XOTC:AKPB Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
(Mark One)

   X  
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2012

____ 
Transition report pursuant to Section 13 or 15(d) of the Exchange Act of 1934
 
For the transition period from _____________  to ___________

Commission file number: 0-26003

ALASKA PACIFIC BANCSHARES, INC.

(Exact name of registrant as specified in its charter)
 
 
Alaska    92-0167101 
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
2094 Jordan Avenue, Juneau, Alaska  99801
(Address of Principal Executive Offices)

(907) 789-4844
(Registrant’s telephone number, including area code)

NA
(Former name, former address and former fiscal year,
if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   X     No        

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   X     No        
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company’ in Rule 12b-2 of the Exchange Act.

Large accelerated filer _____                                                                                     Accelerated filer  _____
Non-accelerated filer  _____                                                                                     Smaller reporting company  __X___
(do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes         No     X   

State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practicable date:        654,486   shares outstanding on August 1, 2012
 
 
1

 
ALASKA PACIFIC BANCSHARES, INC.
Juneau, Alaska

INDEX
 
PART I.  FINANCIAL INFORMATION
 
   
   
Item 1.  Financial Statements
 
   
Condensed Consolidated Balance Sheets
3
Condensed Consolidated Statements of Operations
4
Condensed Consolidated Statements of
  Comprehensive Income (Loss)
 
5
Condensed Consolidated Statements of Cash Flows
6
Selected Notes to Condensed Consolidated Interim
  Financial Statements
7
   
Item 2.  Management's Discussion and Analysis of
              Financial Condition and Results of Operations
 
39
   
Item 3.  Quantitative and Qualitative Disclosures About
              Market Risk
 
48
   
Item 4.  Controls and Procedures
48
   
   
PART II.  OTHER INFORMATION
 
   
Item 1. Legal Proceedings
49
   
Item 1A. Risk Factors
49
   
Item 2. Unregistered Sales of Equity Securities and Use
    of Proceeds
49
   
Item 3. Defaults Upon Senior Securities
49
   
Item 4.  Mine Safety Disclosures
49
   
Item 5. Other Information
49
   
Item 6. Exhibits
50
   
Signatures
52

 
 
 
 
2

 

 
PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements

Alaska Pacific Bancshares, Inc. and Subsidiary
Condensed Consolidated Balance Sheets

(dollars in thousands except share data)
 
June 30,
 2012
(Unaudited)
   
December 31,
2011
 
Assets
           
Cash and due from banks
  $ 10,561     $ 8,307  
Interest-earning deposits in financial institutions
    848       2,751  
Total cash and cash equivalents
    11,409       11,058  
Investment securities available for sale, at fair value  (amortized cost: June 30,
   2012 - $5,504; December 31, 2011 - $5,546)
    5,709       5,714  
Federal Home Loan Bank stock
    1,784       1,784  
Loans held for sale
    985       976  
Loans
    151,743       147,766  
Less allowance for loan losses
    (1,844 )     (1,865 )
Loans, net
    149,899       145,901  
Interest receivable
    499       585  
Premises and equipment, net
    3,292       2,451  
Real estate owned and repossessed assets, net
    258       880  
Mortgage servicing rights, at fair value
    1,085       1,098  
Other assets
    2,497       1,610  
Total Assets
  $ 177,417     $ 172,057  
Liabilities and Shareholders’ Equity
               
Deposits:
               
Noninterest-bearing demand
  $ 35,882     $ 31,748  
Interest-bearing demand
    32,592       33,033  
Money market
    30,906       27,843  
Savings
    21,229       20,987  
Certificates of deposit
    31,042       33,590  
Total deposits
    151,651       147,201  
Federal Home Loan Bank advances
    3,000       3,000  
Advances from borrowers for taxes and insurance
    1,578       691  
Accounts payable and accrued expenses
    367       331  
Interest payable
    114       131  
Other liabilities
    224       161  
Total liabilities
    156,934       151,515  
Shareholders’ Equity:
               
Preferred stock ($0.01 par value; 1,000,000 shares authorized; Series A –
   Liquidation preference $1,000 per share, 4,781 shares issued and outstanding
   at June 30, 2012 and at December 31, 2011)
     4,667        4,631  
Common stock ($0.01 par value; 20,000,000 shares authorized; 655,415 shares
   issued; 654,486 shares outstanding at June 30, 2012 and at December 31,
   2011)
    7       7  
Additional paid-in capital
    6,492       6,486  
Treasury stock
    (11 )     (11 )
Retained earnings
    9,167       9,290  
   Accumulated other comprehensive income, net
    161       139  
Total shareholders’ equity
    20,483       20,542  
Total Liabilities and Shareholders’ Equity
  $ 177,417     $ 172,057  
                 
See selected notes to condensed consolidated interim financial statements.
         
