Item 1. Business
General
	 	Timberland Bancorp, Inc. ("Company"), a Washington corporation, was organized on September 8, 1997 for the purpose of becoming the holding company for Timberland Savings Bank, SSB ("Bank") upon the Bank's conversion from a Washington-chartered mutual to a Washington-chartered stock savings bank ("Conversion"). The Conversion was completed on January 12, 1998 through the sale and issuance of 6,612,500 shares of common stock by the Company. At September 30, 2003, the Company had total assets of $449.6 million, total deposits of $307.7 million and total shareholders' equity of $77.6 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 consolidated financial statements and related data, relates primarily to the Bank and its subsidiary.
	 	The Bank was established in 1915 as "Southwest Washington Savings and Loan Association." In 1935, the Bank converted from a state-chartered mutual savings and loan association to a federally chartered mutual savings and loan association, and in 1972, changed its name to "Timberland Federal Savings and Loan Association." In 1990, the Bank converted to a federally chartered mutual savings bank under the name "Timberland Savings Bank, FSB." In 1991, the Bank converted to a Washington-chartered mutual savings bank and changed its name to "Timberland Savings Bank, SSB." On December 29, 2000, the Bank changed its name to "Timberland Bank." The Bank's deposits are insured by the FDIC up to applicable legal limits under the Savings Association Insurance Fund ("SAIF"). The Bank has been a member of the Federal Home Loan Bank ("FHLB") System since 1937. The Bank is regulated by the Washington Department of Financial Institutions, Division of Banks ("Division") and the FDIC.	 	The Bank is a community oriented bank which has traditionally offered a variety of savings products to its retail customers while concentrating its lending activities on real estate mortgage loans. Lending activities have been focused primarily on the origination of loans secured by one- to- four family residential dwellings, including an emphasis on construction and land development loans, as well as the origination of multi-family and commercial real estate loans. The Bank actively originates adjustable rate residential mortgage loans that do not qualify for sale in the secondary market under Federal Home Loan Mortgage Corporation ("FHLMC") guidelines. The Bank also originates commercial business loans and in 1998 established a business banking division to increase the origination of these loans.
Market Area
	 	The Bank considers Grays Harbor, Thurston, Pierce, King and Kitsap Counties as its primary market areas. The Bank conducts operations from its main office in Hoquiam (Grays Harbor County), three branch offices in Grays Harbor County (Aberdeen, opened in 1974, Montesano, opened in 1975, and Ocean Shores, opened in 1977), a branch office in King County (Auburn, opened in 1994), four branch offices in Pierce County (Edgewood, opened in 1980, Puyallup, opened in 1996, Spanaway, opened in 1999, and Tacoma, opened in 2001), three branch offices in Thurston County (Lacey, opened in 1997, Yelm, opened in 1999, Tumwater opened in 2001 and Olympia, opened in 2003), and two branch offices in Kitsap County (Poulsbo, opened in 1999 and Silverdale, opened in 2003). See "Item 2.
Item 2. Properties
	 	The Bank operates 15 full-service facilities.	 The following table sets forth certain information regarding the Bank's offices at September 30, 2003, all of which are owned, except for the Tacoma office, and the Data Center office at 504 8th Street, which are leased.
The Bank is scheduled to open a full-service office in Gig Harbor, Washington in March 2004. The branch facility will be leased.
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	The Bank operates 16 proprietary ATMs that are part of a nationwide cash exchange network. The Bank also began remodeling a commercial building in Hoquiam, Washington, during the fiscal year ended September 30, 2003, that will become the future location of the Bank's loan servicing department and escrow department.
Item 3.
Item 3. Legal Proceedings
	 	Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank's business. The Bank is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Bank.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
	 	No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 2003.
PART II Item 5.
Item 5.	Market for the Registrant's Common Equity and Related Stockholder Matters
	 	The Company's common stock is traded on the Nasdaq National Market under the symbol "TSBK". As of September 30, 2003, there were 4,251,680 shares of common stock issued and approximately 735 shareholders of record, excluding persons or entities who hold stock in nominee or "street name" accounts with brokers. Dividend payments by the Company are dependent primarily on dividends received by the Company from the Bank. Under federal regulations, the dollar amount of dividends the Bank may pay is dependent upon its capital position and recent net income. Generally, if the Bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed in the FDIC regulations. However, institutions that have converted to a stock form of ownership may not declare or pay a dividend on, or repurchase any of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the liquidation account which was established in connection with the mutual to stock conversion.
	 	The following table sets forth the market price range of the Company's common stock for the years ended September 30, 2003, 2002 and 2001. This information was provided by the Nasdaq Stock Market.
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Item 6.
Item 6.	Selected Financial Data
	 	The following table sets forth certain information concerning the consolidated financial position and results of operations of the Company and subsidiaries at and for the dates indicated. The consolidated data is derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and its subsidiary presented herein.
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(1) Net income divided by average total assets.
(2) Net income divided by average total equity.
(3) Difference between weighted average yield on interest-earning assets and weighted average interest-bearing liabilities.
(4) Net interest income (before provision for loan losses) as a percentage of average interest-earning assets.
(5) Other expenses (excluding federal income tax expense) divided by the sum of net interest income and noninterest income.
(6) Calculation includes ESOP shares not committed to be released.
(7) Calculation excludes ESOP shares not committed to be released.
(8) Loans receivable includes loans held for sale and is not net of allowance for loan losses.
(9) Average total equity divided by average total assets.
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Item 7.
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General	 	Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to assist in understanding the consolidated financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying notes thereto included in Item 8 of this report.
	 	Certain matters in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements relate to, among others, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding the Company's mission and vision. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties. The Company's actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements due to a wide range of factors including, but not limited to, the general business environment, the direction of future interest rates, competitive conditions between banks and non-bank financial services providers, regulatory changes, labor market competitiveness, and other risks detailed in the Company's reports filed with the Securities and Exchange Commission.
Operating Strategy
	 	The Bank is a community-oriented bank which has traditionally offered a wide variety of savings products to its retail customers while concentrating its lending activities on real estate loans. The primary elements of the Bank's operating strategy include:
	 	Emphasize Residential Mortgage Lending and Residential Construction Lending. The Bank has historically attempted to establish itself as a niche lender in its primary market areas by focusing its lending activities primarily on the origination of loans secured by one- to- four family residential dwellings, including an emphasis on loans for the construction of residential dwellings. In an effort to meet the credit needs of borrowers in its primary area, the Bank actively originates one- to- four family mortgage loans that do not qualify for sale in the secondary market under FHLMC guidelines. The Bank has also been an active participant in the secondary market, originating residential loans for sale to the FHLMC on a servicing retained basis.
	 	Diversify Primary Market Area by Expanding Branch Office Network. In an effort to lessen its dependence on the Grays Harbor County market whose economy has historically been tied to the timber and fishing industries, the Bank has opened branch offices in Pierce, King, Thurston and Kitsap Counties. Thurston, Pierce, King and Kitsap Counties contain the Olympia, Bremerton, and Seattle-Tacoma metropolitan areas and their economies are more diversified with the presence of government, aerospace and computer technology industries.
	 	Limit Exposure to Interest Rate Risk. In recent years, the loans that the Bank has retained in its portfolio generally have periodic interest rate adjustment features or have been relatively short-term in nature. Loans originated for portfolio retention primarily have included ARM loans and short-term construction loans. Longer term fixed-rate mortgage loans have generally been originated for sale in the secondary market. Management believes that the interest rate sensitivity of these adjustable rate and short-term loans more closely match the interest rate sensitivity of the Bank's funding sources than do other longer duration assets with fixed interest rates.
	 	Emphasize the Origination of Commercial Real Estate and Commercial Business Loans. The Bank established a business banking division in 1998 for the purpose of increasing the Bank's origination of commercial real estate and
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	commercial business loans. Originally, three lenders were hired to staff the division. Currently, six lenders are active in the origination of commercial loans.
	 	Increase the Consumer Loan Portfolio. In 2001 the Bank hired a consumer loan specialist to increase the origination of consumer loans. The consumer loans generated since that time have been secured primarily by real estate. The Bank expects to continue expanding its portfolio of consumer loans.
Pursue Low Cost Core Deposits and Deposit Related Fee Income. The Bank has placed an emphasis on attracting commercial and personal checking accounts. These transactional accounts typically provide a lower cost of funding than certificates of deposit accounts and generate non-interest fee income. The Bank implemented a checking account acquisition program in 2000 in increase these transactional accounts.
Market Risk and Asset and Liability Management
General. Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its lending, investment, deposit and borrowing activities. The Bank, like other financial institutions, is subject to interest rate risk to the extent that its interest-earning assets reprice differently than its interest-bearing liabilities. Management actively monitors and manages its interest rate risk exposure. Although the Bank manages other risks, such as credit quality and liquidity risk, in the normal course of business management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Bank's financial condition and results of operations. The Bank does not maintain a trading account for any class of financial instruments nor does it engage in hedging activities or derivative instruments. Furthermore, the Bank is not subject to foreign currency exchange rate risk or commodity price risk.
Qualitative Aspects of Market Risk. The Bank's principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates. The Bank has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. The principal element in achieving this objective is to increase the interest-rate sensitivity of the Bank's interest-earning assets by retaining in its portfolio, short-term loans and loans with interest rates subject to periodic adjustments. The Bank relies on retail deposits as its primary source of funds. Management believes retail deposits, compared to brokered deposits, reduce the effects of interest rate fluctuations because they generally represent a more stable source of funds. As part of its interest rate risk management strategy, the Bank promotes transaction accounts and certificates of deposit with terms of up to six years.
	 	The Bank has adopted a strategy that is designed to substantially match the interest rate sensitivity of assets relative to its liabilities. The primary elements of this strategy involve originating ARM loans for its portfolio; maintaining residential construction loans as a portion of total net loans receivable because of their generally shorter terms and higher yields than other one- to- four family residential mortgage loans; matching asset and liability maturities; investing in short-term securities; originating fixed-rate loans for retention or sale in the secondary market and retaining the related loan servicing rights.
	 	Sharp increases or decreases in interest rates may adversely affect the Bank's earnings. However, based on a rate shock analysis prepared by the FHLB of Seattle, an increase in interest rates of up to 300 basis points would increase the Bank's projected net interest income, primarily because a larger portion of the Bank's interest rate sensitive assets than interest rate sensitive liabilities would reprice within a one year period. Similarly, further decreases in interest rates would negatively affect net interest income, as repricing would have the opposite effect. Management has sought to sustain the match between asset and liability maturities and rates, while maintaining an acceptable interest rate spread. Pursuant to this strategy, the Bank actively originates adjustable rate loans for retention in its loan portfolio. Fixed-rate mortgage loans generally are originated for the immediate or future resale in the secondary mortgage market. At September 30, 2003, adjustable rate mortgage loans and adjustable rate mortgage-backed securities constituted $208.9 million or 60.50%, of the Bank's total combined mortgage loan and mortgage-backed securities portfolio. Although the Bank has sought to originate ARM loans, the ability to originate such loans depends to a great extent on market interest
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	rates and borrowers' preferences. Particularly in lower interest rate environments, borrowers often prefer to obtain fixed rate loans.
	 	Consumer loans and construction and land development loans typically have shorter terms and higher yields than permanent residential mortgage loans, and accordingly reduce the Bank's exposure to fluctuations in interest rates. At September 30, 2003, the construction and land development, and consumer loan portfolios amounted to $94.1 million and $28.0 million, or 25.9% and 7.7% of total loans receivable (including loans held for sale), respectively.
Quantitative Aspects of Market Risk. Management of the Bank monitors the Bank's interest rate sensitivity through the use of a model provided for the Bank by the FHLB of Seattle. The model estimates the changes in NPV (net portfolio value) and net interest income in response to a range of assumed changes in market interest rates. The model first estimates the level of the Bank's NPV (market value of assets, less market value of liabilities, plus or minus the market value of any off-balance sheet items) under the current rate environment. In general, market values are estimated by discounting the estimated cash flows of each instrument by appropriate discount rates. The model then recalculates the Bank's NPV under different interest rate scenarios. The change in NPV under the different interest rate scenarios provides a measure of the Bank's exposure to interest rate risk. The following table is provided by the FHLB of Seattle based on data at September 30, 2003.
