XNAS:RVSB Riverview Bancorp, Inc. Annual Report 10-K Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K
 
[X] 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the Fiscal Year Ended March 31, 2012OR
 
[   ] 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-22957
 

 
RIVERVIEW BANCORP, INC.
 (Exact name of registrant as specified in its charter)
 

 
Washington    91-1838969 
(State or other jurisdiction of incorporation or organization)    (I.R.S. Employer I.D. Number) 
     
900 Washington St., Ste. 900, Vancouver, Washington    98660 
(Address of principal executive offices)    (Zip Code) 
     
Registrant's telephone number, including area code:    (360) 693-6650 
     
Securities registered pursuant to Section 12(b) of the Act:     
     
Common Stock, Par Value $.01 per share    Nasdaq Stock Market LLC 
(Title of Each Class)    (Name of Each Exchange on Which Registered) 
     
 Securities registered pursuant to Section 12(g) of the Act:   None 
                                                                                                            
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [   ]  No  [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [   ]  No  [X]

Indicate by check mark whether the registrant (1) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and disclosure will not be contained, to the best of the registrant's knowledge, in any definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K   [X]

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

The aggregate market value of the voting stock held by non-affiliates of the registrant, based on the closing sales price of the registrant's Common Stock as quoted on the Nasdaq Global Select Market System under the symbol "RVSB" on September 30, 2011 was $53,932,536 (22,471,890 shares at $2.40 per share).  As of May 31, 2012, there were issued and outstanding 22,471,890 shares of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrant's Definitive Proxy Statement for the 2012 Annual Meeting of Shareholders (Part III).
 

 
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2

 
 
 
Table of Contents
PART I
 
PAGE
     
Item 1.
Business
5
Item 1A.
Risk Factors
34
Item 1B.
Unresolved Staff Comments
45
Item 2.
Properties
45
Item 3.
Legal Proceedings
45
Item 4.
Mine Safety Disclosures
45
 
PART II
   
Item 5.
Market of Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
46
Item 6.
Selected Financial Data
48
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
50
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
68
Item 8.
Financial Statements and Supplementary Data
70
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
107
Item 9A.
Controls and Procedures
107
Item 9B.
Other Information
108
 
PART III
   
Item 10.
Directors, Executive Officers and Corporate Governance
108
Item 11.
Executive Compensation
109
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholders
109
Item 13.
Certain Relationships and Related Transactions, and Director Independence
109
Item 14.
Principal Accountant Fees and Services
109
 
PART IV
   
Item 15.
Exhibits and Financial Statement Schedules
110
Signatures
 
111
Index to Exhibits
112

 
 
3

 

Special Note Regarding Forward-Looking Statements

As used in this Form 10-K, the terms “we,” “our” and “Company” refer to Riverview Bancorp, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. When we refer to “Bank” in this Form 10-K, we are referring to Riverview Community Bank, a wholly-owned subsidiary of Riverview Bancorp, Inc.

“Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: When used in this Form 10-K 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.” or similar expression are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. 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 the Company’s 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 the Company’s market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, the Company’s 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 the Company’s market areas;  secondary market conditions for loans and the Company’s ability to sell loans in the secondary market; results of examinations of our bank subsidiary, Riverview Community Bank by the Office of the Comptroller of the Currency and of the Company by the Board of Governors of the Federal Reserve System, or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require the Company to increase its reserve for loan losses, write-down assets, change Riverview Community Bank’s regulatory capital position or affect the Company’s ability to borrow funds or maintain or increase deposits, which could adversely affect its  liquidity and earnings; the Company’s compliance with  regulatory enforcement actions entered into with its banking regulators and the possibility that noncompliance could result in the imposition of additional enforcement actions and additional requirements or restrictions on its operations; legislative or regulatory changes that adversely affect the Company’s business including changes in regulatory policies and principles, or  the interpretation of regulatory capital or other rules; the Company’s ability to attract and retain deposits; further increases in premiums for deposit insurance; the Company’s ability to control operating costs and expenses; the use of estimates in determining fair value of certain of the Company’s assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risks associated with the loans on the Company’s balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect the Company’s workforce and potential associated charges; computer systems on which the Company depends could fail or experience a security breach; the Company’s ability to retain key members of its senior management team; costs and effects of litigation, including settlements and judgments; the Company’s ability to implement its business strategies; the Company’s ability to successfully integrate any assets, liabilities, customers, systems, and management personnel it may acquire into its operations and the Company’s ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; 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; the Company’s ability to pay dividends on its common stock and interest or principal payments on its junior subordinated debentures; 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; other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services and the other risks described from time to time in our filings with the Securities and Exchange Commission.

The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for fiscal 2013 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating and stock price performance.
 
 
4

 
 
PART I

Item 1.  Business

General

Riverview Bancorp, Inc. (the “Company" or “Riverview”), a Washington corporation, is the savings and loan holding company of Riverview Community Bank (the “Bank”). At March 31, 2012, the Company had total assets of $856.0 million, total deposit accounts of $744.5 million and shareholders' equity of $75.6 million. The Company’s executive offices are located in Vancouver Washington. As used throughout this report, the terms “we,” “our,” “us,” “Riverview” or the “Company” refer to Riverview Bancorp, Inc. and the Bank, unless the context otherwise requires.

Substantially all of the Company’s business is conducted through the Bank which is regulated by the Office of the Comptroller of the Currency ("OCC"), its primary regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its deposits. The Bank's deposits are insured by the FDIC up to applicable legal limits under the Deposit Insurance Fund ("DIF").  The Bank has been a member of the Federal Home Loan Bank ("FHLB") of Seattle since 1937.

As a progressive, community-oriented financial services company, the Company emphasizes local, personal service to residents of its primary market area. The Company considers Clark, Cowlitz, Klickitat and Skamania counties of Washington and Multnomah and Marion counties of Oregon as its primary market area. The Counties of Multnomah, Clark and Skamania are part of the Portland metropolitan area as defined by the U.S. Census Bureau. The Company is engaged predominantly in the business of attracting deposits from the general public and using such funds in its primary market area to originate commercial business, commercial real estate, multi-family real estate, real estate construction, residential real estate and other consumer loans. Commercial business, commercial real estate and real estate construction loans have decreased to 80.0% of the loan portfolio at March 31, 2012 from 83.6% at March 31, 2011, decreasing the risk profile of the total loan portfolio. The Company’s strategy over the past several years has been to control balance sheet growth, including the targeted reduction of residential construction related loans, in order to improve its regulatory capital ratios. Speculative construction loans, consisting of unsold properties under construction, represented $10.8 million, or 87.5% of the residential construction portfolio at March 31, 2012, compared to $16.5 million a year ago, a decline of 34.7%. Total real estate construction loans at March 31, 2012 declined to $25.8 million or 5.8% from $27.4 million a year ago. Land acquisition and development loans were $38.9 million at March 31, 2012 compared to $55.3 million a year ago, which represents a decline of 29.6%. Most recently, the Company’s primary focus has been on increasing commercial business loans, owner occupied commercial real estate loans and high-quality one-to-four family mortgage loans.  One-to-four family loans increased $30.4 million to $100.6 million at March 31, 2012 from $70.2 million at March 31, 2011.

The Company’s strategic plan includes targeting the commercial banking customer base in its primary market area, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company manages growth while maintaining a significant amount of commercial and commercial real estate loans in its loan portfolio. Significant portions of these new loan originations carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate mortgages. A related goal is to increase the proportion of personal and business checking account deposits used to fund new loan production. At March 31, 2012, checking accounts totaled $223.8 million, or 30.1% of our total deposit mix compared to $179.8 million or 25.1% a year ago. The strategic plan also stresses increased emphasis on non-interest income, including increased fees for asset management and deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. The Company believes it is well positioned to attract new customers and to increase its market share with seventeen branches, including ten in Clark County, two in the Portland metropolitan area and three lending centers.

Market Area

The Company conducts operations from its home office in Vancouver and seventeen branch offices located in Camas, Washougal, Stevenson, White Salmon, Battle Ground, Goldendale, Vancouver (seven branch offices) and Longview, Washington and Portland, Wood Village and Aumsville, Oregon. Additionally, the Company recently announced plans to open a new branch in Gresham, Oregon expected to be open in June 2012. The Company operates a trust and financial services company, Riverview Asset Management Corp. (“RAMCorp”), located in downtown Vancouver, Washington.  Riverview Mortgage, a mortgage broker division of the Bank, originates mortgage loans for various mortgage companies predominantly in the Vancouver/Portland metropolitan areas, as well as for the Bank.  The Bank’s Business and Professional Banking Division, with one lending office in Vancouver and one lending office in Portland, Oregon offers commercial and business banking services. The Bank also operates a lending office for mortgage banking activities.
 
 
5

 

Vancouver is located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouver area because of the favorable tax structure and lower energy costs in Washington as compared to Oregon. Companies located in the Vancouver area include Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory, Wafer Tech, Nautilus, Barrett Business Services, PeaceHealth and Fisher Investments, as well as several support industries. In addition to this industry base, the Columbia River Gorge Scenic Area is a source of tourism, which has helped to transform the area from its past dependence on the timber industry.

Unemployment in Clark County increased while unemployment in Portland, Oregon decreased during the quarter ended March 31, 2012. According to the Washington State Employment Security Department, unemployment in Clark County increased to 10.9% in February 2012 compared to 9.3% at December 2011 but had decreased compared to 11.8% in September 2011 at 12.5% in June 2011 and 13.2% at March 2011. According to the Oregon Employment Department, unemployment in Portland decreased to 7.8% in March 2012 compared to 8.1% in December 2011, 8.5% in September 2011, 8.5% in June 2011 and 8.6% at March 2011. Home values at March 31, 2012 in the Company’s market area remained lower than home values in 2011, 2010 and 2009, due in large part to an increase in the volume of foreclosures and short sales. However, home values have begun to stabilize after decreasing sharply during the past fiscal years. According to the Regional Multiple Listing Services (RMLS), inventory levels in Portland, Oregon have fallen to 5.0 months as of March 2012, compared to 7.1 months in March 2011 and a peak of 7.2 months in April 2011. Inventory levels in Clark County have decreased to 6.4 months as of March 2012, compared to 8.3 months in March 2011 and a peak of 8.8 months in January 2012. Closed home sales in Clark County increased 5.6% in March 2012 compared to March 2011. Closed home sales in Portland increased 4.9% during the same time period. Commercial real estate leasing activity in the Portland/Vancouver area has performed better than the residential real estate market, but it is generally affected by a slow economy later than other indicators. According to Norris Beggs Simpson, commercial vacancy rates in Clark County and Portland Oregon were approximately 16.0% and 22.4%, respectively as of March 31, 2012.  The Company has seen an increase in sales activity for building lots in recent months.  Since the quarter ended December 2011, the Company has sold $5.3 million in building lots, including recent sales through May 2012.

Lending Activities

General.  At March 31, 2012, the Company's net loans receivable totaled $664.9 million, or 77.7% of total assets at that date. The principal lending activity of the Company is the origination of loans collateralized by commercial properties and commercial business loans. A substantial portion of the Company's loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area. The Company’s lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Bank’s Board of Directors (“Board”) and management. The customary sources of loan originations are realtors, walk-in customers, referrals and existing customers. The Bank also uses commissioned loan brokers and print advertising to market its products and services. Loans are approved at various levels of management, depending upon the amount of the loan.

 
6

 

Loan Portfolio Analysis.  The following table sets forth the composition of the Company's loan portfolio by type of loan at the dates indicated.

   
At March 31,
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in thousands)
 
Commercial and construction:
                                                           
Commercial business
  $ 87,238       12.74 %   $ 85,511       12.44 %   $ 108,368       14.76 %   $ 127,150       15.87 %   $ 109,585       14.28 %
Other real estate mortgage
    434,763       63.49       461,955       67.19       459,178       62.52       447,652       55.88       429,422       55.97  
Real estate construction
    25,791       3.76       27,385       3.98       75,456       10.27       139,476       17.41       148,631       19.37  
Total commercial and construction
    547,792       79.99       574,851       83.61       643,002       87.55       714,278       89.16       687,638       89.62  
                                                                                 
Consumer:
                                                                               
Real estate one-to-four family
    134,975       19.71       110,437       16.06       88,861       12.10       83,762       10.46       75,922       9.90  
Other installment
    2,042       0.30       2,289       0.33       2,616       0.35       3,051       0.38       3,665       0.48  
Total consumer loans
    137,017       20.01       112,726       16.39       91,477       12.45       86,813       10.84       79,587       10.38  
                                                                                 
Total loans
    684,809       100.00 %     687,577       100.00 %     734,479       100.00 %     801,091       100.00 %     767,225       100.00 %
                                                                                 
Less:
                                                                               
Allowance for loan losses
    19,921               14,968               21,642               16,974               10,687          
Total loans receivable, net
  $ 664,888             $ 672,609             $ 712,837             $ 784,117             $ 756,538          
 
 
7

 
 
Loan Portfolio Composition.  The following tables set forth the composition of the Company's commercial and construction loan portfolio based on loan purpose at the dates indicated.