 
3

 
Alaska Pacific Bancshares, Inc. and Subsidiary
Condensed Consolidated Statements of Operations
(Unaudited)
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(in thousands, except per share data)
 
2012
   
2011
   
2012
   
2011
 
Interest Income
                       
Loans
  $ 2,040     $ 2,115     $ 4,093     $ 4,218  
Investment securities
    35       36       69       66  
Interest-earning deposits with financial institutions
    1       5       4       14  
Total interest income
    2,076       2,156       4,166       4,298  
Interest Expense
                               
Deposits
    117       138       236       288  
Federal Home Loan Bank advances
    29       28       57       79  
Total interest expense
    146       166       293       367  
Net Interest Income
    1,930       1,990       3,873       3,931  
 Provision for loan losses
    90       193       180       253  
Net interest income after provision for loan losses
    1,840       1,797       3,693       3,678  
Noninterest Income
                               
Mortgage servicing income
    71       81       151       167  
Service charges on deposit accounts
    175       171       333       316  
Other service charges and fees
    61       62       126       123  
Gain on sale of loans
    87       79       197       129  
Total noninterest income
    394       393       807       735  
Noninterest Expense
                               
Compensation and benefits
    1,169       1,124       2,259       2,247  
Occupancy and equipment
    350       312       695       663  
Data processing
    65       67       133       138  
Professional and consulting fees
    193       155       308       280  
Marketing and public relations
    71       70       111       116  
Real estate owned and repossessed assets, net
    180       (17 )     250       (14 )
FDIC assessment
    127       35       154       169  
Other
    309       247       533       472  
Total noninterest expense
    2,464       1,993       4,443       4,071  
(Loss) Income before (benefit) provision for income taxes
    (230 )     197       57       342  
           (Benefit) Provision for income taxes
    (89 )     -       24       -  
Net (loss) income
  $ (141 )   $ 197     $ 33     $ 342  
Preferred stock dividend and discount accretion
                               
Preferred stock dividends
    60       59       120       121  
Preferred stock discount accretion
    19       18       36       34  
Net (loss) income available to common shareholders
  $ (220 )   $ 120     $ (123 )   $ 187  
 (Loss) income per common share:
                               
Basic
  $ (0.34 )   $ 0.18     $ (0.19 )   $ 0.29  
Diluted
    (0.34 )     0.16     $ (0.19 )   $ 0.26  
                                 
See selected notes to condensed consolidated interim financial statements.
         
 
4

 
Alaska Pacific Bancshares, Inc. and Subsidiary
Condensed Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(in thousands, except per share data)
 
2012
   
2011
   
2012
   
2011
 
Net (loss) income available to common shareholders
  $ (220 )   $ 120     $ (123 )   $ 187  
Other comprehensive (loss) income
                               
   Net unrealized income on investment securities, net of tax
    14       33       22       10  
Comprehensive (loss) income
  $ (206 )   $ 153     $ (101 )   $ 197  
 
 
 
 
 
5

 
Alaska Pacific Bancshares, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows
(Unaudited)
   
Six Months Ended
June 30,
 
(in thousands)
 
2012
   
2011
 
Operating Activities
           
Net income
  $ 33     $ 342  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    180       253  
Gain on sale of loans
    (197 )     (129 )
Fair value valuation adjustment mortgage servicing rights
    13       7  
Depreciation and amortization
    139       137  
Amortization of fees, discounts, and premiums, net
    (44 )     (86 )
Stock compensation expense
    6       8  
(Gain) Loss on sale and impairment of real estate owned and repossessed assets
    211       (40 )
Loans originated for sale
    (12,468 )     (11,344 )
Proceeds from sale of loans originated for sale
    12,656       11,469  
Cash provided by (used in) changes in operating assets and liabilities:
               
Interest receivable
    86       34  
Other assets
    (902 )     46  
Advances from borrowers for taxes and insurance
    887       920  
Interest payable
    (17 )     (36 )
Accounts payable and accrued expenses
    36       (273 )
Other liabilities
    63       (1 )
Net cash provided by operating activities
    682       1,307  
Investing Activities
               
Purchase of investment securities available for sale
    (261 )     (3,004 )
Maturities and principal repayments of investment securities available for sale, net
    288       263  
Loan originations, net of principal repayments
    (4,119 )     (5,574 )
Proceeds from sale of real estate owned and repossessed assets
    411       710  
Purchase of premises and equipment
    (980 )     (87 )
Net cash used in investing activities
    (4,661 )     (7,692 )
Financing Activities
               
