Executive Summary / Key Takeaways

• Timberland Bancorp, operating as a community bank in Western Washington, demonstrated solid profitability growth in the first half of fiscal year 2025, driven primarily by expanding net interest margin.
• Net interest income benefited from higher yields on interest-earning assets, out pacing the increase in funding costs, reflecting effective balance sheet management in the current rate environment.
• Asset quality remains sound with a notable decrease in non-performing assets, although the loan portfolio composition and economic conditions necessitate ongoing vigilance and contribute to the provision for credit losses.
• The company maintains a strong capital position and ample liquidity, supported by significant borrowing capacity and a stable deposit base, providing flexibility for operations and strategic initiatives.
• While facing competitive pressures from larger regional banks and fintechs, TSBK leverages its community presence and invests in technology to enhance efficiency and service delivery, complementing its core real estate lending focus and commitment to shareholder returns through dividends and buybacks.

A Community Bank's Resilience in a Shifting Financial Tide

Timberland Bancorp, Inc. (NASDAQ: TSBK) stands as a deeply rooted community banking institution in Western Washington, tracing its origins back to 1915 with the establishment of Timberland Bank. Over a century later, the Bank operates through 23 offices, including its main office in Hoquiam, serving a diverse clientele across six counties with a full suite of lending and deposit services. Traditionally focused on attracting local deposits and channeling them into real estate-secured loans, TSBK has strategically evolved to include commercial business and other consumer lending, broadening its service offerings and revenue streams. This history of community focus and adaptability forms the bedrock of its current strategy, positioning it to navigate the dynamic financial landscape.

The banking sector in the Pacific Northwest is characterized by intense competition, pitting community banks like TSBK against larger regional players such as First Financial Northwest, Inc. (FFNW), Banner Corporation (BANR), and Washington Federal, Inc. (WAFD), as well as increasingly influential fintech platforms. While larger competitors often boast greater scale and more extensive digital capabilities, TSBK's strength lies in its established local presence, strong community ties, and personalized service – factors that contribute to customer loyalty and deposit retention. However, this competitive environment necessitates continuous strategic response, particularly in areas like technological adoption and operational efficiency, where larger rivals may hold an edge.

TSBK's strategic response includes targeted investments aimed at enhancing its operational capabilities and customer experience. The company has been investing in digital banking platforms and cybersecurity enhancements. While specific proprietary technological differentiators are not detailed, the strategic intent is clear: to improve efficiency and remain competitive in an increasingly digital banking world. These investments are crucial for TSBK to bridge potential technological gaps compared to rivals and streamline internal processes, which is reflected in the improvement of its efficiency ratio.

Financial Performance: Yield Strength Drives Margin Expansion

The financial results for the three and six months ended March 31, 2025, demonstrate TSBK's ability to generate improved profitability in the prevailing interest rate environment. Net income for the quarter ended March 31, 2025, rose to $6.76 million, an 18.3% increase from $5.71 million in the comparable prior-year quarter. For the six-month period, net income increased 13.4% to $13.62 million, up from $12.00 million. This growth translated into higher diluted earnings per common share, reaching $0.85 for the quarter and $1.71 for the six months ended March 31, 2025, compared to $0.70 and $1.47, respectively, in the prior year periods.

The primary driver behind this improved performance was a significant increase in net interest income. For the quarter, net interest income grew by 10.1% to $17.21 million, and for the six months, it increased by 8.0% to $34.18 million. This expansion was fueled by a higher weighted average yield on interest-earning assets, which rose to 5.48% for the quarter and 5.44% for the six months ended March 31, 2025. This yield improvement outpaced the increase in the average cost of interest-bearing liabilities, which stood at 2.47% for the quarter and 2.55% for the six months. The result was an expansion in the net interest margin (NIM) to 3.79% for the quarter and 3.71% for the six months, up from 3.48% and 3.53%, respectively, in the prior year periods.

The increase in asset yields was a direct consequence of originating new loans at higher prevailing rates and the upward repricing of adjustable-rate loans within the portfolio. The average yield on loans receivable increased to 5.90% for the quarter and 5.88% for the six months. Furthermore, the yield on the investment securities portfolio also improved, reaching 3.58% for the quarter and 3.55% for the six months, benefiting from the reinvestment of lower-yielding securities into higher-yielding instruments. While the average balance of interest-bearing liabilities increased, contributing to higher total interest expense, the favorable shift in asset yields relative to funding costs proved beneficial to the net interest margin.

Non-interest income saw a modest increase of 2.8% to $2.69 million for the quarter, primarily due to higher gains on the sale of fixed-rate one-to-four-family mortgages into the secondary market and an increase in the fair value of equity investments. However, for the six-month period, non-interest income experienced a slight decrease of 0.5% to $5.38 million, mainly impacted by lower service charges on deposits and ATM/debit card interchange fees.

Non-interest expense increased by 1.8% to $11.19 million for the quarter and 3.0% to $22.26 million for the six months. Key drivers included increased professional fees and technology and communications expenses, reflecting the aforementioned investments in digital capabilities and cybersecurity. Salary and employee benefits also increased over the six-month period due to annual adjustments. Despite these increases, the improvement in revenue led to a better efficiency ratio, which stood at 56.25% for the quarter and 56.26% for the six months, down from 60.22% and 58.34%, respectively, in the prior year periods. This indicates that the company is becoming more efficient in managing its operating costs relative to its revenue generation.

Balance Sheet Strength and Asset Quality

As of March 31, 2025, TSBK reported total assets of $1.93 billion, a slight increase from $1.92 billion at September 30, 2024. The composition of the balance sheet reflects strategic adjustments in response to market conditions.

Cash and cash equivalents saw a notable increase, reaching $191.21 million, providing enhanced liquidity.

