The Quarterly
ANCB 2011 10-K

Anchor Bancorp (ANCB) SEC Annual Report (10-K) for 2012

ANCB 2013 10-K
ANCB 2011 10-K ANCB 2013 10-K

 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

________________________

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2012                       OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number: 001-34965

ANCHOR BANCORP

(Exact Name of Registrant as Specified in its Charter)

Washington

26-3356075

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

601 Woodland Square Loop SE, Lacey, Washington

98503

(Address of principal executive offices)

(Zip Code)

Registrant's telephone number, including area code:

(360) 491-2250

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.01 per share

(Title of Class)

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


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes     X       No


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


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 definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):

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 Exchange Act).    YES   NO    X    


As of September 7, 2012, there were issued and outstanding 2,550,000 shares of the registrant's Common Stock, which are traded on the over-the-counter market through the NASDAQ Global Market under the symbol "ANCB."  The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the closing price of such stock as of December 31, 2011, was $15.8 million.  (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)


DOCUMENTS INCORPORATED BY REFERENCE


1.

Portions of the Registrant's Proxy Statement for the 2012 Annual Meeting of Stockholders.  (Part III)




ANCHOR BANCORP

2012 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS


Page

Forward-Looking Statements

(iii)

Available Information

(iv)

PART I .

Item 1. Business

1

General

1

Corporate Developments

1

Market Area

2

Lending Activities

4

Asset Quality

19

Investment Activities

28

Deposit Activities and Other Sources of Funds

32

Subsidiaries and Other Activities

37

Competition

37

Natural Disasters

37

Employees

37

How We Are Regulated

39

Taxation

50

Item 1A. Risk Factors

51

Item 2.     Properties

62

Item 3.     Legal Proceedings

63

    Item 4. Mine Safety Disclosures

63

PART II.

Item 5.     Market for Registrant's Common Equity, Related Stockholder Matters and

Issuer Purchases of Equity Securities

64

Item 6.     Selected Financial Data

65

Item 7.     Management's Discussion and Analysis of Financial Condition and Results

                  of Operations

67

Overview

67

Compliance With Regulatory Restrictions

67

Operating Strategy

68

Critical Accounting Policies

70

Comparison of Financial Condition at June 30, 2012 and June 30, 2011

71

Comparison of Operating Results for the Years Ended June 30, 2012

      and June 30, 2011

72

Comparison of Operating Results for the Years Ended June 30, 2011 and

      June 30, 2010

77

Average Balances, Interest and Average Yields/Costs

82

Yields Earned and Rates Paid

84

Rate/Volume Analysis

85

Asset and Liability Management and Market Risk

85

Liquidity

88

Contractual Obligations

89

Commitments and Off-Balance Sheet Arrangements

90

Capital

90

Impact of Inflation

91

Recent Accounting Pronouncements

91

(Table of Contents continued on following page)

(i) 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

93

Item 8.    Financial Statements and Supplementary Data

93

Item 9.    Changes in and Disagreements with Accountants on Accounting and

   Financial Disclosure

138

Item 9A. Controls and Procedures

138

Item 9B. Other Information

139

PART III.

Item 10.  Directors, Executive Officers and Corporate Governance

139

Item 11.  Executive Compensation

139

Item 12.  Security Ownership of Certain Beneficial Owners and Management

   and Related Stockholder Matters

140

Item 13.  Certain Relationships and Related Transactions and Director Independence

140

Item 14.  Principal Accountant Fees and Services

140

PART IV.

Item 15. Exhibits and Financial Statement Schedules

141

Signatures

142


As used in this report, the terms, "we," "our," and "us," and "Company" refer to Anchor Bancorp and its consolidated subsidiaries, unless the context indicates otherwise.  When we refer to "Anchor Bank" or the "Bank" in this report, we are referring to Anchor Bank, a wholly owned subsidiary of Anchor Bancorp.


(ii) 



Forward-Looking Statements


This Form 10-K, including information included or incorporated by reference, future filings by the Company on Form 10-Q, and Form 8-K, and future oral and written statements by Anchor Bancorp (the "Company") and its management may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements often include the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, but not limited to:


the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;


changes in general economic conditions, either nationally or in our market areas;


changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;


fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;


secondary market conditions for loans and our ability to sell loans in the secondary market;


results of examinations of us by the Federal Deposit Insurance Corporation ("FDIC"), the Washington State Department of Financial Institution, Division of Banks ("DFI") or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;


our compliance with regulatory enforcement actions, including the requirements and restrictions with the Order to Cease and Desist the Bank entered into with the FDIC and the DFI and the possibility that the Bank will be unable to fully comply with this enforcement action which could result in the imposition of additional requirements or restrictions;


our ability to attract and retain deposits;


increases in premiums for deposit insurance;


management's assumptions in determining the adequacy of the allowance for loan losses;


our ability to control operating costs and expenses;


the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;


difficulties in reducing risks associated with the loans on our balance sheet;


staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;


computer systems on which we depend could fail or experience a security breach;


our ability to retain key members of our senior management team;


costs and effects of litigation, including settlements and judgments;


our ability to manage loan delinquency rates;

(iii) 

increased competitive pressures among financial services companies;


changes in consumer spending, borrowing and savings habits;


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


changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules;


the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;


our ability to pay dividends on our common stock;


adverse changes in the securities markets;


inability of key third-party providers to perform their obligations to us;


changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, or the Financial Accounting Standards Board, including additional guidance and interpretation on existing accounting issues and details of the implementation of new accounting methods; and


other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services.


These developments could have an adverse impact on our financial position and our results of operations.


Any forward-looking statements are based upon management's beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements.


Available Information


The Company provides a link on its investor information page at www.anchornetbank.com to the Securities and Exchange Commission's ("SEC") website ( www.sec.gov ) for purposes of providing copies of its annual report to shareholders, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and press releases.  Other than an investor's own internet access charges, these filings are available free of charge and also can be obtained by calling the SEC at 1-800-SEC-0330.  The information contained on the Company's website is not included as part of, or incorporated by reference into, this Annual Report on Form 10-K.


(iv) 


PART I


Item 1.  Business


General


Anchor Bancorp, a Washington corporation, was formed for the purpose of becoming the bank holding company for Anchor Bank in connection with the Bank's conversion from mutual to stock form, which was completed on January 25, 2011.  In connection with the mutual to stock conversion, the Bank changed its name from "Anchor Mutual Savings Bank" to "Anchor Bank."  At June 30, 2012, we had total assets of $470.8 million, total deposits of $345.8 million and total stockholders' equity of $54.0 million.  Anchor Bancorp's business activities generally are limited to passive investment activities and oversight of its investment in Anchor Bank.  Accordingly, the information set forth in this report, including consolidated financial statements and related data, relates primarily to Anchor Bank.


Anchor Bancorp is a bank holding company and is subject to regulation by the Board of Governors of the Federal Reserve System ("Federal Reserve").  Anchor Bank is examined and regulated by the Washington State Department of Financial Institutions, Division of Banks ("DFI") and by the Federal Deposit Insurance Corporation ("FDIC").  Anchor Bank is required to have certain reserves set by the Federal Reserve and is a member of the Federal Home Loan Bank of Seattle ("FHLB" or "FHLB of Seattle"), which is one of the 12 regional banks in the Federal Home Loan Bank System ("FHLB System").


