TIMBERLAND BANCORP INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations As used in this Form 10-Q, the terms “we,” “our” and “Company” refer to Timberland Bancorp, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. When we refer to “Bank” in this Form 10-Q, we are referring to Timberland Bank, a wholly-owned subsidiary of Timberland Bancorp, Inc., and the Bank’s wholly-owned subsidiary, Timberland Service Corporation. Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding our financial condition and results of operations. The information contained in this section should be read in conjunction with the consolidated financial statements and accompanying notes to the consolidated financial statements contained in Item 1 of this Form 10-Q. The following analysis discusses the material changes in the consolidated financial condition and results of operations of the Company at and for the three months ended December 31, 2023. Special Note Regarding Forward-Looking Statements Certain matters discussed in this Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause our actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited 38 to: potential adverse impacts to economic conditions in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company's business operations or financial markets, including, without limitation, as a result of employment levels, labor shortages and the effects of inflation, a potential recession or slowed economic growth; continuing elevated levels of inflation and the impact of current and future monetary policies of the Board of Governors of the Federal Reserve System ("Federal Reserve") in response thereto; the effects of any federal government shutdown; credit risks of lending activities, including any deterioration in the housing and commercial real estate markets which may lead to increased losses and non-performing loans in our loan portfolio resulting in our ACL not being adequate to cover actual losses and thus requiring us to materially increase our ACL through the provision for credit losses; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long-term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; secondary market conditions for loans and our ability to sell loans in the secondary market; results of examinations of us by the Federal Reserve and of our bank subsidiary by the Federal Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, institute a formal or informal enforcement action against us or our bank subsidiary which could require us to increase our allowance for credit losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings; the impact of bank failures or adverse developments at other banks and related negative press about the banking industry in general on investor and depositor sentiment; legislative or regulatory changes that adversely affect our business including changes in banking, securities and tax law, in regulatory policies and principles, or the interpretation of regulatory capital or other rules; our ability to attract and retain deposits; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risks associated with the loans in our consolidated balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our business strategies; our ability to manage loan delinquency rates; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock; the quality and composition of our securities portfolio and the impact if any adverse changes in the securities markets, including on market liquidity; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board ("FASB"), including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, and other external events on our business; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and other risks described elsewhere in this Form 10-Q and in the Company's other reports filed with or furnished to the Securities and Exchange Commission, including our 2023 Form 10-K. Any of the forward-looking statements that we make in this Form 10-Q and in the other public statements we make are based upon management's beliefs and assumptions at the time they are made. We do not undertake and specifically disclaim any obligation to publicly update or revise any forward-looking statements included in this quarterly report to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur and we caution readers not to place undue reliance on any forward-looking statements. These risks could cause our actual results for fiscal 2024 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company's consolidated financial condition and results of operations as well as its stock price performance. 39 Overview Timberland Bancorp, Inc., a Washington corporation, is the holding company for Timberland Bank. The Bank opened for business in 1915 and serves consumers and businesses across Grays Harbor, Thurston, Pierce, King, Kitsap and Lewis counties, Washington with a full range of lending and deposit services through its 23 offices (including its main office in Hoquiam). At December 31, 2023, the Company had total assets of $1.90 billion, net loans receivable of $1.34 billion, total deposits of $1.63 billion and total shareholders’ equity of $237.37 million. The Company's business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report, including the unaudited consolidated financial statements and related data, relates primarily to the Bank's operations. The Bank is a community-oriented bank which has traditionally offered a variety of savings products to its retail and business customers while concentrating its lending activities on real estate secured loans. Lending activities have been focused primarily on the origination of loans secured by real estate, including residential construction loans, one- to four-family residential loans, multi-family loans and commercial real estate loans. The Bank also originates commercial business loans and other consumer loans. The profitability of the Company’s operations depends primarily on its net interest income after provision for (recapture of) credit losses. Net interest income is the difference between interest income, which is the income that the