Loans Receivable and Allowance for Loan Losses

Loans receivable by portfolio segment consisted of the following at September 30, 2018 and 2017 (dollars in thousands):



	2018		2017
Mortgage loans:
One- to four-family	$	115,941	$	118,147
Multi-family	61,928		58,607
Commercial	345,113		328,927
Construction – custom and owner/builder	119,555		117,641
Construction – speculative one- to four-family	15,433		9,918
Construction – commercial	39,590		19,630
Construction – multi-family	10,740		21,327
Construction – land development	3,040		—
Land	25,546		23,910
Total mortgage loans	736,886		698,107
Consumer loans:
Home equity and second mortgage	37,341		38,420
Other	3,515		3,823
Total consumer loans	40,856		42,243

Commercial business loans	43,053		44,444
Total loans receivable	820,795		784,794
Less:
Undisbursed portion of construction loans in process	83,237		82,411
Deferred loan origination fees, net	2,637		2,466
Allowance for loan losses	9,530		9,553
	95,404		94,430
Loans receivable, net	$	725,391	$	690,364

Significant Concentrations of Credit Risk

Most of the Company’s lending activity is with customers located in the state of Washington and involves real estate. At September 30, 2018, the Company had $774,227,000 (including $83,237,000 of undisbursed construction loans in process) in loans secured by real estate, which represented 94.3% of total loans receivable. The real estate loan portfolio is primarily secured by one- to four-family properties, multi-family properties, land, and a variety of commercial real estate property types. At September 30, 2018, there were no concentrations of real estate loans to a specific industry or secured by a specific collateral type that equaled or exceeded 20% of the Company’s total loan portfolio, other than loans secured by one-to four-

family properties. The ultimate collectability of a substantial portion of the loan portfolio is susceptible to changes in economic and market conditions in the region and the impact of those changes on the real estate market. The Company typically originates real estate loans with loan-to-value ratios of no greater than 90%. Collateral and/or guarantees are required for all loans.

Certain related parties of the Company, principally Bank directors and officers, are loan customers of the Bank in the ordinary course of business. Such related party loans were performing according to their repayment terms at September 30, 2018 and 2017. Activity in related party loans during the years ended September 30, 2018, 2017 and 2016 was as follows (dollars in thousands):



	2018			2017			2016
Balance, beginning of year	$	741		$	230		$	630
New loans or borrowings	368			592			66
Repayments and reclassifications	(990		)	(81		)	(466		)
Balance, end of year	$	119		$	741		$	230

Loan Segment Risk Characteristics

The Company believes that its loan classes are the same as its loan segments.

One- To Four-Family Residential Lending: The Company originates both fixed-rate and adjustable-rate loans secured by one- to four-family residences. A portion of the fixed-rate one- to four-family loans are sold in the secondary market for asset/liability management purposes and to generate non-interest income. The Company’s lending policies generally limit the maximum loan-to-value on one- to four-family loans to 90% of the lesser of the appraised value or the purchase price. However, the Company usually obtains private mortgage insurance on the portion of the principal amount that exceeds 80% of the appraised value of the property.

Multi-Family Lending: The Company originates loans secured by multi-family dwelling units (more than four units). Multi-family lending generally affords the Company an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by multi-family properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or economy. The Company attempts to minimize these risks by scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.

Commercial Mortgage Lending: The Company originates commercial real estate loans secured by properties such as office buildings, retail/wholesale facilities, motels, restaurants, mini-storage facilities and other commercial properties. Commercial real estate lending generally affords the Company an opportunity to receive interest at higher rates than those available from one- to four-family residential lending. However, loans secured by such properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial properties are often dependent on the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or economy. The Company attempts to mitigate these risks by generally limiting the maximum loan-to-value ratio to 80% and scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.

Construction Lending: The Company currently originates the following types of construction loans: custom construction loans, owner/builder construction loans, speculative construction loans, commercial real estate construction loans, multi-family construction loans and land development loans.

Construction lending affords the Company the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does its single-family permanent mortgage lending. Construction lending, however, is generally considered to involve a higher degree of risk than one- to four family residential 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. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimated cost of construction proves to be inaccurate, the Company may be required to advance funds beyond the amount originally committed to complete the project. If the estimate of value upon completion proves to be inaccurate, the Company may be confronted with a project whose value is insufficient to assure full repayment, and the Company may incur a loss. Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to construct homes for which no purchaser has been identified carry more risk because the payoff for the loan depends on the builder’s ability to sell the property prior to the time that the construction loan is due. The Company attempts to mitigate these risks by adhering to its underwriting policies, disbursement procedures and monitoring practices.