Anchor Bank is a community-based savings bank primarily serving Western Washington through our 13 full-service banking offices (including four Wal-Mart store locations) and located within Grays Harbor, Thurston, Lewis, Pierce and Mason counties, Washington. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans.  We offer a wide range of loan products to meet the demands of our customers, however, at June 30, 2012, 90.5% of our loans were collateralized by real estate. Historically, lending activities have been primarily directed toward the origination of one- to four-family construction, commercial real estate and consumer loans.  Since 1990, we have also offered commercial real estate loans and multi-family loans primarily in Western Washington. In prior years, lending activities had also included the origination of residential construction loans through brokers, in particular within the Portland, Oregon metropolitan area and increased reliance on non-core deposit sources of funds.

The executive office of the Company is located at 601 Woodland Square Loop SE, Lacey, Washington 98503, and its telephone number is (360) 491-2250.


Corporate Developments


Anchor Bank entered into an Order to Cease and Desist ("Order") with the FDIC and the Washington DFI on August 12, 2009.   On September 5, 2012, Anchor Bank's regulators, the FDIC and the DFI terminated the Order, Anchor Bank became subject to the Order primarily because of its increased level of non-performing assets, reduced capital position and pre-tax operating losses in 2010 and 2009.  The Order was a formal corrective action pursuant to which Anchor Bank agreed to take certain measures in the areas of capital, loan loss allowance determination, risk management, liquidity management, Board of Directors oversight and monitoring of compliance, and imposed certain operating restrictions on Anchor Bank, including (i) increasing, in connection with its mutual to stock conversion, and subsequently maintain, Tier 1 capital in an amount equal to or exceeding 10% of Anchor Bank's total assets; (ii) eliminating loans classified as Loss at its regulatory examination, and reducing the loans classified as Substandard and/or Doubtful as a percent of capital; (iii) enhancing its written funds management and liquidity policy and maintaining a liquidity ratio of 15%; and (iv) not increase brokered deposits unless approved by the FDIC.


The mutual to stock conversion of Anchor Mutual Savings Bank was primarily undertaken to raise capital to comply with the capital requirements set forth in the Order, strengthen Anchor Bank's capital position and to permit future managed increases in earning assets.  At June 30, 2012, our Tier 1 capital was $52.3 million, or $4.5 million in excess of the 10.0% requirement of the Order and $33.2 million in excess of the 4% Tier 1 capital requirement.  Since the Order was issued, we have successfully reduced nonaccrual loans to $8.7 million at June 30, 2012, from $42.3 million

1

at June 30, 2009. The Order was terminated as a result of the steps Anchor Bank took in complying with the Order and reducing its level of classified assets, augmenting management and improving the overall condition of the Bank. In place of the Order, Anchor Bank entered into a Supervisory Directive with the DFI.


The Supervisory Directive contains provisions concerning (i) the management and directors of Anchor Bank; (ii) restrictions on paying dividends; (iii) reductions of classified assets; (iv) maintaining  Tier 1 capital in an amount equal to or exceeding 10% of Anchor Bank's total assets; (v) policies concerning the allowance for loan and lease losses ("ALLL"); and (vi) requirements to furnish a revised three-year business plan to improve Anchor Bank's profitability and progress reports to the FDIC and DFI.


Management and the Board of Directors have and will be taking action and implementing programs to comply with the requirements of the Supervisory Directive.  In particular, the Board of Directors has increased its participation in the affairs of Anchor Bank and assumed full responsibility for the formulation and monitoring of its policies and objectives, including the development and implementation of actions, plans, policies and procedures to improve Anchor Bank's operations and financial condition.  In addition, we also have added experienced personnel to the department that monitors our loans to enable us to better identify problem loans in a timely manner and reduce our exposure to further deterioration in asset quality.

Anchor Bank believes that it is in compliance with the requirements set forth in the Supervisory Directive.


Anchor Bank has also been notified that it must notify the FDIC and DFI in writing at least 30 days prior to certain management changes. These changes include the addition or replacement of a board member, or the employment or change in responsibilities of anyone who is, who will become, or who performs the duties of a senior executive officer. In addition prior to entering into any agreement to pay and prior to making any golden parachute payment or excess nondiscriminatory severance plan payment to any institution-affiliated party, Anchor Bank must file an application to obtain the consent of the FDIC.  For additional details, see Item 1A., "Risk Factors – Risks Related to Our Business – We are subject to increased regulatory scrutiny and are subject to certain business limitations.  Further, we may be subject to more severe future regulatory enforcement actions if our financial condition or performance weakens further."


Market Area


Anchor Bank is a community-based financial institution primarily serving Western Washington including Grays Harbor, Thurston, Lewis, Pierce, and Mason counties.  We also conduct lending operations in the Portland, Oregon metropolitan area. However, our lending activities have been materially limited in recent periods.  Since the latter half of 2007, depressed economic conditions have prevailed in portions of the United States, including our market area of Western Washington and the Portland, Oregon metropolitan area, which have experienced substantial home price declines, lower levels of existing home sale activity, increased foreclosures and above average unemployment rates.  Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2012, the median home price in our five-county market area was $170,120, which was a 26.0% decline compared to the quarter ended September 30, 2007.  In addition, existing home sales in our five-county market area for the quarter ended June 30, 2012 was $17.6 million, which reflected a 2.7% increase compared to the quarter ended September 30, 2007.  Using data from the FDIC, foreclosures as a percentage of all mortgage loans in the State of Washington increased from approximately 0.32% as of September 2007 to approximately 0.41% for June 2012.  According to the Department of Labor, the average unemployment rate in the counties in our market area averaged 11.2% during June 2012 compared to 11.3% during June 2011, which reflected an increase from an average of 5.1% during September 2007.  These unemployment rates are higher than the national unemployment rates of 8.9%, 9.2% and 4.5%, as of June 2012, June 2011 and September 2007, respectively.  A continuation of the overall economic weakness in the counties in our market area could negatively impact our lending opportunities and profitability.


Grays Harbor County has a population of 72,000 and a median household income of $43,095 according to the latest information available from the U.S. Census Bureau. The economic base in Grays Harbor has been historically dependent on the timber and fishing industries.  Other industries that support the economic base are tourism, manufacturing, agriculture, shipping, transportation and technology.  The 2012 estimated median family income as

2

provided by data from the FDIC was $38,463.  Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2012, the median home price in Grays Harbor County was $115,600 compared to $121,500 for the quarter ended March 31, 2011, which reflected a decline of 35.8% from the median home price of $180,000 for the quarter ended September 30, 2007.  In addition, existing home sales in Grays Harbor County for the quarter ended June 30, 2012 declined by 26.1% from the total for the quarter ended September 30, 2007.  According to the U.S. Department of Labor, the unemployment rate in Grays Harbor County decreased to 13.2% at June 30, 2012 from 13.8% at June 30, 2011.  We have six branches (including our home office) located throughout this county.


Thurston County has a population of 256,000 and a median household income of $60,237 according to the latest information available from the U.S. Census Bureau.  Thurston County is home of Washington State's capital (Olympia) and its economic base is largely driven by state government related employment.  The 2011 estimated median family income for Thurston County as provided by data from the FDIC was $56,845. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2012, the median home price in Thurston County was $225,600, which reflects a 16.4% decline from the median home price of $270,000 for the quarter ended September 30, 2007.  In addition, existing home sales in Thurston County for the quarter ended June 30, 2012 declined by 26.4% from the quarter ended September 30, 2007. According to the U.S. Department of Labor, the unemployment rate for the Thurston County area had decreased to 8.3% at June 30, 2012 from 8.5% at June 30, 2011.  We currently have four branches in Thurston County.  Thurston County has a stable economic base primarily attributable to the state government presence.


