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ANCB > SEC Filings for ANCB > Form 10-K on 13-Sep-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial conditions and results of operations. The information in this section has been derived from the Consolidated Financial Statements and footnotes thereto, which are included in Item 8 of this Form 10-K. You should read the information in this section in conjunction with the business and financial information regarding us as provided in this Form 10-K. Unless otherwise indicated, the financial information presented in this section reflects the consolidated financial condition and results of operations of Anchor Bancorp and its subsidiary.


Anchor Bancorp is a bank holding company which primarily engages in the business activity of its subsidiary, Anchor Bank. Anchor Bank is a community-based savings bank primarily serving Western Washington through our 11 full-service banking offices (including two Wal-Mart store locations) located within Grays Harbor, Thurston, Lewis, Pierce, and Mason counties, Washington. In addition we have two loan production offices located in Grays Harbor County. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans. We offer a wide range of loan products to meet the demands of our customers. Historically, lending activities have been primarily directed toward the origination of one-to-four family construction, commercial real estate and consumer loans. Since 1990, we have also offered commercial real estate loans and multi-family loans primarily in Western Washington. Lending activities also include the origination of residential construction loans, and prior to fiscal 2010, a significant amount of originations through brokers, in particular within the Portland, Oregon metropolitan area.

Historically, we used wholesale sources to fund wholesale loan growth - typically FHLB advances or brokered certificates of deposit depending on the relative cost of each and our interest rate position. Our current strategy is to utilize FHLB advances consistent with our asset liability objectives. We currently do not utilize brokered certificates of deposit as we are limiting loan growth consistent with our regulatory and capital objectives. While continuing our commitment to real estate lending, management expects to continue to reduce our exposure to construction loans while commercial business lending becomes increasingly more important for us.

Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates also affect our net interest income. Additionally, to offset the impact of the current low interest rate environment, we are seeking other means of increasing interest income while controlling expenses. We intend to enhance the mix of our assets by increasing commercial business relationships which have higher risk-adjusted returns as well as increasing deposits. A secondary source of income is noninterest income, which includes gains on sales of assets, and revenue we receive from providing products and services. In recent years, our noninterest expense has exceeded our net interest income after provision for loan losses and we have relied primarily upon gains on sales of assets (primarily sales of investments and mortgage loans to Freddie Mac) to supplement our net interest income.

Our operating expenses consist primarily of compensation and benefits, general and administrative, information technology, occupancy and equipment, deposit services and marketing expenses. Compensation and benefits expense consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.

Compliance With Regulatory Restrictions

Anchor Bank entered into the Order with the FDIC and the Washington DFI on August 12, 2009. The Order was terminated on September 5, 2012 as a result of the steps Anchor Bank took in complying with the Order and reducing its level of classified assets, augmenting management and improving the overall condition of Anchor Bank. In place of the Order, Anchor Bank entered into a Supervisory Directive with the DFI.

Correcting the problems identified in the Order has caused us to revise our operating strategy and has had a resulting impact on our financial condition and results of operations. We have reduced our asset size from $652.4 million at June 30, 2009 to $452.2 million at June 30, 2013 as we have sought to reduce our concentration in construction lending and commercial real estate loans, to preserve our capital and maximize our regulatory capital ratios. In addition, in fiscal 2010 we sold relatively high yielding performing fixed rate single family loans which has reduced our net interest income in recent periods. Also, because of the reduced demand for commercial real estate loans, we have sold these loans at a discount which has negatively impacted our operating

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results. The reduction in asset size has helped us preserve our capital and maximize our regulatory capital ratios as we took action to achieve and maintain compliance with the requirements of the Order and Supervisory Directive.

In addition to the reduction in assets we also reduced certain types of liabilities. We had relied on wholesale funds such as brokered deposits in some cases to fund lending transactions and as a result of the Order we significantly reduced brokered certificates and our reliance on wholesale funds and have increased our reliance on core deposits which has decreased our cost of funds. At June 30, 2013, we had eliminated all brokered deposits as compared to $84.7 million of brokered deposits at June 30, 2009.