	 	Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan repayments and deposit decay, and should not be relied upon as indicative of actual results. Furthermore, the computations do not reflect any actions management may undertake in response to changes in interest rates.	 	In the event of a 200 basis point decrease in interest rates, the Bank would be expected to experience a 5.4% decrease in NPV and a 14.6% decrease in net interest income. In the event of a 200 basis point increase in interest rates, a 4.8% increase in NPV and an 8.2% increase in net interest income would be expected. Based upon the modeling described above, the Bank's asset and liability structure generally results in decreases in NPV and decreases in net interest income in a declining interest rate scenario. This structure also generally results in increases in NPV and increases in net interest income in a rising interest rate environment.
	 As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates could possibly deviate significantly from those assumed in calculating the table.
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Comparison of Financial Condition at September 30, 2003 and 2002
Total Assets: Total assets increased $18.5 million to $449.6 million at September 30, 2003 from $431.1 million at September 30, 2002. This change is reflected primarily in a $16.7 million increase in investments and interest bearing deposits in banks and a $1.8 million increase in premises and equipment.
Premises and Equipment: Premises and equipment increased $1.8 million to $13.4 million at September 30, 2003 from $11.7 million at September 30, 2002. The increase is primarily related to the opening of two new branches (Silverdale and Olympia), the opening of a new facility to house the Bank's loan servicing department and escrow department, and the purchase of equipment in conjunction with the Bank's technology improvement initiatives.
Cash and Due from Financial Institutions: Cash and due from financial institutions and interest-bearing deposit balances in banks increased to $38.1 million at September 30, 2003 from $36.1 million at September 30, 2002. The increase is primarily due to investing the proceeds from increased customer deposits.
Investments, Mortgage-backed Securities and FHLB Stock: Investments, mortgage-backed securities and FHLB Stock increased $13.0 million to $59.8 million at September 30, 2003 from $46.7 million at September 30, 2002 as proceeds from increased customer deposits were invested. For additional details on investments and mortgage-backed securities, see Note 3 to the Notes to Consolidated Financial Statements contained in "Item 8, Financial Statements and Supplementary Data."
Loans Receivable and Loans Held for Sale, net of allowance for loan losses: Net loans receivable, including loans held-for-sale, decreased slightly to $322.2 million at September 30, 2003 from $322.5 at September 30, 2002. The composition of the portfolio continued to migrate away from the Bank's historical dependence on one-to-four family mortgage loans as the percentage of one-to-four family mortgage loans decreased to 26.2% at September 30, 2003 from 31.3% at September 30, 2002. The lower levels of one-to-four family mortgage loans were partially offset by increased levels of construction loans, commercial real estate loans, and consumer loans. During the year one-to-four family mortgage loans decreased by $17.8 million and multi-family mortgage loans decreased by $5.9 million. However, net construction loans increased by $11.5 million, commercial mortgage loans increased by $5.3 million, and consumer loans increased by $6.2 million. Loan volume was very strong during the year ended September 30, 2003 as the Bank originated loans of $255.5 million and sold $108.8 million in fixed rate one-to-four family mortgage loans. Management elected to sell a majority of the fixed rate residential loans originated rather than adding them to the Bank's portfolio due to the low interest-rate environment.
Real Estate Owned: Real estate owned ("REO") and other repossessed assets increased $578,000 to $1.3 million at September 30, 2003 from $680,000 at September 30, 2002. The balance increased as nine properties totaling $1.0 million were added to REO status and seven properties totaling $422,000 were sold during the year. For additional information, see "Item 1, Business - Lending Activities - Nonperforming Assets" and Note 7 to the Notes to Consolidated Financial Statements contained in "Item 8, Financial Statements and Supplemental Data."
Deposits: Deposits increased by $15.4 million to $307.7 million at September 30, 2003 from $292.3 million at September 30, 2002, primarily due to a $15.4 million increase in the Bank's N.O.W. checking accounts, a $9.2 million increase in passbook savings accounts, and a $5.5 million increase in non-interest bearing accounts. These increases were partially offset by an $8.4 million decrease in money market accounts and a $6.4 million decrease in certificate of deposit accounts. The Bank chose not to compete for high-rate time deposits, electing instead to focus on attracting transaction accounts that typically provide more of a core deposit relationship with customers.
Borrowings: Borrowings decreased $154,000 to $61.6 million at September 30, 2003 from $61.8 million at September 30, 2002 due to scheduled amortization payments on FHLB advances.
Shareholders' Equity: Total shareholders' equity increased by $3.2 million to $77.6 million at September 30, 2003 from $74.4 million at September 30, 2002. The components of shareholders' equity were primarily affected by net income of $6.64 million, the repurchase of 188,367 shares of the Company's stock for $3.85 million and the payment
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	of $2.15 million in dividends to shareholders. Also affecting shareholders' equity was a $1.50 million increase to additional paid in capital from the exercise of stock options, a $364,000 decrease in accumulated other comprehensive income, and decreases of $644,000 and $528,000 in the equity components related to unearned shares issued to the Management Recognition and Development Plan and Employee Stock Ownership Plans, respectively, as more shares vested under the MRDP and were released under the ESOP.
	 	On February 14, 2003 the Company announced a plan to repurchase 380,028 shares of the Company's stock. This marked the Company's eleventh stock repurchase plan. As of September 30, 2003, the Company had purchased 112,108 of these shares and cumulatively had repurchased 2,710,671 (41.0%) of the 6,612,500 shares that were issued when the Company went public in January 1998.
Comparison of Financial Condition at September 30, 2002 and 2001
Total Assets: Total assets increased by $44.7 million to $431.1 million at September 30, 2002 from $386.3 million at September 30, 2001 primarily due to increased deposit levels.
Cash and Due from Financial Institutions: Cash and due from financial institutions and interest-bearing deposit balances in banks increased to $36.1 million at September 30, 2002 from $13.4 million at September 30, 2001. This increase is primarily due to investing proceeds from increased customer deposits.
Investments, Mortgage-backed Securities and FHLB Stock: Investments, mortgage-backed securities and FHLB stock increased to $46.7 million at September 30, 2002 from $34.2 million at September 30, 2001 primarily due to the conversion of $12.2 million in fixed rate loans held for sale to mortgage-backed securities. For additional details on investments and mortgage-backed securities, see Note 3 to the Notes to Consolidated Financial Statements contained in "Item 8, Financial Statements and Supplementary Data."
Loans Receivable and Loans Held for Sale, net of allowance for loan losses: Net loans receivable, including loans held-for-sale, decreased $1.2 million to $322.5 million at September 30, 2002 from $323.8 at September 30, 2001, primarily due to an $18.6 million decrease in the Bank's net construction loan portfolio and a $16.9 million decrease in the Bank's one-to-four family mortgage loan portfolio. The construction loan decrease resulted primarily from the pay down of loans secured by condominium projects pursuant to unit sales and the conversion of construction loans to permanent status. The decrease of one-to-four family mortgages held in the portfolio was primarily due to the conversion of $12.2 million of loans held for sale to mortgage-backed securities and the sale of $70.2 million in fixed rate one-to-four family mortgage loans during the twelve-month period. The decreases in construction and one-to-four family mortgages were partially offset by a $34.1 million increase in commercial real estate and business loans, which were originated primarily by the Bank's Business Banking Division.
Bank owned life insurance ("BOLI"): The Bank purchased $10.0 million of BOLI during the September 30, 2002 quarter to cover certain officers of the Bank and the Company. The annual increases in the cash surrender value of the insurance policies are reported as tax-exempt non-interest income under the current provisions of the IRS code. The Bank anticipates that the tax-equivalent yield on this asset will be greater than alternative investments and will help the Bank offset the cost of its employee benefit plans.
Real Estate Owned, Net: Real Estate Owned, net, decreased to $680,000 from $1.0 million at September 30, 2001. This balance decreased due to $459,000 in one-to-four family REO's and $260,000 in land REO's being sold and was offset by the addition of $430,000 in one-to-four family REO's. For additional information, see "Item 1, Business -- Lending Activities -- Nonperforming Assets" and Note 7 to the Notes to Consolidated Financial Statements contained in "Item 8, Financial Statements and Supplementary Data."
	 	Deposits: Deposits increased by 20.6% to $292.3 million at September 30, 2002 from $242.4 million at September 30, 2001, primarily due to a $20.6 million increase in the Bank's money market accounts, an $11.6 million increase in N.O.W. checking accounts, a $6.1 million increase in passbook savings accounts and a $6.6 million increase
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in non-interest bearing accounts. Management attributes the deposit growth to its targeted marketing program and to consumer uncertainty regarding alternative investment options.
	 	Borrowings: Borrowings decreased $7.2 million to $61.8 million at September 30, 2002 from $69.0 million at September 30, 2001, as funds from increased deposits were used to pay down the level of FHLB advances.
	 Shareholders' Equity: Total shareholders' equity increased by $2.6 million to $74.4 million at September 30, 2002 from $71.8 million at September 30, 2001. The components of shareholder's equity were affected by net income of $6.9 million, the repurchase of 274,272 shares of the Company's stock for $4.4 million, the payment of $2.0 million in dividends to shareholders, and a $255,000 increase in accumulated other comprehensive income. Also affecting shareholders equity were decreases of $645,000 in the equity component related to unearned shares issued to the Management Recognition and Development Plan and $529,000 in the equity component related to the unearned shares issued to the Employee Stock Ownership Plan, and a $588,000 increase to additional paid in capital from the exercise of stock options.
	 	On May 10, 2002 the Company announced a plan to repurchase 193,659 shares of the Company's stock. This marked the Company's tenth 5% stock repurchase plan. As of September 30, 2002, the Company had purchased 117,400 of these shares and cumulatively had repurchased 2,522,304 (38.1%) of the 6,612,500 shares that were issued when the Company went public in January 1998.
Comparison of Operating Results for Years Ended September 30, 2003 and 2002
Net Income: Net income for the year ended September 30, 2003 was $6.64 million, or $1.66 per diluted share ($1.74 per basic share) compared to $6.89 million, or $1.71 per diluted share ($1.76 per basic share) for the year ended September 30, 2002. The lower earnings for the current year were primarily a result of increased non-interest expenses related to technology improvements, higher employee costs resulting from a larger employee base, and higher premises and equipment expenses due to additional branches and remodeling costs. The increased expenses were, however, partially offset by higher non-interest income, largely related to mortgage loan sales and earnings on bank owned life insurance.
	 	During the year a number of technology enhancements were implemented to provide additional opportunities to serve and expand the Bank's customer base. The Bank converted to the Kirchman Bankway core processing system from its in-house supported system, and changed its Internet banking system, its loan platform system and its ATM service provider. The technology related conversion expenses totaled $586,000 ($387,000 net of income tax) and reduced earnings by $0.10 per diluted share. The majority of the Company's planned technology related conversion expenses occurred during the year ended September 30, 2003. However, the Company does anticipate additional conversion expenses related to employee overtime, additional equipment upgrades, and continued training to occur during the quarters ended December 31, 2003 and March 31, 2004 as additional aspects of the technology upgrades are fully implemented. While the technology upgrades reduced profitability in the short term, the Company believes the investment will be beneficial to its customers and ultimately to its long-term investors.
Net Interest Income: Net interest income decreased $596,000 to $18.78 million for the year ended September 30, 2003 from $19.37 million for the year ended September 30, 2002. Total interest income decreased $2.54 million to $27.72 million for the year ended September 30, 2003 from $30.26 million for the year ended September 30, 2002, primarily due to a reduction in average yields on earning assets. The yield on earning assets was 6.80% for the year ended September 30, 2003 compared to 7.93% for the year ended September 30, 2002. In addition to overall lower market rates, the yield on earning assets was also reduced by a change in the composition of total earning assets. In 2002, loans, the Company's highest yielding class of assets, comprised 84.9% of average earning assets. In 2003, loans comprised 78.4% of average earning assets. This change was largely influenced by the decision to sell many of the loans originated during this low interest rate cycle. That had the effect of increasing the gain on loans sold, at the expense of interest income. The impact of lower average yields was, however, partially offset by increased levels of average earning assets. Total interest expense decreased $1.94 million to $8.95 million for the year ended September 30, 2003 from $10.89 million for the year ended September 30, 2002. The average cost of funds for each of the Bank's deposit account
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	types for the current period was lower than a year ago. The overall cost of funds decreased to 2.69% for the year ended September 30, 2003 from 3.59% for the year ended September 30, 2002. As a result of these changes, the net interest margin decreased to 4.61% for the year ended September 30, 2003 from 5.08% for the year ended September 30, 2002.