   
 
 
Commercial
   
Other
Real Estate
Mortgage
   
Real Estate    
Construction
   
Commercial &
Construction
Total
    March 31, 2012
(In thousands)
                       
Commercial business
$
87,238
 
$
-
 
$
-
 
$
87,238
Commercial construction
 
-
   
-
   
13,496
   
13,496
Office buildings
 
-
   
94,541
   
-
   
94,541
Warehouse/industrial
 
-
   
48,605
   
-
   
48,605
Retail/shopping centers/strip malls
 
-
   
80,595
   
-
   
80,595
    Assisted living facilities
 
-
   
35,866
   
-
   
35,866
Single purpose facilities
 
-
   
93,473
   
-
   
93,473
Land
 
-
   
38,888
   
-
   
38,888
Multi-family
 
-
   
42,795
   
-
   
42,795
One-to-four family construction
 
-
   
-
   
12,295
   
12,295
Total
$
87,238
 
$
434,763
 
$
25,791
 
$
547,792

 
   
 
 
Commercial
   
Other
Real Estate
Mortgage
   
Real Estate    
Construction
   
Commercial &
Construction
Total
    March 31, 2011
(In thousands)
                       
Commercial business
$
85,511
 
$
-
 
$
-
 
$
85,511
Commercial construction
 
-
   
-
   
8,608
   
8,608
Office buildings
 
-
   
95,529
   
-
   
95,529
Warehouse/industrial
 
-
   
49,627
   
-
   
49,627
Retail/shopping centers/strip malls
 
-
   
85,719
   
-
   
85,719
    Assisted living facilities
 
-
   
35,162
   
-
   
35,162
Single purpose facilities
 
-
   
98,651
   
-
   
98,651
Land
 
-
   
55,258
   
-
   
55,258
Multi-family
 
-
   
42,009
   
-
   
42,009
One-to-four family construction
 
-
   
-
   
18,777
   
18,777
Total
$
85,511
 
$
461,955
 
$
27,385
 
$
574,851

Commercial Business Lending. At March 31, 2012, the commercial business loan portfolio totaled $87.2 million or 12.74% of total loans. Commercial business loans are typically secured by business equipment, accounts receivable, inventory or other property. The Company’s commercial business loans may be structured as term loans or as lines of credit. Commercial term loans are generally made to finance the purchase of assets and usually have maturities of five years or less. Commercial lines of credit are typically made for the purpose of providing working capital and usually have a term of one year or less. Lines of credit are made at variable rates of interest equal to a negotiated margin above an index rate and term loans are at either a variable or fixed rate. The Company also generally obtains personal guarantees from financially capable parties based on a review of personal financial statements.

Commercial lending involves risks that are different from those associated with residential and commercial real estate lending. Commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things.  Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower.

Other Real Estate Mortgage Lending.  At March 31, 2012, the other real estate lending portfolio totaled $434.8 million, or 63.49% of total loans. The Company originates other real estate loans including office buildings, warehouse/industrial, retail, assisted living facilities and single-purpose facilities (collectively “commercial real estate loans”); as well as land and multi-family loans primarily located in its market area. As a result of the contraction in the real estate market, the Company has ceased the origination of new land acquisition and development loans. At March 31, 2012, owner occupied properties accounted for 29% and non-owner occupied properties accounted for 71% of the Company’s commercial real estate portfolio.

 
 
8

 
Commercial real estate loans typically have higher loan balances, are more difficult to evaluate and monitor, and involve a higher degree of risk than one-to-four family residential loans. As a result, commercial real estate, including multi-family, loans are generally priced at a higher rate of interest than residential one-to-four family loans. Often payments on loans secured by commercial properties are dependent on the successful operation and management of the property securing the loan or business conducted on the property securing the loan; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. The Company seeks to minimize these risks by generally limiting the maximum loan-to-value ratio to 80% and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Loans are secured by first mortgages and often require specified debt service coverage (“DSC”) ratios depending on the characteristics of the collateral. The Company generally imposes a minimum DSC ratio of 1.20 for loans secured by income producing properties. Rates and other terms on such loans generally depend on our assessment of credit risk after considering such factors as the borrower’s financial condition and credit history, loan-to-value ratio, DSC ratio and other factors.

The Company actively pursues commercial real estate loans; however, new loan originations were lower in fiscal year 2012 reflecting the weak economic conditions resulting in a decrease in loan demand from creditworthy borrowers. At March 31, 2012, the Company had nine commercial real estate loans totaling $14.0 million on non-accrual status compared to four commercial real estate loans totaling $1.4 million at March 31, 2011. For more information concerning risks related to commercial real estate loans, see Item 1A. “Risk Factors – Our emphasis on commercial real estate lending may expose us to increased lending risks.”

Land acquisition and development loans are included in the other real estate mortgage portfolio balance, and represent loans made to developers for the purpose of acquiring raw land and/or for the subsequent development and sale of residential lots. Such loans typically finance land purchases and infrastructure development of properties (i.e. roads, utilities, etc.) with the aim of making improved lots ready for subsequent sales to consumers or builders for ultimate construction of residential units. The primary source of repayment is generally the cash flow from developer sale of lots or improved parcels of land, secondary sources and personal guarantees, which may provide an additional measure of security for such loans. Strong demand for housing led to loan growth in this category in previous years. However, the downturn in the real estate market since 2008 has slowed lot and home sales within the Company’s target areas affecting certain developers by lengthening the marketing period of their projects and negatively affecting borrower’s liquidity and collateral values. In recent months, however, statistics reflect an increase in demand and sales of building lots in the Company’s primary market area resulting in an increase in the number of closed sales for land and building lots. In the six month period ended March 31, 2012, the Company has sold a total of $5.6 million in land and lot REO properties, which includes seven subdivision properties.  Additionally, the Company sold $2.4 million in REO land development properties and was paid off on a $4.7 million land development loan subsequent to year-end. The Company has focused on reducing these loans during the past two fiscal years and plans to continue to reduce these portfolios. At March 31, 2012, land acquisition and development loans totaled $38.9 million, or 5.68% of total loans compared to $55.3 million, or 8.04% of total loans at March 31, 2011. The largest land acquisition and development loan had an outstanding balance at March 31, 2012 of $4.7 million and was on non-accrual status. With the exception of this one loan totaling $4.7 million, which was paid off in May 2012, all of the land acquisition and development loans were secured by properties located in Washington and Oregon. At March 31, 2012, the Company had nine land acquisition and development loans totaling $13.0 million on non-accrual status compared to four land acquisition and development loans totaling $2.9 million on non-accrual status at March 31, 2011.

Real Estate Construction.  The Company originates three types of residential construction loans: (i) speculative construction loans, (ii) custom/presold construction loans and (iii) construction/permanent loans. The Company also originates construction loans for the development of business properties and multi-family dwellings. All of the Company’s real estate construction loans were made on properties located in Washington and Oregon.
 
 
9

 

The composition of the Company’s construction loan portfolio including undisbursed funds was as follows:
 
 
At March 31,
 
2012
   
2011
 
Amount (1)
   
Percent
   
Amount (1)
   
Percent
 
(Dollars in thousands)
Speculative construction
$ 11,460       34.87 %   $ 17,322       40.19
Commercial/multi-family construction
  19,096       58.11       19,684       45.67  
Custom/presold construction
  202       0.61       2,609       6.05  
Construction/permanent
  2,106       6.41       3,489       8.09  
Total
$ 32,864       100.00 %   $ 43,104       100.00 %

(1) Includes undisbursed funds of $7.1 million and $15.8 million at March 31, 2012 and 2011, respectively.

The Company has remained diligent in managing its construction loan portfolio and has continued to be successful at reducing its overall exposure to residential construction and commercial construction loans. At March 31, 2012, the balance of the Company’s construction loan portfolio, including loan commitments, was $32.9 million compared to $43.1 million at March 31, 2011. The $10.2 million reduction was a result of loan repayments and charge-offs reflecting the Company’s efforts to reduce its exposure to these types of loans. The Company plans to continue its focus on aggressively managing its construction loan portfolio in fiscal year 2013. Additionally, the Company has significantly slowed the origination of new construction loans. In general, the Company is only originating new construction loans to facilitate the sale of existing loans or real estate owned (“REO”) properties; or on a very limited basis to selected borrowers.

Speculative construction loans are made to home builders and are termed “speculative” because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing with either the Company or another lender for the finished home. The home buyer may be identified either during or after the construction period, with the risk that the builder will have to debt service the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until a home buyer is identified. Included in speculative construction loans are loans to finance the construction of townhouses and condominiums. At March 31, 2012, loans for the construction of townhouses and condominiums totaled $1.3 million and $6.2 million, respectively. At March 31, 2012, the Company had two borrowers with aggregate outstanding loan balances of more than $1.0 million, which totaled $6.2 million (the largest of which was $5.0 million and was on non-accrual status) and were secured by properties located in the Company’s market area. At March 31, 2012, six speculative construction loans totaling $7.8 million were on non-accrual status.

The composition of speculative construction and land acquisition and development loans by geographical area is as follows:
 
   
Northwest
Oregon
   
Other
Oregon
   
Southwest
Washington
   
Other
Washington
   
Other
   
Total
March 31, 2012
           
  (In thousands)
               
                                   
Land development
$
6,044
 
$
3,672
 
$
24,472
 
$
-
 
$
4,700
 
$
38,888
Speculative construction
 
1,246
   
6,117
   
3,006
   
392
   
-
   
10,761
Total land and spec construction
$
7,290
 
$
9,789
 
$
27,478
 
$
392
 
$
4,700
 
$
49,649

Unlike speculative construction loans, presold construction loans are made for homes that have buyers. Presold construction loans are made to homebuilders who, at the time of construction, have a signed contract with a home buyer who has a commitment for permanent financing for the finished home from the Company or another lender. Custom construction loans are made to the homeowner. Custom/presold construction loans are generally originated for a term of 12 months. At March 31, 2012, the Company had no custom construction loans in its portfolio. At March 31, 2012 the Company had one presold construction loan with an outstanding balance of $87,000 that was performing according to the original repayment terms.

Construction/permanent loans are originated to the homeowner rather than the homebuilder along with a commitment by the Company to originate a permanent loan to the homeowner to repay the construction loan at the completion of construction. The construction phase of a construction/permanent loan generally lasts six to nine months. At the completion of construction, the Company may either originate a fixed rate mortgage loan or an adjustable rate mortgage (“ARM”) loan or use its mortgage brokerage capabilities to obtain permanent financing for the customer with another lender. At completion of construction, the interest rate of the Company-originated fixed rate permanent loan is set at a market rate. For adjustable rate loans, the interest rates adjust on their first adjustment date.  See “—Mortgage Brokerage,” and “—Mortgage Loan Servicing.” At March 31, 2012, the largest outstanding construction/permanent loan had an outstanding balance of $1.1
 
 
10

 
 
million and was performing according to its original repayment terms. At March 31, 2012, the Company had no construction/permanent loans on non-accrual status.

The Company provides construction financing for non-residential business properties and multi-family dwellings. At March 31, 2012, such loans totaled $13.5 million, or 52.3% of total real estate construction loans and 2.0% of total loans. Borrowers may be the business owner/occupier of the building who intend to operate their business from the property upon construction, or non-owner developers. The expected source of repayment of these loans is typically the sale or refinancing of the project upon completion of the construction phase. In certain circumstances, the Company may provide or commit to take-out financing upon construction. Take-out financing is subject to the project meeting specific underwriting guidelines. No assurance can be given that such take-out financing will be available upon project completion. These loans are secured by office buildings, retail rental space, mini storage facilities, assisted living facilities and multi-family dwellings located in the Company’s market area. At March 31, 2012, the largest commercial construction loan had a balance of $4.5 million and was performing according to its original repayment terms. At March 31, 2012, the Company had no commercial construction loan on non-accrual status.

Construction lending affords the Company the opportunity to achieve higher interest rates and fees with shorter terms to maturity than the rates and fees generated by its single-family permanent mortgage lending. Construction lending, however, generally involves a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost of the project, as well as the time needed to sell the property at completion. The nature of these loans is such that they are generally more difficult to evaluate and monitor. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. This type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest. If the appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. For additional information concerning the risks related to construction lending, see Item 1A. “Risk Factors – Our real estate construction and land acquisition and development loans are based upon estimates of costs and the value of the completed project.”

The Company has originated construction and land acquisition and development loans where a component of the cost of the project was the interest required to service the debt during the construction period of the loan, sometimes known as interest reserves. The Company allows disbursements of this interest component as long as the project is progressing as originally projected and if there has been no deterioration in the financial standing of the borrower or the underlying project. If the Company makes a determination that there is such deterioration, or if the loan becomes nonperforming, the Company halts any disbursement of those funds identified for use in paying interest. In some cases, additional interest reserves may be taken by use of deposited funds or through credit lines secured by separate and additional collateral.