The Supervisory Directive contains provisions concerning (i) the management and directors of Anchor Bank; (ii) restrictions on paying dividends; (iii) reductions of classified assets; (iv) maintaining Tier 1 capital in an amount equal to or exceeding 10% of Anchor Bank's total assets; (v) policies concerning the allowance for loan and lease losses ("ALLL"); and (vi) requirements to furnish a revised three-year business plan to improve Anchor Bank's profitability and progress reports to the FDIC and DFI.

Management and the Board of Directors have and will be taking action and implementing programs to comply with the requirements of the Supervisory Directive.

Operating Strategy

Our focus is on managing our problem assets, increasing our higher-yielding assets (in particular commercial business loans), increasing our core deposit balances, reducing expenses, and retaining experienced employees with a commercial lending focus. We seek to achieve these results by focusing on the following objectives:

Focusing on Asset Quality. We have de-emphasized new loan originations for investment purposes to focus on monitoring existing performing loans, resolving nonperforming loans and selling foreclosed assets. We have aggressively sought to reduce our level of nonperforming assets through write-downs, collections, modifications and sales of nonperforming loans and the sale of properties once they become real estate owned. We have taken proactive steps to resolve our nonperforming loans, including negotiating repayment plans, forbearances, loan modifications and loan extensions with our borrowers when appropriate, and accepting short payoffs on delinquent loans, particularly when such payoffs result in a smaller loss to us than foreclosure. We also have added experienced personnel to the department that monitors our loans to enable us to better identify problem loans in a timely manner and reduce our exposure to a further deterioration in asset quality, including a new Chief Lending Officer in 2008 and a new Credit Administration Officer in 2009. During the latter part of fiscal 2007, as part of management's decision to reduce the risk profile of our loan portfolio, we implemented more stringent underwriting guidelines and procedures. Prior to this time our underwriting emphasis with respect to commercial real estate, multi-family and construction loans focused heavily on the value of the collateral securing the loan, with less emphasis placed on the borrower's debt servicing capacity or other credit factors. Our revised underwriting guidelines place greater emphasis on the borrower's credit, debt service coverage and cash flows as well as on collateral appraisals. Additionally, our policies with respect to loan extensions became more conservative than our previous policies, and now require that a review of all relevant factors, including loan terms, the condition of the security property, market changes and trends that may affect the security property and financial condition of the borrower conform to our revised underwriting guidelines and that the extension be in our best interest.

Improving our Earnings by Expanding Our Product Offerings. We intend, subject to market conditions, to prudently increase the percentage of our assets consisting of higher-yielding commercial business loans, which offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations. At June 30, 2013, our commercial business loans totaled $18.2 million, or 6.4% of our total loan portfolio. We also intend to selectively add additional products to further diversify revenue sources and to capture more of each customer's banking relationship by cross selling our loan and deposit products and additional services to our customers such as electronic invoicing and payroll services for our business customers.

Attracting Core Deposits and Other Deposit Products. Our strategic focus is to emphasize total relationship banking with our customers to increase core deposits to internally fund our loan growth. The Company has reduced its reliance on other wholesale funding sources, including FHLB advances and brokered deposits, by focusing on customer deposits. We believe that by focusing on customer relationships, our level of core deposits and locally-based retail certificates of deposit will increase.

During the year ended June 30, 2013, our deposits decreased by $17.2 million, of which $21.5 million were locally-based retail certificates of deposit.

Continued Expense Control. Beginning in fiscal 2009 and continuing into fiscal 2013, management has undertaken several initiatives to reduce noninterest expense and will continue to emphasize the identification of cost savings opportunities throughout all phases of our operations. Beginning in fiscal 2009, we instituted expense control measures such as reducing staff, eliminating