Net decrease in Federal Home Loan Bank advances
    -       (2,000 )
Net decrease in demand and savings deposits
    6,998       1,672  
Net decrease in certificates of deposit
    (2,548 )     (2,173 )
Cash dividends paid
    (120 )     (240 )
Net cash provided by (used in) financing activities
    4,330       (2,741 )
Increase (Decrease) in cash and cash equivalents
    351       (9,126 )
Cash and cash equivalents at beginning of period
    11,058       21,023  
Cash and cash equivalents at end of period
  $ 11,409     $ 11,897  
Supplemental information:
               
Cash paid for interest
  $ 310     $ 403  
Net cash paid for (received from) income taxes
    320       (110 )
Net change in fair value of securities available for sale, net of tax
    22       10  
Accrued dividends on Series A preferred stock issued to United States Department of Treasury
               
   in Troubled Asset Relief Program Capital Purchase Plan
    31       31  


 
6

 
Alaska Pacific Bancshares, Inc. and Subsidiary
Selected Notes to Condensed Consolidated Interim Financial Statements
(Unaudited)

Note 1 Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements include the accounts of Alaska Pacific Bancshares, Inc. (the “Company”) and its wholly owned subsidiary, Alaska Pacific Bank (the “Bank”), and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and to general practices within the financial institutions industry, where applicable.  All significant intercompany balances have been eliminated in the consolidation.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  They should be read in conjunction with the audited consolidated financial statements included in the Form 10-K for the year ended December 31, 2011.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included pursuant to the requirements of the Securities and Exchange Commission (“SEC”) for interim reporting.  The results of operations for the interim periods ended June 30, 2012, are not necessarily indicative of the results which may be expected for an entire year or any other period.  In preparing these financial statements, the Company has evaluated events and transactions subsequent to June 30, 2012 for potential recognition and disclosure.
 
Certain amounts in prior-period consolidated financial statements have been reclassified to conform to the current-period presentation.  These reclassifications had no effect on net (loss) income or shareholders’ equity.
 

Note 2 – Mortgage Loan Servicing

The Company generally retains the right to service mortgage loans sold to others.  Loans serviced for others at June 30, 2012 and December 31, 2011 were $137.8 million and $138.5 million, respectively.  The Company accounts for mortgage servicing rights (“MSR”) in accordance with Accounting Standards Codification (“ASC”) 860-50, Servicing Assets and Liabilities, which provides an election to record changes in fair value to be reported in earnings in the period in which the change occurs.  The Company uses a model derived valuation methodology to update the estimate of fair value of the MSR obtained from an independent financial advisor on an annual basis.  The annual valuation is reviewed on a quarterly basis for significant changes in assumptions and current market rates.  The model pools loans into tranches of homogeneous characteristics and performs a present value analysis of the expected future cash flows.  The tranches are created by individual loan characteristics such as note rate, product type, and the remittance schedule.  Current market rates are utilized for discounting the future cash flows.  Significant assumptions used in the annual valuation of the MSR include discount rates, projected repayment speeds, escrow calculations, ancillary income, delinquencies and option adjusted spreads.
 
 
7

 
Key assumptions used in measuring the fair value of the MSR as of June 30, 2012 and 2011 were as follows:
 
(in thousands)
June 30,
 
2012
2011
Constant prepayment rate
18.56%
16.83%
Discount rate
8.08%
7.94%
Weighted average life (years)
23.6
23.9

The change in the balance of mortgage servicing assets is included in the following table:
 
   
Three Months
Ended June 30,
   
Six Months
Ended June 30,
 
(in thousands)
 
2012
   
2011
   
2012
   
2011
 
                         
Balance beginning of period
  $ 1,085     $ 1,235     $ 1,098     $ 1,242  
   Change in fair value:
                               
Due to additions to servicing assets
    104       43       174       68  
Due to payoffs of servicing assets
    (69 )     (36 )     (138 )     (68 )
Fair value adjustment
    (35 )     (7 )     (49 )     (7 )
Total change in fair value
    -       -       (13 )     -  
Balance end of period
  $ 1,085     $ 1,235     $ 1,085     $ 1,235  

Note 3 – Fair Value Measurements

We have elected to record certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The GAAP standard (ASC 820, Fair Value Measurements and Disclosures) establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements.  The standard requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions.  These two types of inputs create the following fair value hierarchy:

Level 1 - Unadjusted quoted prices for identical instruments in active markets;

Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable; and

Level 3 - Instruments whose significant value drivers are unobservable.