Consumer Lending. Consumer loans totaled $137.0 million at March 31, 2012, comprised of $100.6 million of one-to-four family mortgage loans, $28.9 million of home equity lines of credit, $5.5 million of land loans to consumers for the future construction of one-to-four family homes and other secured and unsecured consumer loans, totaling $2.0 million at March 31, 2012.

One-to-four family residences located in the Company’s primary market area secure the majority of the residential loans. Underwriting standards require that one-to-four family portfolio loans generally be owner occupied and that loan amounts not exceed 80% (95% with private mortgage insurance) of the lesser of current appraised value or cost of the underlying collateral. Terms typically range from 15 to 30 years. The Company also offers balloon mortgage loans with terms of either five or seven years and originates both fixed rate mortgages and ARMs with repricing based on the one-year constant maturity U.S. Treasury index or other index.  At March 31, 2012, the Company had sixteen residential real estate loans totaling $3.9 million on non-accrual status compared to seven loans totaling $975,000 at March 31, 2011. All of these loans were located in Oregon and Washington.

The Company made an effort to increase its one-to-four family loan portfolio with a focus on increasing certain high-quality mortgages. The Company began a mortgage program in April 2010 that offers competitive loan pricing for borrowers that meet our new increased underwriting standards for loan-to-value, credit scores, debt to income ratios and job history. The Company has $46.9 million in mortgage loans that were originated through this program. At March 31, 2012, the weighted
 
 
11

 
 
average loan-to-value for these loans was 61.65%, the weighted average credit score was 786 and the weighted average debt to income ratio was 28.42%.

The Company originates a variety of installment loans, including loans for debt consolidation and other purposes, automobile loans, boat loans and savings account loans. Consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as mobile homes, automobiles, boats and recreational vehicles. At March 31, 2012, the Company had no installment loans on non-accrual status.

Loan Maturity. The following table sets forth certain information at March 31, 2012 regarding the dollar amount of loans maturing in the Company’s portfolio based on their contractual terms to maturity, but does not include potential prepayments.  Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less.  Loan balances are reported net of deferred fees.
 
   
Within 1
Year
   
1 – 3 Years
   
After 3 – 5
Years
   
After 5 – 10
Years
   
Beyond 10
Years
   
Total
Commercial and construction:
 
(In thousands)
   Commercial business
$
37,709
 
$
19,056
 
$
14,365
 
$
13,895
 
$
2,213
 
$
87,238
   Other real estate mortgage
 
61,962
   
87,966
   
49,718
   
228,592
   
6,525
   
434,763
   Real estate construction
 
22,176
   
1,971
   
-
   
408
   
1,236
   
25,791
 Total commercial & construction
 
121,847
   
108,993
   
64,083
   
242,895
   
9,974
   
547,792
Consumer:
                                 
   Real estate one-to-four family
 
3,083
   
6,117
   
3,616
   
11,634
   
110,525
   
134,975
   Other installment
 
209
   
444
   
470
   
883
   
36
   
2,042
Total consumer
 
3,292
   
6,561
   
4,086
   
12,517
   
110,561
   
137,017
Total loans
$
125,139
 
$
115,554
 
$
68,169
 
$
255,412
 
$
120,535
 
$
684,809

The following table sets forth the dollar amount of all loans due after one year from March 31, 2012, which have fixed interest rates and have adjustable interest rates.

   
Fixed
Rate
   
Adjustable
Rate
   
Total
 
   
(In thousands)
 
Commercial and Construction:
                 
   Commercial business
$
33,347
 
$
16,182
 
$
49,529
 
   Other real estate mortgage
 
85,770
   
287,031
   
372,801
 
   Real estate construction
 
409
   
3,206
   
3,615
 
      Total commercial and construction
 
119,526
   
306,419
   
425,945
 
Consumer:
                 
   Real estate one-to-four family
 
92,457
   
39,435
   
131,892
 
   Other installment
 
1,243
   
590
   
1,833
 
      Total consumer
 
93,700
   
40,025
   
133,725
 
Total loans
$
213,226
 
$
346,444
 
$
559,670
 

Loan Commitments. The Company issues commitments to originate commercial loans, other real estate mortgage loans, construction loans, residential mortgage loans and other installment loans conditioned upon the occurrence of certain events. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to originate loans are conditional, and are honored for up to 45 days subject to the Company’s usual terms and conditions. Collateral is not required to support commitments. At March 31, 2012, the Company had outstanding commitments to originate loans of $22.5 million, compared to $8.1 million at March 31, 2011.

Mortgage Brokerage. In addition to originating mortgage loans for retention in its portfolio, the Company employs three commissioned brokers who originate mortgage loans (including construction loans) for various mortgage companies, as well as for the Company. The loans brokered to mortgage companies are closed in the name of, and funded by the purchasing mortgage company and are not originated as an asset of the Company. In return, the Company receives a fee ranging from 1.5% to 2.0% of the loan amount that it shares with the commissioned broker. Loans brokered to the Company are closed on the Company's books and the commissioned broker receives a fee of approximately 0.62% of the loan amount. During the year ended March 31, 2012, brokered loans totaled $34.5 million (including $28.9 million brokered to the Company), compared to $41.5 million of brokered loans in fiscal year 2011. Gross fees of $318,000 (excluding the portion paid to the commissioned brokers) were earned for the year ended March 31, 2012. The interest rate environment has a strong influence
 
 
12

 
 
on the loan volume and amount of fees generated from the mortgage broker activity. In general, during periods of rising interest rates the volume of loans and the amount of loan fees generally decrease as a result of slower mortgage loan demand. Conversely, during periods of falling interest rates, the volume of loans and the amount of loan fees generally increase as a result of the increased mortgage loan demand.

Mortgage Loan Servicing.  The Company is a qualified servicer for the Federal Home Loan Mortgage Corporation (“FHLMC”).  The Company generally sells fixed-rate residential one-to-four mortgage loans that it originates with maturities of 15 years or more and balloon mortgages to the FHLMC as part of its asset liability strategy.  Mortgage loans are sold to FHLMC on a non-recourse basis whereby foreclosure losses are generally the responsibility of FHLMC and not the Company.  The Company's general policy is to close its residential loans on the FHLMC modified loan documents to facilitate future sales to FHLMC.  Upon sale, the Company continues to collect payments on the loans, to supervise foreclosure proceedings, and to otherwise service the loans. At March 31, 2012, total loans serviced for others were $108.8 million, of which $90.7 million were serviced for FHLMC.

Nonperforming Assets.  Loans are reviewed regularly and it is the Company’s general policy that when a loan is 90 days delinquent or when collection of principal or interest appears doubtful, it is placed on non-accrual status, at which time the accrual of interest ceases and a reserve for any unrecoverable accrued interest is established and charged against operations. Payments received on non-accrual loans are applied to reduce the outstanding principal balance on a cash-basis method.

Nonperforming assets were $62.9 million or 7.35% of total assets at March 31, 2012 compared with $39.9 million or 4.65% of total assets at March 31, 2011. The Company also had net charge-offs totaling $24.4 million during fiscal 2012 compared to $11.7 million during fiscal 2011. Credit quality challenges continue to be centered in residential land acquisition and development loans and speculative construction loans. The continuing weak real estate market in our primary market area resulted in slower sales and excess housing inventory and has continued to be the primary cause of the elevated levels of delinquencies and foreclosures for such loans. While the Company has not engaged in any sub-prime lending programs, the effect on home values, housing markets and construction lending from problems associated with sub-prime and other non-traditional mortgage lending programs has also contributed to the increased levels of builder and developer delinquencies during recent periods. Although it appears the economic conditions have stabilized, a prolonged weak economy in our market area could result in additional increases in nonperforming assets, further increases in the provision for loan losses and charge-offs in the future.

As noted above, the problem loans identified by the Company have continued to remain concentrated in speculative construction loans and land acquisition and development loans. During the current fiscal year, management continued its focus on managing these portfolios in an attempt to minimize the effects of declining home values and slower home sales. At March 31, 2012, the Company’s residential construction and land acquisition and development loan portfolios were $12.3 million and $38.9 million, respectively as compared to $18.8 million and $55.3 million at March 31, 2011. The percentage of nonperforming loans in the residential construction and land acquisition and development portfolios was 63.08% and 33.39%, respectively as compared to 22.40% and 5.26%, respectively, a year ago. For the year ended March 31, 2012, the charge-off ratio for the residential construction and land development portfolios was 13.51% and 22.92%, respectively.

Nonperforming loans were $44.2 million or 6.45% of total loans at March 31, 2012 compared with $12.3 million or 1.79% of total loans at March 31, 2011. Nonperforming loans increased due primarily to continued strains on borrowers as a result of the continued weak economic conditions in the Company’s primary market area. At March 31, 2012, nonperforming loans consisted of 59 loans to 48 borrowers ranging in size from $10,000 to $6.8 million. As noted above, land acquisition and development loans and speculative construction loans continue to represent the largest portion of our nonperforming loans, totaling $20.7 million, or 46.97%, of the total nonperforming loan balance at March 31, 2012. However, commercial real estate loans also increased to $14.0 million due primarily to a $6.8 million loan placed on non-accrual status in the fourth quarter. The remaining balance includes 16 commercial loans to 15 borrowers totaling $3.9 million, three multi-family loans to three borrowers totaling $1.6 million and 16 residential real estate loans to 14 borrowers totaling $3.9 million. All of these loans are to borrowers located in Oregon and Washington with the exception of one land acquisition and development loan totaling $4.7 million, which was sold in May 2012, to an Oregon borrower who has property located in Southern California and one commercial real estate loan totaling $2.3 million to a California borrower who has property in Southern California. At March 31, 2012, 41 of the Company’s nonperforming loans, totaling $42.4 million or 96.07% of total nonperforming loans, were measured for impairment. These loans have been charged down to their estimated fair market value less selling costs.  The reserve associated with these impaired loans totaled $915,000 at March 31, 2012.

At March 31, 2012, the largest single nonperforming loan was a commercial real estate loan totaling $6.8 million. Net charge-offs for this property totaled $411,000 for fiscal year 2012. This loan was measured for impairment and had a specific
 
 
13

 
reserve of $271,000 that is included in the allowance for loan losses.  The Company believes that it is adequately reserved for this loan.

The balance of nonperforming assets included $18.7 million in REO at March 31, 2012. The REO was comprised of single-family homes totaling $1.1 million, residential building lots totaling $4.9 million, commercial real estate property totaling $7.1 million and land development property totaling $5.6 million.  All of the REO properties are located in Oregon and Washington. As a result of the declining real estate values, the Company had $4.2 million in write-downs on existing REO properties during fiscal year 2012. Total REO sales were $11.7 million during fiscal year 2012. Maintenance and operating expenses for these properties totaled $859,000 during fiscal year 2012. The orderly resolution of nonperforming loans and REO properties remains a priority for management. Because of the uncertain real estate market, no assurance can be given as to the timing of ultimate disposition of such assets or that the selling price will be at or above the carrying value. Continued declines in market values in our area could lead to additional valuation adjustments, which would have an adverse effect on our results of operations.

The following table sets forth information regarding the Company’s nonperforming assets.

   
At March 31,
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
(In thousands)
 
Loans accounted for on a non-accrual basis:
                             
Commercial business
  $ 3,930     $ 2,871     $ 6,430     $ 6,018     $ 1,164  
Other real estate mortgage
    28,562       4,289       15,079       7,316       3,892  
Real estate construction
    7,756       4,206       11,826       12,720       2,124  
Consumer
    3,915       957       2,676       1,329       382  
Total
    44,163       12,323       36,011       27,383       7,562  
Accruing loans which are contractually
past due 90 days or more
    -       -       -       187       115  
Total nonperforming loans
    44,163       12,323       36,011       27,570       7,677  
REO
    18,731       27,590       13,325       14,171       494  
Total nonperforming assets
  $ 62,894     $ 39,913     $ 49,336     $ 41,741     $ 8,171  

The following table sets forth information regarding the Company’s nonperforming assets by loan type and geographical area.
 