Company earns on interest-earning assets, which are primarily loans and investments, and interest expense, the amount that the Company pays on its interest-bearing liabilities, which are primarily deposits and borrowings (as needed). Net interest income is affected by changes in the volume and mix of interest-earning assets, the interest earned on those assets, the volume and mix of interest-bearing liabilities and the interest paid on those interest-bearing liabilities. Management attempts to maintain a net interest margin placing it within the top quartile of its Washington State peers. Changes in market interest rates, the slope of the yield curve, and interest we earn on interest earning assets or pay on interest bearing liabilities, as well as the volume and types of interest earning assets, interest bearing and non-interest bearing liabilities and shareholders’ equity, usually have the largest impact on changes in our net interest spread, net interest margin and net interest income during a reporting period. Since March 2022, in response to inflation, the Federal Open Market Committee ("FOMC") of the Federal Reserve has increased the target range for the federal funds rate by 525 basis points, to a range of 5.25% to 5.50% as of December 31, 2023, taking benchmark borrowing costs to their highest level in more than 22 years. The provision for (recapture of) credit losses is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions. The ACL on loans reflects the amount that management has determined is adequate to cover probable expected credit losses in the loan portfolio. As the loan portfolio increases, or due to an increase in probable expected losses inherent in the loan portfolio, the ACL may increase, resulting in a decrease to net interest income after the provision. Improvement in loan risk ratings, increase in property values, or receipts of recoveries of amounts previously charged off may partially or fully offset any required increases to ACL on loans due to loan growth or an increase in the probable expected credit losses. The Company recorded a provision for credit losses on loans of $379,000 for the three months ended December 31, 2023 using the CECL methodology, primarily due to loan portfolio growth. The Company recorded a $525,000 provision for loan losses, using the prior incurred loss methodology, for the three months ended December 31, 2022. Net income is also affected by non-interest income and non-interest expense. For the three months ended December 31, 2023, non-interest income consisted primarily of service charges on deposit accounts, gain on sales of loans, ATM and debit card interchange transaction fees, an increase in the cash surrender value of BOLI, servicing income on loans sold, escrow fees and other operating income. Non-interest income is also increased by net recoveries on investment securities and for periods prior to the adoption of CECL reduced by net OTTI losses on investment securities, if any. Non-interest income is also decreased by valuation allowances on loan servicing rights and increased by recoveries of valuation allowances on loan servicing rights, if any. Non-interest expense consisted primarily of salaries and employee benefits, premises and equipment, advertising, ATM and debit card interchange transaction fees, postage and courier expenses, state and local taxes, professional fees, FDIC insurance premiums, loan administration and foreclosure expenses, data processing and telecommunication expenses, deposit operation expenses, amortization of CDI, and other non-interest expenses. Non-interest expense in certain periods is reduced by gains on the sale of premises and equipment and gains on the sale of OREO. Non-interest income and non-interest expense are affected by the growth of the Company's operations and growth in the number of loan and deposit accounts. Results of operations may also be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities. 40 Critical Accounting Estimates The discussion and analysis of the Company’s financial condition and results of operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make significant estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions. The Company's critical accounting estimates are described in the Company’s 2023 Form 10-K under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Estimates.” That discussion highlights estimates that the Company makes that involve uncertainty or potential for substantial change. Other than the adoption of CECL, there have been no material changes in the Company’s critical accounting policies and estimates as previously disclosed in the Company’s 2023 Form 10-K. Comparison of Financial Condition at December 31, 2023 and September 30, 2023 Total assets increased by $55.21 million, or 3.0%, to $1.90 billion at December 31, 2023 from $1.84 billion at September 30, 2023. The increase in total assets was primarily due to increases in loans receivable and total cash and cash equivalents, which was partially offset by decreases in investment securities and CDs held for investment. The quarterly increase in assets was primarily funded by an increase in deposits,which was partially offset by a decrease in FHLB borrowings. Net loans receivable increased by $33.98 million, or 2.6%, to $1.34 billion at December 31, 2023 from $1.30 billion at September 30, 2023, primarily due to increases in multi-family loans, commercial real estate loans, one- to four-family loans as well as smaller increases in several other loan categories. These increases to net loans receivable were partially offset by decreases in construction and land development loans as well as decreases in several other loan categories. Total deposits increased by $66.13 million, or 4.2%, to $1.63 billion at December 31, 2023 from $1.56 billion at September 30, 2023, primarily due to increases in money market account balances, certificates of deposit balances, and NOW checking account balances. These increases were partially offset by decreases in non-interest bearing deposit balances and savings account balances. Shareholders’ equity increased by $4.30 million, or 1.8%, to $237.37 million at December 31, 2023 from $233.07 million at September 30, 2023. The increase in shareholders' equity was primarily due to net income and proceeds from stock options exercised and a reduction in accumulated other comprehensive loss during the current quarter. These increases were partially offset by the payment of dividends to common shareholders, a reduction of retained earnings related to adoption of the new CECL accounting standard and the repurchase of common stock during the quarter. A more detailed explanation of the changes in significant balance sheet categories follows: Cash and Cash Equivalents and CDs Held for Investment: Cash and cash equivalents and CDs held for investment increased by $26.56 million, or 18.5%, to $170.47 million at December 31, 2023 from $143.91 million at September 30, 2023. The increase was primarily due to increased deposits and a decrease in investment securities, which was partially offset by an increase in loans and a decrease in FHLB borrowings. Investment Securities: Investment securities (including investments in equity securities) decreased by $5.42 million, or 1.7%, to $307.38 million at December 31, 2023 from $312.80 million at September 30, 2023. This decrease was primarily due to prepayments and scheduled amortization of other investment securities. For additional information on investment securities, see Note 2 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.” 41 FHLB Stock : FHLB stock decreased $1.60 million, or 44.5% to $2.00 million at December 31, 2023 from $3.60 million at September 30, 2023, due to the repayment of a portion of FHLB borrowings and the restructuring of stock requirements by FHLB. Other Investments: Other investments consist solely of the Company's investment in the Solomon Hess SBA Loan Fund LLC, which was unchanged at $3.00 million at both December 31, 2023 and September 30, 2023. This investment is utilized to help satisfy compliance with the Bank's Community Reinvestment Act investment test requirements. Loans: Net loans receivable increased by $33.98 million, or 2.6%, to $1.34 billion at December 31, 2023 from $1.30 billion at September 30, 2023. The increase was due to increases of $20.15 million in multi-family loans, $10.77 million in commercial real estate loans, $9.90 million in one- to four-family loans and smaller increases in other categories. These increases were partially offset by an $8.76 million decrease in construction and land development loans, and smaller decreases in several other loan categories. Loan originations decreased by $12.74 million, or 12.5%, to $88.93 million for the three months ended December 31, 2023 from $101.67 million for the three months ended December 31, 2022. The decrease in loan originations was primarily due to a decrease in the amount of commercial real estate, one- to four-family and commercial business loans originated. The decrease was partially offset by increases in multi-family and consumer loan originations. The Company generally sells longer-term fixed-rate one- to four-family mortgage loans for asset liability management purposes and to generate non-interest income. Sales of fixed-rate one- to four-family mortgage loans increased by $2.64 million, or 227.6%, to $3.8 million for the three months ended December 31, 2023 from $1.16 million for the three months ended December 31, 2022, primarily due to one- to four-family construction loans refinancing to permanent loans. For additional information on loans, see Note 4 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.” Premises and Equipment: Premises and equipment decreased by $58,000, or 0.3%, to $21.58 million at December 31, 2023 from $21.64 million at September 30, 2023. This decrease was primarily due to scheduled depreciation. OREO (Other Real Estate Owned): At December 31, 2023, total OREO and other repossessed assets consisted of one land parcel with no recorded value. At September 30, 2023, total OREO and other repossessed assets consisted of two land parcels with no recorded value. BOLI (Bank Owned Life Insurance): BOLI increased by $156,000 or 0.7%, to $23.12 million at December 31, 2023 from $22.97 million at September 30, 2023. The increase was due to net BOLI earnings, representing the increase in the cash surrender value of the BOLI policies. Goodwill and CDI: The recorded amount of goodwill remained unchanged at $15.13 million at both December 31, 2023 and September 30, 2023. CDI decreased by $56,000, or 8.3%, to $621,000 at December 31, 2023 from $677,000 at September 30, 2023 due to scheduled amortization. For additional information on goodwill and CDI, see Note 3 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.” Loan Servicing Rights, Net : Loan servicing rights, net decreased by $199,000 or 9.4%, to $1.92 million at December 31, 2023 from $2.12 million at September 30, 2023 primarily due to the amortization of servicing rights. The principal amount of loans serviced for Freddie Mac and SBA decreased by $3.25 million to $383.25 million at December 31, 2023 from $386.50 million at September 30, 2023. Deposits: Deposits increased by $66.13 million, or 4.2%, to $1.63 billion at December 31, 2023 from $1.56 billion at September 30, 2023. The increase was primarily due to a $79.81 million increase in money market account balances, an $18.81 million increase in certificates of deposit balances and a $2.73 million increase in NOW checking account balances. These increases were partially offset by a $22.80 million decrease in non-interest bearing demand accounts and a $12.42 million decrease in savings account balances. The increase in money market account balances was primarily due to several larger balance increases with commercial customers. 