Provision for Loan Losses: The provision for loan losses decreased $645,000 to $347,000 for the year ended September 30, 2003 from $992,000 for the year ended September 30, 2002. The provision for loan losses was lower in 2002 primarily because the Bank experienced a lower level of net charge-offs in 2003. For the years ended September 30, 2003 and 2002, net charge-offs were $86,000 and $412,000, respectively.
	 	The Bank has established a systematic methodology for determining the provision for loan losses. On a quarterly basis the Bank performs an analysis taking into consideration historic loss experience for various loan segments, changes in economic conditions, delinquency rates, and other factors to determine the level of allowance for loan losses needed. The allowance for loan losses had a net increase of $261,000 to $3.89 million at September 30, 2003 from $3.63 million at September 30, 2002. The increased level of allowance for loan losses was primarily due to an increased level of loans classified as substandard and changes in the composition of the loan portfolio. The level of loans classified as substandard increased the level of allowance for loan losses deemed necessary by the analysis as the aggregate amount of substandard loans increased $1.1 million to $9.1 million at September 30, 2003 from $8.0 million at September 30, 2002. Also contributing to the higher allowance for loan loss level were changes in the composition of the loan portfolio. The combined percentage of construction and commercial real estate loans in the portfolio increased to 54.2% at September 30, 2003 from 49.2% at September 30, 2002, while the percentage of one-to-four family mortgage loans declined to 26.2% at September 30, 2003 from 31.3% at September 30, 2002. Construction lending and commercial real estate lending typically involve a greater degree of risk than one-to-four family residential mortgage lending and therefore construction loans and commercial real estate loans have been assigned a loss factor that is greater than the loss factor assigned to one-to-four family residential mortgage loans.
	 	Estimated loss factors used in the allowance for loan loss analysis are established based in part on historic charge-off data by loan category and economic conditions. Based on the trends in historical charge-off analysis, the loss factors used in the allowance for loan loss analysis for credit cards were increased during the year ended September 30, 2003 and the loss factors for commercial business loans were decreased.
	 	Based on the systematic methodology, management deemed the allowance for loan losses of $3.89 million at September 30, 2003 (1.19% of loans receivable and 99.9% of non-performing loans) adequate to provide for estimated losses based on an evaluation of known and inherent risks in the loan portfolio at that date. For additional information, see "Item 1, Business - Lending Activities - Allowance for Loan Losses" included herein.
Non-interest Income: For the year ended September 30, 2003 non-interest income increased $1.35 million to $6.01 million from $4.66 million for the year ended September 30, 2002. This increase is primarily due to a $494,000 increase in BOLI income, a $475,000 increase in gain on sale of loans, a $150,000 increase in security sale gains, and a $147,000 increase in service charges on deposits. The increased BOLI income is a result of having a full year's earnings on the BOLI investment that was made in September 2002. The increased loan sale gains are primarily the result of a larger volume of mortgage banking activity due to the strong refinance demand, which was prompted by a decline in interest rates to historically low levels. The Bank sold $108.8 million in fixed rate one-to-four family mortgages during the year ended September 30, 2003 compared to $70.2 million for the previous year.
Non-interest Expense: For the year ended September 30, 2003 non-interest expense increased by $2.12 million to $14.83 million from $12.72 million for the year ended September 30, 2002. The increase is primarily a result of increased employee expenses, increased premises, and equipment expenses and technology enhancement expenses.
	 	During the year, the Company converted to the Kirchman Bankway core processing system from its in-house supported system, and changed its Internet banking system, its loan platform system and its ATM service provider. The technology enhancements were undertaken to provide additional opportunities to serve and expand the Bank's customer base. The technology-related conversion expenses totaled $586,000 for the year ended September 30, 2003 and are reflected in the income statement under other non-interest expenses ($290,000), premises and equipment expenses
<PAGE>
	($210,000) and salaries and employee benefit expenses ($86,000). While the technology upgrades reduced profitability in the short term, the Company believes the investment will be beneficial to its customers and ultimately to its long-term investors.
	 	Salary and benefit expenses increased primarily due to a larger employee base as the Bank opened two new branches during the year and increased staffing levels in several other departments. The number of full time equivalent employees increased during the year to 186 at September 30, 2003 from 159 at September 30, 2002. Premises and equipment expense increased during the year primarily due to the additional branches opened, expenses associated with remodeling the Bank's loan center, and the technology related expenses previously discussed.
As a result of the increased non-interest expenses, the Company's efficiency ratio increased to 59.85% for the year ended September 30, 2003 from 52.91% for the year ended September 30, 2002.
Provision for Income Taxes: The provision for income taxes decreased to $3.0 million for the year ended September 30, 2003 from $3.4 million for the year ended September 30, 2002 primarily as a result of lower income before taxes and an increased level of tax-exempt income. The effective tax rate was 30.9% for the year ended September 30, 2003 and 33.2% for September 30, 2002. The lower effective rate was primarily a result of the increased level of tax-exempt income from the bank owned life insurance program that was implemented in September 2002.
Comparison of Operating Results for Years Ended September 30, 2002 and 2001
	Net Income: Net income for the year ended September 30, 2002 was $6.89 million or $1.71 per diluted share ($1.76 per basic share) compared to net income of $5.46 million or $1.28 per diluted share ($1.30 per basic share) for the year ended September 30, 2001. The primary factors affecting the improved performance for the current year were increased net interest income, increased deposit fee income, increased income from loan sales, and a decreased provision for loan losses. These items were partially offset by higher non-interest expenses.
Net Interest Income: Net interest income increased 9.03 % to $19.37 million for the year ended September 30, 2002 from $17.77 million for the year ended September 30, 2001, primarily due to decreased funding costs. Interest expense decreased by $3.03 million as the Company's overall cost of funds decreased to 3.59% for the year ended September 30, 2002 from 4.95% for the year ended September 30, 2001. Total interest income decreased $1.43 million to $30.26 million for the year ended September 30, 2002 from $31.69 million for the year ended September 30, 2001 primarily due to lower average yields on interest earning assets, from 8.90% in 2001 to 7.93% in 2002. The Company's net interest margin was 5.08% for the year ended September 30, 2002 compared to a net interest margin of 4.99% for the year ended September 30, 2001, primarily due to interest-bearing liabilities repricing more quickly than interest earning assets in the declining rate environment.
	Provision for Loan Losses: The provision for loan losses decreased to $992,000 for the year ended September 30, 2002 from $1.4 million for the year ended September 30, 2001. The provision for loan losses was lower in 2002 primarily because the Bank experienced a lower level of net charge-offs in 2002. For the years ended September 30, 2002 and 2001, net charge-offs were $412,000 and $990,000, respectively. During the year ended September 30, 2001 the Bank made a special $600,000 provision for loan losses when it determined that the credit quality of a large commercial business loan had deteriorated. The loan was subsequently charged off in the year ended September 30, 2001.
	 	The Bank has established a systematic methodology for the determination of provisions for loan losses. On a quarterly basis the Bank performs an analysis taking into consideration historic loss experience for various loan segments, changes in economic conditions, delinquency rates, and other factors to determine the level of allowance for loan losses needed. The allowance for loan losses increased $580,000 to $3.63 million at September 30, 2002 from $3.05 million at September 30, 2001. The increased level of allowance for loan losses was primarily due to changes in the composition of the loan portfolio and increased loss factors utilized in the allowance for loan loss analysis.
<PAGE>
	 	Changes in the composition of the loan portfolio were responsible for a portion of the increased allowance for loan losses. The percentage of commercial real estate loans in the Bank's loan portfolio increased to 27.0% of total loans receivable at September 30, 2002 from 17.8% at September 30, 2001, while the percentage of one- to- four family residential mortgage loans decreased to 31.3% of total loans receivable at September 30, 2002 from 35.1% at September 30, 2001. Commercial real estate lending typically involves a greater degree of risk than one- to- four family residential mortgage lending and therefore commercial real estate loans have been assigned a loss factor that is greater than the loss factor assigned to one- to- four family residential mortgage loans.
	 	Estimated loss factors used in the allowance for loan loss analysis are established based in part on historic charge-off data by loan category and economic conditions. Based on the trends in historical charge-offs analysis, the loss factors used in the allowance for loan loss analysis for commercial business loans and credit cards were increased during the year ended September 30, 2002. The loss estimate factors for one- to- four family mortgage loans, multi family loans, commercial real estate loans, construction loans and land loans were also increased to a lesser extent due to weaknesses and uncertainties in the regional economy.
	 	Based on the systematic methodology management deemed the allowance for loan losses of $3.63 million at September 30, 2002 (1.11% of loans receivable and 97.0 % of non-performing loans) adequate to provide for estimated losses based on an evaluation of known and inherent risks in the loan portfolio at that date. For additional information, see "Item 1, Business -- Lending Activities - Allowance for Loan Losses" included herein.
Non-interest Income: For the year ended September 30, 2002 non-interest income increased $1.73 million to $4.66 million from $2.93 million for the year ended September 30, 2001. This increase is primarily due to an $822,000 increase in service charges on deposits, and a $609,000 increase in gain on sale of loans. The increased deposit-related service charge income is primarily a result of the Bank's checking account acquisition program. The increased loan sale gains are a result of the Company selling $70.2 million in fixed-rate one-to-four family loans during the year compared to $27.6 million in 2001.
Non-interest Expense: Total non-interest expense increased $1.62 million for the year ended September 30, 2002 compared to 2001. This increase is primarily reflected in a $945,000 increase in salary and benefit expense due primarily to increased numbers of employees, a $239,000 increase in ATM operating expenses, a $172,000 increase in expenses related to premises and equipment resulting from new branches, and a $102,000 increase in profitability improvement consulting fees. Also affecting the year-to-year comparison was the recovery in 2001 of a prior NSF kiting related expense. This recovery reduced the non-interest expense for the 2001 year by $150,000.
Provision for Income Taxes: The provision for income taxes increased to $3.4 million for the year ended September 30, 2002 from $2.7 million for the year ended September 30, 2001 primarily as a result of higher income before income taxes. The effective rate was 33.2% for the year ended September 30, 2002 and 33.4% for the year ended September 30, 2001.
Nonperforming Assets
	 	Information with respect to the Bank's nonperforming assets at September 30, 2003 and September 30, 2002 is contained in "Item 1, Business -- Lending Activities -- Nonperforming Assets and Delinquencies."
Average Balances, Interest and Average Yields/Cost
	 	The earnings of the Company depend largely on the spread between the yield on interest-earning assets and the cost of interest-bearing liabilities, as well as the relative amount of the Company's interest-earning assets and interest- bearing liability portfolios.
	 	The following table sets 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 weekly balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from weekly balances. Management does not believe that the use of weekly balances instead of daily balances has caused any material difference in the information presented.
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_________________
(1) Does not include interest on loans 90 days or more past due. Includes loans originated for sale. Amortized net deferred loan fees (2003, $2,140; 2002, $1,930; and 2001, $1,956) are included with interest and dividends.
(2) Average balance includes nonaccrual loans.
(3) Net interest income divided by total interest earning assets.
<PAGE>
Rate/Volume Analysis
	 	The following table sets forth the effects of changing rates and volumes on net interest income on 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); and (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.