 
 
Northwest
Oregon
   
Other
Oregon
   
Southwest
Washington
   
Other
Washington
   
Other
   
Total
    March 31, 2012
(In thousands)
                                   
Commercial business
$
194
 
$
746
 
$
2,990
 
$
-
 
$
-
 
$
3,930
Commercial real estate
 
1,867
   
-
   
9,735
   
-
   
2,348
   
13,950
Multi Family
 
627
   
1,000
   
-
   
-
   
-
   
1,627
Land
 
-
   
1,902
   
6,383
   
-
   
4,700
   
12,985
Commercial construction
 
-
   
-
   
-
   
-
   
-
   
-
    One-to-four family construction
 
1,246
   
6,117
   
393
   
-
   
-
   
7,756
Real estate one-to-four family
 
678
   
189
   
3,048
   
-
   
-
   
3,915
    Total nonperforming loans
 
4,612
   
9,954
   
22,549
   
-
   
7,048
   
44,163
REO
 
2,477
   
5,863
   
6,825
   
3,566
   
-
   
18,731
Total nonperforming assets
$
7,089
 
$
15,817
 
$
29,374
 
$
3,566
 
$
7,048
 
$
62,894

In addition to the nonperforming assets set forth in the table above, at March 31, 2012 and 2011, the Company had other loans of concern totaling $41.9 million and $24.2 million, respectively. Other loans of concern at March 31, 2012 consisted of 61 loans to 43 borrowers. Included in other loans of concern at March 31, 2012 are 32 commercial loans totaling $9.5 million (the largest of which was $1.9 million), 16 commercial real estate loans totaling $21.2 million (the largest of which was $4.3 million), five multifamily loans totaling $6.6 million and eight land acquisition and development loans totaling $4.6 million. Other loans of concern consist of loans where the borrowers have cash flow problems, or the collateral securing the respective loans may be inadequate. In either or both of these situations, the borrowers may be unable to comply with the present loan repayment terms, and the loans may subsequently be included in the non-accrual category. Management considers the allowance for loan losses to be adequate to cover the probable losses inherent in these and other loans.

At March 31, 2012, loans delinquent 30 to 89 days were 1.29% of total loans compared to 1.13% at March 31, 2011. At March 31, 2012, the 30 to 89 day delinquency rate in our commercial business loan portfolio was 0.61%. The 30 to 89 day delinquency rate in our commercial real estate (“CRE”) portfolio was 1.62%. CRE loans represent the largest portion of our loan portfolio at 51.56% of total loans and the commercial business loans represent 12.74% of total loans.
 
 
14

 

Trouble debt restructurings (“TDR”) are loans where the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk.

TDRs are considered impaired loans and as such, when a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows using the original note rate, except when the loan is collateral dependent. In these cases, the estimated fair value of the collateral and when applicable, less selling costs, are used.  Impairment is recognized as a specific component within the allowance for loan losses if the value of the impaired loan is less than the recorded investment in the loan.  When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. At March 31, 2012 the Company had TDRs totaling $16.1 million of which $13.6 million were on accrual status. However, all of the Company’s TDRs are paying as agreed and none of the Company’s TDRs have defaulted since they were modified. The related amount of interest income recognized on these TDRs was $758,000 for the year ended March 31, 2012.

The Company has determined that, in certain circumstances, it is appropriate to split a loan into multiple notes. This typically includes a non-performing charged-off loan that is not supported by the cash flow of the relationship and a performing loan that is supported by the cash flow. These may also be split into multiple notes to align portions of the loan balance with the various sources of repayment when more than one exists. Generally the new loans are restructured based on customary underwriting standards. In situations where they were not, the policy exception qualifies as a concession, and the borrower is experiencing financial difficulties, the loans are accounted for as TDRs.

The Company’s general policy related to TDRs is to perform a credit evaluation of the borrower’s financial condition and prospects for repayment under the revised terms. This evaluation includes consideration of the borrower’s sustained historical repayment performance for a reasonable period of time. A sustained period of repayment performance generally would be a minimum of six months, and may include repayments made prior to the restructuring date. If repayment of principal and interest appears doubtful, it is placed on non-accrual status.

In accordance with the Company’s policy guidelines, unsecured loans are generally charged-off when no payments have been received for three consecutive months unless an alternative action plan is in effect. Consumer installment loans delinquent six months or more that have not received at least 75% of their required monthly payment in the last 90 days are charged-off. In addition, loans discharged in bankruptcy proceedings are charged-off. Loans under bankruptcy protection with no payments received for four consecutive months will be charged-off. The outstanding balance of a secured loan that is in excess of the net realizable value is generally charged-off if no payments are received for four to five consecutive months. However, charge-offs are postponed if alternative proposals to restructure, obtain additional guarantors, obtain additional assets as collateral or a potential sale would result in full repayment of the outstanding loan balance. Once any of these or other repayment potentials are considered exhausted the impaired portion of the loan is charged-off, unless an updated valuation of the collateral reveals no impairment. Regardless of whether a loan is unsecured or collateralized, once an amount is determined to be a confirmed loan loss it is promptly charged off.

Asset Classification. The OCC has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OCC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets:  substandard, doubtful and loss (collectively “classified loans”). Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.

When the Company classifies problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically or we may allow the loss to be addressed in the general allowance. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets.
 
 
15

 
When a problem asset is classified by us as a loss, we are required to charge off the asset in the period in which it is deemed uncollectible.

The aggregate amount of the Company's classified loans, general loss allowances, specific loss allowances and charge-offs were as follows at the dates indicated:
   
At or For the Year
 
   
Ended March 31,
 
   
2012
   
2011
 
   
(In thousands)
 
Classified loans
  $ 86,029     $ 36,389  
                 
General loss allowances
    18,319       12,923  
Specific loss allowances
    1,602       2,045  
Net charge-offs
    24,397       11,749  

All of the loans on non-accrual status as of March 31, 2012 were categorized as classified loans. Classified loans at March 31, 2012 were made up of six real estate construction loans totaling $7.8 million (the largest of which was $5.0 million), 48 commercial business loans totaling $13.5 million (the largest of these loans totaling $1.9 million), 17 land acquisition and development loans totaling $17.6 million (the largest of which was $4.7 million), 16 one-to-four family real estate loans totaling $3.9 million, eight multi-family loans totaling $8.2 million (the largest of which was $3.1 million) and 25 commercial real estate loans totaling $35.0 million (the largest of which was $6.8 million).

Allowance for Loan Losses. The Company maintains an allowance for loan losses to provide for probable losses inherent in the loan portfolio. The adequacy of the allowance is evaluated monthly to maintain the allowance at levels sufficient to provide for inherent losses existing at the balance sheet date. The key components to the evaluation are the Company’s internal loan review function by its credit administration, which reviews and monitors the risk and quality of the loan portfolio; as well as the Company’s external loan reviews and its loan classification systems. Credit officers are expected to monitor their portfolios and make recommendations to change loan grades whenever changes are warranted. Credit administration approves any changes to loan grades and monitors loan grades. For additional discussion of the Company’s methodology for assessing the appropriate level of the allowance for loan losses see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."

At March 31, 2012, the Company had an allowance for loan losses of $19.9 million, or 2.91% of total loans. The increase in the balance of the allowance for loan losses at March 31, 2012 reflects the increased levels of delinquent and classified loans, increased charge-offs as well as declines in real estate values. Nonperforming loans increased $31.8 million and 30-89 day delinquent loans increased $1.1 million during the year ended March 31, 2012. Classified assets were $86.0 million at March 31, 2012 compared to $36.4 million at March 31, 2011. The increase in nonperforming and classified loans can be attributable to the current economic conditions affecting these borrowers’ repayment ability.

The coverage ratio of allowance for loan losses to nonperforming loans was 45.11% at March 31, 2012 compared to 121.46% at March 31, 2011. This coverage ratio decreased from March 31, 2011 primarily as a result of the increase in nonperforming loans. At March 31, 2012, 40 of the Company’s nonperforming loans, totaling $42.4 million or 96.07% of total nonperforming loans, were measured for impairment, with all of these loans being considered collateral dependent. The additional reserves associated with these impaired loans totaled $915,000 at March 31, 2012. As a result of adopting OCC regulatory guidance in connection with the change in our primary bank regulator from the OTS to the OCC, specific valuation allowance which had been recorded for impaired loans were charged-off. As a result of the charge-offs on these impaired loans the Company’s total allowance for loan losses did not increase proportionately to the increase in nonperforming and classified loans. However, the Company’s general valuation allowance to non-impaired loans increased from 1.96% at March 31, 2011 to 2.96% at March 31, 2012 reflecting the increase in nonperforming and classified loan balances.

Management considers the allowance for loan losses to be adequate to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio and the Company believes it has established its existing allowance for loan losses in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles” or "GAAP"). However, a further decline in local economic conditions, results of examinations by the Company’s regulators, or other factors could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses will be adequate or that substantial increases will not be necessary should the quality of any loans
 
 
16

 
deteriorate or should collateral values further decline as a result of the factors discussed elsewhere in this document. The following table sets forth an analysis of the Company's allowance for loan losses for the periods indicated.

   
Year Ended March 31,
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
   
(Dollars in thousands)
 
Balance at beginning of year
  $ 14,968     $ 21,642     $ 16,974     $ 10,687     $ 8,653  
Provision for loan losses
    29,350       5,075       15,900       16,150       2,900  
Recoveries:
                                       
Commercial and construction
                                       
Commercial business
    29       7       5       25       10  
Other real estate mortgage
    103       31       1       -       12  
Real estate construction
    3       7       76       -       -  
Total commercial and construction
    135       45       82       25       22  
Consumer
                                       
 Real estate one-to-four family
    12       11       7       -       -  
 Other installment
    3       2       -       2       17  
Total consumer
    15       13       7       2       17  
                                         
Total recoveries
    150       58       89       27       39  
                                         
Charge-offs:
                                       
Commercial and construction
                                       
Commercial business
    2,801       2,371       2,466       1,311       794  
Other real estate mortgage
    16,895       4,404       3,836       5,913       42  
Real estate construction
    2,101       4,329       3,737       2,073       -  
Total commercial and construction
    21,797       11,104       10,039       9,297       836  
    Consumer
                                       
 Real estate one-to-four family
    2,694       682       1,232       361       48  
 Other installment
    56       21       50       232       21  
Total consumer
    2,750       703       1,282       593       69  
                                         
Total charge-offs
    24,547       11,807       11,321       9,890       905  
                                         
Net charge-offs (recoveries)
    24,397       11,749       11,232       9,863       866  
                                         
Balance at end of year
  $ 19,921     $ 14,968     $ 21,642     $ 16,974     $ 10,687  
                                         
Ratio of allowance to total loans
outstanding at end of year
    2.91 %     2.18 %     2.95 %     2.12 %     1.39 %
Ratio of net charge-offs to average net loans outstanding during year
    3.51       1.67       1.48       1.24       0.12  
Ratio of allowance to total nonperforming loans
    45.11       121.46       60.10       61.57       139.21  

The Company’s allowance consists of specific, general and unallocated components. The Company’s specific allowance decreased from prior year due to an increase in charge-offs on impaired loans during the year. The general component increased from prior year due to an increase in the Company’s calculated historical loss rates as a result of the increase in charge-offs during the year. The unallocated component has remained elevated compared to historical levels as a result of the continued economic uncertainly.
 
 
17

 
The following table sets forth the breakdown of the allowance for loan losses by loan category and is based on applying a specific loan loss factor to the outstanding balances of related loan category as of the date of the allocation for the periods indicated.

   
At March 31,
 
   
2012
     
2011
     
2010
     
2009
     
2008
 
   
Amount
 
Loan Category
as a
Percent
of Total
Loans
     
Amount
 
Loan Category
as a
Percent of Total
Loans
     
Amount
 
Loan Category
as a
Percent of Total
Loans
     
Amount
 
Loan Category as a Percent of Total Loans
     
Amount
 
Loan Category as a Percent
of Total Loans
 
   
(Dollars in thousands)
Commercial and construction:
                                                         
Commercial business
$
2,688
 
12.74
%
 
$
1,822
 
12.44
%
 
$
3,181
 
14.76
%
 
$
2,668
 
15.87
%
 
$
1,339
 
  14.28
%
Other real estate mortgage
 
11,626
 
63.49
     
8,919
 
67.19
     
10,028
 
62.52
     
6,475
 
55.88
     
5,415
 
  55.97
 
Real estate construction
 
412
 
3.76
     
820
 
3.98
     
5,137
 
10.27
     
4,592
 
17.41
     
2,092
 
19.37
 
Consumer:
                                                         
Real estate one-to-four family
 
3,220
 
19.71
     
1,294
 
16.06
     
1,522
 
12.10
     
1,148
 
10.46
     
669
 
9.90
 
Other installment
 
54
 
0.30
     
45
 
0.33
     
52
 
0.35
     
61
 
0.38
     
64
 
0.48
 
Unallocated
 
1,921
         
2,068
 
-
     
1,722
 
-
     
2,030
 
-
     
1,108
 
-
 
Total allowance for loan loss
$
19,921
 
100.00
%
 
$
14,968
 
100.00
%
 
$
21,642
 
100.00
%
 
$
16,974
 
100.00
%
 
$
10,687
 
100.00
%



 
18

 
 
Investment Activities

The Board sets the investment policy of the Company. The Company's investment objectives are: to provide and maintain liquidity within regulatory guidelines; to maintain a balance of high quality, diversified investments to minimize risk; to provide collateral for pledging requirements; to serve as a balance to earnings; and to optimize returns.  The policy permits investment in various types of liquid assets permissible under OCC regulation, which includes U.S. Treasury obligations, securities of various federal agencies, "bank qualified" municipal bonds, certain certificates of deposit of insured banks, repurchase agreements, federal funds and mortgage-backed securities (“MBS”), but does not permit investment in non-investment grade bonds. The policy also dictates the criteria for classifying securities into one of three categories:  held to maturity, available for sale or trading.  At March 31, 2012, no investment securities were held for trading.  See Item 7.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."