Lewis County has a population of 75,000 and a median household income of $44,581 according to the latest information available from the U.S. Census Bureau. The economic base in Lewis County is supported by manufacturing, retail trade, local government and industrial services.  The 2012 estimated median family income for Lewis County as provided by data from the FDIC was $41,358. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2012, the median home price in Lewis County was $158,000, which is a 26.2% decline from the median home price of $214,100 for the quarter ended September 30, 2007.  In addition, existing home sales in Lewis County for the quarter ended June 30, 2012 or by 33.6% from the quarter ended September 30, 2007.  According to the U.S. Department of Labor, the unemployment rate in Lewis County increased to 13.4% at June 30, 2012 from 13.0% at June 30, 2011.  We have two branches located in Lewis County.


Pierce County is the second most populous county in the state and has a population of 813,000 and a median household income of $57,879 according to the latest information available from the U.S. Census Bureau. The economy in Pierce County is diversified with the presence of military related government employment (Lewis/McChord JBLM Base), transportation and shipping employment (Port of Tacoma), and aerospace related employment (Boeing).  The 2012 estimated median family income for Pierce County as provided by data from the FDIC was $54,956. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2012, the median home price in Pierce County was $195,200, which is a 32.4% decline from the median home price of $288,700 for the quarter ended September 30, 2007.  In addition, existing home sales in Pierce County for the quarter ended June 30, 2012 declined by 12.9% from the quarter ended September 30, 2007. According to the U.S. Department of Labor, the unemployment rate for the Pierce County area decreased to 9.8% at June 30, 2012 from 10.0% at June 30, 2011.


Mason County has a population of 59,000 and a median household income of $48,522 according to the latest information available from the U.S. Department of Labor.  The economic base in Mason County is supported by wood products.  The 2012 estimated median family income for Mason County as provided by data from the FDIC was $45,120. Based on information from the Washington Center for Real Estate Research, for the quarter ended June 30, 2012, the median home price in Mason County was $156,200, which is a 30.5% decline from the median home price of $224,700 for the quarter ended September 30, 2007.  In addition, existing home sales in Mason County for the quarter ended June 30, 2012 declined by 23.3% from the quarter ended September 30, 2007. According to the U.S. Department of Labor, the unemployment rate in Mason County increased to 11.2% at June 30, 2012 from 11.0% at June 30, 2011.  We have  one branch located in Mason County.


For a discussion regarding the competition in our primary market area, see "– Competition."

3


Lending Activities


General. Historically, our principal lending activity has consisted of the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences and loans for the construction of one- to four-family residences. We also originate consumer loans, with an emphasis on home equity loans and lines of credit. Since 1990, we have been aggressively offering commercial real estate loans and multi-family loans primarily in Western Washington.  A substantial portion of our loan portfolio is secured by real estate, either as primary or secondary collateral, located in our primary market area. As of June 30, 2012, the net loan portfolio totaled $287.8 million and represented 61.1% of our total assets. As of June 30, 2012, 28.0% of our total loan portfolio was comprised of one- to four-family loans, 10.7% of home equity loans and lines of credit, 32.9% of commercial real estate loans, 14.2% of multi-family real estate loans, 5.6% of commercial business loans, 4.7% of construction and land loans, 2.8% of unsecured consumer loans and 1.1% of secured consumer loans.


As a state chartered savings bank chartered under Washington law, we are not subject to any statutory lending limits.  At June 30, 2012, however, our internal policy limits loans to one borrower and the borrower's related entities to the lesser of 15% of our total capital or $8.0 million, without the express prior consent of the Board of Directors.  At  June 30, 2012, there were no borrowing relationships that were over the legal amount and no relationships that were over our internal limit.  Our ten largest credit relationships at June 30, 2012 were as follows:


•  

Our largest single borrower relationship at June 30, 2012, totaled $6.1 million consisting of 15 loans which range in size from $1.6 million to a line of credit of $500,000 that had a zero balance at that date.  Collateral consists primarily of owner- and non-owner-occupied light industrial commercial real estate;


•  

The second largest borrower relationship totaled $5.5 million, secured by a minority interest in a national shared credit which in turn is secured by an entertainment, hospitality and dining complex;

•  

The third largest borrower relationship totaled $5.5 million and consists of 37 loans, each of which was secured by a single family rental house, with an average balance of $147,000;


•  

The fourth largest borrower relationship consisted of two commercial real estate loans totaling $5.4 million secured by light industrial buildings;


•  

The fifth largest borrower relationship consisted of three loans totaling $5.1 million secured by office and light industrial buildings;


•  

The sixth largest borrower relationship is one loan for $4.9 million, secured by a church complex;

•  

The seventh largest borrower relationship consisted of four loans totaling $4.9 million secured by commercial income-producing properties;

•  

Our eighth largest borrower relationship is one loan for $4.6 million, secured by a commercial retail building;


•  

The ninth largest borrower relationship consisted of two loans secured by intermediate care facilities; and


•  

The tenth largest borrower relationship totaled $4.2 million, consisted of one $3.9 million loan and one $339,000 loan, and is secured by a limited service hotel managed by a national chain.


All of these relationships include personal guarantees except for the second largest (minority interest in the shared national credit), and all of the properties securing these loans are in our primary market area.  These loans were all performing according to their repayment terms as of June 30, 2012, except for the following:

4


•  

The second largest relationship of had a balloon maturity date of August 1, 2012 and as a result the entire loan is now past due.   The interest on this loan, however, remains current.  Prior to the loan's  maturity date, its renewal was successfully negotiated with the borrower by the loan participant's credit committee.  The closing has been delayed as a result of the filing of a restraining order by three of the loan  participants. A court hearing on this is scheduled for October 2012.



•  

The fourth largest borrower relationship, which consists of two commercial real estate loans, is in default, and the subject of voluntary bankruptcy filings under Chapter 11.  One loan of $3.4 million is a construction loan for the development of an industrial park, and is delinquent, past its maturity date, and construction has been halted.  The second loan of $2.0 million is secured by a first lien deed of trust and assignment of rents on other industrial park property.  This loan is currently performing in accordance with its repayment terms.  These two loans are cross collateralized, have cross default provisions, and include personal guarantees.  Recent appraisals have indicated that no valuation allowance is required.  Dismissal of the entire bankruptcy was ordered on August 29, 2012.  We currently intend to pursue the appointment of a receiver to  oversee the management of both properties, while we initiate foreclosure proceedings on these properties.




5


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


At June 30,

2012

2011

2010

2009

2008

Amount

Percent

Amount

Percent

Amount

Percent

Amount

Percent

Amount

Percent

(Dollars in Thousands)

Real Estate:

  One-to-four family

$ 82,709 28.0 % $ 97,133 29.1 % $ 112,835 27.7 % $ 114,823 22.9 % $ 114,695 23.0 %

  Multi-family

42,032 14.2 42,608 12.8 45,983 11.3 52,661 10.5 59,114 11.8

  Commercial

97,306 32.9 105,997 31.8 118,492 29.1 123,902 24.7 117,439 23.5

  Construction.

6,696 2.3 11,650 3.5 36,812 9.0 106,163 21.2 103,924 20.8

  Land loans

7,062 2.4 6,723 2.0 7,843 1.9 9,211 1.8 6,957 1.4

    Total real estate

235,805 79.8 264,111 79.2 321,965 79.1 406,760 81.2 402,129 80.5

Consumer:

  Home equity

31,504 10.7 35,729 10.7 42,446 10.4 49,028 9.8 46,790 9.4

  Credit cards

5,180 1.8 7,101 2.1 7,943 2.0 8,617 1.7 7,989 1.6

  Automobile

3,342 1.1 5,547 1.7 8,884 2.2 14,016 2.8 18,095 3.6

  Other

2,968 1.0 3,595 1.1 4,160 1.0 5,142 1.0 5,757 1.2

    Total consumer

42,994 14.6 51,972 63,433 15.6 76,803 15.3 78,631 15.7

  Commercial business

16,618 5.6 17,268 5.2 21,718 5.3 17,172 3.4 18,507 3.7

Total loans

295,417 100.0 % 333,351 100.0 % 407,116 100.0 % 500,735 100.0 % 499,267 100.0 %

Less:

  Deferred loan fees

605 648 917 1,315 1,267

  Allowance for loan losses

7,057 7,239 16,788 24,463 7,485

Loans receivable, net

$ 287,755 $ 325,464 $ 389,411 $ 474,957 $ 490,515


6





The following table shows the composition of Anchor Bank's loan portfolio by fixed- and adjustable-rate loans at the dates indicated.


