company’s stock price. There were 81,000 options granted during the year ended September 30, 2021 with an aggregate grant date fair value of $ 502,000 . There were 74,000 options granted during the year ended September 30, 2022 with an aggregate grant date fair value of $ 508,000 . There were 1,000 options granted during the year ended September 30, 2023 with an aggregate grant date fair value of $ 9,000 . The weighted average assumptions for options granted during the years ended September 30, 2023, 2022 and 2021 were as follows: 2023 2022 2021 Expected volatility 33 % 33 % 35 % Expected life (in years) 5 5 5 Expected dividend yield 2.99 % 3.61 % 3.39 % Risk free interest rate 3.58 % 4.17 % 1.02 % Grant date fair value per share $ 8.65 $ 6.87 $ 6.20 There were 59,990 options that vested during the year ended September 30, 2023 with a total fair value of $ 316,000 . There were 52,960 options that vested during the year ended September 30, 2022 with a total fair value of $ 239,000 . There were 49,928 options that vested during the year ended September 30, 2021 with a total fair value of $ 170,000 . At September 30, 2023, there were 130,120 unvested options with an aggregate grant date fair value of $ 756,000 , all of which the Company assumes will vest. The unvested options had an aggregate intrinsic value of $ 241,000 at September 30, 2023. At September 30, 2022, there were 191,910 unvested options with an aggregate grant date fair value of $ 428,000 . 111 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Additional information regarding options outstanding at September 30, 2023 is as follows: Options Outstanding Options Exercisable Range of Exercise Prices ($) Number Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) Number Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) 9.00 3,000 9.00 0.1 3,000 9.00 0.1 10.26 - 10.71 43,250 10.55 1.4 43,250 10.55 1.4 15.67 - 19.13 70,770 16.54 5.8 47,110 16.34 5.2 26.50 - 27.40 106,660 27.32 8.0 42,600 27.23 7.1 28.23 - 29.69 110,750 28.78 6.5 69,350 29.11 5.6 31.80 - 33.40 34,720 31.85 5.1 33,720 31.80 5.0 369,150 $ 24.00 6.0 239,030 $ 23.03 4.9 The aggregate intrinsic value of options outstanding at September 30, 2023, 2022 and 2021 was $ 1,518,000 , $ 2,130,000 , and $ 3,119,000 , respectively. As of September 30, 2023, unrecognized compensation cost related to non-vested stock options was $ 777,000 , which is expected to be recognized over a weighted average period of 2.16 years. During the year ended September 30, 2023, the Company granted a total of 26,150 shares of restricted stock from the 2019 Plan subject to time-based vesting. At both September 30, 2022 and 2021, there were no unvested restricted stock awards outstanding. There were no restricted stock grants awarded during the years ended September 30, 2022 and 2021. The fair value of restricted stock awards is equal to the fair value of the Company's stock on the date of the grant. The related stock-based compensation expense is recorded over the requisite service period. At September 30, 2023, unrecognized compensation cost related to unvested restricted stock awards was $716,000, which is expected to be recognized over a weighted average period of 2.83 years. The following table presents the activity related to restricted stock for the year ended September 30, 2023: Time Based Number of Unvested Shares Weighted Average Grant Date Fair Value Outstanding, September 30, 2022 — $ — Granted 26,150 27.37 Forfeited — — Vested — — Outstanding, September 30, 2023 26,150 $ 27.37 Note 16 - Commitments and Contingencies In the normal course of business, the Company is party to financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk not recognized in the consolidated balance sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is 112 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit - worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the party. However, such loan to value ratios will subsequently change, based on increases and decreases in the supporting collateral values. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, land and income-producing commercial properties. A summary of the Company’s commitments at September 30, 2023 and 2022 is as follows (dollars in thousands): 2023 2022 Undisbursed portion of construction loans in process (see Note 4) $ 103,194 $ 103,168 Undisbursed lines of credit 141,537 128,791 Commitments to extend credit 31,667 14,699 The Company maintains a separate reserve for losses related to unfunded loan commitments. Management estimates the amount of probable losses related to unfunded loan commitments by applying the loss factors used in the allowance for loan loss methodology to an estimate of the expected amount of funding and applies this adjusted factor to the unused portion of unfunded loan commitments. The reserve for unfunded loan commitments totaled $ 332,000 and $ 305,000 at September 30, 2023 and 2022, respectively. These amounts are included in other liabilities and accrued expenses in the accompanying consolidated balance sheets. Increases (decreases) in the reserve for unfunded loan commitments are recorded in non-interest expense in the accompanying consolidated statements of income. The Bank has an employee severance compensation plan which expires in 2027 that provides severance pay benefits to eligible employees in the event of a change in control of Timberland Bancorp or the Bank (as defined in the plan). In general, all employees with two or more years of service are eligible to participate in the plan. Under the plan, in the event of a change in control of Timberland Bancorp or the Bank, eligible employees who are terminated or who terminate employment (but only upon the occurrence of events specified in the plan) within 12 months of the effective date of a change in control would be entitled to a payment based on years of service or officer rank with the Bank. The maximum payment for any eligible employee would be equal to 18 months of the employee’s current compensation. Timberland Bancorp has employment agreements with the Chief Executive Officer and the Chief Operating Officer which provide for a severance payment and other benefits if the officers are involuntarily terminated following a change in control of Timberland Bancorp or the Bank. The maximum value of the severance benefits under the employment agreements is 2.99 times the officer's average annual compensation during the five -year period prior to the effective date of the change in control. Because of the nature of its activities, the Company is subject to various pending and threatened legal actions which arise in the ordinary course of business. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on the future consolidated financial position of the Company. Note 17 - Regulatory Matters The Bank, as a state-chartered, federally insured savings bank, is subject to the capital requirements established by the FDIC. Under the FDIC's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by bank regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. The minimum requirements are a common equity Tier 1 ("CET1") capital ratio of 4.5 %, a Tier 1 capital ratio of 6.0 %, a total capital ratio of 8.0 % and a leverage ratio of 4.0 %. In addition to the minimum regulatory capital ratios, the Bank is required to 113 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of retained income that could be utilized for such actions. At September 30, 2023, the Bank's CET1 capital exceeded the required capital conservation buffer. At September 30, 2023 and 2022, the Bank exceeded all regulatory capital requirements. The Bank was categorized as "well capitalized" at September 30, 2023 and 2022 under the regulations of the FDIC. The following tables compare the Bank’s actual capital amounts at September 30, 2023 and 2022 to its minimum regulatory capital requirements and "Well Capitalized" regulatory capital at those dates (dollars in thousands): Actual Regulatory Minimum To Be "Adequately Capitalized" Regulatory Minimum To Be "Well Capitalized" Under Prompt Corrective Action Provisions September 30, 2023 Amount Ratio Amount Ratio Amount Ratio Leverage Capital Ratio: Tier 1 capital $ 218,749 12.0 % $ 72,983 4.0 % $ 91,229 5.0 % Risk-based Capital Ratios: CET1 218,749 18.0 54,549 4.5 78,792 6.5 Tier 1 capital 218,749 18.0 72,731 6.0 96,975 8.0 Total capital 233,914 19.3 96,975 8.0 121,219 10.0 September 30, 2022 Leverage Capital Ratio: Tier 1 capital $ 202,438 10.9 % $ 74,039 4.0 % $ 92,549 5.0 % Risk-based Capital Ratios: CET1 202,438 18.0 50,551 4.5 73,018 6.5 Tier 1 capital 202,438 18.0 67,402 6.0 89,869 8.0 Total capital 216,446 19.3 89,869 8.0 112,336 10.0 Timberland Bancorp is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only basis, and the Federal Reserve expects the holding company's subsidiary bank to be well capitalized under the prompt corrective action regulations. If Timberland Bancorp were subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets at September 30, 2023, Timberland Bancorp would have exceeded all regulatory