At March 31, 2012, the Company’s investment portfolio totaled $8.0 million, primarily consisting of $5.0 million in U.S. agency securities available-for-sale, $974,000 in mortgage-backed securities available-for-sale, and $1.2 million in trust preferred securities available-for-sale. This compares with a total investment portfolio of $8.8 million at March 31, 2011, primarily consisting of $4.9 million in U.S. agency securities available-for-sale, $1.8 million in mortgage-backed securities available-for-sale, and $916,000 in a trust preferred securities available-for-sale. At March 31, 2012, the Company owned no privately issued mortgage-backed securities. The real estate mortgage investment conduits (“REMICS”) consists of FHLMC and Fannie Mae (“FNMA”) securities. The Company does not believe that it has any exposure to sub-prime lending in its mortgage-backed securities portfolio. See Note 4 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information.

The following table sets forth the investment securities portfolio and carrying values at the dates indicated.

 
At March 31,
 
   
2012
     
2011
     
2010
 
   
Carrying
Value
 
Percent of
Portfolio
     
Carrying
Value
 
Percent of
Portfolio
     
Carrying
Value
 
Percent of
Portfolio
 
   
   (Dollars in thousands)
 
Held to maturity (at amortized cost):
                                 
REMICs
$
-
 
-
%
 
$
-
 
-
%
 
$
53
 
0.51
%
FHLMC mortgage-backed securities
 
69
 
0.87
     
78
 
0.89
     
86
 
0.83
 
FNMA mortgage-backed securities
 
102
 
1.28
     
112
 
1.27
     
120
 
1.15
 
Municipal securities
 
493
 
6.20
     
506
 
5.76
     
517
 
4.97
 
   
664
 
8.35
     
696
 
7.92
     
776
 
7.46
 
Available for sale (at fair value):
                                 
Agency securities
 
4,999
 
62.87
     
4,864
 
55.32
     
5,017
 
48.21
 
REMICs
 
329
 
4.14
     
433
 
4.92
     
556
 
5.34
 
FHLMC mortgage-backed securities
 
636
 
8.00
     
1,304
 
14.83
     
2,219
 
21.33
 
FNMA mortgage-backed securities
 
9
 
0.11
     
40
 
0.45
     
53
 
0.51
 
Municipal securities
 
149
 
1.87
     
540
 
6.14
     
743
 
7.14
 
Trust preferred securities
 
1,166
 
14.66
     
916
 
10.42
     
1,042
 
10.01
 
   
7,288
 
91.65
     
8,097
 
92.08
     
9,630
 
92.54
 
Total investment securities
$
7,952
 
100.00
%
 
$
8,793
 
100.00
%
 
$
10,406
 
100.00
%
 
 
19

 
The following table sets forth the maturities and weighted average yields in the securities portfolio at March 31, 2012.

 
Less Than One Year
   
One to Five Years
   
More Than Five to Ten
Years
   
More Than
Ten Years
 
 
Amount
 
Weighted
Average
Yield (1)
   
Amount
 
Weighted
Average
Yield (1)
   
Amount
 
Weighted
Average
Yield (1)
   
Amount
 
Weighted
Average
Yield (1)
 
   
(Dollars in thousands)
 
Municipal securities
$
-
 
-
%
 
$
-
 
-
%
 
$
493
 
4.97
%
 
$
149
 
4.38
%
                                               
Agency securities
 
-
 
-
     
4,999
 
1.50
     
-
 
-
     
-
 
-
 
                                               
REMICs
 
-
 
-
     
98
 
5.00
     
-
 
-
     
231
 
1.38
 
FHLMC mortgage-
   backed securities
 
-
 
-
     
636
 
4.00
     
-
 
-
     
69
 
2.99
 
FNMA mortgage-
   backed securities
 
-
 
-
     
12
 
6.31
     
-
 
-
     
99
 
2.52
 
Trust preferred
   securities
 
-
 
-
     
-
 
-
     
-
 
-
     
1,166
 
2.27
 
Total
$
-
 
-
%
 
$
5,745
 
1.85
%
 
$
493
 
4.97
%
 
$
1,714
 
2.38
%

(1)    For available for sale securities carried at fair value, the weighted average yield is computed using amortized cost without a tax equivalent
adjustment for tax-exempt obligations.

Investment securities available-for-sale were $6.3 million at March 31, 2012, compared to $6.3 million at March 31, 2011. Management reviews investment securities quarterly for the presence of other than temporary impairment (“OTTI”), taking into consideration current market conditions, the extent and nature of changes in fair value, issuer rating changes and trends, financial condition of the underlying issuers, current analysts’ evaluations, the Company’s ability and intent to hold investments until a recovery of fair value, which may be maturity, as well as other factors. The investment security that the Company recognized a non-cash impairment charge on during the year ended March 31, 2010 is a collateralized debt obligation (“CDO”) secured by trust preferred securities issued by other bank holding companies. There was no impairment charge of this security for the years ended March 31, 2012 or 2011. Management believes that it is probable that principal payments will exceed the Company’s recorded investment in this security, that the Company does not intend to sell this security and it is not more likely than not that the Company will be required to sell this security before the anticipated recovery of the remaining amortized cost basis.

At March 31, 2012, the market for the Company’s CDO was determined to be inactive in management’s judgment. This determination was made by the Company after considering the last known trade date for this specific security, the low number of transactions for similar types of securities, the significant widening of the bid-ask spread in the brokered markets in which these securities trade, the low number of new issuances for similar securities, the significant increase in the implied liquidity risk premium for similar securities, the lack of information that is released publicly and discussions with third-party industry analysts. Due to the inactivity in the market, observable market data was not readily available for all significant inputs for this security. Accordingly, the trust preferred pooled security was classified as Level 3 in the fair value hierarchy. Consistent with previous valuations, the Company determined that an income approach valuation technique (using cash flows and present value techniques) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs was the most appropriate valuation technique. Management used significant unobservable inputs that reflect our assumptions of what a market participant would use to price this security. Significant unobservable inputs included selecting an appropriate discount rate, default rate and repayment assumptions. The Company estimated the discount rate by comparing rates for similarly rated corporate bonds, with additional consideration given to market liquidity. The default rates and repayment assumptions were estimated based on the individual issuer’s financial condition, historical repayment information, as well as our future expectations of the capital markets. Using this information, the Company estimated the fair value of the security at March 31, 2012 to be $1.2 million.

Additionally, the Company received two independent Level 3 valuation estimates for this security. Those valuation estimates were based on proprietary pricing models utilizing significant unobservable inputs. Although the Company’s estimate of fair value fell outside the range of valuations provided, the magnitude in the range of fair value estimates further supported the difficulty in estimating the fair value for these types of securities in the current environment. Additionally, the
 
 
20

 
 
Company believes that some of the assumptions used by the independent parties were overly aggressive and unrealistic. Therefore, the Company believes its valuation at March 31, 2012 is reasonable.

For additional information on our Level 3 fair value measurements see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Comparison of Financial Condition at March 31, 2012 and 2011,” “Fair Value of Level 3 Assets,” and Note 17 of the Notes to the Consolidated Financial Statements contained in Item 8 of the Form 10-K.

Deposit Activities and Other Sources of Funds

General. Deposits, loan repayments and loan sales are the major sources of the Company's funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes.

Deposit Accounts. The Company attracts deposits from within its primary market area by offering a broad selection of deposit instruments, including demand deposits, negotiable order of withdrawal ("NOW") accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. Historically, the Company has focused on retail deposits. Expansion in commercial lending has led to growth in business deposits including demand deposit accounts. Business checking accounts increased $34.2 million or 39.3% to $121.2 million at March 31, 2012 from $87.0 million at March 31, 2011. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Company considers the rates offered by its competition, profitability to the Company, matching deposit and loan products and customer preferences and concerns.

The following table sets forth the average balances of deposit accounts offered by the Company at the dates indicated.

 
Year Ended March 31,
 
  2012      2011     2010  
 
Average
Balance
 
Average
Rate
   
Average
Balance
 
Average
Rate
   
Average
Balance
 
 Average
Rate
 
 
(Dollars in thousands)
 
Non-interest-bearing demand
$
110,959
 
0.00
%
 
$
91,167
 
0.00
%
 
$
87,508
 
0.00
%
Interest checking
 
96,764
 
0.29
     
81,279
 
0.29
     
79,444
 
0.42
 
Regular savings accounts
 
40,345
 
0.31
     
34,124
 
0.47
     
29,526
 
0.55
 
Money market accounts
 
234,325
 
0.45
     
214,490
 
0.86
     
192,064
 
1.23
 
Certificates of deposit
 
248,696
 
1.17
     
287,109
 
1.51
     
277,639
 
2.44
 
Total
$
731,089
 
0.60
%
 
$
708,169
 
0.93
%
 
$
666,181
 
1.45
%

Deposit accounts totaled $744.5 million at March 31, 2012 compared to $716.5 million at March 31, 2011. The Company has seen a shift in deposit mix from higher costing certificates of deposits to lower costing transaction accounts and non-interest bearing accounts. Money market accounts increased $8.6 million at March 31, 2012 compared to March 31, 2011. Savings accounts increased $8.5 million at March 31, 2012 compared to March 31, 2011. For additional information regarding our deposit accounts, see Note 10 of the Notes to the Consolidated Financial Statements contained in Item 8 of the Form 10-K.

The Company did not have any wholesale-brokered deposits at March 31, 2012 and 2011. The Company continues to put forth a concerted effort to increase its core deposits and to focus deposit growth around customer relationships as opposed to obtaining deposits through the wholesale markets. However, the Company has continued to experience increased competition for customer deposits within its market area. Customer branch deposit balances increased $39.3 million since March 31, 2011. Overall, growth in deposits was reduced by a decrease in the average account balances of many of our real estate related customers reflecting the slowdown of home sales and the weak economic environment. Additionally, the Company had $37.2 million, or 5.0% of total deposits, in Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) deposits, which were gathered from customers within the Company’s primary market-area. CDARS and ICS deposits allow customers access to FDIC insurance on deposits exceeding the $250,000 FDIC insurance limit. The Company is currently under the direction of a Supervisory Letter Directive regarding the Bank’s ability to increase and hold brokered deposits, including the Bank’s reciprocal CDARS and ICS programs, to no more than 20% of total deposits.
 
 
21

 

At March 31, 2012 and 2011, deposits from RAMCorp. totaled $16.7 million and $22.8 million, respectively. These deposits were included in interest bearing and non-interest bearing accounts and represent assets under management by RAMCorp. At March 31, 2012, the Company also had $8.9 million in deposits from public entities located in the State of Washington and Oregon, all of which were fully covered by FDIC insurance or secured by pledged collateral.

The Company is enrolled in an internet deposit listing service.  Under this listing service, the Company may post certificates of deposit rates on an internet site where institutional investors have the ability to deposit funds with the Company. At March 31, 2012 and 2011, the Company had $21.9 million and $31.6 million, respectively, in deposits through this listing service. The Company plans to continue to reduce its balance of internet based deposits during fiscal year 2013.  Furthermore, the Company may utilize the internet deposit listing service to purchase certificates of deposit at other financial institutions.

Deposit growth remains a key strategic focus for the Company and our ability to achieve deposit growth, particularly growth in core deposits, is subject to many risk factors including the effects of competitive pricing pressures, changing customer deposit behavior, and increasing or decreasing interest rate environments.  Adverse developments with respect to any of these risk factors could limit the Company’s ability to attract and retain deposits and could have a material negative impact on the Company’s financial condition, results of operations and cash flows.

The following table presents the amount and weighted average rate of certificates of deposit equal to or greater than $100,000 at March 31, 2012.
 
Maturity Period
 
Amount
   
Weighted
Average Rate
 
   
(Dollars in thousands)
 
Three months or less
  $ 39,267       0.71 %
Over three through six months
    25,999       0.88  
Over six through 12 months
    41,527       0.80  
Over 12 Months
    35,161       1.68  
Total
  $ 141,954       1.01 %

Borrowings. Deposits are the primary source of funds for the Company's lending and investment activities and for its general business purposes.  The Company relies upon advances from the FHLB and borrowings from the Federal Reserve Bank of San Francisco (“FRB”) to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB and borrowings from the FRB are typically secured by the Bank's commercial loans, commercial real estate loans, first mortgage loans and investment securities.

The FHLB functions as a central reserve bank providing credit for member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (primarily securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met.  The FHLB determines specific lines of credit for each member institution and the Bank has a line of credit with the FHLB equal to 30% of its total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At March 31, 2012, the Bank had no outstanding advances from the FHLB-Seattle under an available credit facility of $255.2 million, which is limited to available collateral.