______________
(1) Excludes interest on loans 90 days or more past due. Includes loans originated for sale.Liquidity and Capital Resources
	 	The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on and the sale of loans, maturing securities and FHLB advances. The Company also raised $65.0 million in net proceeds from the January 1998 stock offering. While the maturity and 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 ensure the availability of sufficient funds to fund loan originations and deposit withdrawals, to satisfy other financial commitments and to take advantage of investment opportunities. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2003, 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 32.03%. At September 30, 2003, the Bank also maintained
<PAGE>
	an uncommitted credit facility with the FHLB of Seattle that provided for immediately available advances up to an aggregate equal to 35% of total assets, under which $61.6 million was outstanding.
	 	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 and other 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 and collateral for repurchase agreements.
	 	The Bank's primary investing activity is the origination of one- to- four family mortgage loans and construction and land development loans. During the years ended September 30, 2003, 2002, and 2001, the Bank originated $115.0 million, $83.1 million and $47.5 million of one- to- four family mortgage loans and $90.5 million, $52.6 million and $80.1 million of construction and land development loans, respectively. At September 30, 2003, the Bank had mortgage loan commitments totaling $37.4 million, standby letters of credit totaling $75,000, and undisbursed loans in process totaling $34.8 million. The Bank anticipates that it will have sufficient funds available to meet current loan commitments. Certificates of deposit that are scheduled to mature in less than one year from September 30, 2003 totaled $99.2 million. Historically, the Bank has been able to retain a significant amount of its deposits as they mature.
	 	The Bank's liquidity is also impacted by the volume of loans sold and loan principal payments. During the years ended September 30, 2003, 2002, and 2001, the Bank sold $108.8 million, $70.2 million and $27.6 million in fixed rate one- to- four family mortgage loans. The increased loans sales were due in large part to the refinancing cycle brought on by decreasing interest rates. During the years ended September 30, 2003, 2002, and 2001, the Bank received $145.7 million, $136.7 million and $96.1 million in principal repayments.
	 	The Bank's liquidity has been impacted by increases in deposit levels. During the years ended September 30, 2003, 2002, and 2001, deposits increased by $15.4 million, $49.9 million, and $29.8 million.
	 	Investment securities and interest bearing deposits increased to $83.8 million at September 30, 2003 from $67.1 million at September 30, 2002.
	 	Federally-insured state-chartered banks are required to maintain minimum levels of regulatory capital. Under current FDIC regulations, insured state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most highly rated banks), (ii) a ratio of Tier 1 capital to risk weighted assets of at least 4.0% and (iii) a ratio of total capital to risk weighted assets of at least 8.0%. At September 30, 2003, the Bank was in compliance with all applicable capital requirements. For additional details see the regulatory capital table in Note 18 to the Notes to Consolidated Financial Statements contained in "Item 8, Financial Statements and Supplementary Data" and "Item 1, Business -- Regulation of the Bank -- Capital Requirements."
Effect of Inflation and Changing Prices
	 	The consolidated financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operation of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
<PAGE>
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
	 	The information contained under "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk and Asset and Liability Management" of this Form 10-K is incorporated herein by reference.
Item 8.
Item 8.	Financial Statements and Supplementary Data
TIMBERLAND BANCORP, INC. AND SUBSIDIARY Index to Consolidated Financial Statements
<PAGE>
McGladrey & Pullen
Certified Public Accountants
Independent Auditor's Report
The Board of Directors
Timberland Bancorp, Inc.
Hoquiam, Washington
We have audited the accompanying consolidated balance sheets of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2003 and 2002, and the related consolidated statements of income, shareholders' equity, cash flows and comprehensive income for each of the three years in the period ended September 30, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/McGladrey & Pullen, LLP
Tacoma, Washington
November 12, 2003
<PAGE>
Consolidated Balance Sheets (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Assets
Cash and due from financial institutions $ 8,587 $ 10,580
Interest bearing deposits in banks 29,511 25,493
Investments and mortgage-backed securities - held to maturity (market value $279) - -
Investments and mortgage-backed securities - available for sale 54,031 41,582
Federal Home Loan Bank stock (at cost) 5,454 5,139
Loans receivable, net of allowance for loan losses of $3,891 and $3,630, respectively 321,235 319,367
Loans held for sale 1,001 3,161
322,236 322,528
Premises and equipment 13,429 11,664
Real estate owned and other repossessed items 1,258
Accrued interest receivable 1,687 1,604
Bank owned life insurance (BOLI) 10,566 10,036
Other assets 2,595 1,748
Total assets $ 449,633 $ 431,054
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand, noninterest bearing $ 29,133 $ 23,585
Interest bearing 278,539 268,731
Total deposits 307,672 292,316
Federal Home Loan Bank advances 61,605 61,759
Other liabilities and accrued expenses 2,745 2,583
Total liabilities 372,022 356,658
Shareholders' Equity
Preferred stock, $0.01 par value; 1,000,000 shares authorized;
none issued
- -
- -
Common stock, $0.01 par value; 50,000,000 shares authorized;
2003 - 4,251,680 shares issued, 3,843,493 shares outstanding;
2002 - 4,340,976 shares issued, 3,856,536 shares outstanding;
(unallocated ESOP shares and unvested MRDP shares are
not considered outstanding)
Additional paid-in capital 33,775 35,857
Unearned shares issued to employee stock ownership trust (4,891) (5,419)
Unearned shares issued to management recognition and
development plan
(1,182)
(1,826)
Retained earnings 49,699 45,210
Accumulated other comprehensive income
Total shareholders' equity 77,611 74,396
Total liabilities and shareholders' equity $ 449,633 $ 431,054
See notes to consolidated financial statements.
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Consolidated Statements of Income (Dollars in Thousands, Except Per Share Amounts)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2003, 2002 and 2001
Interest and Dividend Income
Loans receivable $ 25,391 $ 27,764 $ 29,777
Investments and mortgage-backed securities 1,416
Dividends from investments 1,064
Interest bearing deposits in banks
Total interest and dividend income 27,723 30,263 31,692
Interest Expense
Deposits 5,570 7,516 9,491
Federal Home Loan Bank advances 3,376 3,374 4,433
Total interest expense 8,946 10,890 13,924
Net interest income 18,777 19,373 17,768
Provision for Loan Losses 1,400
Net interest income after provision for loan losses 18,430 18,381 16,368
Non-Interest Income
Service charges on deposits 2,009 1,862 1,040
Gain on sale of loans, net 1,451
Market value adjustment on loans held for sale - - - -
Gain (loss) on sale of securities available for sale, net (15)
BOLI net earnings - -
Escrow fees
Servicing income on loans sold
ATM transaction fees
Other
Total non-interest income 6,007 4,658 2,927
Non-Interest Expense
Salaries and employee benefits 8,301 6,987 6,042
Premises and equipment 1,799 1,380 1,208
Advertising
Real estate owned
ATM expenses
Postage
Other 2,920 2,654 1,844
Total non-interest expense 14,832 12,716 11,092
Income before federal income taxes 9,605 10,323 8,203
Federal Income Taxes 2,966 3,432 2,741
Net income $ 6,639 $ 6,891 $ 5,462
Earnings Per Common Share
Basic $1.74 $1.76 $1.30
Diluted 1.66 1.71 1.28
See notes to consolidated financial statements.
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Consolidated Statements of Shareholders' Equity (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2003, 2002 and 2001
Common
Shares
Stock
Amount
Additional
Paid-in
Capital
Unearned
Shares
Issued to
Employee
Stock
Ownership
Trust Unearned
Shares
Issued to
Management
Recognition
and Develop-
ment
Plan
Retained
Earnings
Accumulated
Other
Compre-
hensive
Income
(Loss)
Total
Balance, September 30,
4,361,279
$48
$42,250
($6,477)
$ - -
$36,795
($304)
$72,312
Net income - - - - - - - - - - 5,462 - - 5,462
Issuance of MRDP shares - - 3,222 - - (3,224) - - - - - -
Repurchase of common
stock
(428,827)
(4)
(5,914)
- -
- -
- -
- -
(5,918)
Exercise of stock options 1,600 - - - - - - - - - -
Cash dividends ($.41 per
share)
- -
- -
- -
- -
- -
(1,925)
- -
(1,925)
Earned ESOP shares 35,266 - - (26) - - - - - -
Earned MRDP shares 40,985 - - - - - - - -
Change in fair value of
securities available for sale,
net of tax
- -
- -
- -
- -
- -
- -
Balance,
September 30, 2001
4,010,303
39,574
(5,948)
(2,471)
40,332
71,809
Net income - - - - - - - - - - 6,891 - - 6,891
Repurchase of common
stock
(274,272)
(3)
(4,411)
- -
- -
- -
- -
(4,414)
Exercise of stock options 44,253 - - - - - - - - - -
Cash dividends ($.45 per
share)
- -
- -
- -
- -
- -
(2,013)
- -
(2,013)
Earned ESOP shares 35,267 - - - - - - - -
Earned MRDP shares 40,985 - - - - - - - -
Change in fair value of
securities available for sale,
net of tax
- -
- -
- -
- -
- -
- -
Balance,
September 30, 2002
3,856,536
35,857
(5,419)
(1,826)
45,210
74,396
Net income - - - - - - - - - - 6,639 - - 6,639
Repurchase of common
stock
(188,367)
(1)
(3,851)
- -
- -
- -
- -
(3,852)
Exercise of stock options 99,071 1,490 - - - - - - - - 1,491
Cash dividends ($.50 per
share)
- -
- -
- -
- -
- -
(2,150)
- -
(2,150)
Earned ESOP shares 35,267 - - - - - - - -
Earned MRDP shares 40,986 - - - - - - - -
Change in fair value of
securities available for sale,
net of tax
- -
- -
- -
- -
- -
- -
(364)
(364)
Balance,
September 30, 2003
3,843,493
$43
$33,775
($4,891)
($1,182)
$49,699
$167
$77,611
See notes to consolidated financial statements.
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Consolidated Statements of Cash Flows (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2003, 2002 and 2001
Cash Flows from Operating Activities
Net income $ 6,639 $ 6,891 $ 5,462
Noncash revenues, expenses, gains and losses
included in net income:
Depreciation
Deferred federal income taxes (171) (207)
Earned ESOP shares
Earned MRDP Shares
Federal Home Loan Bank stock dividends (315) (309) (310)
Market value adjustment on loans held for sale - - - - (175)
(Gain) loss on sale of real estate owned, net (1)
(Gain) loss on sale of securities available for sale (135) (205)
Gain on sale of loans (1,451) (976) (367)
Provision for loan and real estate owned losses 1,114 1,756
Loans originated for sale (106,652) (67,531) (29,027)
Proceeds from loans held for sale 110,263 71,141 27,964
BOLI net earnings (530) (36) - -
Net change in accrued interest receivable and other assets,
and other liabilities and accrued expenses
(583)
(986)
1,173
Net cash provided by operating activities 9,746 11,115 7,885
Cash Flows from Investing Activities
Net increase in interest-bearing deposits in banks (4,018) (22,071) (313)
Activity in securities held to maturity:
Maturities and prepayments - - - -
Purchases (519) - - - -
Activity in securities available for sale:
Sales 2,064 12,293 12,334
Maturities and prepayments 8,595 5,326 10,549
Purchases (23,560) (17,200) (14,720)
Increase in loans receivable, net (3,160) (14,879) (23,653)
Additions to premises and equipment (2,462) (1,641) (2,573)
Additions to real estate owned (29) (63) (198)
Proceeds from sale of real estate owned 2,035
Purchase of BOLI - - (10,000) - -
Net cash used in investing activities (22,430) (47,438) (16,539)
(continued)
See notes to consolidated financial statements.