Construction Lending – Custom and Owner/Builder: Custom construction loans are made to home builders who, at the time of construction, have a signed contract with a home buyer who has a commitment to purchase the finished home. Owner/builder construction loans are originated to home owners rather than home builders and are typically refinanced into permanent loans at the completion of construction.

Construction Lending – Speculative One- To Four-Family: Speculative one-to four-family construction loans are made to home builders and are termed “speculative” because the home builder does not have, at the time of the loan origination, a signed contract with a home buyer who has a commitment for permanent financing with the Company or another lender for the finished home. The home buyer may be identified either during or after the construction period.

Construction Lending – Commercial: Commercial construction loans are originated to construct properties such as office buildings, hotels, retail rental space and mini-storage facilities.

Construction Lending – Multi-Family: Multi-family construction loans are originated to construct apartment buildings and condominium projects.

Construction Lending - Land Development: Land development loans are originated to real estate developers for the purpose of developing residential subdivisions. The Company is currently originating land development loans on a limited basis.

Land Lending: The Company originates loans for the acquisition of land upon which the purchaser can then build or make improvements necessary to build or to sell as improved lots. Loans secured by undeveloped land or improved lots involve greater risks than one- to four-family residential mortgage loans because these loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in the event of default or foreclosure, the Company may be confronted with a property value which is insufficient to assure full repayment. The Company attempts to minimize this risk by generally limiting the maximum loan-to-value ratio on land loans to 75%.

Consumer Lending – Home Equity and Second Mortgage: The Company originates home equity lines of credit and second mortgage loans. Home equity lines of credit and second mortgage loans have a greater credit risk than one- to four-family residential mortgage loans because they are secured by mortgages subordinated to the existing first mortgage on the property, which may or may not be held by the Company. The Company attempts to mitigate these risks by adhering to its underwriting policies in evaluating the collateral and the credit-worthiness of the borrower.

Consumer Lending – Other: The Company originates other consumer loans, which include automobile loans, boat loans, motorcycle loans, recreational vehicle loans, savings account loans and unsecured loans. Other consumer loans generally have shorter terms to maturity than mortgage loans. Other consumer loans generally involve a greater degree of risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The Company attempts to mitigate these risks by adhering to its underwriting policies in evaluating the credit-worthiness of the borrower.

Commercial Business Lending: The Company originates commercial business loans which are generally secured by business equipment, accounts receivable, inventory or other property. The Company also generally obtains personal guarantees from the business owners based on a review of personal financial statements. Commercial business lending generally involves risks that are different from those associated with residential and commercial real estate lending. 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 is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment, because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use. Accordingly, the repayment of a commercial business loan depends primarily on the credit-worthiness of the borrower (and any guarantors), while the liquidation of collateral is a secondary and potentially insufficient source of repayment. The Company attempts to mitigate

these risks by adhering to its underwriting policies in evaluating the management of the business and the credit-worthiness of the borrowers and the guarantors.

Allowance for Loan Losses

The following table sets forth information for the year ended September 30, 2018 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):



	Beginning Allowance		Provision for (Recapture of) Loan Losses			Charge- offs			Recoveries		Ending Allowance
Mortgage loans:
One- to four-family	$	1,082	$	4		$	—		$	—	$	1,086
Multi-family	447		(14		)	—			—		433
Commercial	4,184		92			(28		)	—		4,248
Construction – custom and owner/builder	699		(28		)	—			—		671
Construction – speculative one- to four-family	128		37			—			13		178
Construction – commercial	303		260			—			—		563
Construction – multi-family	173		(38		)	—			—		135
Construction – land development	—		49			—			—		49
Land	918		(71		)	(22		)	19		844
Consumer loans:
Home equity and second mortgage	983		(334		)	—			—		649
Other	121		1			(6		)	1		117
Commercial business loans	515		42			—			—		557
Total	$	9,553	$	—		$	(56	)	$	33	$	9,530

The following table sets forth information for the year ended September 30, 2017 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):



	Beginning Allowance		Provision for (Recapture of) Loan Losses			Charge- offs			Recoveries		Ending Allowance
Mortgage loans:
One- to four-family	$	1,239	$	(178	)	$	—		$	21	$	1,082
Multi-family	473		(26		)	—			—		447
Commercial	4,384		(1,248		)	(13		)	1,061		4,184
Construction – custom and owner/builder	619		80			—			—		699
Construction – speculative one- to four-family	130		(8		)	—			6		128
Construction – commercial	268		35			—			—		303
Construction – multi-family	316		(143		)	—			—		173
Land	820		189			(110		)	19		918
Consumer loans:
Home equity and second mortgage	939		44			—			—		983
Other	156		(28		)	(10		)	3		121
Commercial business loans	482		33			—			—		515
Total	$	9,826	$	(1,250	)	$	(133	)	$	1,110	$	9,553