requirements. The following table presents for informational purposes the regulatory capital ratios for Timberland Bancorp at September 30, 2023 and 2022 assuming that Timberland Bancorp was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets (dollars in thousands): 2023 2022 Amount Ratio Amount Ratio Leverage Capital Ratio: Tier 1 capital $ 219,851 12.1 % $ 204,659 11.0 % Risk-based Capital Ratios: CET1 219,851 18.1 204,659 18.2 Tier 1 capital 219,851 18.1 204,659 18.2 Total capital 235,023 19.4 218,667 19.5 114 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 18 - Condensed Financial Information - Parent Company Only Condensed Balance Sheets - September 30, 2023 and 2022 (dollars in thousands) 2023 2022 Assets Cash and cash equivalents: Cash and due from financial institutions $ 517 $ 162 Interest-bearing deposits in banks — 1,548 Total cash and cash equivalents 517 1,710 Investment securities held to maturity, at amortized cost (estimated fair value $ 449 and $ 469 ) 500 500 Investment in Bank 232,145 216,348 Other assets 51 56 Total assets $ 233,213 $ 218,614 Liabilities and shareholders’ equity Accrued expenses $ 140 $ 45 Shareholders’ equity 233,073 218,569 Total liabilities and shareholders’ equity $ 233,213 $ 218,614 Condensed Statements of Income - Years Ended September 30, 2023, 2022 and 2021 (dollars in thousands) 2023 2022 2021 Operating income Interest on deposits in banks $ — $ 3 $ 5 Interest on investment securities 24 24 24 Dividends from Bank 11,400 10,255 9,085 Total operating income 11,424 10,282 9,114 Operating expenses 351 303 495 Income before income taxes and equity in undistributed income of Bank 11,073 9,979 8,619 Benefit for income taxes ( 148 ) ( 139 ) ( 238 ) Income before undistributed income of Bank 11,221 10,118 8,857 Equity in undistributed income of Bank 15,897 13,482 18,726 Net income $ 27,118 $ 23,600 $ 27,583 115 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Condensed Statements of Cash Flows - Years Ended September 30, 2023, 2022 and 2021 (dollars in thousands) 2023 2022 2021 Cash flows from operating activities Net income $ 27,118 $ 23,600 $ 27,583 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed income of Bank ( 15,897 ) ( 13,482 ) ( 18,726 ) Stock option compensation expense 320 246 173 Other, net 100 16 ( 97 ) Net cash provided by operating activities 11,641 10,380 8,933 Cash flows from investing activities Investment in Bank ( 267 ) ( 202 ) ( 149 ) Net cash used in investing activities ( 267 ) ( 202 ) ( 149 ) Cash flows from financing activities Proceeds from exercise of stock options 698 415 631 Repurchase of common stock ( 4,998 ) ( 4,583 ) ( 527 ) Payment of dividends ( 8,267 ) ( 7,232 ) ( 8,589 ) Net cash used in financing activities ( 12,567 ) ( 11,400 ) ( 8,485 ) Net (decrease) increase in cash and cash equivalents ( 1,193 ) ( 1,222 ) 299 Cash and cash equivalents Beginning of year 1,710 2,932 2,633 End of year $ 517 $ 1,710 $ 2,932 Note 19 - Net Income Per Common Share Information regarding the calculation of basic and diluted net income per common share for the years ended September 30, 2023, 2022 and 2021 is as follows (dollars in thousands, except per share amounts): 2023 2022 2021 Basic net income per common share computation Numerator - net income $ 27,118 $ 23,600 $ 27,583 Denominator - weighted average common shares outstanding 8,175,898 8,304,002 8,340,983 Basic net income per common share $ 3.32 $ 2.84 $ 3.31 Diluted net income per common share computation Numerator - net income $ 27,118 $ 23,600 $ 27,583 Denominator - weighted average common shares outstanding 8,175,898 8,304,002 8,340,983 Effect of dilutive stock options (1) 72,283 79,333 103,350 Weighted average common shares outstanding-assuming dilution 8,248,181 8,383,335 8,444,333 Diluted net income per common share $ 3.29 $ 2.82 $ 3.27 ______________ (1) For the years ended September 30, 2023, 2022 and 2021, average options to purchase 207,803 , 204,265 and 136,148 shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per common share, because their effect would have been anti-dilutive. 