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ANCB > SEC Filings for ANCB > Form 10-Q on 5-Nov-2012All 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 the Supervisory Directive or other regulatory enforcement actions and the possibility that we will be unable to fully comply with the Directive which could result in the imposition of additional requirements or restrictions;

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

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;

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 this

Form 10-Q.

Some of these and other factors are discussed in our 2012 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 2013 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 13 full-service banking offices (including three Wal-Mart store locations) and one loan production office located within Grays Harbor, Thurston, Lewis, Pierce, and Mason counties, Washington. 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. To an increasing extent in recent years, lending activities have also included the origination of residential construction loans through brokers, in particular within the Portland, Oregon metropolitan area and increased reliance on non-deposit sources of funds.

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. Under the Order, however, we were not permitted to increase our brokered deposits. Our current strategy is to utilize FHLB advances consistent with our asset liability objectives and replace brokered deposits with retail deposits while limiting loan growth consistent with our regulatory and capital objectives. While continuing our commitment to all 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 interest rate environment, we are seeking to find 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 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. From time to time, 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 mortgage loans to Freddie Mac) to supplement our net interest income and to improve earnings.

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 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 an Order to Cease and Desist ("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 non-performing 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 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 2012 Form10-K.

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 $7.8 million at September 30, 2012. The deferred 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 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 monthly 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 September 30, 2012 and June 30, 2012

General. Total assets decreased by $4.7 million, or 1.0%, to $466.1 million at September 30, 2012, from $470.8 million at June 30, 2012. The decrease in assets during this period was primarily a result of cash and due from banks decreasing $4.9 million or 6.2% and total real estate owned decreasing $1.2 million, or 18.3%, partially offset by an increase in securities available for sale of $1.8 million, or 3.7%. Total liabilities decreased $5.1 million or 1.2% to $411.7 million at September 30, 2012 compared to $416.8 million at June 30, 2012. Total deposits decreased $8.2 million, or 2.4%, to $337.6 million at September 30, 2012 from $345.8 million at June 30, 2012 primarily as a result of decreases in money market deposits and certificate of deposits.

Assets. Total assets decreased $4.7 million or 1.0% at September 30, 2012 from June 30, 2012. The following table details the increases and decreases in the composition of the Bank's assets from June 30, 2012 to September 30, 2012:


                                                Balance at         Balance at
                                               September 30,        June 30,
                                                    2012              2012            Amount          Percent
                                                                   (Dollars in thousands)

Cash and due from banks                       $        73,785     $      78,673     $    (4,888 )          (6.2 )%
Mortgage-backed securities, available-for-
   sale                                                48,850            47,061           1,789             3.8
Mortgage-backed securities, held to
   maturity                                             7,778             7,037             741            10.5
Loans receivable, net of allowance for loan
   losses                                             287,500           287,755            (255 )          (0.1 )
Real estate owned , net                                 5,482             6,708          (1,226 )         (18.3 )

Cash and due from banks decreased $4.9 million or 6.2% at September 30, 2012 from June 30, 2012. We used $5.6 million to purchase FHLMC mortgage- backed securities during the quarter.

Mortgage-backed securities available-for-sale increased $1.8 million, or 3.8%, to $48.9 million at September 30, 2012 from $47.1 million at June 30, 2012. The increase in this portfolio was primarily the result of purchases of five FHLMC mortgage- backed securities totaling $5.6 million, contractual payments of $4.0 million, and $200,000 increase for mark-to-market.

Loans receivable, net, decreased $255,000 or 0.1% to $287.5 million at September 30, 2012 from $287.8 million at June 30, 2012. Commercial real estate loans increased $4.9 million or 5.1% to $102.2 million from $97.3 million at June 30, 2012 and one-to-four family residential loans decreased $2.7 million or 3.3% to $80.0 million from $82.7 million at June 30, 2012.

Deposits. Deposits decreased $8.2 million, or 2.4%, to $337.6 million at September 30, 2012 from $345.8 million at June 30, 2012.