42 Deposits consisted of the following at December 31, 2023 and September 30, 2023 (dollars in thousands): December 31, 2023 September 30, 2023 Amount Percent Amount Percent Non-interest-bearing demand $ 433,065 26.6 % $ 455,864 29.2 % NOW checking 389,463 23.9 386,730 24.8 Savings 215,948 13.3 228,366 14.6 Money market 269,686 16.6 189,875 12.2 Certificates of deposit under $250 181,762 11.2 170,221 10.8 Certificates of deposit $250 and over 96,145 5.9 91,714 5.9 Certificates of deposit - brokered 41,000 2.5 38,165 2.5 Total $ 1,627,069 100.0 % $ 1,560,935 100.0 % FHLB Borrowings: The Company has short- and long-term borrowing lines with the FHLB with total credit available on the lines equal to 45% of the Bank's total assets, limited by available collateral. FHLB borrowings decreased to $20.00 million at December 31, 2023, from $35.00 million at September 30, 2023. The borrowings consist of one $5.00 million short-term borrowing, with a scheduled maturity in September 2024, that bears interest at 5.52%, and one $5.00 million borrowing and one $10.00 million borrowing with scheduled maturities in May 2026, both of which bear interest at 3.95%. Shareholders’ Equity: Total shareholders’ equity increased by $4.30 million, or 1.8%, to $237.37 million at December 31, 2023 from $233.07 million at September 30, 2023. The increase was primarily due to net income of $6.30 million and proceeds of $355,000 from the exercise of stock options and a $257,000 reduction in the accumulated other comprehensive loss category for fair value adjustment on available for sale investment securities . This increase was partially offset by dividend payments to common shareholders of $1.87 million, a $488,000 adjustment to equity for the adoption of the new CECL accounting standard, and the repurchase of 12,330 shares of the Company's common stock for $362,000 during the current quarter. 43 Asset Quality and Commercial Real Estate Portfolio Breakdown: Non-performing assets to total assets was 0.18% at December 31, 2023 and 0.09% at September 30, 2023. Total non-performing assets increased by $1.86 million, or 116.2%, to $3.45 million at December 31, 2023 from $1.60 million at September 30, 2023. The increase in non-performing assets was due to a $1.85 million increase in non-accrual loans and a $3,000 increase in non-accrual investment securities. The following table sets forth information with respect to the Company’s non-performing assets at December 31, 2023 and September 30, 2023 (dollars in thousands): December 31, 2023 September 30, 2023 Loans accounted for on a non-accrual basis: Mortgage loans: One- to four-family (1) $ 602 $ 368 Commercial 683 683 Construction – custom and owner/builder 150 — Consumer loans: Home equity and second mortgage 171 177 Commercial business loans 1,760 286 Total loans accounted for on a non-accrual basis 3,366 1,514 Accruing loans which are contractually past due 90 days or more — — Total of non-accrual and 90 days or more past due loans 3,366 1,514 Non-accrual investment securities 85 82 Total non-performing assets (2) $ 3,451 $ 1,596 TDRs on accrual status (3) $ — $ 2,495 Non-accrual and 90 days or more past due loans as a percentage of loans receivable 0.25 % 0.11 % Non-accrual and 90 days or more past due loans as a percentage of total assets 0.18 % 0.08 % Non-performing assets as a percentage of total assets 0.18 % 0.09 % Loans receivable (4) $ 1,336,283 $ 1,318,122 Total assets $ 1,895,115 $ 1,839,905 ___________________________________ (1) As of December 31, 2023 and September 30, 2023, there were no one- to four-family properties in the process of foreclosure. (2) Does not include TDRs on accrual status as of September 30, 2023. For more information regarding TDRs please see Note 4 of the Notes to Unaudited Financial Statements contained in "Item 1 Financial Statements". (3) Does not include TDRs totaling $0 reported as non-accrual loans at September 30, 2023. For more information regarding TDRs please see Note 4 of the Notes to Unaudited Financial Statements contained in "Item 1 Financial Statements". (4) Does not include loans held for sale, and loan balances are before the ACL. 44 The following tables provide a breakdown of commercial real estate ("CRE") loans by collateral types as of December 31, 2023 and September 30, 2023: CRE Loan Portfolio Breakdown by Collateral at December 31, 2023 ($ in thousands) Collateral Type Balance Percent of CRE Portfolio Percent of Total Loan Portfolio Average Balance per Loan Non-Accrual Industrial warehouse $ 114,355 20 % 8 % $ 1,132 $ 195 Medical/dental offices 80,767 14 6 % 1,324 — Office buildings 65,543 11 5 % 745 — Other retail buildings 50,003 9 3 % 538 — Mini-storage 37,131 6 2 % 1,375 — Hotel/motel 31,973 5 2 % 2,906 — Restaurants 27,346 5 2 % 558 — Gas stations/convenience stores 21,346 4 1 % 970 — Nursing homes 18,024 3 1 % 2,575 — Shopping centers 10,922 2 1 % 1,820 — Mobile home parks 10,917 2 1 % 520 — Churches 7,121 1 1 % 475 — Other 103,590 18 7 % 719 488 Total CRE $ 579,038 100 % 40 % $ 898 $ 683 CRE Loan Portfolio Breakdown by Collateral at September 30, 2023 ($ in thousands) Collateral Type Balance Percent of CRE Portfolio Percent of Total Loan Portfolio Average Balance per Loan Non-Accrual Industrial warehouse $ 115,804 20 % 8 % $ 1,135 $ 195 Medical/dental offices 76,498 14 5 % 1,319 — Office buildings 66,108 12 5 % 760 — Other retail buildings 51,730 9 4 % 545 — Hotel/motel 30,718 5 2 % 3,072 — Mini-storage 27,750 5 2 % 1,156 — Restaurants 27,640 5 2 % 564 — Gas stations/convenience stores 21,588 4 1 % 939 — Nursing homes 18,051 3 1 % 3,008 — Shopping centers 10,790 2 1 % 2,158 — Mobile home parks 9,696 2 1 % 510 — Churches 7,253 1 1 % 484 — Other 104,639 18 7 % 731 488 Total CRE $ 568,265 100 % 40 % $ 893 $ 683 45 Comparison of Operating Results for the Three Months Ended December 31, 2023 and 2022 Net income decreased by $1.21 million, or 16.1%, to $6.30 million for the quarter ended December 31, 2023 from $7.51 million for the quarter ended December 31, 2022. Net income per diluted common share decreased by $0.13, or 14.4%, to $0.77 for the quarter ended December 31, 2023 from $0.90 for the quarter ended December 31, 2022. The decreases in net income and net income per diluted common share for the three months ended December 31, 2023 were primarily due to a $1.74 million decrease in net interest income and an $89,000 increase in non-interest expense.. This decrease was partially offset by a $93,000 increase in non-interest