The investment securities portfolio decreased to $226.61 million, primarily due to maturities and prepayments, partially offset by new purchases of available-for-sale securities. Net loans receivable remained relatively stable at $1.42 billion, with a decrease in construction and commercial business loans largely offset by growth in one-to-four-family loans.

The deposit base, the primary source of funding, saw a modest increase of 0.2% to $1.65 billion. While certificates of deposit and savings accounts grew, money market and non-interest-bearing demand accounts experienced decreases. This shift in deposit mix can influence funding costs, although the overall average cost of interest-bearing liabilities saw a slight decrease in the recent quarter.

Asset quality metrics showed improvement. Non-performing assets decreased significantly by 34.2% to $2.59 million at March 31, 2025, representing just 0.13% of total assets. Non-accrual loans also declined by 40.1% to $2.33 million. This improvement was mainly attributed to loan payoffs in the commercial real estate and commercial business portfolios. The provision for credit losses on loans for the recent periods was primarily influenced by changes in the loan portfolio composition and overall loan growth, rather than a significant deterioration in credit quality indicators. The allowance for credit losses on loans stood at $17.53 million at March 31, 2025, considered adequate by management based on current conditions and expected losses.

TSBK maintains a strong capital position, with the Bank exceeding all regulatory minimum capital requirements and the capital conservation buffer, classifying it as well-capitalized. This robust capital base provides a buffer against potential losses and supports future growth initiatives. Liquidity is further bolstered by significant available borrowing capacity with the Federal Home Loan Bank ($618.87 million available), the Federal Reserve ($76.03 million available), and Pacific Coast Bankers Bank ($50 million available), providing ample resources to meet funding needs and capitalize on opportunities.

Competitive Pressures and Strategic Positioning

The competitive landscape in Western Washington is dynamic, with TSBK facing pressure from various financial institutions. Larger regional banks like BANR and WAFD often possess greater scale, enabling potentially higher operational efficiencies and broader product offerings. For instance, BANR's reported higher net margins and ROE suggest a stronger financial performance profile compared to TSBK's current metrics. WAFD's focus on real estate lending mirrors TSBK's core business but with potentially greater efficiency in processing. Fintech companies, while not direct deposit-taking institutions in the same vein, compete in specific product areas like consumer lending through faster, digitally-driven processes.

TSBK's strategy appears to be one of leveraging its core strengths – deep community ties and an established branch network – while selectively investing in technology to enhance its competitive posture. The investment in digital banking and cybersecurity, while impacting expenses, is a necessary step to meet evolving customer expectations and improve internal processes. The focus on real estate lending remains central, complemented by growth in commercial and consumer portfolios. The ability to sell longer-term fixed-rate mortgages helps manage interest rate risk and generates non-interest income, a strategic lever in a rising rate environment.

While direct quantitative comparisons across all operational metrics are challenging, TSBK's improved efficiency ratio suggests that its efforts to control costs and enhance revenue generation are yielding results. Its strong capital and liquidity positions provide resilience against market volatility and competitive pressures, allowing it to continue serving its local market effectively.

Outlook and Shareholder Returns

Looking ahead, TSBK's outlook is shaped by the prevailing interest rate environment, economic conditions in its service area, and its ongoing strategic initiatives. While specific forward-looking financial guidance beyond certain operational aspects was not detailed, the company's recent performance indicates positive momentum driven by margin expansion.

A key signal of management's confidence and commitment to shareholders is the recent increase in the quarterly stock dividend rate to $0.26 per share, approved by the Board on April 22, 2025. This follows a previous dividend payment of $0.25 per share. The company expects to continue this practice, balancing the need to reinvest in the Bank with returning capital to shareholders. Furthermore, the active stock repurchase program, with 65,998 shares remaining available for purchase as of March 31, 2025, underscores this commitment to enhancing shareholder value.

Operational considerations for the remainder of fiscal year 2025 include managing the loan portfolio in response to economic trends and competitive dynamics, continuing to optimize the deposit mix, and realizing the benefits of technology investments. The company has no material capital expenditures projected for the rest of the fiscal year and no FHLB borrowings scheduled to mature, providing stability in its funding structure.

Risks to Consider

Despite the positive recent performance, several risks could impact TSBK's future results. Adverse changes in economic conditions, including inflation, recession, or slowed growth, could negatively affect loan demand, credit quality, and deposit levels. Fluctuations in interest rates remain a significant market risk, potentially impacting net interest margin depending on the pace and direction of changes. Credit risks inherent in lending activities, including potential increases in delinquencies and charge-offs, could necessitate higher provisions for credit losses, impacting profitability. Regulatory actions, including potential adjustments to the allowance for credit losses based on supervisory reviews, also pose a risk. Furthermore, the increasing adoption of AI and other emerging technologies introduces new risks, including model risk, cybersecurity threats, regulatory compliance concerns, and operational challenges, requiring robust governance and investment in mitigation strategies. Increased competitive pressures could also constrain loan and deposit growth and impact pricing.

Conclusion

Timberland Bancorp's performance in the first half of fiscal year 2025 highlights a community bank effectively leveraging its balance sheet in a complex interest rate environment. The expansion of the net interest margin, driven by improving asset yields, underscores operational strength. While facing a competitive landscape that includes larger, more technologically advanced institutions, TSBK is strategically investing in its digital capabilities and relying on its deep community ties. The sound asset quality, strong capital position, and ample liquidity provide a stable foundation. Management's commitment to shareholder returns, evidenced by the increased dividend and ongoing share repurchase program, signals confidence in the company's financial health and future prospects. Investors should monitor TSBK's ability to sustain margin performance, manage credit risk in a changing economy, and effectively execute its technology strategy to maintain its competitive standing and continue delivering value.