An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 
8

 
The following table sets forth the Company’s assets and liabilities by level within the fair value hierarchy that were measured at fair value on a recurring and non-recurring basis at June 30, 2012 and December 31, 2011.

 (in thousands)
 
Fair Value
   
Quoted Prices
in Active
Markets for
Identical
Instruments
(Level 1)
   
Significant
Other
Observable
Inputs (Level
2)
   
Significant Unobservable
Inputs
 (Level 3)
 
June 30, 2012:
                       
Recurring:
                       
Available for sale securities:
                       
   Mortgage-backed securities
  $ 2,150     $ -     $ 2,150     $ -  
   Municipal securities
    1,974       -       1,974       -  
   U.S. government agencies
    1,585       -       1,585       -  
Mortgage servicing rights
    1,085       -       -       1,085  
                                 
Non-recurring:
                               
Impaired loans
    1,982       -       -       1,982  
Real estate owned and repossessed assets
    258       -       -       258  
                                 
December 31, 2011:
                               
Recurring:
                               
Available for sale securities:
                               
   Mortgage-backed securities
  $ 2,421     $ -     $ 2,421     $ -  
   Municipal securities
    1,706       -       1,706       -  
   U.S. government agencies
    1,587       -       1,587       -  
Mortgage servicing rights
    1,098       -       -       1,098  
                                 
Non-recurring:
                               
Impaired loans
    2,045       -       -       2,045  
Real estate owned and repossessed assets
    880       -       -       880  

For three months ended June 30, 2012, the changes in Level 3 assets and liabilities measured at fair value on a recurring and non-recurring basis were as follows:

(in thousands)
 
Mortgage
Servicing
Rights
   
Impaired
Loans
   
Real Estate Owned
and Repossessed Assets
   
For the Three
Months Ended
June 30,
 
Balance as of March 31, 2012
  $ 1,085     $ 2,035     $ 754     $ 3,874  
Additions to servicing assets, net
    35       -       -       35  
Principal repayments
    -       (53 )     -       (53 )
Proceeds from sale of real estate owned and repossessed assets
    -       -       (325 )     (325 )
Fair value adjustment
    (35 )     -       -       (35 )
Impairment and loss on sale of real estate owned and repossessed assets
    -       -       (171 )     (171 )
Balance as of June 30, 2012
  $ 1,085     $ 1,982     $ 258     $ 3,325  


 
9

 
For six months ended June 30, 2012, the changes in Level 3 assets and liabilities measured at fair value on a recurring and non-recurring basis were as follows:

(in thousands)
 
Mortgage
Servicing
Rights
   
Impaired
Loans
   
Real Estate Owned
and Repossessed
Assets
   
For the Six
Months Ended
June 30,
 
Balance as of January 1, 2012
  $ 1,098     $ 2,045     $ 880     $ 4,023  
Additions to servicing assets, net
    36       -       -       36  
Principal repayments
    -       (63 )     -       (63 )
Proceeds from sale of real estate owned and repossessed assets
    -       -       (411 )     (411 )
Fair value adjustment
    (49 )     -       -       (49 )
Impairment and loss on sale of real estate owned and repossessed assets
    -       -       (211 )     (211 )
Balance as of June 30, 2012
  $ 1,085     $ 1,982     $ 258     $ 3,325  
 
 
 

 
 
10

 
 
 
The following table presents the total losses resulting from nonrecurring fair value adjustments for the periods presented:

 
Three Months Ended June 30,
Six Months Ended June 30,
(in thousands)
2011
2011
Impaired loans *
$  262
$  572
Real estate owned and repossessed assets
        -
         1
   Total
$  262
$  573

*Amounts include specific reserves on impaired loans at June 30, 2011.
 
 

 
11

 
 
For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of June 30, 2012, the significant unobservable inputs used in the fair value measurements were as follows:
 
   
Fair Value at
June 30, 2012
(in thousands)
 
Valuation Technique
Significant
Unobservable
Inputs
 
Significant Unobservable
Input
 
Mortgage servicing
    rights
  $ 1,085  
Discounted Cash Flow
Weighted Average Constant Prepayment Rate
    19.0 %
           
Weighted Average Discount Rate
    8.0 %
                     
Impaired loans
    1,982  
Appraised value less cost to sell, net of discount
Discount Rate Range
    10% - 30 %
                     
Real estate
   owned and
   repossessed
   assets
    258  
Appraised value less cost to sell, net of discount
Discount Rate Range
    10% - 30 %

 
The following table sets forth the estimated fair values of the Company’s financial instruments at June 30, 2012 and December 31, 2011:
 