income, a $189,000 decrease in the provision for credit losses and a $335,000 decrease in the provision for income taxes. A more detailed explanation of the income statement categories is presented below. Net Interest Income: Net interest income decreased by $1.74 million, or 9.8%, to $16.00 million for the quarter ended December 31, 2023 from $17.74 million for the quarter ended December 31, 2022. This decrease was primarily due to an increase in the weighted average cost of interest-bearing liabilities to 2.22% at December 31, 2023 from 0.50% at December 31, 2022 and, to a lesser extent, a $67.35 million increase in average balance of total interest-bearing liabilities. Partially offsetting the increase in funding costs, was an increase in the average yields of interest-earning assets to 5.07% for the current quarter from 4.34% at December 31, 2022, and a $16.18 million increase in average total interest-bearing assets. Total interest and dividend income increased by $3.38 million, or 17.7%, to $22.50 million for the quarter ended December 31, 2023 from $19.11 million for the quarter ended December 31, 2022, primarily due to increases in the average yield and average balance of loans receivable, and the average yields on interest-bearing deposits in banks and CDs and investment securities. These increases were partially offset by a decrease in the average balance of interest-bearing deposits in banks and CDs. The average balance of total interest-earning assets increased by $16.18 million, or 0.9%, to $1.78 billion for the quarter ended December 31, 2023 from $1.76 billion for the quarter ended December 31, 2022. The average balance of investment securities decreased by $13.19 million, or 4.1% and the average balance of loans receivable increased by $168.60 million, or 14.5%, which was partially offset by a decrease in the average balance of interest-bearing deposits in banks and CDs of $140.19 million, or 52.6% between the periods. During the quarter ended December 31, 2023, the accretion of the purchase accounting fair value discount on acquired loans increased interest income on loans by $10,000 compared to $28,000 for the quarter ended December 31, 2022. The incremental accretion will change during any period based on the volume of prepayments but is expected to decrease over time as the balance of the net discount declines. During the quarter ended December 31, 2023, there was a total of $142,000 of pre-payment penalties, non-accrual interest and late fees collected, compared to $120,000 collected for the quarter ended December 31, 2022. The average yield on interest-earning assets increased by 73 basis points to 5.07% for the quarter ended December 31, 2023 from 4.34% for the quarter ended December 31, 2022. The average yield on interest-bearing deposits in banks and CDs and on investment securities increased 176 basis points and 22 basis points to 5.35% and 2.96%, respectively, for the quarter ended December 31, 2023 compared to the quarter ended December 31, 2022, while the average yield on loans receivable increased 55 basis points to 5.52% during the same period. Total interest expense increased by $5.12 million, or 374.2%, to $6.49 million for the quarter ended December 31, 2023 from $1.37 million for the quarter ended December 31, 2022. The increase in interest expense was due to an increase in the average cost and, to a lesser extent, an increase in the average balance of interest-bearing liabilities, primarily deposits. The average cost of interest-bearing liabilities increased to 2.22% for the quarter ended December 31, 2023 from 0.50% for the quarter ended December 31, 2022. The average balance of interest-bearing liabilities increased by $67.35 million, or 6.2%, to $1.16 billion for the quarter ended December 31, 2023 from $1.09 billion for the quarter ended December 31, 2022, primarily due to decreases in the average balances of NOW checking, saving and money market accounts, partially offset by an increase in the average balance of certificate of deposit accounts and borrowings. Interest expense on deposits increased by $4.77 million, or 348.7%, to $6.14 million for the quarter ended December 31, 2023 from $1.37 million for the quarter ended December 31, 2022, driven by an increase in the average cost of interest-bearing deposits in all categories and an increase in the average balance of certificates of deposit. The average cost of interest bearing deposits increased 113 basis points to 2.17% for the three months ended December 31, 2023, which included a 297 basis point increase in the cost of certificates of deposit to 4.16%, compared to the same period last year. The average balance of certificates of deposit increased $175.89 million, or 129.8%, to $311.35 million for the three months ended December 31, 2023, compared to the same period last year, which includes $42.73 million in brokered certificates of deposit. 46 Interest expense on borrowing increased to $348,000 for the quarter ended December 31, 2023, compared to none for the quarter ended December 31, 2022. The average balance of borrowing was $28.80 million and the average rate paid on borrowings was 4.05% for the quarter ended December 31, 2023. As a result of the increase in interest expense, the net interest margin ("NIM") decreased to 3.60% for the quarter ended December 31, 2023 from 4.03% for the quarter ended December 31, 2022. Average Balances, Interest and Average Yields/Cost The following tables set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the periods presented (dollars in thousands). Three Months Ended December 31, 2023 2022 Average Balance Interest and Dividends Yield/ Cost Average Balance Interest and Dividends Yield/ Cost Interest-earning assets: Loans receivable (1)(2) $ 1,332,971 $ 18,395 5.52 % $ 1,164,369 $ 14,457 4.97 % Investment securities (2) 310,183 2,311 2.96 323,368 2,214 2.74 Dividends from mutual funds, FHLB stock and other investments 6,981 91 5.19 6,028 51 3.38 Interest-bearing deposits in banks and CDs 126,253 1,699 5.35 266,439 2,390 3.59 Total interest-earning assets 1,776,388 22,496 5.07 1,760,204 19,112 4.34 