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ANCB > SEC Filings for ANCB > Form 10-Q on 7-May-2014All Recent SEC Filings

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Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements and "Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995

This report contains forward-looking statements, which are not statements of historical fact and often include the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future performance. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, but not limited to:

the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

changes in general economic conditions, either nationally or in our market areas;

changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;

fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;

secondary market conditions for loans and our ability to sell loans in the secondary market;

results of examinations of us by the FDIC, DFI or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

our compliance with regulatory enforcement actions, including the requirements and restrictions of the Supervisory Directive the Bank entered into with the DFI and the possibility that the Bank will be unable to fully comply with this enforcement action which could result in the imposition of additional requirements or restrictions;

our ability to attract and retain deposits;

increases in premiums for deposit insurance;

management's assumptions in determining the adequacy of the allowance for loan losses;

our ability to control operating costs and expenses;

the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

difficulties in reducing risks associated with the loans on our balance sheet;

staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

computer systems on which we depend could fail or experience a security breach;

our ability to retain key members of our senior management team;

costs and effects of litigation, including settlements and judgments;

our ability to manage loan delinquency rates;

increased competitive pressures among financial services companies;

changes in consumer spending, borrowing and savings habits;

legislative or regulatory changes that adversely affect our business including the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including as a result of Basel III;

changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules;

the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

our ability to pay dividends on our common stock;

adverse changes in the securities markets;

inability of key third-party providers to perform their obligations to us;

changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods including relating to fair value accounting and loan loss reserve requirements; and

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in our filings with the Securities and Exchange Commission, including this Form 10-Q.

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Some of these and other factors are discussed in our 2013 Form10-K under Item 1A. "Risk Factors." Such developments could have an adverse impact on our financial position and results of operations.

Any of the forward-looking statements that we make in this quarterly report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. Because of these and other uncertainties, our actual results for fiscal year 2014 and beyond may differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect our financial condition, liquidity and operating and stock price performance.

Background and Overview

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) 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.

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.

Anchor Bank entered into the Order with the FDIC and the Washington DFI on August 12, 2009. Anchor Bank became subject to the Order primarily because of its increased level of nonperforming assets, reduced capital position and pre-tax operating losses in 2010 and 2009. On September 5, 2012, Anchor Bank's regulators, the FDIC and the DFI terminated the Order and the Bank became subject to a Supervisory Directive. The Order was terminated 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 the Bank. The Bank believes that it is in compliance with the requirements set forth in the Supervisory Directive.
Additional information regarding the Supervisory Directive is included in Note 5 to the Selected Notes to Consolidated Financial Statements included in Item 1 of this Form 10-Q and Item 1A. "Risk Factors - Compliance with Regulatory Restrictions" in the 2013 Form10-K.

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Correcting the problems identified in the Order has had a resulting impact on our financial condition and results of operations. We have reduced our asset size and sold relatively high yielding performing fixed rate single family loans. Also, because of the reduced demand for commercial real estate loans, we have sold these loans at a discount. Although the reduction in asset size and loan sales have helped us preserve our capital and maximize our regulatory capital ratios, these actions have also negatively impacted our operating results, including reducing our net interest income in recent periods. Critical Accounting Estimates and Related 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, the 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. 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 March 31, 2014. 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.

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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 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 March 31, 2014 and June 30, 2013

General. Total assets decreased by $59.0 million, or 13.0%, to $393.2 million at March 31, 2014 from $452.2 million at June 30, 2013. The decrease in assets during this period was primarily a result of cash and cash equivalents decreasing $43.3 million or 66.2% as we used our excess cash to repay $47.4 million of maturing FHLB advances. Total liabilities decreased $59.5 million or 14.9% to $340.3 million at March 31, 2014 compared to $399.8 million at June 30, 2013 primarily due to the decrease in FHLB advances. Total deposits decreased $12.9 million, or 3.9%, to $315.7 million at March 31, 2014 from $328.6 million at June 30, 2013 primarily as a result of decreases in certificates of deposit.

Assets. The following table details the increases and decreases in the composition of the Company's assets from June 30, 2013 to March 31, 2014:

                                    Balance at March   Balance at June       Increase/(Decrease)
                                        31, 2014          30, 2013          Amount         Percent
                                                         (Dollars in thousands)
Cash and cash equivalents           $       22,083     $      65,353     $   (43,270 )       (66.2 )%
Mortgage-backed securities,
available-for-sale                          39,948            46,852          (6,904 )       (14.7 )
Mortgage-backed securities,
held-to-maturity                             8,934            10,160          (1,226 )       (12.1 )
Loans receivable, net of allowance
for loan losses                            275,766           277,454          (1,688 )        (0.6 )
Real estate owned, net                       5,529             6,212            (683 )       (11.0 )

Mortgage-backed securities available-for-sale decreased $6.9 million, or 14.7%, to $39.9 million at March 31, 2014 from $46.9 million at June 30, 2013. Mortgage-backed securities held-to-maturity decreased $1.2 million or 12.1%, to $8.9 million at March 31, 2014 from $10.2 million at June 30, 2013. The decreases in these portfolios were primarily the result of contractual principal repayments.