The Bank also has a borrowing arrangement with the FRB with an available credit facility of $106.5 million, subject to pledged collateral, as of March 31, 2012.  At March 31, 2012, the Bank had no outstanding borrowings from the FRB.
 
 
22

 
 
The following tables set forth certain information concerning the Company's FHLB advances and FRB borrowings at the dates and for the periods indicated.

 
At March 31,
 
   
2012
     
2011
     
2010
 
   
(Dollars in thousands)
 
FHLB advances outstanding
$
-
   
$
-
   
$
23,000
 
Weighted average rate on FHLB advances
 
-
%
   
-
%
   
0.64
%
 
FRB borrowings outstanding
$
-
   
$
-
   
$
10,000
 
Weighted average rate on FRB advances
 
-
%
   
-
%
   
0.50
%


 
Year Ended March 31,
 
   
2012
     
2011
     
2010
 
   
(Dollars in thousands)
 
Maximum amounts of FHLB advances
   outstanding at any month end
$
-
   
$
28,000
   
$
23,000
 
Average FHLB advances outstanding
 
3
     
6,877
     
7,116
 
Weighted average rate on FHLB advances
 
0.25
%
   
0.73
%
   
1.07
%
                       
Maximum amounts of FRB borrowings
   outstanding at any month end
$
-
   
$
-
   
$
145,000
 
Average FRB borrowings outstanding
 
11
     
192
     
85,978
 
Weighted average rate on FRB borrowings
 
0.75
%
   
0.50
%
   
0.28
%


At March 31, 2012, the Company had two wholly-owned subsidiary grantor trusts totaling $22.7 million for the purpose of issuing trust preferred securities and common securities. The trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in trust agreements. The trusts used the net proceeds from each of the offerings to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company. The Debentures are the sole assets of the trusts. The Company’s obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or in part on or after specific dates, at a redemption price specified in the indentures governing the Debentures plus any accrued but unpaid interest to the redemption date.  The Company also has the right to defer the payment of interest on each of the Debentures for a period not to exceed 20 consecutive quarters, provided that the deferral period does not extend beyond the stated maturity. During such deferral period, distributions on the corresponding trust preferred securities will also be deferred and the Company may not pay cash dividends to the holders of shares of our common stock. Beginning in the first quarter of fiscal 2011, the Company elected to defer regularly scheduled interest payments on its outstanding $22.7 million aggregate principal amount of Debentures and distributions on the corresponding trust preferred securities are also being deferred. The Company continued with the interest deferral through March 31, 2012. As of March 31, 2012, the Company had deferred a total of $2.6 million of interest payments. The common securities issued by the grantor trusts were purchased by the Company, and the Company’s investment in the common securities of $681,000 at March 31, 2012 and 2011 is included in prepaid expenses and other assets in the Consolidated Balance Sheets included in the Consolidated Financial Statements contained in Item 8 of the Form 10-K. See also Note 11 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Taxation

For details regarding the Company’s taxes, see Item 8 – “Financial Statements and Supplementary Data - Note 12 of the Notes to the Consolidated Financial Statements.”

Personnel

As of March 31, 2012, the Company had 224 full-time equivalent employees, none of whom are represented by a collective bargaining unit.  The Company believes its relationship with its employees is good.

 
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Corporate Information

The Company’s principal executive offices are located at 900 Washington Street, Vancouver, Washington 98660. Its telephone number is (360) 693-6650. The Company maintains a website with the address www.riverviewbank.com. The information contained on the Company’s website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own internet access charges, the Company makes available free of charge through its website the Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after it has electronically filed such material with, or furnished such material to, the Securities and Exchange Commission (“SEC”).

Subsidiary Activities

Under OCC regulations, the Bank is authorized to invest up to 3% of its assets in subsidiary corporations, with amounts in excess of 2% only if primarily for community purposes. At March 31, 2012, the Bank’s investments of $1.1 million in Riverview Services, Inc. (“Riverview Services”), its wholly owned subsidiary, and $2.9 million in RAMCorp., an 85% owned subsidiary, were within these limitations.

Riverview Services acts as a trustee for deeds of trust on mortgage loans granted by the Bank, and receives a reconveyance fee for each deed of trust. Riverview Services had net income of $19,000 for the fiscal year ended March 31, 2012 and total assets of $1.1 million at that date. Riverview Services’ operations are included in the Consolidated Financial Statements of the Company contained in Item 8 of the Form 10-K.

RAMCorp is an asset management company providing trust, estate planning and investment management services. RAMCorp commenced business in December 1998 and had net income of $522,000 for the fiscal year ended March 31, 2012 and total assets of $3.6 million at that date. RAMCorp earns fees on the management of assets held in fiduciary or agency capacity. At March 31, 2012, total assets under management totaled $359.6 million. RAMCorp’s operations are included in the Consolidated Financial Statements of the Company contained in Item 8 of this Form 10-K.

Executive Officers.  The following table sets forth certain information regarding the executive officers of the Company.

Name
Age (1)
Position
Patrick Sheaffer
72
Chairman of the Board and Chief Executive Officer
Ronald A. Wysaske
59
President and Chief Operating Officer
David A. Dahlstrom
61
Executive Vice President and Chief Credit Officer
Kevin J. Lycklama
34
Executive Vice President and Chief Financial Officer
John A. Karas
63
Executive Vice President
James D. Baldovin
53
Executive Vice President Retail Banking
Kim J. Capeloto
50
Executive Vice President Marketing and Operations
(1) At March 31, 2012

Patrick Sheaffer is Chairman of the Board and Chief Executive Officer of the Company and Chief Executive Officer of the Bank, positions he has held since February 2004. Prior to February 2004, Mr. Sheaffer served as Chairman of the Board, President and Chief Executive Officer of the Company since its inception in 1997. He became Chairman of the Board of the Bank in 1993. Mr. Sheaffer joined the Bank in 1963. He is responsible for leadership and management of the Company. Mr. Sheaffer is active in numerous professional and civic organizations.

Ronald A. Wysaske is President and Chief Operating Officer of the Bank, positions he has held since February 2004. Prior to February 2004, Mr. Wysaske served as Executive Vice President, Treasurer and Chief Financial Officer of the Bank from 1981 to 2004 and of the Company since its inception in 1997. He joined the Bank in 1976. Mr. Wysaske is responsible for daily operations and management of the Bank. He holds an M.B.A. from Washington State University and is active in numerous professional, educational and civic organizations.

David A. Dahlstrom is Executive Vice President and Chief Credit Officer and is responsible for credit administration related to its commercial, mortgage and consumer loan activities.  Prior to joining Riverview in May 2002, Mr. Dahlstrom spent 14 years with First Interstate Bank and progressed through a number of management positions, including serving as Senior Vice President of the Business Banking Group in Portland.  In 1999, Mr. Dahlstrom joined a regional bank as Executive Vice President/Community Banking, responsible for all branch operations and small business banking.

 
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Kevin J. Lycklama is Executive Vice President and Chief Financial Officer of the Company, positions he has held since February 2008. Prior to February 2008, Mr. Lycklama served as Vice President and Controller of the Bank since 2006. Prior to joining Riverview, Mr. Lycklama spent five years with a local public accounting firm advancing to the level of audit manager.  He is responsible for accounting, SEC reporting as well as treasury functions for the Bank and the Company. He holds a Bachelor of Arts degree from Washington State University and is a certified public accountant.

John A. Karas is Executive Vice President of the Bank and also serves as Chairman of the Board, President and CEO of its subsidiary, RAMCorp.  Mr. Karas has been employed by the Company since 1999 and has over 30 years of trust experience.  He is familiar with all phases of the trust business and his experience includes trust administration, trust legal counsel, investments and real estate. Mr. Karas received his B.A. from Willamette University and his Juris Doctor degree from Lewis & Clark Law School’s Northwestern School of Law.  He is a member of the Oregon, Multnomah County and American Bar Associations and is a Certified Trust and Financial Advisor.  Mr. Karas is also active in numerous civic organizations.

James D. Baldovin is Executive Vice President of Retail Banking and is responsible for the Bank’s branch banking network, customer service, sales and community development.  Mr. Baldovin has been employed by the Bank since January 2003 and has over 25 years of banking expertise in developing and leading sales and service cultures. He holds a Bachelor of Arts degree in economics from Linfield College and is a graduate of the Pacific Coast Banking School.

Kim J. Capeloto is Executive Vice President of Marketing and Operations. Mr. Capeloto has been employed by the Bank since September 2010. Mr. Capeloto has over 25 years of banking expertise serving as regional manager for Union Bank of California directing small business and personal banking activities. Mr. Capeloto also served as district manager for Wells Fargo Bank. Prior to joining the Bank, Mr. Capeloto held the position of President and Chief Executive Officer of the Vancouver Chamber of Commerce. Mr. Capeloto is active in numerous professional and civic organizations.

REGULATION

The following is a brief description of certain laws and regulations, which are applicable to the Company and the Bank.  The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

Legislation is introduced from time to time in the United States Congress (“Congress”) that may affect the Company’s and Bank’s operations.  In addition, the regulations governing the Company and the Bank may be amended from time to time by the OCC, the FDIC, the Board of Governors of the Federal Reserve System (“Federal Reserve” or “Federal Reserve Board”) or the SEC, as appropriate.  Any such legislation or regulatory changes in the future could have an adverse effect on our operations and financial condition.  We cannot predict whether any such changes may occur.

General

As a federally chartered savings institution, the Bank is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as the insurer of its deposits. Additionally, the Company is subject to extensive regulation, examination and supervision by the Federal Reserve Board as its primary federal regulator. The Bank is a member of the FHLB System and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund, which is administered by the FDIC. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OCC, the Federal Reserve and under certain circumstances, the FDIC, to evaluate the Bank’s safety and soundness and compliance with various regulatory requirements. This regulatory structure establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OCC, the Federal Reserve, the FDIC or Congress, could have a material adverse impact on the Company and the Bank and their operations.

On July 8, 2011, the Company announced that the Boards of the Company and the Bank adopted a Plan of Reorganization and Charter Conversion to convert the Bank from a federally chartered stock savings bank to a Washington commercial bank and to reorganize the Company as a bank holding company. In April 2012, the Company notified both the OCC and the FRB that it was withdrawing its application to convert to a commercial bank and bank holding company.

 
25

 
Federal Regulation of Savings Institutions

Office of the Comptroller of the Currency.  The OCC has extensive authority over the operations of savings institutions.  As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. The OCC also has extensive enforcement authority over all savings institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate prompt corrective action orders.  In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices.  Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required by law.

In January 2009, the Bank entered into a Memorandum of Understanding (“MOU”) with the Office of Thrift Supervision (“OTS”), at the time the Bank’s primary regulator. Following the transfer of the responsibilities and authority of the OTS to the OCC on July 21, 2011, the MOU was enforced by the OCC. On January 25, 2012, the Bank entered into a formal written agreement (“Agreement”) with the OCC. Upon effectiveness of the Agreement, the MOU was terminated by the OCC. The Agreement will remain in effect and enforceable until modified, waived or terminated in writing by the OCC.

Entry into the Agreement does not change the Bank’s “well capitalized” status as of the date of this Form 10-K. The Agreement is based on the findings of the OCC during its on-site examination of the Bank as of June 30, 2011 (“OCC Exam”). Since the completion of the OCC Exam, the Bank’s Board of Directors (“Board”) and its management have already successfully implemented initiatives and strategies to address and resolve a number of the issues noted in the Agreement. The Bank continues to work in cooperation with its regulators to bring its policies and procedures into conformity with the requirements contained in the Agreement.

Under the Agreement, the Bank is required to take the following actions: (a) refrain from paying dividends without prior OCC non-objection; (b) adopt, implement and adhere to a three year capital plan, including objectives, projections and implementation strategies for the Bank’s overall risk profile, dividend policy, capital requirements, primary capital structure sources and alternatives, various balance sheet items, as well as systems to monitor the Bank’s progress in meeting the plans, goals and objectives of the plan; (c) add a credit risk management function and appoint a Chief Lending Officer that is independent from the credit risk management function; (d) update the Bank’s credit policy and not grant, extend, renew or alter any loan over $250,000 without meeting certain requirements set forth in the Agreement; (e) adopt, implement and adhere to a program to ensure that risk associated with the Bank’s loans and other assets is properly reflected on the Bank’s books and records; (f) adopt, implement and adhere to a program to reduce the Bank’s criticized assets; (g) retain a consultant to perform semi-annual asset quality reviews of the Bank’s loan portfolio; (h) adopt, implement and adhere to policies related to asset diversification and reducing concentrations of credit; and (i) submit quarterly progress reports to the OCC regarding various aspects of the foregoing actions.

The Bank’s Board must ensure that the Bank has the processes, personnel and control systems in place to ensure implementation of, and adherence to, the requirements of the Agreement.  In connection with this requirement, the Bank’s Board has appointed a compliance committee to submit reports to the OCC and to monitor and coordinate the Bank’s performance under the Agreement.