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Anchor Bank's discretionary matching contribution to its 401(k) plan, reducing most marketing expenses and charitable contributions, cancelling certain projects and capital purchases, and reducing travel and entertainment expenditures. We have also reduced our number of full-time equivalent employees from 194 at September 30, 2008 to 134 at June 30, 2013. During fiscal 2009, four in store Wal-Mart branch offices were closed as a result of their failure to meet our required growth standards. During fiscal 2010, two additional in store Wal-Mart branch offices were closed. The reduction in personnel, cost savings and closure of offices, resulted in savings of approximately $1.8 million per year from the closure of these six offices. Notwithstanding these initiatives, our efforts to reduce noninterest expense were until fiscal 2013 adversely affected by the $1.0 million increase in our FDIC insurance premiums beginning in fiscal 2009 and continuing significant costs associated with our REO. Despite these significant REO costs, noninterest expense decreased by $2.6 million or 12.0% to $19.4 million during fiscal 2013 from $22.0 during fiscal 2012.

Retaining Experienced Personnel with a Focus on Relationship Banking. Our ability to continue to retain banking professionals with strong community relationships and significant knowledge of our markets will be a key to our success. We believe that we enhance our market position and add profitable growth opportunities by focusing on retaining experienced bankers who are established in their communities. We emphasize to our employees the importance of delivering exemplary customer service and seeking opportunities to build further relationships with our customers. Our goal is to compete with other financial service providers by relying on the strength of our customer service and relationship banking approach.

Disciplined Franchise Expansion. We intend to maintain our current asset size to facilitate compliance with the capital requirements of the Supervisory Directive. Once the Supervisory Directive is lifted and general economic conditions improve, we anticipate modest organic growth. We will seek to increase our loan originations and core deposits through targeted marketing efforts designed to take advantage of the opportunities being created as a result of the consolidation of financial institutions that is occurring in our market area.

Critical Accounting Policies

We use estimates and assumptions in our consolidated financial statements in accordance with generally accepted accounting principles. Management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our consolidated financial statements. These policies relate to the determination of the allowance for loan losses and the associated provision for loan losses, deferred income taxes and the associated income tax expense, as well as valuation of real estate owned. Management reviews the allowance for loan losses for adequacy on a monthly basis and establishes a provision for loan losses that it believes is sufficient for the loan portfolio growth expected and the loan quality of the existing portfolio. The carrying value of real estate owned is assessed on a quarterly basis. Income tax expense and deferred income taxes are calculated using an estimated tax rate and are based on management's understanding of our effective tax rate and the tax code.

Allowance for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our Board of Directors and management assess the allowance for loan losses on a quarterly basis. The Executive Loan Committee analyzes several different factors including delinquency rates, charge-off rates and the changing risk profile of our loan portfolio, as well as local economic conditions such as unemployment rates, number of bankruptcies and vacancy rates of business and residential properties.

We believe that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period, requiring management to make assumptions about future losses on loans. The impact of a sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.

Our methodology for analyzing the allowance for loan losses consists of specific allocations on significant individual credits that meet the definition of impaired and a general allowance amount. The specific allowance component is determined when management believes that the collectability of a specifically identified large loan has been impaired and a loss is probable. The general allowance component relates to assets with no well-defined deficiency or weakness and takes into consideration loss that is inherent within the portfolio but has not been realized. The general allowance is determined by applying an expected loss percentage to various classes of loans with similar characteristics and classified loans that are not analyzed specifically for impairment. Because of the imprecision in calculating inherent and potential losses, the national and local economic conditions are also assessed to determine if the general allowance is adequate to cover losses.

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The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual loan charge-offs, net of recoveries.

Deferred Income Taxes. Deferred income taxes are reported for temporary differences between items of income or expense reported in the financial statements and those reported for income tax purposes. Deferred taxes are computed using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in an institution's income tax returns. Deferred tax assets are deferred tax consequences attributable to deductible temporary differences and carryforwards. After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance. A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. As required by GAAP, available evidence is weighted heavily on cumulative losses with less weight placed on future projected profitability. Realization of the deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character in the period during which deductible temporary differences reverse or within the carryback and carryforward periods available under tax law. Based upon the available evidence, we carried a valuation allowance of $8.7 million at June 30, 2013. The tax provision for the period is equal to the net change in the net deferred tax asset from the beginning to the end of the period, less amounts applicable to the change in value related to securities available-for-sale. The effect on deferred taxes of a change in tax rates is recognized as income in the period that includes the enactment date. The primary differences between financial statement income and taxable income result from deferred loan fees and costs, mortgage servicing rights, loan loss reserves and dividends received from the FHLB of Seattle. Deferred income taxes do not include a liability for pre-1988 bad debt deductions allowed to thrift institutions that may be recaptured if the institution fails to qualify as a bank for income tax purposes in the future.