Loans receivable, net, decreased $1.7 million or 0.6% to $275.8 million at March 31, 2014 from $277.5 million at June 30, 2013 as a result of principal reductions, transfers to REO and loan charge-offs exceeding new loan production. Multi-family loans increased $8.4 million or 22.0% to $46.9 million at March 31, 2014 from $38.4 million at June 30, 2013. Construction and land loans increased $4.6 million or 41.9% to $15.6 million at March 31, 2014 from $11.0 million at June 30, 2013. Commercial real estate loans increased $1.3 million or 1.2% to $108.2 million at March 31, 2014 from $106.9 million at June 30, 2013 and one-to-four family loans decreased $8.0 million or 10.8% to $65.9 million from $73.9 million at June 30, 2013. Commercial business loans decreased $2.8 million or 15.6% to $15.4 million at March 31, 2014 from $18.2 million at June 30, 2013. Consumer loans decreased $6.0 million or 17.1% to $29.1 million at March 31, 2014 from $35.1 million at June 30, 2013 as consumers continue to reduce their debt. The demand for loans in our market area has been modest during the current economic recovery.

As of March 31, 2014, the Company had 19 REO properties with an aggregate book value of $5.5 million compared to 21 properties with an aggregate book value of $6.2 million at June 30, 2013, and 31 properties with an aggregate book value of $7.0 million at March 31, 2013. The decrease in number of properties during the quarter ended March 31, 2014 was primarily attributable to ongoing sales of residential properties. During the quarter ended March 31, 2014, the Company sold four residential real estate properties for $509,000 and a commercial real estate property for $55,000 resulting in an aggregate gain on sale of $14,000. At March 31, 2014, the largest of the REO properties is a commercial real estate property located in Pierce County, Washington.

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The following is a summary as of March 31, 2014 of our REO properties listed by property type and county location:

                                              County                                             Number of      Percent of
                    Grays Harbor       Thurston       Pierce        All Other        Total       properties      Total REO
                                                 (In thousands)
One-to-four family $         464     $      495     $       -     $       104     $   1,063              9         19.2 %
Commercial                   922              -         3,415               -         4,337              4         78.4
Land                          68              -            23              38           129              6          2.3
Total              $       1,454     $      495     $   3,438     $       142     $   5,529             19        100.0 %

Liabilities. Total liabilities decreased $59.5 million between June 30, 2013 and March 31, 2014, primarily as the result of a $47.4 million or 73.0% decrease in Federal Home Loan Bank advances.

Deposits decreased $12.9 million, or 3.9%, to $315.7 million at March 31, 2014 from $328.6 million at June 30, 2013. Our core deposits, which consist of all deposits other than certificates of deposit, decreased by $2.7 million or 1.5% to $176.2 million from $178.9 million at June 30, 2013. Certificates of deposit decreased $10.2 million or 6.8% to $139.5 million from $149.7 million at June 30, 2013.

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

                                    Balance at March     Balance at         Increase/(Decrease)
                                        31, 2014       June 30, 2013       Amount         Percent
                                                         (Dollars in thousands)
Noninterest-bearing demand deposits $       41,551     $     39,713     $     1,838           4.6  %
Interest-bearing demand deposits            22,004           20,067           1,937           9.7
Money market accounts                       72,434           82,603         (10,169 )       (12.3 )
Savings deposits                            40,229           36,518           3,711          10.2
Certificates of deposit                    139,516          149,683         (10,167 )        (6.8 )
Total deposit accounts              $      315,734     $    328,584     $   (12,850 )        (3.9 )%

Stockholders' Equity. Total stockholders' equity increased $472,000 or 0.9% to $52.8 million at March 31, 2014 from $52.4 million at June 30, 2013. The increase was primarily due to our net income of $125,000 during the nine months ended March 31, 2014 and improvement in our accumulated other comprehensive loss. Accumulated other comprehensive loss improved $258,000 to $1.3 million at March 31, 2014 from $1.5 million at June 30, 2013.

Comparison of Operating Results for the Three and Nine Months Ended March 31, 2014 and 2013

General. Net income for the three months ended March 31, 2014 was $385,000 or $0.16 per diluted share compared to net income of $55,000 or $0.02 per diluted share for the three months ended March 31, 2013. For the nine months ended March 31, 2014 the net income was $125,000 or $0.05 per diluted share compared to a net income of $558,000 or $0.23 per diluted share for the comparable period in 2013.

Net Interest Income. Net interest income before the provision for loan losses decreased $394,000, or 9.9%, to $3.6 million for the quarter ended March 31, 2014 from $4.0 million for the quarter ended March 31, 2013. For the nine months ended March 31, 2014, net interest income before the provision for loan losses decreased $1.1 million or 9.7% to $10.7 million from $11.8 million for the same period in 2013.

The Company's net interest margin increased 32 basis points to 4.09% for the quarter ended March 31, 2014 from 3.77% for the comparable period in 2013, reflecting the decline in our average interest-earning asset balance and a decline in the interest bearing liabilities. The higher net interest margin for this quarter was also partially due to a one time recovery of interest for nonperforming loans of $97,000. Our net interest margin would have been 3.97% without the recovered interest income. The average yield on interest-earning assets increased 21 basis points to 5.07% for the quarter ended March 31, 2014 compared to

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4.86% for the same period in 2013 despite a 37 basis point decline in the average loan yield as adjustable rate loans repriced to current interest rates. The average yield on interest-earning assets increased due to the decline in the average balance of lower yielding cash and cash equivalents, resulting in an increase in the percentage of higher-yielding loans to total average interest-earning assets. The average cost of interest-bearing liabilities decreased seven basis points to 1.18% for the quarter ended March 31, 2014 compared to 1.25% for the same period in the prior year as the cost of our liabilities continued to decline, due to the payoff of FHLB borrowings, the reduction in balance of certificates of deposit and, to a lesser extent, the renewal of certificates of deposit at currently low interest rates.

The following table sets forth the changes to our net interest income for the three months ended March 31, 2014 compared to the same period in 2013. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.

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