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Consolidated Statements of Cash Flows (concluded) (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2003, 2002 and 2001
Cash Flows from Financing Activities
Increase in deposits $ 15,356 $ 49,944 $ 29,761
Repayment of Federal Home Loan Bank advances (154) (16,119) (227,859)
Proceeds from Federal Home Loan Bank advances - - 8,900 215,700
Proceeds from exercise of stock options 1,491
Repurchase of common stock (3,852) (4,414) (5,918)
Payment of dividends (2,150) (2,013) (1,925)
Net cash provided by financing activities 10,691 36,886 9,778
Net increase (decrease) in cash (1,993) 1,124
Cash and Due from Financial Institutions
Beginning of year 10,580 10,017 8,893
End of year $ 8,587 $ 10,580 $ 10,017
Supplemental Disclosures of Cash Flow Information
Income taxes paid $ 2,790 $ 3,700 $ 2,260
Interest paid 9,011 11,073 14,024
Supplemental Disclosures of Non-Cash Investing
and Financing Activities
Market value adjustment of securities held for sale,
net of tax
$ (364)
$ 255
$ 580
Loans transferred to real estate owned 1,157 1,254
Shares issued to management recognition
and development plan
- -
- -
3,224
Investment securities acquired in loan securitization - - 12,227 11,926
Financed sale of real estate owned - - - -
See notes to consolidated financial statements.
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Consolidated Statements of Comprehensive Income (Dollars in Thousands)
Timberland Bancorp, Inc. and Subsidiaries
Years Ended September 30, 2003, 2002 and 2001
Comprehensive Income
Net income $ 6,639 $ 6,891 $ 5,462
Change in fair value of
securities available for sale, net of tax
(364)
Total comprehensive income $ 6,275 $ 7,146 $ 6,042
See notes to consolidated financial statements.
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Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Timberland Bancorp, Inc. (the Company); its wholly owned subsidiary, Timberland Bank (the Bank); and the Bank's wholly owned subsidiary, Timberland Service Corp. All significant intercompany transactions and balances have been eliminated.
Nature of Operations
The Company is a holding company which operates primarily through its subsidiary, the Bank. The Bank was established in 1915 and, through its fifteen branches located in Grays Harbor, Pierce, Thurston, Kitsap and King Counties in Washington State, attracts deposits from the general public, and uses those funds, along with other borrowings, to provide primarily real estate loans to borrowers in western Washington, and to invest in investment securities and mortgage-backed securities.
Consolidated Financial Statement Presentation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and 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 balance sheet, and the reported amounts of revenues and expenses during the reporting period. 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 and the valuation of real estate owned and deferred tax assets.
Certain prior year amounts have been reclassified to conform to the 2003 presentation with no change to net income or shareholders' equity previously reported.
Investments and Mortgage-Backed Securities - Available for Sale
Debt and equity securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest rates, prepayment rates, need for liquidity, and changes in the availability of and the yield of alternative investments, are considered securities available for sale, and are reported at fair value. Fair value is determined using published quotes as of the close of business on reporting dates. Unrealized gains and losses are excluded from earnings, and are reported as a separate component of shareholders' equity, net of the related deferred tax effect, entitled “Accumulated other comprehensive income (loss).” Realized gains and losses on securities available for sale, determined using the specific identification method, are included in earnings. Amortization of premiums and accretion of discounts are recognized in interest income over the period to maturity.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Investments and Mortgage-Backed Securities - Held for Maturity
Debt securities for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized in interest income over the period to maturity.
Declines in the fair value of individual securities held to maturity and available for sale below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. Such write-downs would be included in earnings as realized losses.
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank (FHLB) system, is required to maintain an investment in capital stock of the FHLB in an amount equal to the greater of 1% of its outstanding home loans or 5% of advances from the FHLB. The recorded amount of FHLB stock equals its fair value because the shares can only be redeemed by the FHLB at the $100 per share par value.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are stated in the aggregate at the lower of cost or estimated market 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 fees.
Loans Receivable
Loans are stated at the amount of unpaid principal, reduced by the undisbursed portion of loans in process, unearned income and an allowance for loan losses.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level sufficient to provide for estimated loan losses based on evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon management's continuing analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which full collectibility may not be assured. The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The appropriateness of the allowance for losses on loans is estimated based upon these factors and trends identified by management at the time financial statements are prepared.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses (concluded)
When available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged against the allowance for loan losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: the loan is significantly delinquent and the borrower has not demonstrated the ability or intent to bring the loan current; the Bank has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt; the estimated fair value of the loan collateral is significantly below the current loan balance, and there is little or no near-term prospect for improvement.
In accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, an amendment of SFAS No. 114, a loan is considered impaired when it is probable that a creditor will be unable to collect all amounts (principal and interest) due according to the contractual terms of the loan agreement. Smaller balance homogenous loans, such as residential mortgage loans and consumer loans, are collectively evaluated for potential loss. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when, as a practical expedient, the current fair value of the collateral, reduced by costs to sell, is used. When the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest and net deferred loan fees or costs), an impairment is recognized by creating or adjusting an allocation of the allowance for loan losses. Uncollected accrued interest is reversed against interest income. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance.
A provision for loan losses is charged against income and is added to the allowance for loan losses based on quarterly assessments 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 Bank's control. These factors may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations.
Interest on Loans and Loan Fees
Interest on loans is accrued daily based on the principal amount outstanding. Allowances are established for uncollected interest on loans for which the interest is determined to be uncollectible. Generally, all loans past due 90 days or more are placed on nonaccrual status and internally classified as substandard. Any interest income accrued at that time is fully reserved. Subsequent collections are applied proportionately to past due principal and interest, unless collectability of principal is in doubt, in which case all payments would be applied to principal. Loans are removed from nonaccrual status only when the loan is deemed current, and the collectibility of principal and interest is no longer doubtful, or on 1-4 family loans, when the loan is less than 90 days delinquent.
The Bank 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 fee is recognized in income at the time of repayment.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Loan Servicing Rights
Loan servicing rights are capitalized when acquired through the origination of loans that are subsequently sold or securitized with the servicing rights retained and are amortized as an offset to servicing income on loans sold 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 determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the servicing assets to those estimated at the time servicing assets were originated. Fair values are estimated using discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized mortgage servicing rights based on product type, interest rate and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed their fair value.
Premises and Equipment
Premises and equipment are recorded at cost. Depreciation is computed on the straight-line method over the following estimated useful lives: buildings and improvements - up to forty years; furniture and equipment - three to seven years; and automobiles - five years. The cost of maintenance and repairs is charged to expense as incurred. Gains and losses on dispositions are reflected in earnings.
Real Estate Owned and Other Repossessed Items
Real estate owned consists of properties acquired through or in lieu of foreclosure, and are recorded initially at the lower of cost or fair value of the properties less estimated costs of disposal. Costs relating to development and improvement of the properties are capitalized while costs relating to holding the properties are expensed.
Valuations are periodically performed by management, and an allowance for losses is established by a charge to earnings if the recorded value of a property exceeds its estimated net realizable value.
Income Taxes
The Company files a consolidated federal income tax return with its subsidiaries. Prior to fiscal year 1997, the Bank qualified under provisions of the Internal Revenue Code which permitted, as a deduction from taxable income, an allowance for bad debts based on a percentage of taxable income.
In 1996, the percentage-of-income bad debt deduction for federal tax purposes was eliminated. In addition, federal tax bad debt reserves which had been accumulated since October 1, 1988, that exceeded the reserves which would have been accumulated based on actual experience, are subject to recapture over a six-year recapture period. As of September 30, 2003, the Bank's federal tax bad debt reserves subject to recapture approximated $300,000.
Deferred federal income taxes result from temporary differences between the tax basis of assets and liabilities, and their reported amounts in the consolidated financial statements. These 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.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Employee Stock Ownership Plan
The Bank sponsors a leveraged Employee Stock Ownership Plan (ESOP). The ESOP is accounted for in accordance with the American Institute of Certified Public Accountants Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plan. Accordingly, the debt of the ESOP is recorded as other borrowed funds of the Bank, and the shares pledged as collateral are reported as unearned shares issued to the employee stock ownership trust on the consolidated balance sheets. The debt of the ESOP is with the Company and is thereby eliminated in the consolidated financial statements. As shares are released from collateral, compensation expense is recorded equal to the average market price of the shares for the period, and the shares become available for earnings per share calculations.
Cash Equivalents and Cash Flows
The Company considers all amounts included in the balance sheets caption “Cash and due from financial institutions” to be cash equivalents. Cash flows from interest bearing deposits in banks, loans and deposits are reported net.
Stock-Based Compensation
At September 30, 2003, the Company has a stock-based option plan, which is described more fully in Note 14. The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for this plan. Accordingly, no compensation cost has been recognized for the plan. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards granted under this plan, consistent with the method prescribed in SFAS No. 123, the Company's reported and pro forma net income and earnings per share for the years ended September 30 would be as follows (dollars in thousands, except per share amounts):
Net income, as reported $ 6,639 $ 6,891 $ 5,462
Less total stock-based compensation expense determined
under fair value method for all qualifying awards
Pro forma net income $ 6,415 $ 6,632 $ 5,161
Earnings Per Share
Basic:
As reported $1.74 $1.76 $1.30
Pro forma 1.68 1.70 1.23
Diluted:
As reported 1.66 1.71 1.28
Pro forma 1.61 1.66 1.23
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (continued)
Earnings Per Share
Basic earnings per share exclude dilution and are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if common shares were issued under the Company's stock option and management recognition and development plans.
Recent Accounting Pronouncements
In December 2002, the Financial Accounting Standards Board issued FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, and APB Opinion No. 28, Interim Financial Reporting, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement does not require any change from the method currently used by the Company to account for stock-based compensation, but does require more prominent disclosure in the annual and interim financial statements about the method of accounting for such compensation and the effect of the method used on reported results. This statement was effective for years ending after December 15, 2002. The Company has adopted the disclosure provisions of SFAS No. 148 in the accompanying financial statements, and accordingly, the disclosure requirements are set forth in Note 1, in the Stock Based Compensation section.
In April 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this Statement (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of Statement No. 133, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and (4) amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments. SFAS No. 149 is effective prospectively for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. Adoption of SFAS No. 149 did not have a material impact on the Company's financial position or results of operations.
The FASB has issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. Statement No. 150 requires that certain freestanding financial instruments be reported as liabilities on the balance sheet. Depending on the type of financial instrument, it will be accounted for at either fair value or the present value of future cash flows determined at each balance sheet date with the change in that value reported as interest expense on the income statement. Prior to the application of Statement No. 150, either those financial instruments were not required to be recognized, or if recognized were reported on the balance sheet as equity and changes in the value of those instruments were normally not recognized in net income. The Company does not expect the application of Statement No. 150 to have an effect on its financial position.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 1 - Summary of Significant Accounting Policies (concluded)
Recent Accounting Pronouncements
In November 2002, the FASB issued Interpretation No. 45 (FIN), Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires a company, at the time it issues a guarantee, to recognize an initial liability for the fair value of obligations assumed under the guarantee and elaborates on existing disclosure requirements. The initial recognition requirements of FIN 45 are effective for guarantees issued or modified after December 31, 2002, and adoption of disclosure requirements is effective for the Company in the current year. The adopting of FIN 45 did not have an impact on the Company's financial position or results of operations.
Note 2 - Restricted Assets
Federal Reserve Board regulations require that the Bank maintain certain minimum reserve balances on hand or on deposit with the Federal Reserve Bank. The amount of such balances for the years ended September 30, 2003 and 2002 was approximately $5,423,000 and $2,405,000, respectively.
Note 3 - Investments and Mortgage-Backed Securities
Investments and mortgage-backed securities have been classified according to management's intent (dollars in thousands):
Amortized
Cost Gross
Unrealized
Gains Gross
Unrealized
Losses
Fair
Value
September 30, 2003
Held to Maturity
Mortgage-backed securities $279 $- - $- - $279
Available for Sale
Mortgage-backed securities $16,722 $402 ($ 26) $17,098
Municipal bonds - -
Mutual funds 34,546 (148) 34,410
U.S. Agency Securities 2,500 - - 2,511
Total $53,779 $426 ($174) $54,031
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 3 - Investments and Mortgage-Backed Securities (concluded)
Amortized
Cost Gross
Unrealized
Gains Gross
Unrealized
Losses
Fair
Value
September 30, 2002
Available for Sale
Mortgage-backed securities $17,196 $698 ($ 6) $17,888
Municipal bonds - -
Mutual funds 23,545 - - 23,654
Total $40,778 $810 ($ 6) $41,582
Mortgage-backed securities pledged as collateral for public fund deposits and federal treasury tax and loan deposits totaled $1,564,000 and $2,402,000 at September 30, 2003 and 2002, respectively.