The following table sets forth information for the year ended September 30, 2016 regarding activity in the allowance for loan losses by portfolio segment (dollars in thousands):



	Beginning Allowance		Provision for (Recapture of) Loan Losses			Charge- offs			Recoveries		Ending Allowance
Mortgage loans:
One- to four-family	$	1,480	$	(225	)	$	(72	)	$	56	$	1,239
Multi-family	392		81			—			—		473
Commercial	4,065		528			(209		)	—		4,384
Construction – custom and owner/builder	451		168			—			—		619
Construction – speculative one- to four-family	123		5			—			2		130
Construction – commercial	426		(158		)	—			—		268
Construction – multi-family	283		(148		)	—			181		316
Land	1,021		(164		)	(61		)	24		820
Consumer loans:
Home equity and second mortgage	1,073		(116		)	(18		)	—		939
Other	187		(25		)	(8		)	2		156
Commercial business loans	423		54			—			5		482
Total	$	9,924	$	—		$	(368	)	$	270	$	9,826

The following table presents information on loans evaluated individually and collectively for impairment in the allowance for loan losses by portfolio segment at September 30, 2018 (dollars in thousands):



	Allowance for Loan Losses						Recorded Investment in Loans
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total
Mortgage loans:
One- to four-family	$	—	$	1,086	$	1,086	$	1,054	$	114,887	$	115,941
Multi-family	—		433		433		—		61,928		61,928
Commercial	—		4,248		4,248		2,446		342,667		345,113
Construction – custom and owner/ builder	—		671		671		—		67,024		67,024
Construction – speculative one- to four-family	—		178		178		—		7,107		7,107
Construction – commercial	—		563		563		—		23,440		23,440
Construction – multi-family	—		135		135		—		5,983		5,983
Construction – land development	—		49		49		—		1,567		1,567
Land	34		810		844		243		25,303		25,546
Consumer loans:
Home equity and second mortgage	—		649		649		359		36,982		37,341
Other	—		117		117		—		3,515		3,515
Commercial business loans	63		494		557		170		42,883		43,053
Total	$	97	$	9,433	$	9,530	$	4,272	$	733,286	$	737,558



	Allowance for Loan Losses						Recorded Investment in Loans
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total
Mortgage loans:
One- to four-family	$	—	$	1,082	$	1,082	$	1,443	$	116,704	$	118,147
Multi-family	—		447		447		—		58,607		58,607
Commercial	26		4,158		4,184		3,873		325,054		328,927
Construction – custom and owner/ builder	—		699		699		—		63,538		63,538
Construction – speculative one- to four-family	—		128		128		—		4,639		4,639
Construction – commercial	—		303		303		—		11,016		11,016
Construction – multi-family	—		173		173		—		6,912		6,912
Land	125		793		918		1,119		22,791		23,910
Consumer loans:
Home equity and second mortgage	325		658		983		557		37,863		38,420
Other	—		121		121		—		3,823		3,823
Commercial business loans	—		515		515		—		44,444		44,444
Total	$	476	$	9,077	$	9,553	$	6,992	$	695,391	$	702,383

The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2018 (dollars in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Non- Accrual(1)		Past Due 90 Days or More and Still Accruing		Total Past Due		Current		Total Loans
Mortgage loans:
One- to four-family	$	557	$	—	$	545	$	—	$	1,102	$	114,839	$	115,941
Multi-family	—		—		—		—		—		61,928		61,928
Commercial	574		—		—		—		574		344,539		345,113
Construction – custom and owner/ builder	—		—		—		—		—		67,024		67,024
Construction – speculative one- to four-family	—		—		—		—		—		7,107		7,107
Construction – commercial	—		—		—		—		—		23,440		23,440
Construction – multi-family	—		—		—		—		—		5,983		5,983
Construction – land development	—		—		—		—		—		1,567		1,567
Land	40		—		243		—		283		25,263		25,546
Consumer loans:
Home equity and second mortgage	42		—		359		—		401		36,940		37,341
Other	10		16		—		—		26		3,489		3,515
Commercial business loans	—		—		170		—		170		42,883		43,053
Total	$	1,223	$	16	$	1,317	$	—	$	2,556	$	735,002	$	737,558

__________________


(1)	Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual.