Real Estate Owned. Real estate acquired through foreclosure is transferred to the real estate owned asset classification at fair value estimated fair market value less estimated costs of disposal and subsequently carried at the lower of cost or market. Costs associated with real estate owned for maintenance, repair, property tax, etc., are expensed during the period incurred. Assets held in real estate owned are reviewed quarterly for potential impairment. When impairment is indicated the impairment is charged against current period operating results and netted against the real estate owned to reflect a net book value. At disposition any residual difference is either charged to current period earnings as a loss on sale or reflected as income in a gain on sale.

Comparison of Financial Condition at June 30, 2013 and June 30, 2012

General. Total assets decreased $18.6 million, or 4.0%, to $452.2 million at June 30, 2013 from $470.8 million at June 30, 2012. The decrease in assets during this period was primarily a result of a $13.3 million or 16.9% decline in cash and due from banks and a $10.3 million or 3.6% decrease in loans receivable since June 30, 2012. Securities available-for-sale decreased $409,000, or 0.8% and securities held-to-maturity increased $3.1 million, or 43.4% from June 30, 2012 as we reinvested excess liquidity into securities yielding a higher rate than obtained from our cash deposits in other banks. In addition, total real estate owned decreased $496,000, or 7.4%, to $6.2 million at June 30, 2013 from $6.7 million at June 30, 2012. Total liabilities decreased $17.0 million or 4.0% to $399.8 million at June 30, 2013 compared to $416.8 million at June 30, 2012. Total deposits decreased $17.2 million, or 5.0%, to $328.6 million at June 30, 2013 from $345.8 million at June 30, 2012 primarily as a result of a $21.5 million or 12.6% decrease in certificates of deposit. Our total borrowings, which consisted of FHLB advances, remained unchanged at $64.9 million at both June 30, 2013 and June 30, 2012. The average cost of advances increased to 1.91% during the year ended June 30, 2013 from 1.87% during the year ended June 30, 2012.

Assets. For the year ended June 30, 2013, total assets decreased $18.6 million. The following table details the increases and decreases in the composition of our assets from June 30, 2012 to June 30, 2013:

                                    Balance at June    Balance at June       Increase/(Decrease)
                                        30, 2013          30, 2012          Amount         Percent
                                                         (Dollars in thousands)
Cash and due from banks             $       65,353     $      78,673     $   (13,320 )       (16.9 )%
Mortgage-backed securities,
available-for-sale                          46,852            47,061            (209 )        (0.4 )
Mortgage-backed securities,
held-to-maturity                            10,160             7,037           3,123          44.4
Loans receivable, net of allowance
for loan losses                            277,454           287,755         (10,301 )        (3.6 )
Real estate owned, net                       6,212             6,708            (496 )        (7.4 )

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From June 30, 2012 to June 30, 2013, cash and due from banks decreased $13.3 million. The decrease is primarily a result of a $17.2 million decline in deposits.

Mortgage-backed securities available-for-sale decreased slightly by $209,000 or 0.4% to $46.9 million at June 30, 2013 from $47.1 million at June 30, 2012. The decrease in this portfolio was primarily the result of the purchase of 13 mortgage-backed securities totaling $19.6 million, contractual principal repayments of $18.7 million, and the sale of four mortgage-backed securities totaling $1.0 million. Mortgage-backed securities held-to-maturity increased $3.1 million or 44.4% to $10.2 million at June 30, 2013 from $7.0 million at June 30, 2012. The increase in this portfolio was primarily the result of purchases of four mortgage-backed securities totaling $5.8 million and contractual principal repayments of $2.6 million.