Non-interest-earning assets 81,612 84,806 Total assets $ 1,858,000 $ 1,845,010 Interest-bearing liabilities: Savings $ 220,042 121 0.22 $ 279,832 82 0.12 Money market 224,939 1,329 2.34 239,424 321 0.53 NOW checking 376,682 1,435 1.51 439,750 498 0.45 Certificates of deposit 268,628 2,681 3.97 135,467 468 1.37 Brokered CDs 42,725 578 5.38 — — — Short-term borrowings 13,804 195 5.62 — — — Long-term borrowings 15,000 153 4.06 — — — Total interest-bearing liabilities 1,161,820 6,492 2.22 1,094,473 1,369 0.50 Non-interest-bearing deposits 450,027 519,307 Other liabilities 11,878 11,002 Total liabilities 1,623,725 1,624,782 Shareholders' equity 234,275 220,228 Total liabilities and shareholders' equity $ 1,858,000 $ 1,845,010 Net interest income $ 16,004 $ 17,743 Interest rate spread 2.85 % 3.84 % Net interest margin (3) 3.60 % 4.03 % Ratio of average interest-earning assets to average interest- bearing liabilities 152.90 % 160.83 % 47 _______________ (1) Does not include interest on loans on non-accrual status. Includes loans held for sale. Amortized net deferred loan fees, late fees, extension fees, prepayment penalties, and the accretion of the fair value discount on loans are included with interest and dividends. (2) Average balances include loans and investment securities on non-accrual status. (3) Net interest income divided by total average interest-earning assets, annualized. Rate Volume Analysis The following table sets forth the effects of changing rates and volumes on the net interest income of the Company. Information is provided with respect to the (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate), (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) the net change (sum of the prior columns). Changes in rate/volume have been allocated to rate and volume variances based on the absolute values of each (dollars in thousands). Three months ended December 31, 2023 compared to three months ended December 31, 2022 increase (decrease) due to Rate Volume Net Change Interest-earning assets: Loans receivable and loans held for sale $ 1,714 $ 2,224 $ 3,938 Investment securities 190 (93) 97 Dividends from mutual funds, FHLB stock and other investments 31 9 40 Interest-bearing deposits in banks and CDs 888 (1,579) (691) Total net increase in income on interest-earning assets 2,823 561 3,384 Interest-bearing liabilities: Savings 60 (21) 39 Money market 1,028 (20) 1,008 NOW checking 1,017 (80) 937 Certificates of deposit 1,690 1,100 2,790 Short term FHLB borrowings 97 98 195 Long-term borrowings 76 77 153 Total net increase in expense on interest-bearing liabilities 3,968 1,154 5,122 Net decrease in net interest income $ (1,145) $ (593) $ (1,738) Provision for Credit Losses: A net $336,000 provision for credit losses was recorded for the quarter ended December 31, 2023, which consisted of a $379,000 provision for credit losses on loans which was primarily due to an increase in loans receivable, a $10,000 recapture of credit losses on investment securities which is primarily due to maturities and principal payments, and a $33,000 recapture of credit losses on unfunded commitments which is primarily due to the change in mix of unfunded commitments. There was a $525,000 provision made for loan losses, under the prior incurred loan loss method, for the quarter ended December 31, 2022. The Company adopted the CECL methodology as of October 1, 2023, which resulted in one-time upward adjustments to the ACL on loans of $461,000, to the ACL on investment securities of $92,000, and to the ACL on unfunded commitments of $65,000, resulting in an after-tax decrease to opening retained earnings of $488,000. Amounts reported prior to October 1, 2023 were calculated using the previous incurred loss methodology to compute our allowance for credit losses, which is not directly comparable to the new CECL methodology. The provision for credit losses for the three months ended December 31, 2023 also reflects assumptions related to forecasts concerning the economic environment as a result of local, national and global events, including recent bank failures. In addition, expected loss estimates consider 48 various factors, including customer specific information, changes in risk ratings, projected delinquencies, and the impact of economic conditions on borrowers ability to repay. For the quarter ended December 31, 2023, net charge-offs were $2,000 compared to a $1,000 recovery for the quarter ended December 31, 2022. Non-accrual loans increased by $1.85 million, or 122.3%, to $3.36 million at December 31, 2023 from $1.51 million at September 30, 2023. At December 31, 2023, non-accrual loans increased by $1.32 million, or 64.7%, to $3.36 million from $2.04 million at December 31, 2022. Total delinquent loans (past due 30 days or more) and non-accrual loans increased by $1.94 million, or 116.4%, to $3.60 million at December 31, 2023, from $1.67 million at September 30, 2023 and increased by $1.35 million, or 59.9%, from $2.25 million one year ago. The $423,000 balance of SBA PPP loans was omitted from the Company's normal allowance for credit losses calculation at December 31, 2023, as these loans are fully guaranteed by the SBA and management expects that most PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which will in turn reimburse the Bank for the amount forgiven. While management believes the estimates and assumptions used in the determination of the adequacy of the ACL are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not have a material adverse impact on financial condition and results of operations. A further decline in national and local economic conditions, as a result of the effects of inflation, and a potential recession or slowed economic growth, among other factors, could result in a material increase in the ACL and have a material adverse impact on the financial condition and results of operations. In addition, the determination of the amount of the ACL is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination and have a material adverse impact on the financial condition and results of operations. In accordance with GAAP, acquired