At June 30,

2012

2011

2010

2009

2008

Amount

Percent

Amount

Percent

Amount

Percent

Amount

Percent

Amount

Percent

FIXED-RATE LOANS

(Dollars in Thousands)

Real estate:

  One-to-four family

$ 69,635 23.6 % $ 80,938 24.3 % $ 94,872 23.3 % $ 95,931 19.2 % $ 94,498 18.9 %

  Multi-family

33,174 11.2 32,967 9.9 33,606 8.3 42,032 8.4 55,157 11.0

  Commercial

57,449 19.4 71,493 21.4 86,667 21.3 94,567 18.9 104,680 21.0

  Land loans

6,045 2.0 5,869 1.8 7,244 1.8 8,759 1.7 6,505 1.3

     Total real estate

166,303 56.3 191,267 57.4 222,389 54.6 241,289 48.2 260,840 52.2

Real estate construction:

  One-to-four family

449 0.2 1,481 0.4 9,481 2.3 27,671 5.5 23,725 4.8

  Multi-family

1,370 0.5 -- -- -- -- -- -- 4,713 0.9

  Commercial

4,044 1.4 3,642 1.1 7,690 1.9 5,809 1.2 3,959 0.8

     Total real estate construction

5,863 2.0 5,123 1.5 17,171 4.2 33,480 6.7 32,397 6.5

Consumer:

  Home equity

20,805 7.0 25,806 7.7 31,074 7.6 36,260 7.2 45,796 9.2

  Automobile

3,342 1.1 5,547 1.7 8,884 2.2 14,016 2.8 18,095 3.6

  Other

2,968 1.0 3,510 1.1 4,084 1.0 5,078 1.0 5,741 1.1

     Total consumer

27,115 9.2 34,663 10.5 44,042 10.8 55,354 11.1 69,632 13.9

Commercial business

9,690 3.3 8,460 2.5 9,226 2.3 8,721 1.7 13,265 2.7

Total fixed-rate loans

$ 208,971 $ 239,713 $ 292,828 $ 338,844 $ 376,134

ADJUSTABLE-RATE LOANS

Real estate:

  One-to-four family

$ 13,074 4.4 $ 16,195 4.9 $ 17,963 4.4 $ 18,892 3.8 $ 20,197 4.0

  Multi-family

8,858 3.0 9,641 2.9 12,377 3.0 10,629 2.1 3,957 0.8

  Commercial

39,857 13.5 34,504 10.4 31,825 7.8 29,335 5.9 12,759 2.6

   Land loans

1,017 0.3 854 0.3 599 0.1 452 0.1 452 0.1

     Total real estate

62,806 21.3 61,194 18.4 62,764 15.4 59,308 11.8 37,365 7.5

Real estate construction:

  One-to-four family

-- -- 3,829 1.1 7,299 1.8 37,187 7.4 46,298 9.3

  Multi-family

-- -- -- -- -- -- 2,493 0.5 6,041 1.2

  Commercial

833 0.3 2,698 0.8 12,342 3.0 33,003 6.6 19,188 3.8

     Total real estate construction

833 0.3 6,527 2.0 19,641 4.8 72,683 14.5 71,527 14.3

(table continued on following page)

7

At June 30,

2012

2011

2010

2009

2008

Amount

Percent

Amount

Percent

Amount

Percent

Amount

Percent

Amount

Percent

(Dollars in Thousands)

Consumer:

  Home equity

10,699 3.6 9,923 3.0 11,372 2.8 12,768 2.6 994 0.2

  Automobile

-- -- -- -- -- -- -- -- -- --

  Credit cards

5,180 1.8 7,101 2.1 7,943 2.0 8,617 1.7 7,988 1.6

  Other

-- -- 85 -- 76 -- 64 -- 16 --

     Total consumer

15,879 5.4 17,109 5.1 19,391 4.8 21,449 4.3 8,999 1.8

Commercial business

6,928 2.3 8,808 2.6 12,492 3.1 8,451 1.7 5,242 1.0

Total adjustable rate loans

86,446 29.3 93,638 28.1 114,288 28.1 161,891 32.3 123,133 --

Total loans

295,417 333,351 407,116 500,735 499,267

Less:

  Deferred loan fees

605 648 917 1,315 1,267

  Allowance for loan losses

7,057 7,239 16,788 24,463 7,485

  Loans receivable, net

$ 287,755 $ 325,464 $ 389,411 $ 474,957 $ 490,515


8


One- to Four-Family Real Estate Lending. As of June 30, 2012, $82.7 million, or 28.0%, of our total loan portfolio consisted of permanent loans secured by one- to four-family residences. We originate both fixed rate and adjustable rate loans in our residential lending program and use Freddie Mac underwriting guidelines.  None of our residential loan products allow for negative amortization of principal.  We typically base our decision on whether to sell or retain secondary market quality loans on the rate and fees for each loan, market conditions and liquidity needs.  Although we have sold the majority of our residential loans over the last two years, we do not sell all qualified loans on the secondary market as we hold in our portfolio many residential loans that may not meet all Freddie Mac guidelines yet meet our investment and liquidity objectives.  At June 30, 2012, $69.6 million of this loan portfolio consisted of fixed rate loans.  This amount was 84.2% of our total one- to four-family portfolio and 23.6% of our total loans at that date.


Specifically, we offer fixed rate, residential mortgages from 15 to 30 year terms and we use Freddie Mac daily pricing to set our own pricing.  Borrowers have a variety of buy-down options with each loan and most mortgages have a duration of less than ten years.  The average loan duration is a function of several factors, including real estate supply and demand, current interest rates, expected future rates and interest rates payable on outstanding loans.


Additionally, we offer a full range of adjustable rate mortgage products.  These loans offer three, five or seven year fixed-rate terms with annual adjustments thereafter.  The annual adjustments are limited to increases or decreases of no more than two percent and carry a typical lifetime cap of 5% above the original rate.  At this time, we hold these adjustable rate mortgages in our portfolio.  Similar to fixed rate loans, borrower demand for adjustable rate mortgage loans is a function of the current rate environment, the expectations of future interest rates and the difference between the initial interest rates and fees charged for each type of loan. The relative amount of fixed rate mortgage loans and adjustable rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment.


While adjustable rate mortgages in our loan portfolio helps us reduce our exposure to changes in interest rates, it is possible that, during periods of rising interest rates, the risk of default on adjustable rate mortgage loans may increase as a result of annual repricing and the subsequent higher payment to the borrower.  In some rate environments, adjustable rate mortgages may be offered at initial rates of interest below a comparable fixed rate and could result in a higher risk of default or delinquency. Another consideration is that although adjustable rate mortgage loans allow us to decrease the sensitivity of our asset base as a result of changes in the interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Our historical experience with adjustable rate mortgages has been very favorable.  We do not, however, offer adjustable rate mortgages with initial teaser rates.  At June 30, 2012, $13.1 million of our permanent one- to four-family mortgage loans were adjustable rate loans.  This amount represents 15.8% of our total one- to four-family loan portfolio and 4.4% of our total loans at that date.