Loans receivable, net, decreased $10.3 million or 3.6% to $277.5 million at June 30, 2013 from $287.8 million at June 30, 2012 as a result of normal principal reductions, transfers to REO and loan charge-offs exceeding new loan production. Commercial real estate loans increased $9.6 million or 9.8% to $106.9 million at June 30, 2013 from $97.3 million at June 30, 2012 and one-to-four family loans decreased $8.8 million or 10.6% to $73.9 million at June 30, 2013 from $82.7 million during the same period in 2012. The balance of construction and land loans declined to $11.0 million at June 30, 2013 compared to $13.8 million at June 30, 2012. Consumer loans decreased $7.8 million or 18.2% to $35.1 million from June 30, 2012 as consumers continue to reduce debt and demand for consumer loans has been modest during the current economic uncertainty.

Real estate owned, net decreased $496,000, or 7.4% to $6.2 million at June 30, 2013 from $6.7 million at June 30, 2012 as a result of ongoing sales to reduce our nonperforming assets. The $496,000 decline was a result of REO sales of $4.9 million and $1.5 million of REO valuation write-downs partially offset by the transfer of loans to REO totaling $5.0 million as well as $793,000 of capital improvements.

Deposits. Deposits decreased $17.2 million, or 5.0%, to $328.6 million at June 30, 2013 from $345.8 million at June 30, 2012.

The following table details the changes in deposit accounts at the dates indicated:

                                    Balance at June     Balance at         Increase/(Decrease)
                                       30, 2013       June 30, 2012       Amount         Percent
                                                        (Dollars in thousands)
Noninterest-bearing demand deposits $      39,713     $     37,941     $     1,772           4.7  %
Interest-bearing demand deposits           20,067           16,434           3,633          22.1
Money market accounts                      82,603           83,750          (1,147 )        (1.4 )
Savings deposits                           36,518           36,475              43           0.1
Certificates of deposit                   149,683          171,198         (21,515 )       (12.6 )
Total deposit accounts              $     328,584     $    345,798     $   (17,214 )        (5.0 )%

Borrowings. FHLB advances remained unchanged at $64.9 million at both June 30, 2013 and June 30, 2012.

Equity. Total stockholders' equity decreased $1.7 million, or 3.1%, to $52.4 million at June 30, 2013 from $54.0 million at June 30, 2012. The decrease was primarily due to the increase in accumulated other comprehensive loss of $1.5 million related to our unrealized losses on securities available-for-sale, which increased due to the recent rise in long term mortgage interest rates.

Comparison of Operating Results for the Years Ended June 30, 2013 and June 30, 2012

General. Net loss for the year ended June 30, 2013 was $255,000 or $0.10 per diluted share compared to a net loss of $1.7 million or $0.70 per diluted share for the year ended June 30, 2012.

Net Interest Income. Net interest income before the provision for loan losses decreased $1.4 million, or 8.6%, to $15.0 million for the year ended June 30, 2013, from $16.4 million for the year ended June 30, 2012. For the year ended June 30, 2013, average loans receivable, net, decreased $26.1 million or 8.2% to $292.3 million from $318.4 million for the year ended June 30, 2012.

Our net interest margin decreased 12 basis points to 3.53% for the year ended June 30, 2013, from 3.65% for the prior fiscal year. Over the last fiscal year, our net interest margin declined as a result of the decline in our cost of funds not exceeding the reduction in yield on interest-earning assets. Our yield on earnings assets decreased to 4.66% for the year ended June 30, 2013

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from 5.01% for the year ended June 30, 2012. Our funding costs have decreased from 1.58% during the year ended June 30, 2012 to 1.30% during the year ended June 30, 2013. All these declines reflect the low interest rate environment that has persisted throughout the year. We expect further declines in our funding costs as our certificates of deposit mature and reprice to current market rates. The cost for certificates of deposit decreased to 2.01%, respectively during the year ended June 30, 2013 from 2.19% for the same period of the prior year. At June 30, 2013, $51.7 million of our certificates of deposit with a . . .

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