loans are recorded at their estimated fair value, which results in a net discount to the loan's contractual amounts, of which a portion reflects a discount for possible credit losses. Credit discounts are included in the determination of fair value. With the adoption of CECL, the loans are evaluated for impairment in the same manner as the rest of the loan portfolio. The remaining fair value discount associated with $11.2 million in loans that were acquired in the South Sound Acquisition was $182,000 at December 31, 2023. This discount will continue to accrete into income as these loans continue to pay down. For additional information, see Note 4 of the Notes to Unaudited Consolidated Financial Statements contained in “Item 1, Financial Statements.” Non-interest Income: Total non-interest income increased by $93,000, or 3.4%, to $2.80 million for the quarter ended December 31, 2023 from $2.71 million for the quarter ended December 31, 2022. This increase was primarily due to a $76,000 increase in service charges on deposits, a $57,000 increase in net gain on sales of loans, and smaller increases in several other categories. These increases were partially offset by small decreases in several other categories. The increase in net gain on sales of loans was primarily due to an increase in the dollar amount of fixed-rate one- to four-family loans originated and sold during the current quarter reflecting a slight increase in refinance activity compared to the same period last year. These increases were partially offset by small decreases in several other categories. Non-interest Expense: Total non-interest expense increased by $89,000, or 0.8%, to $10.62 million for the quarter ended December 31, 2023 from $10.54 million for the quarter ended December 31, 2022. This increase was primarily due to increased expenses of $185,000 in technology and communications expense, $132,000 in ATM and debit card interchange expense, $86,000 in FDIC insurance and smaller increases in several other categories, which were partially offset by a $176,000 decrease in professional fees expense and smaller decreases in several categories. The increase in technology and communications expense was primarily due to the addition of several technology products and increased processing volumes. The increase in FDIC insurance was due to an increase in deposit insurance rates by the FDIC in January 2023. The efficiency ratio for the current quarter was 56.50% compared to 51.52% for the comparable quarter one year ago. The deterioration in the efficiency ratio was due to lower total revenue coupled with slightly higher non-interest expense. Provision for Income Taxes: The provision for income taxes decreased by $335,000, or 17.8%, to $1.55 million for the quarter ended December 31, 2023 from $1.88 million for the quarter ended December 31, 2022. The decrease in the provision for income taxes was primarily due to lower pre-tax income. The Company's effective income tax rate was 19.6% for the quarter ended December 31, 2023 and 20.0% for the quarter ended December 31, 2022. 49 Liquidity The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on loans, the sale of loans, maturing investment securities, maturing CDs held for investment and borrowings, if needed, from the FHLB and FRB. While the maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Bank must maintain an adequate level of liquidity to help ensure the availability of sufficient funds to fund its operations. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At December 31, 2023, the Bank's regulatory liquidity ratio (net cash, and short-term and marketable assets, as a percentage of net deposits and short-term liabilities) was 13.07%. At December 31, 2023, the Bank maintained an uncommitted credit facility with the FHLB that provided for immediately available borrowings up to an aggregate amount equal to 45% of total assets, limited by available collateral, under which $20.00 million was outstanding. The Bank had $576.42 million available for borrowings with the FHLB at December 31, 2023. The Bank 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 December 31, 2023, the Bank had no outstanding balance on the BIC line, under which $74.03 million was available for future borrowings. At December 31, 2023, the Bank had no outstanding balance on the BTFP line, under which $20.00 million was available for future borrowings. The Bank also maintains a $50.00 million overnight borrowing line with Pacific Coast Bankers' Bank ("PCBB"). At December 31, 2023, the Bank did not have an outstanding balance on this borrowing line. Subject to market conditions, the Bank expects to utilize these borrowing facilities from time to time in the future to fund loan originations and deposits withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible. Liquidity management is both a short and long-term responsibility of the Bank's management. The Bank adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, and (iv) yields available on interest-bearing deposits. Excess liquidity is invested generally in interest-bearing overnight deposits, CDs held for investment and short-term government and agency obligations. If the Bank requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB, the FRB and PCBB. The Bank's primary investing activity is the origination of loans and, to a lesser extent, the purchase of investment securities. During the three months ended December 31, 2023 and 2022, the Bank originated $88.93 million and $101.67 million of loans, respectively. At December 31, 2023, the Bank had loan commitments totaling $147.06 million and undisbursed construction loans in process totaling $104.68 million. Investment securities purchased during the three months ended December 31, 2023 and 2022 totaled $1.92 million and $31.31 million, respectively. The Bank’s liquidity is also affected by the volume of loans sold and loan principal payments. During the three months ended December 31, 2023 and 2022, the Bank sold $9.60 million and $1.16 million, respectively, in loans and loan participation interests. During the three months ended December 