Regardless of the type of loan product chosen, we underwrite our residential loans based on Freddie Mac's Loan Prospector guidelines.  This underwriting considers a variety of factors such as credit history, debt to income, property type, loan to value, and occupancy, to name a few.  Generally, we use the same Freddie Mac criteria for establishing maximum loan to values and also consider whether a transaction is a purchase, rate and term refinance, or cash-out refinance. For loans above 80% loan to value, we typically require private mortgage insurance in order to reduce our risk exposure should the loan default.  Regardless of the loan to value, our one- to four-family loans are appraised by independent fee appraisers that have been approved by us and generally carry no prepayment restrictions. We also require title insurance, hazard insurance, and if necessary, flood insurance in an amount not less than the current regulatory requirements.


We also have additional products designed to make home ownership available to qualified borrowers in low to moderate income brackets.  The underwriting guidelines for these programs are usually more flexible in the areas of credit or work history.  For example, some segments of the low to moderate income population have non-traditional credit histories and pay cash for many of their consumer purchases.  They may also work in seasonal industries that do not offer a standard work schedule or salary.  Loans such as Freddie Mac's "Homestart Program" are designed to meet this market's needs and often require a borrower to show a history of saving and budgeting as well as providing education on the costs and benefits of homeownership.  We plan on continuing to offer these and other programs which reach out to qualifying borrowers in all the markets we serve.

9

The following table describes certain credit risk characteristics of Anchor Bank's single-family first trust deed mortgage loans held for investment as of June 30, 2012.


Outstanding

Principal

Balance (1)

Weighted-

Average

FICO (2)

Weighted-

Average

LTV (3)

Weighted-

Average

Seasoning (4)

(Dollars in Thousands)

Interest only

$ 2,732 694 95.0 % 36

Stated income (5)

669 718 67.0 48

FICO less than or equal to 660 (6)

6,428 620 63.0 62

__________

(1)

The outstanding balance presented on this table may overlap more than one category.

(2)

The FICO score represents the creditworthiness, as reported by an independent third party, of a borrower based on the borrower's credit history.  A higher FICO score indicates a greater degree of creditworthiness.

(3)

LTV (loan-to-value) is the ratio calculated by dividing the original loan balance by the original appraised value of the real estate collateral.  As a result of the decline in single-family real estate values, the weighted-average LTV presented above may be substantially understated to current market value.

(4)

Seasoning describes the number of months since the funding date of the loans.

(5)

Stated income is defined as a borrower provided level of income which was not subject to verification during the loan origination process.

(6)

These loans are considered "subprime" as defined by the FDIC.


Anchor Bank does not actively engage in subprime lending, either through advertising, marketing, underwriting and/or risk selection, and has no established program to originate or  purchase subprime loans to be held in its portfolio.  Residential mortgage loans identified as subprime, with FICO scores of less than 660, were originated and managed in the ordinary course of business, and totaled $6.4 million at June 30, 2012, representing 2.2% of total loans, 7.7% of one-to-four family mortgage loans, and 12.2% of Tier 1 Capital.  Our one-to-four family mortgage loans identified as subprime based on the borrower's FICO score at time the loan was originated do not represent a material part of our lending activity.  Accordingly, these loans are identified as "exclusions" as defined pursuant to regulatory guidance issued by the FDIC in Financial Institutions Letter FIL-9-2001.


Construction and Land Loans.   We had been an active originator of real estate construction loans in our market area since 1990 although recently we have been significantly reducing the balance of these loans in accordance with the Order and limited new loan originations.  At June 30, 2012, our construction loans amounted to $6.7 million, or 2.3% of the total loan portfolio, most of which is for the construction of commercial and multi-family real estate.  Included within our construction loan portfolio are $308,000 of land acquisition and development loans to developers.  Prior to fiscal 2010 a substantial number of our speculative residential construction loans for both attached and detached housing units, as well as residential land acquisition and development loans were referred through a broker relationship in Portland, Oregon, and were secured by first lien construction deeds of trust on properties in the greater Portland, Oregon metroplitan area.  We originated $2.7 million, $32.9 million and $48.9 million of construction loans through this broker during the years ended June 30, 2009, 2008, 2007 of which $700,000 remains outstanding at June 30, 2012. Much of the increase in our non-performing assets since 2007 was related to these construction loans and we ceased working with this broker.


As a result of the recent slowdown in the housing market, we have extended the terms of construction loans totaling $1.8 million at June 30, 2012 to permit completion of the project or the borrower additional time to market the underlying collateral.  All of these loans mature within 12 months.  To the extent these loans are not further extended or the borrower cannot otherwise refinance with a third party lender our non-performing construction loans may increase further.  We generally provide an interest reserve for funds on builder construction loans that have been advanced.  Interest reserves are a means by which a lender builds in, as a part of the loan approval and as a component of the cost of the project, the amount of the monthly interest required to service the debt during the construction period of the loan.  

10

At June 30, 2012, our construction loan portfolio did not contain any loans which had been previously extended or renewed and which included unfunded interest reserves.  Our entire construction loan portfolio at June 30, 2012 consisted of loans requiring interest only payments, two of which totaled $1.3 million and were relying on the interest reserve to make this payment. At June 30, 2012, no construction loans were delinquent more than 90 days and accruing interest and one commercial real estate construction loan totaling $3.4 million was on non-accrual status.  This loan is in bankruptcy with foreclosure likely in fiscal 2013.  During the years ended June 30, 2012, 2011, and 2010, seven, 22 and 27 construction loans were charged-off totaling $561,000, $8.9 million and $5.0 million, respectively.


At the dates indicated, the composition of our construction portfolio was as follows:


At June 30,

2012

2011

2010

(In Thousands)

One-to-four family:

  Speculative

$ 308 $ 3,984 $ 9,448

  Permanent

-- 1,326 --

  Custom

141 2,053 9,468

  Land acquisition and development loans

833 -- 11,100

Multi-family

1,370 -- --

Commercial real estate:

  Construction

4,044 4,287 6,796

Total construction (1)

$ 6,696 $ 11,650 $ 36,812

           ___________

(1)

Loans in process for these loans at June 30, 2012, 2011 and 2010 were $1.9 million, $1.4 million and $3.2 million, respectively.


For the year ended June 30, 2012 we originated two builder construction loans to fund the construction of one- to four-family properties totaling $284,000, as compared to none during the years ended June 30, 2011 and 2012 and the origination of 17 loans during the year ended June 30, 2009, aggregating $6.0 million.  We originate construction and site development loans to experienced contractors and builders in our primary market area primarily to finance the construction of single-family homes and subdivisions, which homes typically have an average price ranging from $200,000 to $500,000.  All builders were qualified using the same standards as other commercial loan credits, requiring minimum debt service coverage ratios and established cash reserves to carry projects through construction completion and sale of the project. The maximum loan-to-value limit on both pre-sold and speculative projects is generally up to 75% of the appraised market value or sales price upon completion of the project. We generally do not require any cash equity from the borrower if there is sufficient equity in the land being used as collateral. Development plans are required from builders prior to making the loan. We also require that builders maintain adequate insurance coverage. Maturity dates for residential construction loans are largely a function of the estimated construction period of the project, and generally did not exceed 18 months for residential subdivision development loans at the time of origination. Substantially all of our residential construction loans have adjustable rates of interest based on The Wall Street Journal prime rate and during the term of construction, the accumulated interest is added to the principal of the loan through an interest reserve. Construction loan proceeds are disbursed periodically in increments as construction progresses and as inspection by our approved inspectors warrant.  At June 30, 2012, our largest builder and sole remaining relationship consisted of one loan for $308,000.