116 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Note 20 - Accumulated Other Comprehensive Income (Loss) The changes in accumulated other comprehensive income (loss) ("AOCI") by component during the years ended September 30, 2023, 2022 and 2021 are as follows (dollars in thousands): Changes in fair value of available for sale securities [1] Changes in OTTI on held to maturity securities [1] Total [1] 2023 Balance of AOCI at the beginning of period $ ( 706 ) $ ( 11 ) $ ( 717 ) Other comprehensive income (loss) ( 369 ) 2 ( 367 ) Balance of AOCI at the end of period $ ( 1,075 ) $ ( 9 ) $ ( 1,084 ) 2022 Balance of AOCI at the beginning of period $ 75 $ ( 16 ) $ 59 Other comprehensive income (loss) ( 781 ) 5 ( 776 ) Balance of AOCI at the end of period $ ( 706 ) $ ( 11 ) $ ( 717 ) 2021 Balance of AOCI at the beginning of period $ 87 $ ( 26 ) $ 61 Other comprehensive income (loss) ( 12 ) 10 ( 2 ) Balance of AOCI at the end of period $ 75 $ ( 16 ) $ 59 ___________________ [1] All amounts are net of income taxes. Note 21 - Fair Value Measurements Fair value is defined under GAAP as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of three levels. These levels are: Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2: Significant observable inputs other than quoted prices included within Level 1, such as quoted prices for similar (as opposed to identical) assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted prices that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability based on the best information available in the circumstances. The Company's assets measured at fair value on a recurring basis consist of investment securities available for sale and investments in equity securities. The estimated fair values of MBS are based upon market prices of similar securities or observable inputs (Level 2). The estimated fair values of mutual funds are based upon quoted market prices (Level 1). The Company had no liabilities measured at fair value on a recurring basis at September 30, 2023 and 2022. The Company's assets measured at estimated fair value on a recurring basis at September 30, 2023 and 2022 are as follows (dollars in thousands): 117 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 Estimated Fair Value September 30, 2023 Level 1 Level 2 Level 3 Total Available for sale investment securities MBS: U.S. government agencies $ — $ 41,771 $ — $ 41,771 Investments in equity securities Mutual funds 811 — — 811 Total $ 811 $ 41,771 $ — $ 42,582 September 30, 2022 Available for sale investment securities MBS: U.S. government agencies $ — $ 41,415 $ — $ 41,415 Investments in equity securities Mutual funds 835 — — 835 Total $ 835 $ 41,415 $ — $ 42,250 There were no transfers among Level 1, Level 2 and Level 3 during the years ended September 30, 2023 and 2022. The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period. The Company uses the following methods and significant assumptions to estimate fair value on a non-recurring basis: Impaired Loans : The estimated fair value of impaired loans is calculated using the collateral value method or on a discounted cash flow basis. The specific reserve for collateral dependent impaired loans is based on the estimated fair value of the collateral less estimated costs to sell, if applicable. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal and known changes in the market and in the collateral. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. Investment Securities Held to Maturity: The estimated fair value of investment securities held to maturity is based upon the assumptions market participants would use in pricing the investment security. Such assumptions include quoted market prices (Level 1), market prices of similar securities or observable inputs (Level 2) and unobservable inputs such as dealer quotes, discounted cash flows or similar techniques (Level 3). OREO and Other Repossessed Assets, net: OREO and other repossessed assets are recorded at estimated fair value less estimated costs to sell. Estimated fair value is generally determined by management based on a number of factors, including third-party appraisals of estimated fair value in an orderly sale. Estimated costs to sell are based on standard market factors. The valuation of OREO and other repossessed assets is subject to significant external and internal judgment (Level 3). 