The contractual maturities of debt securities at September 30, 2003 are as follows (dollars in thousands). Expected maturities may differ from scheduled maturities due to the prepayment of principal or call provisions.
Gross realized gains on sales of securities available for sale were $135,000, $8,000 and $227,000 for the years ended September 30, 2003, 2002 and 2001, respectively. There were no gross realized losses on sales of securities available for sale for the year ended September 30, 2003. Gross realized losses on sales of securities available for sale were $23,000 and $22,000, for the years ended September 30, 2002 and 2001, respectively.
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 4 - Loans Receivable and Loans Held for Sale
Loans receivable and loans held for sale consisted of the following at September 30 (dollars in thousands):
Mortgage loans:
One- to four-family $ 94,370 $ 109,983
Multi-family 18,241 24,135
Commercial 102,972 97,644
Construction and land development 94,117 80,144
Land 15,628 15,453
Total mortgage loans 325,328 327,359
Consumer loans:
Home equity and second mortgage 19,233 13,718
Other 8,799 8,097
Total consumer loans 28,032 21,815
Commercial business loans 9,475 9,365
Total loans receivable 362,835 358,539
Less:
Undisbursed portion of loans in process 34,785 32,324
Deferred loan origination fees 2,924 3,218
Allowance for loan losses 3,891 3,630
41,600 39,172
Loans receivable, net 321,235 319,367
Loans held for sale (one- to four-family) 1,001 3,161
Total loans receivable and loans held for sale $322,236 $322,528
Certain related parties of the Bank, principally Bank directors and officers, were loan customers of the Bank in the ordinary course of business during 2003 and 2002. Activity in related party loans during the years ended September 30 is as follows (dollars in thousands):
Balance, beginning of year $ 1,348 $ 793
New loans 1,640 1,246
Repayments (1,947) (691)
Balance, end of year $ 1,041 $ 1,348
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 4 - Loans Receivable and Loans Held for Sale (concluded)
At September 30, 2003 and 2002, the Bank had non-accruing loans totaling approximately $3,895,000 and $3,741,000, respectively. At September 30, 2003 and 2002, no loans were 90 days or more past due and still accruing interest. No interest income was recorded on non-accrual loans for the years ended September 30, 2003, 2002 and 2001. The average investment in non-accrual loans for the years ended September 30, 2003, 2002 and 2001 was $3,478,000, $4,095,000 and $3,778,000, respectively.
An analysis of the allowance for loan losses for the years ended September 30 follows (dollars in thousands):
Balance, beginning of year $3,630 $3,050 $2,640
Provision for loan losses 1,400
Loans charged off (168) (521) (1,012)
Recoveries
Net charge-offs (86) (412) (990)
Balance, end of year $3,891 $3,630 $3,050
Following is a summary of information relating to impaired loans as of September 30 (dollars in thousands):
Impaired loans without a valuation allowance
$3,560 $3,599
Impaired loans with a valuation allowance
$3,895 $3,741
Valuation allowance related to impaired loans
$61 $57
Note 5 - Loan Servicing
Loans serviced for the Federal Home Loan Mortgage Corporation and others are not included in the consolidated balance sheets. The principal amounts of those loans at September 30, 2003 and 2002 were $161,702,000 and $140,387,000, respectively.
Following is an analysis of the changes in mortgage servicing rights for the years ended September 30 (dollars in thousands):
Balance, at beginning of year $ 834 $ 508 $ 356
Additions
Amortization (654) (294) (148)
Balance, end of year $ 1,017 $ 834 $ 508
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 5 - Loan Servicing (concluded)
In October and June 2001, the Bank securitized and sold approximately $12.2 million and $11.9 million, respectively, in first mortgage loans. In the securitization, the Bank retained servicing responsibilities, but has no other retained interest in the loans sold (see Note 24).
At September 30, 2003, the servicing rights fair value totaled $1,700,000, which was estimated using discount rate of 9.7% and a prepayment speed factor of 309.
There was no valuation allowance at September 30, 2003 and 2002.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at September 30 (dollars in thousands):
Land
$ 3,241 $ 2,654
Buildings and improvements
9,388 7,798
Furniture and equipment
3,956 3,282
Property held for future expansion
Construction and purchases in progress
1,546 1,428
18,384 15,921
Less accumulated depreciation
4,955 4,257
Total premises and equipment
$ 13,429 $ 11,664
Note 7 - Real Estate Owned
Real estate owned consisted of the following at September 30 (dollars in thousands):
Real estate acquired through foreclosure
$ 1,462 $ 900
Allowance for possible losses
(204) (220)
Total real estate owned
$ 1,258 $ 680
An analysis of the allowance for possible losses for the years ended September 30 follows (dollars in thousands):
Balance, beginning of year $ 220 $ 137 $ 26
Provision for additional losses
Write-downs (100) (158) (245)
Balance, end of year $ 204 $ 220 $ 137
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 8 - Deposits
Deposits consisted of the following at September 30 (dollars in thousands):
Non-interest bearing
$ 29,133 $ 23,585
NOW checking
57,614 42,222
Passbook savings
49,572 40,328
Money market accounts
39,444 47,888
Certificates of deposit
131,909 138,293
Total deposits
$ 307,672 $ 292,316
Time deposits of $100,000 or greater totaled $22,189,000 and $36,241,000 at September 30, 2003 and 2002, respectively.
Scheduled maturities of certificates of deposit for future years ending September 30 are as follows (dollars in thousands):
$ 99,241
23,640
1,650
2,925
2,439
Thereafter
2,014
Total
$ 131,909
Interest expense by account type is as follows for the years ended September 30 (dollars in thousands):
NOW checking $ 335 $ 410 $ 446
Passbook savings
Money market accounts 1,101
Certificates of deposit 3,961 5,278 7,396
Total $ 5,570 $ 7,516 $ 9,491
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 9 - Federal Home Loan Bank Advances
The Bank has long-term borrowing lines with the Federal Home Loan Bank of Seattle; maximum total credit on the lines is 35% of the Bank's total assets. Total borrowings under these lines were $61,605,000 and $61,759,000 at September 30, 2003 and 2002, respectively.
The long-term borrowings mature at various dates through January 2011, bear interest at rates ranging from 3.2% to 6.6%, and are due in monthly payments aggregating $13,000 plus interest. Under the Advances, Security and Deposit Agreement, virtually all of the Bank's assets, not otherwise encumbered, are pledged as collateral for advances. Principal reductions due for future years ending September 30 are as follows (dollars in thousands):
$ 6,668
4,583
10,591
15,070
Thereafter
24,628
$ 61,605
Note 10 - Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses comprise the following at September 30 (dollars in thousands):
Federal income taxes
$ - - $ 318
Accrued pension and profit sharing payable
Accrued interest payable on deposits and FHLB advances
Accounts payable and accrued expenses - other
1,504 1,057
Total other liabilities and accrued expenses
$ 2,745 $ 2,583
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 11 - Federal Income Taxes
The Bank previously qualified under provisions of the Internal Revenue Code that permitted federal income taxes to be computed after a deduction for additions to bad debt reserves. Accordingly, retained earnings include approximately $2,200,000 for which no provision for federal income taxes has been made. If in the future this portion of retained earnings were used for any purpose other than to absorb bad debt losses, federal income taxes at the current applicable rates would be imposed.
The components of the provision for income taxes at September 30 are as follows (dollars in thousands):
Current $ 3,008 $ 3,603 $ 2,948
Deferred benefit (42) (171) (207)
Total federal income taxes $ 2,966 $ 3,432 $ 2,741
The components of the Company's deferred tax assets and liabilities at September 30 are as follows (dollars in thousands):
Deferred Tax Assets
Accrued interest on loans
$ 96 $ 80
Accrued vacation
Deferred compensation
Unearned ESOP shares
Allowance for possible losses
1,255 1,075
Unearned MRDP shares
Total deferred tax assets
1,942 1,703
Deferred Tax Liabilities
FHLB stock dividends
Depreciation
Unrealized securities gains
Mortgage servicing rights
Total deferred tax liabilities
1,290 1,197
Net deferred tax assets
$ 652 $ 506
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 11 - Federal Income Taxes (concluded)
The provision for federal income taxes differs from that computed at the statutory corporate tax rate as follows (dollars in thousands):
Amount
Percent
Amount
Percent
Amount
Percent
Taxes at statutory rate $3,362 35.0% $3,613 35.0% $2,871 35.0%
BOLI income (185) (1.9) (13) (.1) - - - -
Other - net (211) (2.2) (168) (1.7) (130) (1.6)
Federal income taxes $2,966 30.9% $3,432 33.2% $2,741 33.4%
Note 12 - Profit Sharing Plans
The Bank has established a 401(k) profit sharing plan for those employees who meet the eligibility requirements set forth in the plan. Eligible employees may contribute a maximum of 15% of their compensation. Contributions by the Bank are at the discretion of the Board of Directors. Bank contributions totaled $497,000, $385,000 and $362,000 for the years ended September 30, 2003, 2002 and 2001, respectively.
In addition, the Bank has an employee bonus plan based on net income. Bonuses accrued for the years ended September 30, 2003, 2002 and 2001 totaled $261,000, $275,000 and $208,000, respectively.
Note 13 - Employee Stock Ownership Plan
In 1998, the Bank established an Employee Stock Ownership Plan (ESOP) that benefits all employees with at least one year of service who are 21 years of age or older. The ESOP may be funded by Bank contributions in cash or stock. Employee vesting occurs over six years. The amount of the annual contribution is discretionary, except that it must be sufficient to enable the ESOP to service its debt. All dividends received by the ESOP are used to pay debt service. As of September 30, 2003, 16,958 ESOP shares had been distributed to participants.
In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase 529,000 shares of common stock of the Company. The loan will be repaid primarily from the Company's contributions to the ESOP over 15 years. The interest rate on the loan is 8.5%. The balance of the loan at September 30, 2003 was $5,959,000.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 13 - Employee Stock Ownership Plan (concluded)
Shares held by the ESOP as of September 30 were classified as follows:
Unallocated shares 326,216 361,483 396,750
Shares released for allocation 185,826 162,918 129,722
Total ESOP shares 512,042 524,401 526,472
The approximate fair market value of the Bank's unallocated shares at September 30, 2003, 2002 and 2001, is $7,797,000, $6,051,000 and $5,872,000, respectively. Compensation expense recognized under the ESOP was $454,000, $320,000 and $273,000 for the years ended September 30, 2003, 2002 and 2001, respectively.
Note 14 - Stock Options
Under the Company's stock option plan, the Company may grant options for up to 661,250 shares of its common stock to certain key employees and directors. The exercise price of each option equals the fair market value of the Company's stock on the date of grant. An option's maximum term is ten years. Options are exercisable on a cumulative basis in annual installments of 10% on each of the ten anniversaries from the date of grant. If certain Company performance criteria are met vesting will be accelerated to 20% per year. These criteria were met in 2003, 2002 and 2001. At September 30, 2003, options for 16,207 shares are available for future grant under this plan.
The fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 14 - Stock Options (concluded)
Stock option activity is summarized in the following table:
Number of
Shares Weighted
Average
Exercise
Price
Outstanding September 30, 2000
572,494 $12.02
Grants
38,339 14.35
Options exercised
(1,600) 12.00
Outstanding September 30, 2001
609,233 12.16
Grants
15,000 15.62
Options exercised
(44,253) 12.00
Forfeited
(11,630) 12.00
Outstanding September 30, 2002
568,350 12.27
Grants
30,840 19.37
Options exercised
(99,071) 12.02
Outstanding September 30, 2003
500,119 12.75
Additional information regarding options outstanding as of September 30, 2003 is as follows:
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 15 - Deferred Compensation/Non-Competition Agreement and Severance Compensation Agreement
The Bank has a deferred compensation/noncompetition arrangement with its chief executive officer which will provide monthly payments of $2,000 per month upon retirement. Once payments have commenced, they will continue until his death, at which time payments will continue to his surviving spouse until her death or for 60 months. The present value of the payments, based on the life expectancy of the chief executive officer, has been accrued based on a retirement age of 65 and is included in other liabilities in the consolidated financial statements. As of September 30, 2003 and 2002, $239,000 has been accrued under the agreement. Payment under this agreement is expected to begin in February 2004.