We have made, from time to time, construction loans for commercial development projects. These projects include multi-family, apartment, retail, office/warehouse and office buildings. These loans generally have an interest-only phase during construction, and generally convert to permanent financing when construction is completed. Disbursement of funds is at our sole discretion and is based on the progress of construction. The maximum loan-to-value limit applicable to these loans is generally 75% of the appraised post-construction value.  Additional analysis and underwriting

11

of these loans typically results in lower loan to value ratios based on the debt service coverage analysis, including our interest rate and vacancy stress testing.  Our target minimum debt coverage ratio is 1.20 for loans on these projects. At June 30, 2012 our portfolio of construction loans for commercial projects included five loans totaling $5.4 million of which one commercial real estate loan of $3.4 million secured by light industrial office warehouse property located in Puyallup, Washington and is on non-accrual status.  The other four construction loans consisted of two multi-family complexes, rehabilitation of a multi-family complex, and one school remodel project all in Washington.


Properties which are the subject of a construction loan are monitored for progress through our construction loan administration department, and include monthly site inspections, inspection reports and photographs provided by a qualified staff inspector or a licensed and bonded third party inspection service contracted by and for us.  If we make a determination that there is deterioration, or if the loan becomes non-performing, we halt any disbursement of those funds identified for use in paying interest and bill the borrower directly for interest payments.  Construction loans with interest reserves are underwritten similarly to construction loans without interest reserves.

We have originated land acquisition and development loans to local contractors and developers for the purpose of holding the land for future development. These loans are secured by a first lien on the property, are generally limited up to 75% of the lower of the acquisition price or the appraised value of the land or sales price, and generally have a term of one to two years with a fixed interest rate based on the prime rate. Our land acquisition and development loans are generally secured by property in our primary market area. We require title insurance and, if applicable, a hazardous waste survey reporting that the land is free of hazardous or toxic waste.


At June 30, 2012, our land acquisition and development loans totaled $833,000.  We also originate land loans.  These loans are typically made to individual consumers to buy a lot or parcel of land for the future construction of the buyer's primary residence and are included in "land loans".   At June 30, 2012, our land loans to individuals totaled $7.1 million or 2.4% of the total loan portfolio.


Construction lending contains the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost (including interest) of the project.  If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project.  If the estimate of value upon completion proves to be inaccurate, we may be confronted at, or prior to, the maturity of the loan with a project the value of which is insufficient to assure full repayment.  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 to us than construction loans to individuals on their personal residences. This type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. In addition, generally during the term of a construction loan, no payment from the borrower is generally required since the accumulated interest is added to the principal of the loan through an interest reserve.  Land loans 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 the supply and demand conditions.  As a result, construction lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property rather than the ability of the borrower or guarantor themselves to repay principal and interest.


Commercial and Multi-Family Real Estate Lending.   As of June 30, 2012, $139.3 million, or 47.2%  of our total loan portfolio was secured by commercial and multi-family real estate property.  Of this amount, $26.2 million was identified as owner occupied commercial real estate, and the remainder or $113.1 million, or 38.3% of our total loan portfolio was secured by income producing, or non-owner occupied commercial real estate.  In accordance with the Order, we have been reducing the balance of our commercial real estate loans.  Our commercial real estate loans include loans secured by hotels and motels, office space, office/warehouse, retail strip centers, self-storage facilities, mobile home parks, medical and professional office buildings, and assisted living facilities in our market area.  As of June 30, 2012, commercial real estate loans totaled $97.3 million, or 32.9% of our portfolio and multi-family real estate totaled $42.0 million, or 14.2% of our portfolio.  These loans generally are priced at a higher rate of interest than one- to four-family loans. Typically, these loans have higher loan balances, are more difficult to evaluate and monitor, and involve a greater degree of risk than one- to four-family loans. Often payments on loans secured by commercial or

12

multi-family properties are dependent on the successful operation and management of the property; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. We generally require and obtain loan guarantees from financially capable parties based upon the review of personal financial statements. If the borrower is a corporation, we generally require and obtain personal guarantees from the corporate principals based upon a review of their personal financial statements and individual credit reports.


The average loan size in our commercial and multi-family real estate portfolio was $770,000 as of June 30, 2012.  We target individual commercial and multi-family real estate loans to small and mid-size owner occupants and investors in our market area, between $1.0 million and $6.0 million. At June 30, 2012, the largest commercial loan in our portfolio was a $5.5 million purchased minority interest in a loan secured by a dining, entertainment, and hotel facility, located near Olympia, Washington.  Our largest multi-family loan as of June 30, 2012, was an 75 unit apartment complex with an outstanding principal balance of $2.9 million, located in Pacific, Washington.  These loans were performing according to repayment terms as of June 30, 2012.


We offer both fixed and adjustable rate loans on commercial and multi-family real estate loans. Loans originated on a fixed rate basis generally are originated at fixed terms up to ten years, with amortization terms up to 30 years. As of June 30, 2012, we had $33.2 million and $8.9 million in fixed and adjustable rate multi-family loans, respectively, and $57.4 million and $39.9 million in fixed and adjustable rate commercial real estate loans, respectively.


Commercial and multi-family real estate loans are originated with rates that generally adjust after an initial period ranging from three to ten years. Adjustable rate multi-family and commercial real estate loans are generally priced utilizing the applicable FHLB or U.S. Treasury Term Borrowing Rate plus an acceptable margin. These loans are typically amortized for up to 30 years with a prepayment penalty.  The maximum loan to value ratio for commercial and multi-family real estate loans is generally 75%.  We require appraisals of all properties securing commercial and multi-family real estate loans, performed by independent appraisers designated by us.  We require our commercial and multi-family real estate loan borrowers with outstanding balances in excess of $750,000, or a loan to value in excess of 60% to submit annual financial statements and rent rolls on the subject property.  The properties that fit within this profile are also inspected annually, and an inspection report and photograph are included.  We generally require a minimum pro forma debt coverage ratio of 1.20 times for loans secured by commercial and multi-family properties.


The following is an analysis of the types of collateral securing our commercial real estate and multi-family loans at June 30, 2012.

Collateral

Amount

Percent of

Total

(Dollars in Thousands)

Multi-family

$ 42,032 30.2 %

Office

18,166 13.0

Hospitality

11,457 8.2

Mini storage

21,675 15.6

Mobile home park

4,228 3.0

Congregate care

6,803 4.9

Retail

68 --

Education/Worship

5,254 3.8

Other non-residential

29,655 21.3

     Total

$ 139,338 100.0 %

If we foreclose on a multi-family or commercial real estate loan, our holding period for the collateral typically is longer than for one- to four-family mortgage loans because there are fewer potential purchasers of the collateral. Additionally, as a result of our increasing emphasis on this type of lending, a portion of our multi-family and commercial real estate loan portfolio is relatively unseasoned and has not been subjected to unfavorable economic conditions. As a result, we may not have enough payment history with which to judge future collectibility or to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our historical

13

experience, which could adversely affect our future performance. Further, our multi-family and commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, if we make any errors in judgment in the collectibility of our commercial real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios. At June 30, 2012 , there were no commercial real estate loans or multi-family loans that were delinquent in excess of 90 days and on non-accrual status.  Commercial real estate loan charge offs for the years ended June 30, 2012, 2011 and 2010 were $571,000, $584,000 and  $31,000, respectively.  There were no multi-family loan charge-offs during these periods.


Consumer Lending.   We offer a variety of consumer loans, including home equity loans and lines of credit, automobile loans, credit cards and personal lines of credit. At June 30, 2012, the largest component of the consumer loan portfolio consisted of home equity loans and lines of credit, which totaled $31.5 million, or 10.7%, of the total loan portfolio.  Our equity loans are risk priced based on credit score, loan to value and overall credit quality of the applicant.  Home equity loans are made for, among other purposes, the improvement of residential properties, debt consolidation and education expenses. The majority of these loans are secured by a second deed of trust on residential property.  Fixed rate terms are available up to 240 months, and our equity line of credit is a prime rate based loan with the ability to lock in portions of the line for five to 20 years.  Maximum loan to values are dependent on creditworthiness and may be originated at up to 95% of collateral value.