118 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The following table summarizes the balances of assets measured at estimated fair value on a non-recurring basis at September 30, 2023 and 2022 (dollars in thousands): Total Estimated Estimated Fair Value Measurements Using Fair Value Level 1 Level 2 Level 3 September 30, 2023 Impaired loans $ 122 $ — $ — $ 122 September 30, 2022 Impaired loans $ 123 $ — $ — $ 123 The following table presents quantitative information about Level 3 inputs for financial instruments measured at fair value on a non-recurring basis at September 30, 2023 and 2022: Valuation Technique Significant Unobservable Inputs Range Impaired loans Market approach Appraised value less selling costs N/A GAAP requires disclosure of estimated fair values for financial instruments. Such estimates are subjective in nature, and significant judgment is required regarding the risk characteristics of various financial instruments at a discrete point in time. Therefore, such estimates could vary significantly if assumptions regarding uncertain factors were to change. In addition, as the Company normally intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the estimated amounts disclosed. The disclosures also do not include estimated fair value amounts for certain items which are not defined as financial instruments but which may have significant value. The Company does not believe that it would be practicable to estimate a fair value for these types of items as of September 30, 2023 and 2022. Because GAAP excludes certain items from fair value disclosure requirements, any aggregation of the fair value amounts presented would not represent the underlying value of the Company. Additionally, the Company uses the exit price notion in calculating the fair values of financial instruments not measured at fair value on a recurring basis. The recorded amounts and estimated fair values of financial instruments were as follows as of September 30, 2023 (dollars in thousands): Fair Value Measurements Using: Recorded Amount Estimated Fair Value Level 1 Level 2 Level 3 Financial Assets Cash and cash equivalents $ 128,721 $ 128,721 $ 128,721 $ — $ — CDs held for investment 15,188 15,188 15,188 — — Investment securities 311,989 295,538 161,538 134,000 — Investments in equity securities 811 811 811 — — FHLB stock 3,602 3,602 3,602 — — Other investments 3,000 3,000 3,000 — — Loans held for sale 400 407 407 — — Loans receivable, net 1,302,305 1,246,538 — — 1,246,538 Accrued interest receivable 6,004 6,004 6,004 — — Financial Liabilities Certificates of deposit 300,100 297,542 — — 297,542 FHLB borrowings 35,000 34,747 — — 34,747 Accrued interest payable 1,397 1,397 1,397 — — 119 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 The recorded amounts and estimated fair values of financial instruments were as follows as of September 30, 2022 (dollars in thousands): Fair Value Measurements Using: Recorded Amount Estimated Fair Value Level 1 Level 2 Level 3 Financial Assets Cash and cash equivalents $ 316,755 $ 316,755 $ 316,755 $ — $ — CDs held for investment 22,894 22,519 22,519 — — Investment securities 308,023 291,198 158,578 132,620 — Investments in equity securities 835 835 835 — — FHLB stock 2,194 2,194 2,194 — — Other investments 3,000 3,000 3,000 — — Loans held for sale 748 758 758 — — Loans receivable, net 1,132,426 1,124,579 — — 1,124,579 Accrued interest receivable 4,483 4,483 4,483 — — Financial Liabilities Certificates of deposit 122,584 120,807 — — 120,807 Accrued interest payable 108 108 108 — — The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the estimated fair value of the Company’s financial instruments will change when interest rate levels change, and that change may either be favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to appropriately manage interest rate risk. However, borrowers with fixed interest rate obligations are less likely to prepay in a rising interest rate environment and more likely to prepay in a falling interest rate environment. Conversely, depositors who are receiving fixed interest rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management monitors interest rates and maturities of assets and liabilities, and attempts to manage interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk. Note 22 - Selected Quarterly Financial Data (Unaudited) The following selected financial data is presented for the quarters ended (dollars in thousands, except per share amounts): September 30, 2023 June 30, 2023 March 31, 2023 December 31, 2022 Interest and dividend income $ 21,562 $ 19,889 $ 19,387 $ 19,112 Interest expense ( 4,731 ) ( 3,255 ) ( 2,236 ) ( 1,369 ) Net interest income 16,831 16,634 17,151 17,743 Provision for loan losses ( 522 ) ( 610 ) ( 475 ) ( 525 ) Non-interest income 2,924 2,875 2,636 2,705 Non-interest expense ( 10,967 ) ( 10,927 ) ( 10,944 ) ( 10,535 ) Income before income taxes 8,266 7,972 8,368 9,388 Provision for income taxes 1,624 1,666 1,705 1,881 Net income $ 6,642 $ 6,306 $ 6,663 $ 7,507 Net income per common share Basic (1) $ 0.82 $ 0.77 $ 0.81 $ 0.91 Diluted (1) $ 0.81 $ 0.77 $ 0.80 $ 0.90 120 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 