The Bank has also separately agreed to the OCC establishing higher minimum capital ratios for the Bank, specifically that the Bank maintain a Tier 1 capital (leverage) ratio of not less than 9.00% and a total risk-based capital ratio of not less than 12.00%. As of March 31, 2012, the Bank’s Tier 1 capital (leverage) ratio was 8.76% and its total risk-based capital ratio was 12.11%. Subsequent to March 31, 2012, the Company invested an additional $2.7 million into the Bank, increasing the Bank’s leverage ratio above the 9.00% minimum. The Bank has also entered into an agreement to sell $32 million of one-to-four family mortgage loans for a gain of $202,000. If completed, the sale could further increase the Bank’s leverage ratio an estimated 30 basis points.

All savings institutions are required to pay assessments to the OCC to fund the agency's operations.  The general assessments, paid on a semi-annual basis, are determined based on the savings institution's total assets, including consolidated subsidiaries.  The Bank's OCC assessment for the fiscal year ended March 31, 2012 was $305,000.

The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At March 31, 2012, the Bank's lending limit under this restriction was $13.7 million and, at that date, the Bank’s largest lending relationship with one borrower was $13.1 million,
 
 
26

 
which consisted of one commercial business loan with a commitment of $750,000 and three commercial real estate loans with a total commitment of $12.3 million. Each of these loans were performing according to their original payment terms at March 31, 2012.

The OCC’s oversight of the Bank includes reviewing its compliance with the customer privacy requirements imposed by the Gramm-Leach-Bliley Act of 1999 (“GLBA”) and the anti-money laundering provisions of the USA Patriot Act. The Gramm-Leach-Bliley privacy requirements place limitations on the sharing of consumer financial information with unaffiliated third parties. They also require each financial institution offering financial products or services to retail customers to provide such customers with its privacy policy and with the opportunity to “opt out” of the sharing of their personal information with unaffiliated third parties. The USA Patriot Act significantly expands the responsibilities of financial institutions in preventing the use of the United States financial system to fund terrorist activities. Its anti-money laundering provisions require financial institutions operating in the United States to develop anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. These compliance programs are intended to supplement existing compliance requirements under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations.

The OCC, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits.  Any institution that fails to comply with these standards must submit a compliance plan.

Federal Home Loan Bank System.  The Bank is a member of the FHLB of Seattle, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions.  Each FHLB serves as a reserve or central bank for its members within its assigned region.  It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System.  It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board.  All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.  In addition, all long-term advances are required to provide funds for residential home financing.  See Business – “Deposit Activities and Other Sources of Funds – Borrowings.”

As a member, the Bank is required to purchase and maintain stock in the FHLB.  At March 31, 2012, the Bank had $7.4 million in FHLB stock, which was in compliance with this requirement. The FHLB has reported a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (“FHFA”), its primary regulator as of December 31, 2008, and stated that it would suspend future dividends and the repurchase and redemption of outstanding common stock. As a result, the FHLB has stopped paying a dividend since the fourth quarter of 2008. The Bank is continually monitoring this issue. The FHLB has communicated to its members, including us, that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market and credit 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. In addition, on October 25, 2010, the FHLB received a consent order from the FHFA. The potential impact of the consent order is unknown at this time. The consent order required, among other matters, the FHLB meet and maintains certain minimum financial requirements. The FHLB has communicated that with the exception of a retained earnings requirement, it is in compliance with the minimum financial requirements and has continued taking the specified actions and is working toward meeting the agreed-upon milestones and timelines for completing capital management, asset composition, and other operational and risk management improvements as indicated in the consent order. As a result, the Bank has not recorded an other-than-temporary impairment on its investment in FHLB stock. However, continued deterioration in the FHLB’s financial position may result in impairment in the value of those securities, or the requirement that the Bank contribute additional funds to recapitalize the FHLB, or reduce the Bank’s ability to borrow funds from the FHLB, which may impair the Bank’s ability to meet liquidity demands. We will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of the Bank’s investment.

The FHLBs have continued and continue to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects.  These contributions have in the past affected adversely the level of FHLB dividends paid and could continue to do so in the future if dividend payments resume. These contributions could also have an adverse effect on the value of FHLB stock in the future.  A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital.

Federal Deposit Insurance Corporation.  The Bank's deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and such insurance is backed by the full faith and credit of the United States Government. As insurer, the
 
 
27

 
FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The Bank’s deposit insurance premiums for the year ended March 31, 2012 were $1.1 million. Those premiums have increased compared to historical levels due to recent strains on the FDIC deposit insurance fund due to the cost of bank failures and increase in the number of troubled banks.
 
The FDIC assesses deposit insurance premiums on each FDIC-insured institution quarterly based on annualized rates for four risk categories applied to its deposits, subject to certain adjustments. Each institution is assigned to one of four risk categories based on its capital, supervisory ratings and other factors. Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risks to the DIF. Under FDIC’s risk-based assessment rules, effective April 1, 2011 through March 31, 2012, the initial base assessment rates prior to adjustments range from 5 to 9 basis points for Risk Category I, and are 14 basis points for Risk Category II, 23 basis points for Risk Category III, and 35 basis points for Risk Category IV.  Initial base assessment rates are subject to adjustments based on an institution’s unsecured debt, secured liabilities and brokered deposits, such that the total base assessment rates after adjustments range from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV.

As required by the Dodd-Frank Act, the FDIC has adopted rules effective April 1, 2011, under which insurance premium assessments are based on an institution’s total assets minus its tangible equity (defined as tier 1 capital) instead of its deposits. Under these rules, an institution with total assets of less than $10 billion will be assigned to a Risk Category as described above, and a range of initial base assessment rates will apply to each category, subject to adjustment downward based on unsecured debt issued by the institution and, except for an institution in Risk Category I, adjustment upward if the institution’s brokered deposits exceed 10% of its domestic deposits, to produce total base assessment rates. The FDIC may increase or decrease its rates by 2.0 basis points without further rulemaking. In an emergency, the FDIC may also impose a special assessment.

As a result of a decline in the reserve ratio (the ratio of the DIF to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the DIF, the FDIC adopted a rule requiring each insured institution to prepay on December 30, 2009 the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the regular quarterly assessment for the third quarter which was due on December 30, 2009). The prepaid amount is recorded as an asset with a zero risk weight and the institution will continue to record quarterly expenses for deposit insurance. For purposes of calculating the prepaid amount, assessments were measured at the institution’s assessment rate as of September 30, 2009, with a uniform increase of 3 basis points effective January 1, 2011, and were based on the institution’s assessment base for the third quarter of 2009, with growth assumed quarterly at annual rate of 5%. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash or receive a rebate of prepaid amounts not exhausted after collection of assessments due on June 30, 2013, as applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future. The rule includes a process for exemption from the prepayment for institutions whose safety and soundness would be affected adversely. The Bank prepaid $5.4 million in FDIC assessments during December 2009, which will be expensed until the prepaid amount has been fully utilized. The balance of the prepaid assessment was $2.1 million at March 31, 2012.

The Dodd-Frank Act establishes 1.35% as the minimum reserve ratio. The FDIC has adopted a plan under which it will meet this ratio by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum reserve ratio to 1.35% from the former statutory minimum of 1.15%. The FDIC has not yet announced how it will implement this offset. In addition to the statutory minimum ratio, the FDIC must designate a reserve ratio, known as the designated reserve ratio (the “DRR”), which may exceed the statutory minimum. The FDIC has established 2.0% as the DRR. In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, an agency of the Federal government established to fund the costs of failed thrifts in the 1980’s. For the quarterly period ended March 31, 2012, the Financing Corporation assessment equaled 0.66 basis points for each $100 in domestic deposits. These assessments, which may be revised based upon the level of DIF deposits, will continue until the bonds mature in the years 2017 through 2019.

Under the Dodd-Frank Act, beginning on January 1, 2011, all non-interest bearing transaction accounts and Interest on Lawyer Trust Accounts (“IOLTA”) accounts qualify for unlimited deposit insurance by the FDIC through December 31, 2012.  NOW accounts, which were previously fully insured under the Transaction Account Guarantee Program, are no longer eligible for an unlimited guarantee due to the expiration of this program on December 31, 2010.  NOW accounts, along with all other deposits maintained at the Bank are now insured by the FDIC up to $250,000 per account owner. 
 
 
28

 

In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. This payment is established quarterly and during the fiscal year ended March 31, 2012 averaged 3.5 basis points of assessable deposits. The Financing Corporation was chartered in 1987, by the Federal Home Loan Bank Board solely for the purpose of functioning as a vehicle for the recapitalization of the deposit insurance system.

As insurer, the FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured institutions.  It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF.  The FDIC also has the authority to take enforcement actions against banks and savings associations.

The Dodd-Frank Act contains a number of provisions that will affect the capital requirements applicable to the Company and the Bank, including the requirement that thrift holding companies be subject to consolidated capital requirements, effective on the Designated Transfer Date. We cannot predict what impact such new regulations may have.

Prompt Corrective Action.  The OCC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization.  Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of tier 1 (core) capital to risk-weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized."  An institution that has a total risk-based capital ratio less than 6%, a tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized."  Subject to a narrow exception, the OCC is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized."  OCC regulations also require that a capital restoration plan be filed with the OCC within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion.  “Significantly undercapitalized” and “critically undercapitalized” institutions are subject to more extensive mandatory regulatory actions.  The OCC also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.  At March 31, 2012, the Bank’s capital ratios met the "well capitalized" standards.

Qualified Thrift Lender Test.  All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations.  This test requires a savings institution to have at least 65% of its total assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis.  As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a) (19) of the Internal Revenue Code ("Code").  Under either test, such assets primarily consist of residential housing related loans and investments.

Any institution that fails to meet the QTL test must either become a national bank or be prohibited from making new investments or engaging in activities not allowed for both a national bank and a savings association, from establishing a new branch unless such branch is allowable for a national bank, and from paying dividends unless allowable for a national bank; unless within one year it meets the test, and thereafter remains a qualified thrift lender. Any holding company of an institution that fails the test and does not re-qualify within a year must become a bank holding company. If such an institution has not converted to a bank within three years after it failed the test, it must divest of any investments and cease any activities not permissible for both a national bank and a savings association. The Company does not believe that any of its investments or operating activities would be prohibited under such circumstances. As of March 31, 2012, the Bank did not meet the QTL test.

Capital Requirements.  Federally insured savings institutions, such as the Bank, are required by the OCC to maintain minimum levels of regulatory capital.  These minimum capital standards include: a 1.5% tangible capital to total assets ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards, discussed above, also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% tier 1 risk-based capital standard. The OCC regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

 
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The risk-based capital standard requires federal savings institutions to maintain tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OCC capital regulation based on the risks believed inherent in the type of asset. Tier 1 (core) capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

The OCC also has authority to establish individual minimum capital requirements for financial institutions. As previously discussed, in January 2012, the Bank agreed to the OCC establishing minimum capital ratios for the Bank in excess of the minimum capital standards required under OCC’s Prompt Corrective Actions.  Specifically, the Bank must achieve and maintain tier 1 (core) leverage ratio of 9% and total risk-based capital ratio of 12%.  For additional information, see Item 1A, “Risk Factors – We are required to comply with the terms of an agreement with the OCC and a memorandum of understanding with the Federal Reserve and lack of compliance could result in monetary penalties and /or additional regulatory actions.” and Note 15 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.

Limitations on Capital Distributions.  OCC regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OCC, such as the Bank, may have its dividend authority restricted by the OCC. In accordance with the provisions of the Agreement, the Bank may not pay dividends to the Company without prior approval of the OCC.

Generally, savings institutions proposing to make any capital distribution need not submit written notice to the OCC prior to such distribution unless they are a subsidiary of a holding company or would not remain well capitalized following the distribution.  Savings institutions that do not, or would not meet their current minimum capital requirements following a proposed capital distribution or propose to exceed these net income limitations, must obtain OCC approval prior to making such distribution.  The OCC may object to the distribution during that 30-day period based on safety and soundness concerns.  See "- Capital Requirements."

Activities of Associations and their Subsidiaries.  When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the association controls, the savings institution must file a notice or application with the FDIC and the OCC at least 30 days in advance and receive regulatory approval or non-objection.  Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders.

The OCC may determine that the continuation by a savings institution of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the association or is inconsistent with sound banking practices or with the purposes of the FDIC.  Based upon that determination, the FDIC or the OCC has the authority to order the savings institution to divest itself of control of the subsidiary.  The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the Deposit Insurance Fund.  If so, it may require that no FDIC insured institution engage in that activity directly.

Transactions with Affiliates. The Bank’s authority to engage in transactions with “affiliates” is limited by OCC regulations and by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve Board’s Regulation W. The term “affiliates” for these purposes generally means any company that controls or is under common control with an institution. The Company and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution’s capital. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
 
 
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The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") generally prohibits a company from making loans to its executive officers and directors. However, that act contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% stockholders of the Bank and its affiliates (“insiders”), as well as entities such persons control is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.