Our credit card portfolio includes both VISA and MasterCard brands, and totaled $5.2 million, or 1.8% of the total loan portfolio at June 30, 2012.  We have been offering credit cards for more than 20 years, and currently offer only business credit card products.  All of our credit cards have interest rates and credit limits determined by the creditworthiness of the borrower.  We use credit bureau scores in addition to other criteria such as income in our underwriting decision process on these loans.


Our automobile loan portfolio totaled $3.3 million, or 1.1% of the total loan portfolio at June 30, 2012.  We offer several options for vehicle purchase or refinance with a maximum term of 84 months for newer vehicles and 72 months for older vehicles.  As with home equity loans, our vehicle and recreational vehicle loans are risk priced based on creditworthiness, loan term and loan-to-value.  We currently access a Carfax Vehicle Report to ensure that the collateral being loaned against is acceptable and to protect borrowers from a "lemon" or other undesirable histories.


Consumer loans entail greater 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 these 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 remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment.  In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans.  These risks are not as prevalent with respect to our consumer loan portfolio because a large percentage of the portfolio consists of home equity lines of credit that are underwritten in a manner such that they result in credit risk that is substantially similar to one- to four-family mortgage loans.  Nevertheless, home equity lines of credit have greater credit risk than one- to four-family  mortgage loans because they are secured by mortgages subordinated to the existing first mortgage on the property, which we may or may not hold and do not have private mortgage insurance coverage.  At June 30, 2012, consumer loans of $242,000 were delinquent in excess of 90 days or in nonaccrual status.  Consumer loans of $1.4 million were charged off during the year ended June 30, 2012 compared to $1.9 million and $2.0 million of consumer loans that were charged-off during the years ended June 30, 2011 and 2010, respectively, primarily as a result of increased delinquencies on our credit cards.


Commercial Business Lending.   These loans are primarily originated as conventional loans to business borrowers, which include lines of credit, term loans and letters of credit.  These loans are typically secured by collateral and are used for general business purposes, including working capital financing, equipment financing, capital investment and general investments.  Loan terms vary from one to seven years.  The interest rates on such loans are generally floating rates indexed to The Wall Street Journal prime rate.  Inherent with our extension of business credit is the business deposit

14

relationship which frequently includes multiple accounts and related services from which we realize low cost deposits plus service and ancillary fee income.


Commercial business loans typically have shorter maturity terms and higher interest spreads than real estate loans, but generally involve more credit risk because of the type and nature of the collateral. We are focusing our efforts on small- to medium-sized, privately-held companies with local or regional businesses that operate in our market area. Our commercial business lending policy includes credit file documentation and analysis of the borrower's background, capacity to repay the loan, the adequacy of the borrower's capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower's past, present and future cash flows is also an important aspect of our credit analysis. We generally obtain personal guarantees on our commercial business loans.  At June 30, 2012, commercial business loans totaled $16.6 million, or 5.6% of our loan portfolio comprised of 161 loans in 93 different business classifications as identified by the North American Industrial Classification System.  The largest commercial business relationship at June 30, 2012 included four loans whish totalled $2.4 million to a borrower located in Washington and involved in the manufacture of veneer, plywood and engineered wood projects.  These loans are on non-accrual status as the borrower is operating under a Chapter 11 bankruptcy filing.


Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. Our commercial business loans are originated primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral consists of accounts receivable, inventory or equipment. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any. As a result, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.  For the year ended June 30, 2012, Anchor Bank charged off $63,000 from its commercial business loan portfolio.


Loan Maturity and Repricing .  The following table sets forth certain information at June 30, 2012 regarding the dollar amount of loans maturing in our portfolio based on their contractual terms to maturity, but does not include scheduled payments or potential prepayments.  Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.  Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses.


After

After

After

One Year

3 Years

5 Years

Within

Through

Through

Through

Beyond

One Year

3 Years

5 Years

10 Years

10 Years

Total

(In Thousands)

Real Estate:

  One-to-four family

$ 6,103 $ 3,957 $ 5,357 $ 4,923 $ 62,369 $ 82,709

  Multi-family

2,588 8,379 4,199 14,012 12,854 42,032

  Commercial

16,450 34,250 21,430 20,533 4,643 97,306

  Construction

5,326 1,280 -- -- 90 6,696

  Land loans

3,553 2,486 531 -- 492 7,062

     Total real estate

34,020 50,352 31,517 39,468 80,448 235,805

Consumer:

  Home equity

48 882 2,129 12,170 16,275 31,504

  Credit cards

5,180 -- -- -- -- 5,180

  Automobile

182 1,116 816 359 869 3,342

  Other

360 476 290 199 1,643 2,968

     Total consumer

5,770 2,474 3,235 12,728 18,787 42,994

Commercial business

5,561 4,043 3,762 2,997 255 16,618

Total

$ 45,351 $ 56,869 $ 38,514 $ 55,193 $ 99,490 $ 295,417


15


The following table sets forth the dollar amount of all loans due after June 30, 2013, which have fixed interest rates and have floating or adjustable interest rates.


Fixed

Floating or

Rates

Adjustable Rates

Total

(In Thousands)

Real Estate:

  One-to-four family

$ 63,583 $ 13,023 $ 76,606

  Multi-family

30,586 8,858 39,444

  Commercial

47,738 33,118 80,856

  Construction

1,370 -- 1,370

  Land loans

2,918 591 3,509

     Total real estate

146,195 55,590 201,785

Consumer:

  Home equity

20,782 10,674 31,456

  Automobile

3,160 -- 3,160

  Other

2,608 -- 2,608

     Total consumer

26,550 10,674 37,224

     Commercial business

7,981 3,076 11,057

Total

$ 180,726 $ 69,340 $ 250,066

Loan Solicitation and Processing   Loan originations are obtained from a variety of sources, including follow up, direct mail and telephone solicitation, trade and business organization participation.  Our management and staff are also involved in a wide variety of professional, charitable, service and social organizations within the communities in which we operate, and our branch managers, loan representatives and business bankers solicit referrals from existing clients and new prospects.  We also originate and cross sell loans and services to our existing customer base as well as our walk-in/call-in/internet traffic as a result of our long standing community presence and broad based advertising efforts.  Loan processing and underwriting, closing and funding are determined by the type of loan.. Consumer loans, including conforming one-to-four family  mortgage loans are processed, underwritten, documented and funded through our centralized processing and underwriting center located in Aberdeen, Washington.  Commercial business loans, including commercial and multi-family real estate loans and any non-conforming one-to-four family mortgage loans are processed and underwritten in one of our two Business Banking Center offices located in Lacey and Aberdeen, Washington. Our consumer and residential loan underwriters have specific approval authority, and requests that exceed such authority are referred to the appropriate supervisory level.


Depending upon the size of the loan request and the total borrower credit relationship with us, loan decisions may include the Executive Loan Committee, Senior Loan Committee, and/or Board of Directors.  Credit relationships up to $4 million may be considered by the Executive Loan Committee.  Loans or aggregated credit relationships which exceed $4 million must be approved by the Board of Directors, either in the form of its Senior Loan Committee with an authority limit of $6 million, or by the full membership of the Board.