(in thousands
       
Fair Value Measurements at June 30, 2012
 
   
Carrying
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial Assets
                             
Cash and cash equivalents
  $ 11,409     $ 11,409     $ -     $ -     $ 11,409  
Investment securities available for sale
    5,709       -       5,709       -       5,709  
Federal Home Loan Bank stock
    1,784       -       1,784       -       1,784  
Loans, including held for sale, net
    152,728       -       -       137,631       137,631  
Interest receivable
    499       -       499       -       499  
Mortgage servicing rights
    1,085       -       -       1,085       1,085  
                                         
Financial Liabilities
                                       
Demand and savings deposits
    120,609       -       120,609       -       120,609  
Certificates of deposit
    31,042       -       -       30,838       30,838  
Federal Home Loan Bank advances
    3,000       -       -       3,012       3,012  
Interest payable
    114       -       114       -       114  
                                         

 
12

 

(in thousands
       
Fair Value Measurements at December 31, 2011
 
   
Carrying
Amount
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Financial Assets
                             
Cash and cash equivalents
  $ 11,058     $ 11,058     $ -     $ -     $ 11,058  
Investment securities available for sale
    5,714       -       5,714       -       5,714  
Federal Home Loan Bank stock
    1,784       -       1,784       -       1,784  
Loans, including held for sale, net
    148,742       -       -       129,941       129,941  
Interest receivable
    585       -       585       -       585  
Mortgage servicing rights
    1,098       -       -       1,098       1,098  
                                         
Financial Liabilities
                                       
Demand and savings deposits
    113,611       -       113,611       -       113,611  
Certificates of deposit
    33,590       -       -       33,888       33,888  
Federal Home Loan Bank advances
    3,000       -       -       3,111       3,111  
Interest payable
    131       -       131       -       131  
                                         

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash, cash equivalents, and accrued interest:  The fair value of cash and cash equivalents and accrued interest is estimated to be equal to the carrying value, due to their short-term nature.
 
Investment Securities:   Securities available-for-sale are recorded at fair value on a recurring basis.  Fair values are based on quoted market prices, where available.  If quoted market prices are not available, fair values are estimated based on quoted market prices of comparable instruments with similar characteristics.  Changes in fair market value are recorded in other comprehensive income.

Mortgage servicing rights:  MSR are measured at fair value on a recurring basis.  These assets are classified as Level 3 as quoted prices are not available and the Company uses a model derived valuation methodology to estimate the fair value of MSR obtained from an independent financial advisor on an annual basis.   The annual valuation is reviewed on a quarterly basis for significant changes in assumptions and current market rates.  The model pools loans into tranches of homogeneous characteristics and performs a present value analysis of the expected future cash flows.  The tranches are created by individual loan characteristics such as note rate, product type, and the remittance schedule.  Current market rate assumptions are utilized for discounting the future cash flows.

Impaired loans:  Impaired loans are measured at fair value on a non-recurring basis and included in the table are impaired loans with a current specific valuation allowance.  These assets are classified as Level 3 where significant value drivers are unobservable.  The fair value of impaired
 
 
13

 
loans are determined using a discounted cash flow basis or the fair value of each loan’s collateral for collateral-dependent loans as determined by an appraisal of the property, less estimated costs related to liquidation of the collateral.  The appraisal amount may also be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business.  Impaired loans with a specific valuation allowance were $2.5 million at both June 30, 2012 and December 31, 2011 with estimated reserves for impairment of $473,000 on both dates.

Real estate owned and repossessed assets:  The $258,000 in real estate owned and repossessed assets at June 30, 2012, represents impaired real estate and repossessed assets that have been adjusted to fair value. Real estate owned and repossessed assets primarily represents real estate and other assets which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, real estate owned and repossessed assets are recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell.  The fair value of real estate owned is determined by appraisal of the property, less estimated costs related to liquidation of the asset.  The appraisal amount may also be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the asset.  Fair value adjustments on real estate owned and repossessed assets are recognized in noninterest expense.

Federal Home Loan Bank (“FHLB”) stock:  The fair value of FHLB stock is considered to be equal to its carrying value, since it may be redeemed at that value.
 
Loans including held for sale, net:  The fair value of loans net of allowance for loan losses is estimated using present value methods which discount the estimated cash flows, including prepayments as well as contractual principal and interest, using current interest rates appropriate for the type and maturity of the loans.
 
Deposits and other liabilities:  The fair value disclosed for demand deposits, savings, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date.  For accrued interest payable, fair value is considered to be carrying value.

Certificates of deposit:  The fair values of fixed-rate certificates of deposit are estimated using present value methods and current offering rates for such deposits.