September 30, 2022 June 30, 2022 March 31, 2022 December 31, 2021 Interest and dividend income $ 17,019 $ 14,627 $ 13,520 $ 13,342 Interest expense ( 756 ) ( 645 ) ( 627 ) ( 646 ) Net interest income 16,263 13,982 12,893 12,696 Provision for loan losses ( 270 ) — — — Non-interest income 2,997 3,102 3,083 3,442 Non-interest expense ( 10,155 ) ( 9,874 ) ( 9,333 ) ( 9,264 ) Income before income taxes 8,835 7,210 6,643 6,874 Provision for income taxes 1,785 1,472 1,316 1,389 Net income $ 7,050 $ 5,738 $ 5,327 $ 5,485 Net income per common share Basic $ 0.86 $ 0.69 $ 0.64 $ 0.66 Diluted $ 0.85 $ 0.69 $ 0.63 $ 0.65 __________________________________________ (1) The net income per common share amounts for the quarters do not add to the total for the fiscal year due to rounding. Note 23 - Revenue from Contracts with Customers In accordance with ASU 2014-09, Revenue from Contracts with Customers ("ASC 606") , revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration that the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, the Company performs the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the Company will collect the consideration that it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. ASC 606 applies to all contracts with customers to provide goods or services in the ordinary course of business, except for contracts that are specifically excluded from its scope. The majority of the Company's revenues are composed of interest income, deferred loan fee accretion, premium/discount accretion, gains on sales of loans and investments, BOLI net earnings, servicing income on loans sold and other loan fee income, which are not within the scope of ASC 606. Revenue reported as service charges on deposits, ATM and debit card interchange transaction fees, merchant services fees, non-deposit investment fees and escrow fees are within the scope of ASC 606. All of the Company's revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income with the exception of gains on sales of OREO and gains on sales/dispositions of premises and equipment, which are included in non-interest expense. For the year ended September 30, 2023, the Company recognized $ 3,824,000 in service charges on deposits, $ 5,194,000 in ATM and debit card interchange transaction fees, $ 109,000 in escrow fees and $ 36,000 in fee income from non-deposit investment sales, all considered within the scope of ASC 606. For the year ended September 30, 2022, the Company recognized $ 3,964,000 in service charges on deposits, $ 5,210,000 in ATM and debit card interchange transaction fees, $ 211,000 in escrow fees and $ 27,000 in fee income from non-deposit investment sales, all considered within the scope of ASC 606. Descriptions of the Company's revenue-generating activities that are within the scope of ASC 606 are as follows: 121 Notes to Consolidated Financial Statements Timberland Bancorp, Inc. and Subsidiary September 30, 2023 and 2022 • Service Charges on Deposits: The Company earns fees from its deposit customers from a variety of deposit products and services. Non-transaction based fees such as account maintenance fees and monthly statement fees are considered to be provided to the customer under a day-to-day contract with ongoing renewals. Revenue for these non-transaction fees are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Transaction-based fees such as non-sufficient fund charges, stop payment charges and wire fees are recognized at the time that the transaction is executed, as the contract duration does not extend beyond the service performed. • ATM and Debit Card Interchange Transaction Fees: The Company earns fees from cardholder transactions conducted through third-party payment network providers which consist of interchange fees earned from the payment networks as a debit card issuer. These fees are recognized when the transaction occurs but may settle on a daily or monthly basis. • Escrow Fees: The Company earns fees from real estate escrow contracts with customers. The Company receives and disburses money and/or property according to the customer's contract. Such fees are recognized when the escrow contract closes. • Fee income from Non-Deposit Investment Sales: The Company earns fees from contracts with customers for investment activities. Revenues are generally recognized on a monthly basis and are generally based on a percentage of the customer's assets under management or based on investment solutions that are implemented for the customer. 122 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.