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


                                              Balance at         Balance at
                                             September 30,        June 30,
                                                 2012               2012             Amount          Percent
                                                                 (Dollars in thousands)

Noninterest-bearing demand deposits        $         38,184     $      37,941     $         243            0.6 %
Interest-bearing demand deposits                     17,199            16,434               765            4.7
Money market accounts                                81,476            83,750            (2,274 )         (2.7 )
Savings deposits                                     36,364            36,475              (111 )         (0.3 )
Certificates of deposit
  Retail certificates                               164,346           171,198            (6,852 )         (4.0 )
  Brokered certificates                                   -                 -                 -              -
Total deposit accounts                     $        337,569     $     345,798     $    $ (8,229 )         (2.4 )%

Borrowings. FHLB advances remained at $64.9 million at September 30, 2012 and June 30, 2012.

Stockholders' Equity. Total stockholders' equity increased $426,000 or 0.8% to $54.5 million at September 30, 2012 from $54.0 million at June 30, 2012. The increase was primarily due to the $278,000 net income during the three months ended September 30, 2012. Accumulated other comprehensive income increased $128,000 to $103,000 at September 30, 2012 from a loss of $(25,000) at June 30, 2012.

Comparison of Operating Results for the Three Months ended September 30, 2012 and 2011

General. Net income for the three months ended September 30, 2012 was $278,000 compared to a net loss of $1.7 million for the three months ended September 30, 2011.

Net Interest Income. Net interest income before the provision for loan losses decreased $203,000, or 4.9%, to $4.0 million for the quarter ended September 30, 2012 from $4.2 million for the quarter ended September 30, 2011.

The Company's net interest margin decreased one basis point to 3.68% for the quarter ended September 30, 2012, from 3.69% for the comparable period in 2011. The average yield on interest-earning assets decreased 24 basis points to 4.89% for the quarter ended September 30, 2012 compared to 5.13% for the same period in the prior year. The decline in the yield of interest-earning assets was primarily attributable to the downward repricing of investment securities, and a higher level of liquidity.

The average cost of interest-bearing liabilities decreased 25 basis points to 1.41% for the quarter ended September 30, 2012 compared to 1.66% for the same period in the prior year.

This decline in the average cost of interest-bearing liabilities was primarily due to a 45 basis point decrease in the average cost of money market accounts and a 19 basis point decrease in certificates of deposit.

The following table sets forth the changes to our net interest income for the three months ended September 30, 2012 compared to the same period in 2011. 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.

                                                           Three Months Ended September 30, 2012
                                                              Compared to Three Months Ended
                                                                    September 30, 2011
                                                       Increase (Decrease) Due to
                                                         Rate              Volume             Total
                                                                      (In thousands)
Interest-earning assets:
Loans receivable, including fees                     $         111       $      (613 )     $      (502 )
Mortgage-backed securities                                    (160 )             171                11
Investment securities, FHLB stock
  and cash and due from banks                                  (37 )               4               (33 )
Total net change in income on interest-earning
assets                                               $         (86 )     $      (438 )     $      (524 )
Interest-bearing liabilities:
Savings deposits                                     $         (32 )     $         5       $       (27 )
Interest-bearing demand deposits                                (4 )              (2 )              (6 )
Money market accounts                                          (93 )               8               (85 )
Certificates of deposit                                        (80 )             (77 )            (157 )
FHLB advances                                                   10               (56 )             (46 )

Total net change in expense on interest-bearing
liabilities                                                   (199 )            (122 )            (321 )
 Total increase (decrease) in net interest income    $         113       $      (316 )     $      (203 )

Interest Income. Total interest income for the three months ended September 30, 2012 decreased $524,000, or 9.0%, to $5.3 million, from $5.8 million for the three months ended September 30, 2011. The decrease during the period was attributable to the decline in net loans receivable. Average loans receivable declined $39.2 million during the quarter ended September 30, 2012, compared to the same quarter last year.

The following table compares average interest-earning asset balances, associated yields, and resulting changes in interest income for the three months ended September 30, 2012 and 2011:

                                                Three Months Ended September 30,
                                        2012                     2011                Increase/
                                                                                   (Decrease) in
                                                                                   Interest and
                                 Average                  Average                   Income from
                                 Balance      Yield       Balance      Yield           2011
                                                     (Dollars in thousands)

Loans receivable, net (1)       $ 296,466       6.40 %   $ 335,698       6.25 %   $          (502 )
Mortgage-backed securities         53,735       3.53        39,216       4.72                  11
Investment securities               1,795       4.90         5,583       4.44                 (40 )
FHLB stock                          6,505          -         6,510          -                   -
. . .
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