FHLB advances:  The estimated fair value approximates carrying value for short-term borrowings. The fair value of long-term fixed-rate borrowings is estimated by discounting future cash flows using current interest rates for similar financial instruments.

 
14

 
 
Note 4 – Investment Securities Available for Sale
 
Amortized cost and fair values of investment securities available for sale, including mortgage-backed securities, are summarized as follows:
 
(in thousands)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
June 30, 2012:
                       
Mortgage-backed securities:
  $ 2,019     $ 131     $ -     $ 2,150  
Municipal securities:
    1,915       59       -       1,974  
U.S. government agencies
    1,570       15       -       1,585  
Total
  $ 5,504     $ 205       -     $ 5,709  
                                 
December 31, 2011:
                               
Mortgage-backed securities:
  $ 2,303     $ 118     $ -     $ 2,421  
Municipal securities:
    1,668       38       -       1,706  
U.S. government agencies
    1,575       13       (1 )     1,587  
Total
  $ 5,546     $ 169     $ (1 )   $ 5,714  

There are no available for sale securities that have been in a continuous unrealized loss position at June 30, 2012.
 
Available for sale securities at December 31, 2011 that have been in a continuous unrealized loss position are as follows:
 
   
Impaired less than
12 months
   
Impaired 12 months
or more
   
Total
 
(in thousands)
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
U.S. Government Agencies
  $ 499     $ (1 )   $ -     $ -     $ 499     $ (1 )

There were no securities with unrealized losses at June 30, 2012 and one security at December 31, 2011 which were agency securities issued by the U.S. government and state government agencies; collectability of principal and interest of these securities is considered to be reasonably assured.  The fair values of individual securities fluctuate significantly with interest rates and with market demand for securities with specific structures and characteristics.  Management does not consider these unrealized losses to be other than temporary because the Company does not intend to sell them and the Company will likely not be required to sell them.
 
No securities were designated as trading or held to maturity at June 30, 2012 or December 31, 2011.
 
The fair value and amortized cost of investment securities at June 30, 2012 is presented below by contractual maturity.  Actual maturities may vary as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
15

 

 
in
thousands
 
Fair
Value
Mortgage
Backed
Securities
   
Amortized
Cost
Mortgage
Back
Securities
   
Fair
Value
Municipal
Securities
   
Amortized
Cost
Municipal
Securities
   
Fair Value
U.S
Government
Agencies
   
Amortized
Cost U.S
Government
Agencies
 
Maturing within 1 to 5 years
  $ 6     $ 6       -       -     $ 500     $ 500  
Maturing between 5 and 10 years
    334       323       1,974       1,915       1,085       1,070  
Maturing beyond 10 years
    1,810       1,690       -       -       -       -  
Total
  $ 2,150     $ 2,019     $ 1,974     $ 1,915     $ 1,585     $ 1,570  

 
The amortized cost and market value of investment securities pledged to secure public funds deposited with the Bank at June 30, 2012 was $5.5 million and $5.7 million, respectively.  The amortized cost and market value of investment securities pledged to secure public funds deposited with the Bank at December 31, 2011 were $5.5 million and $5.7 million, respectively.
 
There were no sales of securities during the six months ended June 30, 2012 or 2011.
 
 
16

 
At June 30, 2012 the Bank owned $1.8 million of stock of the FHLB of Seattle. As a condition of membership in the FHLB, the Bank is required to purchase and hold a certain amount of FHLB stock, which is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the Capital Plan of the FHLB.  FHLB stock has a par value of $100 per share, is carried at cost, and is subject to impairment testing per ASC 320-10-35. The FHLB announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (“FHFA”), its primary regulator, and that it would suspend future dividends and the repurchase and redemption of outstanding capital stock. In October 2010, the FHLB entered into a Stipulation and Consent to the Issuance of a Consent Order with the Federal Housing Finance Agency (Finance Agency). The Stipulation and Consent provides that the FHLB of Seattle agrees to a Consent Order issued by the Finance Agency, which requires the bank to take certain specified actions related to its business and operations. The FHLB has communicated that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market risk of the FHLB’s private label mortgage-backed securities in the current market environment and that it has enough capital to cover the risks reflected in the FHLB’s balance sheet. As a result, an “other than temporary impairment” has not been recorded for the Bank’s investment in FHLB stock. However, continued deterioration in the FHLB’s financial position may result in impairment in the value of those securities. Management will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of the Bank’s investment.
 