The following table presents an analysis of loans by aging category and portfolio segment at September 30, 2017 (dollars in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Non- Accrual(1)		Past Due 90 Days or More and Still Accruing		Total Past Due		Current		Total Loans
Mortgage loans:
One- to four-family	$	193	$	—	$	874	$	—	$	1,067	$	117,080	$	118,147
Multi-family	—		—		—		—		—		58,607		58,607
Commercial	—		107		213		—		320		328,607		328,927
Construction – custom and owner/ builder	—		—		—		—		—		63,538		63,538
Construction – speculative one- to four-family	—		—		—		—		—		4,639		4,639
Construction – commercial	—		—		—		—		—		11,016		11,016
Construction – multi-family	—		—		—		—		—		6,912		6,912
Land	—		—		566		—		566		23,344		23,910
Consumer loans:
Home equity and second mortgage	56		—		258		—		314		38,106		38,420
Other	36		—		—		—		36		3,787		3,823
Commercial business loans	110		—		—		—		110		44,334		44,444
Total	$	395	$	107	$	1,911	$	—	$	2,413	$	699,970	$	702,383

___________________

(1) Includes non-accrual loans past due 90 days or more and other loans classified as non-accrual.

Credit Quality Indicators

The Company uses credit risk grades which reflect the Company’s assessment of a loan’s risk or loss potential. The Company categorizes loans into risk grade categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors such as the estimated fair value of the collateral. The Company uses the following definitions for credit risk ratings as part of the on-going monitoring of the credit quality of its loan portfolio:

Pass: Pass loans are defined as those loans that meet acceptable quality underwriting standards.

Watch: Watch loans are defined as those loans that still exhibit acceptable quality but have some concerns that justify greater attention. If these concerns are not corrected, a potential for further adverse categorization exists. These concerns could relate to a specific condition peculiar to the borrower, its industry segment or the general economic environment.

Special Mention: Special mention loans are defined as those loans deemed by management to have some potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the payment prospects of the loan.

Substandard: Substandard loans are defined as those loans that are inadequately protected by the current net worth and paying capacity of the obligor, or of the collateral pledged. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. If the weakness or weaknesses are not corrected, there is the distinct possibility that some loss will be sustained.

Loss: Loans in this classification are considered uncollectible and of such little value that continuance as an asset is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this loan even though partial recovery may be realized in the future. At September 30, 2018 and 2017, there were no loans classified as loss.

The following table presents an analysis of loans by credit quality indicator and portfolio segment at September 30, 2018 (dollars in thousands):



	Loan Grades
	Pass		Watch		Special Mention		Substandard		Total
Mortgage loans:
One- to four-family	$	113,148	$	882	$	581	$	1,330	$	115,941
Multi-family	61,928		—		—		—		61,928
Commercial	334,908		8,375		988		842		345,113
Construction – custom and owner / builder	66,720		304		—		—		67,024
Construction – speculative one- to four-family	7,107		—		—		—		7,107
Construction – commercial	23,440		—		—		—		23,440
Construction – multi-family	5,983		—		—		—		5,983
Construction – land development	1,567		—		—		—		1,567
Land	22,810		988		1,505		243		25,546
Consumer loans:
Home equity and second mortgage	36,697		82		—		562		37,341
Other	3,480		—		—		35		3,515
Commercial business loans	42,812		22		49		170		43,053
Total	$	720,600	$	10,653	$	3,123	$	3,182	$	737,558

The following table presents an analysis of loans by credit quality indicator and portfolio segment at September 30, 2017 (dollars in thousands):



	Loan Grades
	Pass		Watch		Special Mention		Substandard		Total
Mortgage loans:
One- to four-family	$	115,481	$	422	$	644	$	1,600	$	118,147
Multi-family	56,857		—		1,750		—		58,607
Commercial	318,717		6,059		3,540		611		328,927
Construction – custom and owner / builder	63,210		328		—		—		63,538
Construction – speculative one- to four-family	4,639		—		—		—		4,639
Construction – commercial	11,016		—		—		—		11,016
Construction – multi-family	6,912		—		—		—		6,912
Land	20,528		1,022		1,794		566		23,910
Consumer loans:
Home equity and second mortgage	37,828		152		—		440		38,420
Other	3,787		—		—		36		3,823
Commercial business loans	43,416		973		55		—		44,444
Total	$	682,391	$	8,956	$	7,783	$	3,253	$	702,383