In connection with the January 1998 conversion, the Bank adopted an Employee Severance Compensation Plan, which expires in ten years, to provide benefits to eligible employees in the event of a change in control of the Company or the Bank (as defined in the plan). In general, all employees with two or more years of service will be eligible to participate in the plan. Under the plan, in the event of a change in control of the Company 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 with the Bank. The maximum payment for any eligible employee would be equal to 24 months of their current compensation.
Note 16 - Management Recognition and Development Plan
On November 10, 1998, the Board of Directors adopted a Management Recognition and Development Plan (MRDP). On January 25, 1999, shareholders approved the adoption of the MRDP for the benefit of officers, employees and non-employee directors of the Company. The objective of the MRDP is to retain personnel of experience and ability in key positions by providing them with a proprietary interest in the Company.
The Plan allows for the issuance to participants of up to 264,500 shares of the Company's common stock. Shares issued may be purchased in the open market or may be issued from authorized and unissued shares. On July 26, 2001, the Company awarded 204,927 shares under the Plan to employees and directors. No shares were awarded during the years ended September 30, 2002 and 2003. Awards under the MRDP were made in the form of restricted shares of common stock that are subject to restrictions on the transfer of ownership. Compensation expense in the amount of the fair value of the common stock at the date of the grant to the plan participants will be recognized over a five-year vesting period, with 20% vesting immediately upon grant. At September 30, 2003, participants were vested in 122,955 of the shares initially awarded. Compensation expense was $693,000, $713,000 and $770,000 for the years ended September 30, 2003, 2002 and 2001, respectively.
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 17 - Commitments and Contingencies
The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business 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 Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is 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. A summary of the Bank's commitments at September 30 is as follows (dollars in thousands):
Commitments to extend credit
$37,448 $19,599
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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.
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 financial position of the Company.
Note 18 - Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Bank must meet specific capital adequacy 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 classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios as defined in the regulations (set forth in the table below) of Tier 1 capital to average assets, and minimum ratios of Tier 1 and total capital to risk-weighted assets.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 18 - Regulatory Matters (continued)
As of September 30, 2003, the most recent notification from the Bank's regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category.
The Company's and the Bank's actual capital amounts (dollars in thousands) and ratios are also presented in the table.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 18 - Regulatory Matters (concluded)
Restrictions on Retained Earnings
The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval.
At the time of conversion of the Bank from a Washington-chartered mutual savings bank to a Washington-chartered stock savings bank, the Bank established a liquidation account in an amount equal to its retained earnings of $23,866,000 as of June 30, 1997, the date of the latest statement of financial condition used in the final conversion prospectus. The liquidation account will be maintained for the benefit of eligible withdrawable account holders who have maintained their deposit accounts in the Bank after conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an eligible account holder's interest in the liquidation account. In the event of a complete liquidation of the Bank (and only in such an event), eligible depositors who have continued to maintain accounts will be entitled to receive a distribution from the liquidation account before any liquidation may be made with respect to common stock. The Bank may not declare or pay cash dividends if the effect thereof would reduce its regulatory capital below the amount required for the liquidation account.
Note 19 - Condensed Financial Information - Parent Company Only
Condensed Balance Sheets - September 30
(Dollars in Thousands)
Assets
Cash and due from financial institutions
$ 143 $ 51
Interest bearing deposits in banks
1,352
Investments and mortgage-backed securities (available for sale)
3,723 3,748
Loan receivable from Bank
5,959 6,367
Investment in Bank
66,159 65,285
Other assets
Total assets
$ 77,665 $ 75,726
Liabilities and Shareholders' Equity
Note payable to Bank
$ 35 $ 1,325
Accrued expenses
Shareholders' equity
77,611 74,396
Total liabilities and shareholders' equity
$ 77,665 $ 75,726
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 19 - Condensed Financial Information - Parent Company Only (continued)
Condensed Statements of Income - Years Ended September 30
(Dollars in Thousands)
Operating Income
Interest bearing deposits in banks $ 12 $ 4 $ 40
Interest on investments and mortgage-backed securities - - - -
Interest on loan receivable from Bank
Dividends on investments
Gain on sale of investment securities available for sale - -
Dividends from Bank 6,650 5,010 1,949
Other - - - -
Total operating income 7,278 5,710 3,056
Operating Expenses
Income before income taxes and equity
in undistributed income of Bank
6,949
5,473
2,865
Income Taxes
Income before equity in undistributed income of Bank 6,933 5,390 2,627
Equity in Undistributed Income of Bank (Dividends in Excess
of Income of Bank)
(294)
1,501
2,835
Net income $ 6,639 $ 6,891 $ 5,462
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 19 - Condensed Financial Information - Parent Company Only (concluded)
Condensed Statements of Cash Flows - Years Ended September 30
(Dollars in Thousands)
Cash Flows from Operating Activities
Net income $ 6,639 $ 6,891 $ 5,462
Adjustments to reconcile net income to net cash provided:
Equity in undistributed income of Bank (dividends in excess
of income of Bank)
(1,501)
(2,835)
ESOP shares earned
MRDP shares earned
Gain on sale of securities available for sale - - (5) (227)
Other, net (291) (739)
Net cash provided by operating activities 8,093 5,926 4,433
Cash Flows from Investing Activities
Net (increase) decrease in interest-bearing deposits in banks (1,093) (32)
Investment in Bank (1,515) (1,280) (485)
Purchases of securities available for sale - - - - (2,500)
Proceeds from maturities of securities available for sale - - - - 4,122
Proceeds from sales of securities available for sale - -
Principal repayments on loan receivable from Bank
Net cash provided by (used in) investing activities (2,200) (810) 2,826
Cash Flows from Financing Activities
Increase (decrease) in note payable (1,290)
Proceeds from exercise of stock options 1,491
Repurchase of common stock (3,852) (4,414) (5,918)
Payment of dividends (2,150) (2,013) (1,925)
Net cash used in financing activities (5,801) (5,089) (7,249)
Net increase in cash
Cash and Due from Financial Institutions
Beginning of year
End of year $ 143 $ 51 $ 24
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 20 - Earnings Per Share Disclosures
Basic earnings per share are computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Diluted earnings per share are computed by dividing net income applicable to common stock 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 assumed conversion of outstanding stock options and from assumed vesting of shares awarded but not released under the Company's Management Recognition and Development Plan. In accordance with Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans, issued by the American Institute of Certified Public Accountants, shares owned by the Bank's Employee Stock Ownership Plan that have not been allocated are not considered to be outstanding for the purpose of computing earnings per share. Information regarding the calculation of basic and diluted earnings per share for the years ended September 30 is as follows (dollars in thousands, except per share amounts):
Basic EPS Computation
Numerator - net income $ 6,639 $ 6,891 $ 5,462
Denominator - weighted average common shares outstanding 3,814,344 3,905,544 4,193,314
Basic EPS $1.74 $1.76 $1.30
Diluted EPS Computation
Numerator - net income $ 6,639 $ 6,891 $ 5,462
Denominator - weighted average common shares outstanding 3,814,344 3,905,544 4,193,314
Effect of dilutive stock options 158,238 108,563 79,299
Effect of dilutive MRDP shares 31,619 19,078 - -
Weighted average common shares outstanding-assuming dilution 4,004,201 4,033,185 4,272,613
Diluted EPS $1.66 $1.71 $1.28
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 21 - Comprehensive Income
Net unrealized gains and losses included in comprehensive income were computed as follows for the years ended September 30 (dollars in thousands):
Before-Tax
Amount Tax
(Benefit)
Expense
Net-of-Tax
Amount
Unrealized holding losses arising during the year ($417) ($142) ($275)
Reclassification adjustment for gains
included in net income
(135)
(46)
(89)
Net unrealized losses ($552) ($188) ($364)
Unrealized holding gains arising during the year $372 $127 $245
Reclassification adjustment for losses
included in net income
Net unrealized gains $387 $132 $255
Unrealized holding gains arising during the year $1,084 $369 $715
Reclassification adjustment for gains
included in net income
(205)
(70)
(135)
Net unrealized gains $879 $299 $580
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 22 - Fair Values of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments, 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. Major assumptions, methods and fair value estimates for the Company's significant financial instruments are set forth below:
Cash and Due from Financial Institutions and Interest Bearing Deposits in Banks
The recorded amount is a reasonable estimate of fair value.
Investments and Mortgage-Backed Securities
The fair value of investments and mortgage-backed securities has been based on quoted market prices or dealer quotes.
Federal Home Loan Bank Stock
The recorded values of stock holdings approximate fair value.
Loans Receivable and Loans Held for Sale
Fair values for loans are estimated for portfolios of loans with similar financial characteristics. Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers for the same remaining maturities. Prepayments are based on the historical experience of the Bank. Loans held for sale has been based on quoted market prices.
Deposits
The fair value of deposits with no stated maturity date is included at the amount payable on demand. The fair value of fixed maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered by the Bank for deposits of similar remaining maturities.
Federal Home Loan Bank Advances
The fair value of borrowed funds is estimated by discounting the future cash flows of the borrowings at a rate which approximates the current offering rate of the borrowings with a comparable remaining life.
Accrued Interest
The recorded amounts of accrued interest approximate fair value.
Off-Balance Sheet Instruments
The fair value of commitments to extend credit was estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the customers. Since the majority of the Bank's off-balance sheet instruments consist of non-fee producing, variable-rate commitments, the Bank has determined they do not have a distinguishable fair value.
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 22 - Fair Values of Financial Instruments (concluded)
The estimated fair values of financial instruments at September 30 were as follows (dollars in thousands):
Recorded
Amount
Fair
Value
Recorded
Amount
Fair
Value
Financial Assets
Cash and due from financial institutions
and interest bearing deposits in banks
$ 38,098
$ 38,098
$ 36,073
$ 36,073
Investments and mortgage-backed securities 54,310 54,310 41,582 41,582
Federal Home Loan Bank stock 5,454 5,454 5,139 5,139
Loans receivable 322,236 324,374 322,528 324,927
Accrued interest receivable 1,687 1,687 1,604 1,604
Financial Liabilities
Deposits $ 307,672 $ 309,087 $ 292,316 $ 293,411
Federal Home Loan Bank advances 61,605 67,274 61,759 68,695
Accrued interest payable 308
The Bank assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Bank's financial instruments will change when interest rate levels change and that change may either be favorable or unfavorable to the Bank. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities, and attempts to minimize interest rate risk by adjusting terms of new loans, and deposits and by investing in securities with terms that mitigate the Bank's overall interest rate risk.
Note 23 - Stock Repurchase Plan
In February 2003, the Company initiated a stock repurchase plan for the purchase of 380,028 shares of stock, which had not been completed as of September 30, 2003. As of September 30, 2003, 112,108 shares had been repurchased. The remainder is anticipated to be purchased during the year ending September 30, 2004.
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 24 - Securitization of Mortgage Loans
In October 2001, the Bank securitized approximately $12.2 million in first mortgage loans. The Bank retained servicing responsibilities, but has no other interest in the loans sold. The Bank receives servicing fees of .25% of the outstanding principal balance of the loans sold. A servicing asset of $95,700 was recognized in this transaction, based on the following factors: estimated life of loans of 84 months and cash flow discount rate of 6.7%. Investors have no recourse to the Bank's other assets in the event debtors fail to pay the balance owned.
In June 2001, the Bank securitized and sold approximately $11.9 million in first mortgage loans. Upon closing the transaction, the Bank sold the securities received, recognizing a loss of $22,000, and invested the majority of the proceeds in other investment securities. The Bank retained servicing responsibilities, but has no other interest in the loans sold. The Bank receives servicing fees of .25% of the outstanding principal balance of the loans sold. A servicing asset of $92,000 was recognized in this transaction, based on the following factors: estimated life of loans of 84 months and cash flow discount rate of 6.87%. Investors have no recourse to the Bank's other assets in the event debtors fail to pay the balance owned.