Note 5 – Loans

Loans are summarized as follows:
 
(in thousands)
 
June 30,
 2012
   
December 31,
2011
 
Real estate:
           
Permanent:
           
One- to four-family
  $ 23,491     $ 24,554  
Multifamily
    2,711       2,951  
Commercial nonresidential
    71,466       70,926  
   Land
    8,380       8,435  
Construction:
               
One- to four-family
    1,929       1,103  
Commercial nonresidential
    2,412       2,042  
Commercial business
    24,129       19,197  
Consumer:
               
Home equity
    10,834       11,532  
Boat
    4,597       5,011  
Automobile
    795       913  
Other
    999       1,102  
Total loans
  $ 151,743     $ 147,766  

 
17

 
Impaired Loans.  Loans are deemed to be impaired when management determines that it is probable that all amounts due under the contractual terms of the loan agreements will not be collectible in accordance with the original loan agreement. All problem-graded loans are evaluated for impairment.  Impairment is measured by comparing the fair value of the collateral or discounted cash flows to the recorded investment in the loan.  Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.
 
Impaired loans are set forth in the following table as of June 30, 2012.
 
 (in thousands)
 
Unpaid
Contractual
Principal
Balance
   
Recorded
Investment
With No
Allowance
   
Recorded
Investment
With
Allowance
   
Total
Recorded
Investment
   
Related
Allowance
 
Real estate:
                             
Permanent:
                             
One- to four-family
  $ 223     $ 223     $ -     $ 223     $ -  
Multifamily
    -       -       -       -       -  
Commercial nonresidential
    7,404       4,714       2,455       7,169       473  
Land
    2,236       2,207       -       2,207       -  
Construction:
                                       
One- to four-family
    -       -       -       -       -  
Commercial nonresidential
    -       -       -       -       -  
Commercial business
    1,557       1,557       -       1,557       -  
Consumer:
                                       
Home equity
    60       60       -       60       -  
Boat
    -       -       -       -       -  
Automobile
    -       -       -       -       -  
Other
    -       -       -       -       -  
Total
  $ 11,480     $ 8,761     $ 2,455     $ 11,216     $ 473  
 
Impaired loans are set forth in the following table as of December 31, 2011.
 
 (in thousands)
 
Unpaid
Contractual
Principal
Balance
   
Recorded
Investment
With No
Allowance
   
Recorded
Investment
With
Allowance
   
Total
Recorded
Investment
   
Related
Allowance
 
Real estate:
                             
Permanent:
                             
One- to four-family
  $ -     $ -     $ -     $ -     $ -  
Multifamily
    659       659       -       659       -  
Commercial nonresidential
    7,479       4,877       2,518       7,395       473  
   Land
    2,237       2,224       -       2,224       -  
Construction:
                                       
 
One- to four-family
    -       -       -       -       -  
Commercial nonresidential
    -       -       -       -       -  
Commercial business
    1,626       1,626       -       1,626       -  
Consumer:
                                       
Home equity
    123       76       -       76       -  
Boat
    -       -       -       -       -  
Automobile
    -       -       -       -       -  
Other
    -       -       -       -       -  
Total
  $ 12,124     $ 9,462     $ 2,518     $ 11,980     $ 473  
 
 
18

 
 
The following table presents interest income recognized and average recorded investment of impaired loans for the period ended:
 
   
Three Months Ended
June 30, 2012
   
Three Months Ended
June 30, 2011
 
 (in thousands)
 
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
 
Real estate:
                       
Permanent:
                       
One- to four-family
  $ -     $ 223     $ -     $ -  
Multifamily
    -       328       11       334  
Commercial nonresidential
    66       10,858       154       8,512  
   Land
    17       3,319       34       2,021  
Construction:
                               
One- to four-family
    -       -       -       -  
Commercial nonresidential
    -       -       -       -  
Commercial business
    3       2,379       40       1,404  
Consumer:
                               
Home equity
    -       80       2       21  
Boat
    -       -       -       -  
Automobile
    -       -       -       -  
Other
    -       -       -       21  
Total
  $ 86     $ 17,187     $ 241     $ 12,313  

 
   
Six Months Ended
June 30, 2012
   
Six Months Ended
June 30, 2011
 
 (in thousands)
 
Interest
Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
   
Average
Recorded
Investment
 
Real estate:
                       
Permanent:
                       
One- to four-family
  $ -     $ 74     $ -     $ -  
Multifamily
    5       438       11       223  
Commercial nonresidential
    139       7,314       267       8,523  
   Land
    36       2,218       59       2,021  
Construction:
                               
One- to four-family
    -       -       -       -  
Commercial nonresidential
    -       -       -       -  
Commercial business
    11       1,609       45       1,163  
Consumer:
                               