Community Reinvestment Act.  Under the Community Reinvestment Act (“CRA”), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.  The CRA requires the OCC, in connection with the examination of the Bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank.  An unsatisfactory rating may be used as the basis for the denial of an application by the OCC.  Due to the heightened attention being given to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank received a satisfactory rating during its most recent examination.

Enforcement.  The OCC has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution.  Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance.  Civil penalties cover a wide range of violations and can range from $25,000 to $1.1 million per day.  The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution.  If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

Standards for Safety and Soundness.  As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard.

Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts, primarily checking, NOW and Super NOW checking accounts. At March 31, 2012, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy any liquidity requirements that may be imposed by the OCC.

Environmental Issues Associated with Real Estate Lending.  The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste.  However, Congress asked to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site.  Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan.  In addition, we may be subject to environmental liabilities with respect to real estate properties that are placed in foreclosure that we subsequently take title to.

To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which could substantially exceed the value of the collateral property.

 
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Savings and Loan Holding Company Regulations

General.  The Company is a unitary savings and loan holding company subject to regulatory oversight of the Federal Reserve.  Accordingly, the Company is required to register and file reports with the Federal Reserve and is subject to regulation and examination by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over the Company and its non-savings institution subsidiaries, which also permits the Federal Reserve to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution.

In October 2009, the Company also entered into a separate MOU agreement with the OTS which is now enforced by the Federal Reserve the successor to the OTS. This MOU requires the Company to: (a) provide notice to and obtain written non-objection from the Federal Reserve prior to the Company declaring a dividend or redeeming any capital stock or receiving dividends or other payments from the Bank; (b) provide notice to and obtain written non-objection from the Federal Reserve prior to the Company incurring, issuing, renewing or repurchasing any new debt; and (c) submit quarterly updates to its written operations plan and consolidated capital plan.

The Company believes it is currently in compliance with all of the requirements of the MOU through its normal business operations.  These requirements will remain in effect until modified or terminated by the Federal Reserve.

Activities Restrictions. The GLBA provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the GLBA specifies that, subject to a grandfather provision, existing savings and loan holding companies may only engage in such activities. The Company qualifies for the grandfathering and is therefore not restricted in terms of its activities. Upon any non-supervisory acquisition by the Company of another savings association as a separate subsidiary, the Company would become a multiple savings and loan holding company and would be limited to activities permitted multiple holding companies by Federal Reserve regulation. Federal Reserve has issued an interpretation concluding that multiple savings holding companies may also engage in activities permitted for financial holding companies, including lending, trust services, insurance activities and underwriting, investment banking and real estate investments.

Mergers and Acquisitions. The Company must obtain approval from the Federal Reserve before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets.  In evaluating an application for the Company to acquire control of a savings institution, the Federal Reserve would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the Deposit Insurance Fund, the convenience and the needs of the community and competitive factors.

The Federal Reserve may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
 
Acquisition of the Company. Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal Reserve and must obtain the prior approval of the Federal Reserve under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company.  A bank holding company must obtain the prior approval of the Federal Reserve under the Bank Holding Company Act before obtaining control of a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act.  The term “company” includes corporations, partnerships, associations, and certain trusts and other entities.  “Control” of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly of more than 25% of any class of the savings association’s voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding 10% or more of a class of voting securities if the institution has a class of registered securities, as Riverview Bancorp, Inc. has.  Control may be direct or indirect and may occur through acting in concert with one or more other persons.  In addition, a savings and loan holding company must obtain Federal Reserve approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company.  A similar provision limiting the acquisition by a bank holding company of 5% or more of a class of voting stock of any company is included in the Bank Holding Company Act.
 
 
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Accordingly, the prior approval of the Federal Reserve Board would be required:
 
•  
before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of Riverview Bancorp, Inc.; and
 
•  
before any other company could acquire 25% or more of the common stock of Riverview Bancorp, Inc., and may be required for an acquisition of as little as 10% of such stock.
 
In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations and requirements for prior regulatory approval by the Federal Reserve in the case of control of a savings and loan holding company or by the OCC in the case of control of a savings association not obtained through control of a holding company of such savings association.

Sarbanes-Oxley Act of 2002.  The Sarbanes-Oxley Act was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, including the Company.

The SOX Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules.  The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010:  On July 21, 2010, the Dodd-Frank Act was signed into law.  In addition to those changes discussed above, the Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provision that, among other things has or will:

(i)  
Centralize responsibility for consumer financial protection by creating a new agency within the Federal Reserve Board, the Bureau of Consumer Financial Protection, with broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws that would apply to all banks and thrifts.  Smaller financial institutions, including the Banks, will be subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws.

(ii)  
Require the federal banking regulators to promulgate new capital regulations and seek to make their capital requirements countercyclical, so that capital requirements increase in times of economic expansion and decrease in times of economic contraction. Savings and loan holding companies, like the Company, will be subject to the same capital requirements as bank holding companies in 2015.

(iii)  
Provide for new disclosure and other requirements relating to executive compensation and corporate governance.

(iv)  
Made permanent the $250,000 limit for federal deposit insurance and provide unlimited federal deposit insurance until January 1, 2013 for non-interest-bearing demand transaction accounts at all insured depository institutions.

(v)  
Effective July 21, 2011, repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

(vi)  
Required all depository institution holding companies to serve as a source of financial strength to their depository institution subsidiaries in the event such subsidiaries suffer from financial distress.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company and the financial services industry more generally. Provisions in the legislation that require revisions to the capital requirements of the Company and the Bank could require the Company and the Bank to seek additional sources of capital in the future.

 
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Item1A.  Risk Factors

An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations. The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment.  The risks below also include forward-looking statements. This report is qualified in its entirety by these risk factors.

We are required to comply with the terms of an agreement with the OCC and a memorandum of understanding with the Federal Reserve and lack of compliance could result in monetary penalties and /or additional regulatory actions.
 
In January 2009, Riverview Community Bank, the Company’s wholly-owned banking subsidiary, entered into a Memorandum of Understanding (“MOU”) with the Office of Thrift Supervision (“OTS”), at the time the Bank’s primary regulator. Following the transfer of the responsibilities and authority of the OTS to the Office of the Comptroller of the Currency (“OCC”) on July 21, 2011, the MOU was enforced by the OCC. On January 25, 2012, the Bank entered into a formal written agreement (“Agreement”) with the OCC. Upon effectiveness of the Agreement, the MOU was terminated by the OCC.

The Agreement is based on the findings of the OCC during their on-site examination of the Bank as of June 30, 2011 (“OCC Exam”). Since the completion of the OCC Exam, we have aggressively worked to address the findings of the OCC Exam and have already successfully implemented initiatives and strategies to address and resolve a number of the issues noted in the Agreement. Under the Agreement, the Bank is required to take the following actions: (a) refrain from paying dividends without prior OCC non-objection; (b) adopt, implement and adhere to a three year capital plan, including objectives, projections and implementation strategies for the Bank’s overall risk profile, dividend policy, capital requirements, primary capital structure sources and alternatives, various balance sheet items, as well as systems to monitor the Bank’s progress in meeting the plans, goals and objectives of the plan; (c) add a credit risk management function and appoint a Chief Lending Officer that is independent from the credit risk management function; (d) update the Bank’s credit policy and not grant, extend, renew or alter any loan over $250,000 without meeting certain requirements set forth in the Agreement; (e) adopt, implement and adhere to a program to ensure that risk associated with the Bank’s loans and other assets is properly reflected on the Bank’s books and records; (f) adopt, implement and adhere to a program to reduce the Bank’s criticized assets; (g) maintain a consultant to perform semi-annual asset quality reviews of the Bank’s loan portfolio; (h) adopt, implement and adhere to policies related to asset diversification and reducing concentrations of credit; and (i) submit quarterly progress reports to the OCC regarding various aspects of the foregoing actions.

The Bank’s Board must ensure that the Bank has the processes, personnel and control systems in place to ensure implementation of and adherence to the requirements of the Agreement.  In connection with this requirement, the Bank’s Board has appointed a compliance committee to submit such reports and monitor and coordinate the Bank’s performance under the Agreement.

In October 2009, Riverview Bancorp, Inc. (the “Company”) entered into a separate MOU agreement with the OTS which is now enforced by the Board of Governors of the Federal Reserve System (“Federal Reserve”) as the successor to the OTS. The MOU requires the Company to: (a) provide notice to and obtain written non-objection from the Federal Reserve prior to the Company declaring a dividend or redeeming any capital stock or receiving dividends or other payments from the Bank; (b) provide notice to and obtain written non-objection from the Federal Reserve prior to the Company incurring, issuing, renewing or repurchasing any new debt; and (c) submit quarterly updates to its written operations plan and consolidated capital plan.

The MOU and Agreement will remain in effect until stayed, modified, terminated or suspended by the Federal Reserve and OCC, respectively. If either the Company or Bank is found not in compliance with the MOU or Agreement, as the case may be, it could be subject to various remedies, including among others, the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to direct an increase in capital, to restrict the growth of the Company or the Bank, to remove officers and/or directors, and to assess civil monetary penalties. Management of the Company and the Bank have been taking action and implementing programs to comply with the requirements of the MOU and Agreement and compliance will be determined by the Federal Reserve and OCC, respectively. Management believes that the Company and the Bank have or will comply in all material respects with the provisions of the MOU and Agreement. Either of these regulators may determine, however, in its sole discretion that the issues raised by the MOU or the Agreement have not been addressed satisfactorily, or that any current or past actions, violations or deficiencies
 
 
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could be the subject of further regulatory enforcement actions. Such enforcement actions could involve penalties or limitations on the business of the Bank or the Company and negatively affect our ability to implement our business plan, pay dividends on our common stock and the value of our common stock as well as our financial condition and results of operations.

The Bank has also separately agreed to the OCC establishing higher minimum capital ratios for the Bank, specifically that the Bank maintain a Tier 1 capital (leverage) ratio of not less than 9.00% and a total risk-based capital ratio of not less than 12.00%. As of March 31, 2012, the Bank’s Tier 1 capital (leverage) ratio was 8.76% and its total risk-based capital ratio was 12.11%. Subsequent to March 31, 2012, the Company invested an additional $2.7 million into the Bank, increasing the Bank’s leverage ratio above the 9.00% minimum. The Bank has also entered into an agreement to sell $32 million of one-to-four family mortgage loans for a gain of $202,000. If completed, the sale could further increase the Bank’s leverage ratio an estimated 30 basis points.

The current weak economy in the market areas we serve may continue to adversely impact our earnings and could increase the credit risk associated with our loan portfolio.

Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A continuing decline in the economies of the seven counties, in which we operate, including the Portland, Oregon metropolitan area, which we consider to be our primary market area, could have a material adverse effect on our business, financial condition, results of operations and prospects.  In particular, Washington and Oregon have experienced substantial home price declines and increased foreclosures and have experienced above average unemployment rates.

A further deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
 
·  
loan delinquencies, problem assets and foreclosures may increase;
 
·  
demand for our products and services may decline;
 
·  
collateral for loans made may decline further in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans; and
 
·  
the amount of our low-cost or non-interest bearing deposits may decrease.
 
Our real estate construction and land acquisition or development loans are based upon estimates of costs and the value of the completed project.

We make real estate construction loans to individuals and builders, primarily for the construction of residential properties. We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At March 31, 2012, construction loans totaled $25.8 million, or 3.8% of our total loan portfolio, of which $12.3 million were for residential real estate projects. Land loans, which are loans made with land as security, totaled $38.9 million, or 5.7%, of our total loan portfolio at March 31, 2012. Land loans include raw land and land acquisition and development loans.  In our primary market area, the housing market has slowed, with weaker demand for housing, higher inventory levels and longer marketing times. A further downturn in housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure.

In general, construction, and land lending involves additional risks because of the inherent difficulty in estimating a property's value both before and at completion of the project as well as the estimated cost of the project. Construction costs may exceed original estimates as a result of increased materials, labor or other costs. In addition, because of current uncertainties in the residential real estate market, property values have become more difficult to determine than they have historically been. Construction loans and land acquisition and development loans often involve the disbursement of funds with repayment dependent, in part, on the success of the project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest. These loans are also generally more difficult to monitor. Loans on land under development or held for future construction as well as lot loans made to individuals for the future construction of a residence also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to individuals on their personal residences. At March 31, 2012, $49.6 million of our construction and land loans were for speculative construction loans, of which, $20.7 million, or 41.8%, were nonperforming at March 31, 2012.

 
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Our emphasis on commercial real estate lending may expose us to increased lending risks.
 
Our current business strategy is focused on the expansion of commercial real estate lending. This type of lending activity, while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. Many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.

At March 31, 2012, we had $395.9 million of commercial and multi-family real estate mortgage loans, representing 57.8% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans, and repayment is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the