Note 25 - Subsequent Event
On October 28, 2003, the Board of Directors approved a dividend in the amount of $.14 per share to be paid on November 24, 2003 to shareholders of record as of November 10, 2003.
Note 26 - Selected Quarterly Financial Data (Unaudited)
The following selected financial data are presented for the quarters ended (dollars in thousands, except per share amounts):
September 30,
June 30,
March 31,
December 31,
Interest and dividend income $ 6,748 $ 6,774 $ 6,994 $ 7,207
Interest expense (2,064) (2,178) (2,243) (2,461)
Net interest income 4,684 4,596 4,751 4,746
Provision for loan losses - - (66) (108) (173)
Noninterest income 1,214 1,648 1,499 1,646
Noninterest expense (3,864) (3,943) (3,534) (3,491)
Income before income taxes 2,034 2,235 2,608 2,728
Federal income taxes 860
Net income $ 1,440 $ 1,541 $ 1,790 $ 1,868
Basic earnings per share $.38 $.41 $.47 $.48
Diluted earnings per share .36 .39 .45 .46
(continued)
<PAGE>
Notes to Consolidated Financial Statements
Timberland Bancorp, Inc. and Subsidiaries
September 30, 2003 and 2002
Note 26 - Selected Quarterly Financial Data (Unaudited) (concluded)
September 30,
June 30,
March 31,
December 31,
Interest and dividend income $ 7,400 $ 7,406 $ 7,516 $ 7,941
Interest expense (2,600) (2,635) (2,693) (2,962)
Net interest income 4,800 4,771 4,823 4,979
Provision for loan losses (200) (200) (200) (392)
Noninterest income 1,261 1,190 1,046 1,161
Noninterest expense (3,326) (3,138) (3,146) (3,106)
Income before income taxes 2,535 2,623 2,523 2,642
Federal income taxes 936
Net income $ 1,758 $ 1,798 $ 1,629 $ 1,706
Basic earnings per share $.45 $.46 $.42 $.43
Diluted earnings per share .44 .45 .41 .42
<PAGE>
Item 9.
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
	Not applicable.
Item 9A.
Item 9A. Controls and Procedures
	 	(a) 	Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the "Act")) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management within the 90-day period preceding the filing date of this annual report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
	 	(b) 	Changes in Internal Controls: In the year ended September 30, 2003, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls. A number of internal control procedures were, however, modified during the year in conjuction with the Bank's conversion to a new core processing system. The Company also continued to implement suggestions from its internal auditor and independent auditors on ways to strengthen existing controls.
PART III Item 10.
Item 10. Directors and Executive Officers of the Registrant	 	The information contained under the section captioned "Proposal I -- Election of Directors" is included in the Company's Definitive Proxy Statement for the 2004 Annual Meeting of Stockholders ("Proxy Statement") and is incorporated herein by reference.
	 	The following table sets forth certain information with respect to the executive officers of the Company and the Bank. Each of the executive officers holds the same position with the Company and the Bank.
Executive Officers of the Company and Bank
Biographical Information
Clarence E. Hamre is Chairman of the Board of the Company and the Bank. He has been affiliated with the Bank since 1969 and served as President and Chief Executive Officer of the Bank since 1969 and as President and Chief Executive Officer of the Company since 1997. In January 2003, Mr. Hamre retired as President of the Bank and the Company and on September 30, 2003, he retired as Chief Executive Officer of the Bank and the Company.
<PAGE>
	 	Michael R. Sand has been affiliated with the Bank since 1977 and has served as President of the Bank and the Company since January 23, 2003. On September 30, 2003, he was appointed as Chief Executive Officer of the Bank and Company. Prior to appointment as President and Chief Executive Officer, Mr. Sand had served as Executive Vice President and Secretary of the Bank since 1993 and as Executive Vice President and Secretary of the Company since its formation in 1997.
	 	Dean J. Brydon has been affiliated with the Bank since 1994 and has served as the Chief Financial Officer of the Company and the Bank since January 2000. Mr. Brydon is a Certified Public Accountant.
		 		Marci A. Basich has been affiliated with the Bank since 1999 and has served as Treasurer of the Company and the Bank since January 2002. Ms. Basich is a Certified Public Accountant. From 1998 to 1999, Ms. Basich was the Senior Accountant of 4th Dimension Computers, Inc., a computer software and service company.
Audit Committee Financial Expert
		 		The Audit Committee of the Company is composed of Directors Backstrom, Warren, Robbel and Smith. Each member of the Audit Committee is "independent" as defined in the Nasdaq Stock Market listing standards. The Company's Board of Directors has designated Directors Warren and Robbel as the Audit Committee financial experts, as defined in the SEC's Regulation S-K. Directors Warren and Robbel are independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A promulgated under the Exchange Act.
Code of Ethics
		 		The Board of Directors adopted a Code of Ethics for the Company's officers (including its senior financial officers), directors and employees. The Code of Ethics requires the Company's officers, directors and employees to maintain the highest standards of professional conduct. A copy of the Code of Ethics is attached hereto as Exhibit 14.
Item 11.
Item 11. Executive Compensation
		The information contained under the section captioned "Proposal I -- Election of Directors" is included in the Company's Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Equity Compensation Plan Information. 	The information contained under the section captioned "Executive Compensation -- Equity Compensation Plan Information" is included in the Company's Proxy Statement and is incorporated herein by reference.
	 	(a) 	Security Ownership of Certain Beneficial Owners.
		The information contained under the section captioned "Security Ownership of Certain Beneficial Owners and Management" is included in the Company's Proxy Statement and is incorporated herein by reference.
	 	(b) 	Security Ownership of Management.
		 		The information contained under the sections captioned "Security Ownership of Certain Beneficial Owners and Management" and "Proposal I -- Election of Directors" is included in the Company's Proxy Statement and are incorporated herein by reference.
<PAGE>
	 	(c) 	Changes In Control
		 		The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
Item 13.
Item 13. Certain Relationships and Related Transactions
		 		The information contained under the section captioned "Proposal I -- Election of Directors -- Transactions with Management" is included in the Company's Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
		 		The information contained under the section captioned "Independent Auditors" is included in the Company's Proxy Statement and is incorporated herein by reference.
PART IV Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K	 	(a) 	Exhibits
3.1 Articles of Incorporation of the Registrant (1)
3.2 Bylaws of the Registrant (1)
3.3 Amendment to Bylaws(2)
10.1 Employee Severance Compensation Plan (3)
10.2 Employee Stock Ownership Plan (3)
10.3 1999 Stock Option Plan (4)
10.4 Management Recognition and Development Plan (4)
Code of Ethics
Subsidiaries of the Registrant
Consent of Accountants
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
____________
(1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1 (333-35817).
(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended September 30, 2002.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997.
(4) Incorporated by reference to the Registrant's 1999 Annual Meeting Proxy Statement dated December 15, 1998.
	 	(b) 	Reports on Form 8-K
	 	A Current Report on Form 8-K was filed on July 22, 2003 to report the Registrant's earnings for the quarter ended June 30, 2003.
<PAGE>
SIGNATURES
	 	Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
		 		TIMBERLAND BANCORP, INC.
	 	Pursuant to the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
<PAGE>
Exhibit 14
Code of Ethics
<PAGE>
September 23, 2003
TIMBERLAND BANCORP, INC.
CODE OF ETHICS
FOR PRINCIPAL EXECUTIVE OFFICER
AND SENIOR FINANCIAL OFFICERS
Introduction
	 	The business of Timberland Bancorp, Inc. ("Timberland") is built on trust. Our stockholders, customers and employees depend upon our honesty and integrity. Accordingly, the Board of Directors of Timberland has adopted this Code of Ethics ("Code") to express a code of conduct applicable to our Chief Executive Officer, President, Chief Financial Officer, and Treasurer (collectively, the "Senior Financial Officers"). This Code does not constitute a new set of requirements to which the Senior Financial Officers must adhere, but simply reduces to writing the behavior that has always been required of the Senior Financial Officers.
	 	The Code sets forth certain standards for the guidance of the Senior Financial Officers. The Code should be considered as illustrative, but not regarded as all-inclusive. The Senior Financial Officers are also subject to Timberland's Code of Ethics applicable to all officers and employees.
Honest and Ethical Conduct
	 	Each Senior Financial Officer must act honestly and ethically. Senior Financial Officers should also promote honest and ethical behavior within Timberland.
	 	Acting honestly and ethically includes the duty to avoid actual or apparent conflicts of interest, as well as situations which could result in an actual or apparent conflict of interest. A conflict of interest may arise when personal or financial interest is adverse to, or appears adverse to, the interests of Timberland. Each Senior Financial Officer should report to the Audit Committee of the Board of Directors any material transaction or relationship that reasonably could be expected to result in a conflict of interest.
	 	In addition to the duty to avoid conflicts of interest, Senior Financial Officers must treat confidential information properly. All information obtained by virtue of employment with Timberland should be held in strictest confidence. Confidential information must not be disclosed to anyone except as required for business transactions or as required by law. When confidential information is disclosed, it must be done in a manner that does not risk violating confidentiality.
Preparation of Public Documents
	 	Each Senior Financial Officer must ensure that all public documents and documents filed with the Securities and Exchange Commission which he or she is involved in preparing or reviewing contain full, fair, accurate, timely and understandable disclosure. In order to ensure this, the Senior Financial Officers must maintain the skills relevant to Timberland's needs. The Senior Financial Officers are also responsible for establishing and maintaining appropriate disclosure controls and procedures and internal controls.
Compliance with Laws, Rules and Regulations
	 	Each Senior Financial Officer must comply with all local, state and federal laws, rules and regulations. Any Senior Financial Officer engaged in activities found to be in conflict with and against these laws, rules and regulations will be subject to termination of employment. The Senior Financial Officers should also cause other officers and employees to comply with all local, state and federal laws, rules and regulations.
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Administration of the Code
	 	Any violation or suspected violation of this Code of Ethics must be promptly reported to the Audit Committee of the Board of Directors. Violators of the Code may be subject to disciplinary action, up to and including termination of employment. Questions regarding the Code and requests for a waiver from the Code should be brought to the Audit Committee. The Audit Committee will administer the Code and will make periodic reports to the Board of Directors, as necessary.
	 	This Code of Ethics shall be publicly available. Changes to, and waivers from, the Code shall also be disclosed to the public.
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Exhibit 21
Subsidiaries of the Registrant
Parent
Timberland Bancorp, Inc.
Percentage Jurisdiction or
Subsidiaries
of Ownership
State of Incorporation
Timberland Bank 100% Washington
Timberland Service Corporation (1) 100% Washington
(1) This corporation is a wholly owned subsidiary of Timberland Bank.
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Exhibit 23
Consent of Accountants
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INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in Registration Statement No. 333-32386 of Timberland Bancorp, Inc. on Form S-8 of our report dated November 12, 2003, appearing in the Annual Report on Form 10-K of Timberland Bancorp, Inc. for the year ended September 30, 2003.
/s/ McGladrey & Pullen, LLP
MCGLADREY & PULLEN, LLP
Tacoma, Washington
December 24, 2003
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Exhibit 31.1
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Michael R. Sand, certify that:
(1) I have reviewed this annual report on Form 10-K of Timberland Bancorp, Inc.;
(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
(4) The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
(5) The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: December 15, 2003
/s/ Michael R. Sand
Michael R. Sand
Chief Executive Officer
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Exhibit 31.2
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Dean J. Brydon, certify that:
(1) I have reviewed this annual report on Form 10-K of Timberland Bancorp, Inc.;
(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
(4) The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
(5) The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: December 15, 2003
/s/ Dean J. Brydon
Dean J. Brydon
Chief Financial Officer
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Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF TIMBERLAND BANCORP, INC.
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
	 	The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that:
(1) the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and
(2) the information contained in the report fairly presents, in all material respects, the Company's financial condition and results of operations.
/s/Michael R. Sand
/s/ Dean J. Brydon
Michael R. Sand Dean J. Brydon
Chief Executive Officer Chief Financial Officer
Dated: December 15, 2003
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