Home equity
    1       59       2       14  
Boat
    -       -       -       -  
 
Automobile
    -       -       -       -  
Other
    -       -       1       28  
Total
  $ 192     $ 11,712     $ 385     $ 11,972  

 
 
19

 
Nonaccrual loans at June 30, 2012 and December 31, 2011, were as follows:
 
   
June 30,
   
December 31,
 
(in thousands)
 
2012
   
2011
 
Commercial business
  $ 1,447     $ 1,449  
Real Estate:
               
One- to four-family
    223          
Commercial nonresidential
    3,837       957  
Land
    186       202  
Consumer:
               
Home equity
    60       37  
   Total
  $ 5,753     $ 2,645  

 
Troubled Debt Restructurings.  Troubled debt restructured loans are loans for which the Company, for economic or legal reasons related to the borrower’s financial condition, has granted a significant concession to the borrower that it would otherwise not consider.  The Company accounts for troubled debt restructurings in accordance with ASU No. 2011-02.  Troubled debt restructurings of certain receivables identified are deemed impaired under the guidance of Section 310-10-35 of ASU No. 2011-02.  As of June 30, 2012 and December 31,
2011, the recorded investment in receivables that have been modified in a troubled debt restructuring and that are impaired was $9.3 million and $9.6 million, respectively.  Included in these amounts, the Company had $5.0 million and $9.6 million of troubled debt restructurings as of June 30, 2012 and December 31, 2011, respectively, which were performing in accordance with their modified loan terms.  The Company has not committed any additional amounts to lend to borrowers with loans considered to be troubled debt restructurings.

Modification Categories:  The Bank considers a variety of modifications to borrowers.  The types of modifications considered can generally be described in the following categories:
 
·  
Rate Modification: A modification in which the interest rate is changed.
 
·  
Term Modification:  A modification in which the maturity date, timing of payments, or frequency of payments is changed.
 
·  
Interest Only Modification:  A modification in which the loan is converted to interest only payments for a period of time.
 
·  
Payment Modification:  A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.
 
·  
Combination Modification:  Any other type of modification, including the use of multiple categories above.
 
 
20

 
The following tables present troubled debt restructurings by concession (terms modified) as of June 30, 2012:
 
(dollars in thousands)
 
Number of
Contracts
   
Accrual
Status
   
Non-
Accrual
Status
   
Total
Modifications
 
Real Estate:
                       
Commercial nonresidential
    11     $ 3,332     $ 3,837     $ 7,169  
Land
    3       400       186       586  
Commercial business
    3       130       1,427       1,557  
   Total
    17     $ 3,862     $ 5,450     $ 9,312  

The following table presents the accrual status of troubled debt restructurings as of December 31, 2011:
 
(dollars in thousands)
 
Number of
Contracts
   
Accrual
Status
   
Non-Accrual
Status
   
Total
Modifications
 
Real Estate:
                       
Commercial nonresidential
    11     $ 6,438     $ 957     $ 7,395  
Land
    3       400       202       602  
Commercial business
    4       177       1,427       1,604  
Consumer:
                               
Home equity
    1       40       -       40  
   Total
    19     $ 7,055     $ 2,586     $ 9,641  

There were no newly restructured loans that occurred during the three months ended June 30, 2012.
 
The following tables present newly restructured loans that occurred during the six months ended June 30, 2012:
 
(dollars in thousands)
 
Number of Contracts
   
Payment Modification
 
Real Estate:
           
Commercial nonresidential
    1     $ 537  

 
There was one commercial business loan for $1.4 million, three commercial non-residential loan for $2.7 million, and two land loans for $186,000 modified as troubled debt restructuring within the previous 12 months for which there was a payment default.
 
The Bank’s policy is that loans placed in nonaccrual may be restored to accrual status when delinquent principal and interest payments are brought current and future monthly principal and interest payments are expected to be collected.  In general, the Bank’s policy refers to six months of payment performance as sufficient to warrant a return to accrual status.
 
 
21

 
An age analysis of past due loans, segregated by class of loans, as of June 30, 2012 were as follows:
 
(in thousands)
Loans
30-59
Days
Past
Due
 
Loans
60-89
Days
Past
Due
 
Loans
90 or
More
Days
Past Due
 
Total
Past
Due
Loans
 
Current
Loans
 
Total
Loans
   
Accruing
Loans 90
or More
Days
Past Due
 
Real estate:
                             
Permanent:
                             
One- to four-family
$ -   $ -   $ 223   $ 223   $ 23,268   $ 23,491     $ -  
Multifamily
  -     -     -     -     2,711     2,711       -  
Commercial nonresidential
  -     2,100     630     2,730     68,736     71,466       <