31, 2023, the Bank received $44.35 million in principal repayments. During the three months ended December 31, 2022, the Bank received $50.71 million in principal repayments. The Bank's liquid assets in the form of cash and cash equivalents, CDs held for investment and investment securities available for sale (including equity securities) increased to $211.76 million at December 31, 2023 from $186.49 million at September 30, 2023. CDs that are scheduled to mature in less than one year from December 31, 2023 totaled $274.31 million. Historically, the Bank has been able to retain a significant amount of its deposits as they mature. Capital expenditures are incurred on an ongoing basis to expand and improve the Bank's product offerings, enhance and modernize technology infrastructure, and to introduce new technology-based products to compete effectively in the various markets. Capital expenditure projects are evaluated based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and the expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations. Based on current objectives, there are no projects scheduled for capital investments in premises and equipment during the remaining nine months ending September 30, 2024 that would materially impact liquidity. 50 For the remaining nine months in the year ending September 30, 2024, the Bank projects that fixed commitments will include $250,000 of operating lease payments. One FHLB borrowing totaling $5.00 million will mature during the fiscal year 2024. In addition, at December 31, 2023, there were other future obligations and accrued expenses of $8.88 million. The Bank's management believes that the liquid assets combined with the available lines of credit provide adequate liquidity to meet current financial obligations for at least the next 12 months. Timberland Bancorp is a separate legal entity from the Bank and must provide for its own liquidity and pay its own operating expenses. In addition to is operating expenses, Timberland Bancorp is responsible for paying any dividends declared, if any, to its shareholders and funds paid for Company stock repurchases. Sources of capital and liquidity for Timberland Bancorp include distributions from the Bank and the issuance of debt or equity securities, although there are regulatory restrictions on the ability of the Bank to pay dividends. At December 31, 2023, Timberland Bancorp (on an unconsolidated basis) had liquid assets of $1.01 million. The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. The current quarterly common stock dividend rate is $0.24 per share, as approved by the Board of Directors, which is a dividend rate per share that enables the Company to balance multiple objectives of managing and investing in the Bank and returning a substantial portion of cash to shareholders. Assuming continued payment during fiscal year 2024 at the rate of $0.24 per share, the average total dividend paid each quarter would be approximately $1.95 million based on the number of current outstanding shares at December 31, 2023 (which assumes no increases or decrease in the number of shares). In addition, from time to time, our Board of Directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans may also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On July 25, 2023, the Company announced the adoption of a new stock repurchase program pursuant to which the Company may repurchase up to 404,708 shares of Company common stock, of which 361,812 shares remained available for future purchases as of December 31, 2023. The repurchase program may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, the availability of alternative investment opportunities, liquidity, and other factors deemed appropriate. The repurchase program does not obligate the Company to purchase any particular number of shares. Capital Resources 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. Based on its capital levels at December 31, 2023, the Bank exceeded all regulatory capital requirements. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at December 31, 2023, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status. 51 The following table compares the Bank’s actual capital amounts at December 31, 2023 to its minimum regulatory capital requirements at that date (dollars in thousands): Actual Regulatory Minimum To Be “Adequately Capitalized” To Be “Well Capitalized” Under Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio Leverage Capital Ratio: Tier 1 capital $222,238 12.06 % $73,718 4.00 % $92,147 5.00 % Risk-based Capital Ratios: Common equity Tier 1 capital 222,238 18.10 55,247 4.50 79,801 6.50 Tier 1 capital 222,238 18.10 73,662 6.00 98,216 8.00 Total capital 237,606 19.35 98,216 8.00 122,770 10.00 In addition to the minimum common equity Tier 1 ("CET1"), Tier 1 and total capital ratios, the Bank is required to 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 December 31, 2023, the Bank's CET1 capital exceeded the required capital conservation buffer. Timberland Bancorp, Inc. 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 (as of June 30th of the preceding year), 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, Inc. were subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2023, Timberland Bancorp, Inc. would have exceeded all regulatory requirements. The following table presents for informational purposes the regulatory capital ratios for Timberland Bancorp, Inc. as of December 31, 2023 (dollars in thousands): Actual Amount Ratio Leverage Capital Ratio: Tier 1 capital $223,774 12.14 % Risk-based Capital Ratios: Common equity Tier 1 capital 223,774 18.22 Tier 1 capital 223,774 18.22 Total capital 239,147 19.47 Key Financial Ratios and Data Three Months Ended December 31, 2023 2022 PERFORMANCE RATIOS : Return on average assets 1.36 % 1.63 % Return on average equity 10.75 % 13.63 % Net interest margin 3.60 % 4.03 % Efficiency ratio 56.50 % 51.52 % Item 3. Quantitative and Qualitative Disclosures About Market Risk There were no material changes in information concerning market risk from the information provided in the Company’s 2023 Form 10-K. 52