Commercial and multi-family real estate loans can be approved up to $250,000 by the Chief Financial Officer, and up to $500,000 by any of the Credit Administrator, Business Banking Manager or Loan Operations Officer.  These loans can be approved up to $1.0 million by either the President/Chief Executive Officer or Chief Lending Officer, and up to $2.0 million with the combination of both President/Chief Executive Officer and Chief Lending Officer.  Our Executive Loan Committee, which presently consists of the President/Chief Executive Officer, Chief Financial Officer, Chief Lending Officer, Credit Administrator,  Business Banking Manager, Note Department Manager, and Loan Operations Manager is authorized to approve loans to one borrower or a group of related borrowers up to $4.0 million.  Loans over $4.0 million must be approved by the Senior Loan Committee of the Board with a limit of $6.0 million, or the full Board of Directors.

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Loan Originations, Servicing, Purchases and Sales.   During the years ended June 30, 2012 and 2011, our total loan originations were $55.8 million and $30.8 million, respectively.


One- to four-family loans are generally originated in accordance with the guidelines established by Freddie Mac, with the exception of our special community development loans under the Community Reinvestment Act. We utilize the Freddie Mac Loan Prospector, an automated loan system to underwrite the majority of our residential first mortgage loans (excluding community development loans). The remaining loans are underwritten by designated real estate loan underwriters internally in accordance with standards as provided by our Board-approved loan policy.


We actively sell the majority of our residential fixed rate first mortgage loans to the secondary market at the time of origination. During the years ended June 30, 2012 and 2011, we sold $20.6 million and $15.5 million, respectively, in whole loans to the secondary market and $4.7 million and $0, respectively, were securitized.  The increase in whole loan sales and securitizations was attributable to an increase in the origination of one-to four-family  loans to $26.8 million from $15.8 million during the years ended June 30, 2012 and 2011, respectively.  Our secondary market relationships are with Freddie Mac and Branch Bank & Trust.  We generally retain the servicing on the loans we sell into the secondary market.  Loans are generally sold on a non-recourse basis. As of June 30, 2012, our residential loan servicing portfolio was $124.5 million.




17


The following table shows total loans originated, purchased, sold and repaid during the periods indicated.

Year Ended June 30,

2012

2011

2010

Loans originated:

(In Thousands)

Real estate:

  One-to- four family

$ 26,840 $ 15,819 $ 41,401

  Multi-family

6,682 1,976 580

  Commercial

12,415 3,101 4,677

  Construction

4,385 1,319 8,281

  Land loans

117 355 655

    Total real estate

50,439 22,570 55,594

Consumer:

  Home equity

204 397 1,920

  Credit cards

-- -- 13

  Automobile

295 467 475

  Other

615 840 1,126

    Total consumer

1,114 1,704 3,534

  Commercial business

4,284 6,549 8,081

Total loans originated

55,837 30,823 67,209

Loans purchased:

Real estate loans:

  One- to four-family

-- -- --

  Multi-family

-- -- --

  Commercial

-- -- --

  Construction

-- -- --

    Total real estate

-- -- --

    Total loans purchased

-- -- --

Loans sold:

  One-to-four family (1)

20,641 15,503 38,846

   Commercial real estate

-- -- 4,250

  Participation loans

20,641 -- --

  Total loans sold

15,503 43,096

Principal repayments

55,030 46,678 62,097

Loans securitized

4,682 -- 5,016

Transfer to real estate owned

11,810 11,615 30,220

Increase (decrease) in other items, net

(1,071 ) (20,749 ) (8,310 )

Loans held for sale

312 225 4,016

Net increase (decrease) in loans

   receivable, net

$ (37,709 ) $ (63,947 ) $ (85,546 )

__________

(1)           Including $13.2 million of fixed rate loans from our loan portfolio for the year ended June 30, 2010.


Loan Origination and Other Fees.   In some instances, we receive loan origination fees on real estate related products.  Loan fees generally represent a percentage of the principal amount of the loan that is paid by the borrower. Accounting standards require that certain fees received, net of certain origination costs, be deferred and amortized over the contractual life of the loan. Net deferred fees or costs associated with loans that are prepaid or sold are recognized

18

as income at the time of prepayment. We had $605,000 of net deferred loan fees and costs as of June 30, 2012 compared to $648,000 and $917,000 at June 30, 2011 and 2010, respectively.


Asset Quality


The objective of our loan review process is to determine risk levels and exposure to loss. The depth of review varies by asset types, depending on the nature of those assets. While certain assets may represent a substantial investment and warrant individual reviews, other assets may have less risk because the asset size is small, the risk is spread over a large number of obligors or the obligations are well collateralized and further analysis of individual assets would expand the review process without measurable advantage to risk assessment. Asset types with these characteristics may be reviewed as a total portfolio on the basis of risk indicators such as delinquency (consumer and residential real estate loans) or credit rating. A formal review process is conducted on individual assets that represent greater potential risk. A formal review process is a total reevaluation of the risks associated with the asset and is documented by completing an asset review report. Certain real estate-related assets must be evaluated in terms of their fair market value or net realizable value in order to determine the likelihood of loss exposure and, consequently, the adequacy of valuation allowances.


We define a loan as being impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due under the contractual terms of the loan agreement. Large groups of smaller balance homogenous loans such as consumer secured loans, residential mortgage loans and consumer unsecured loans are collectively evaluated for potential loss. All other loans are evaluated for impairment on an individual basis.


We generally assess late fees or penalty charges on delinquent loans of five percent of the monthly payment amount due. Substantially all fixed rate and adjustable rate mortgage loan payments are due on the first day of the month, however, the borrower is given a 15-day grace period to make the loan payment. When a mortgage loan borrower fails to make a required payment when it is due, we institute collection procedures. The first notice is mailed to the borrower on the 16th day requesting payment and assessing a late charge. Attempts to contact the borrower by telephone generally begin upon the 30th day of delinquency. If a satisfactory response is not obtained, continual follow-up contacts are attempted until the loan has been brought current. Before the 90th day of delinquency, attempts to interview the borrower are made to establish the cause of the delinquency, whether the cause is temporary, the attitude of the borrower toward the debt and a mutually satisfactory arrangement for curing the default.


When a consumer loan borrower fails to make a required payment on a consumer loan by the payment due date, we institute the same collection procedures as for our mortgage loan borrowers.


The Board of Directors is informed monthly as to the number and dollar amount of mortgage and consumer loans that are delinquent by more than 30 days, and is given information regarding classified assets.


If the borrower is chronically delinquent and all reasonable means of obtaining payments have been exercised, we will seek to recover the collateral securing the loan according to the terms of the security instrument and applicable law.  In the event of an unsecured loan, we will either seek legal action against the borrower or refer the loan to an outside collection agency.




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Non-performing Assets.   The following table sets forth information with respect to our non-performing assets and restructured loans for the periods indicated.

At June 30,

2012

2011

2010

2009

2008

Loans accounted for on a nonaccrual basis:

(Dollars in Thousands)

Real estate:

  One-to-four family

$ 1,878 $ 3,113 $ 3,855 $ 3,803 $ 337

  Multi-family

-- -- -- -- --

  Commercial

-- 2,280 433 -- 51

  Construction

3,369 4,055 13,964 36,954 6,719

  Land loans

109 90 -- -- --

    Total real estate

5,356 9,538 18,252 40,757 7,107

Consumer:

  Home equity

159 121 70 347 190

  Credit cards

16 -- -- -- --

  Automobile

66 63 63 190 92

  Other

1 9 47 54 9

    Total consumer

242 193 180 591 291

    Commercial business

3,124 1,245 1,324 997 --

Total

8,722 10,976 19,756 42,345 7,398

Accruing loans which are contractually past

  due 90 days or more:

  One-to-four family

55 44 -- -- --

  Multi-family

-- -- -- -- --

  Commercial

-- -- -- -- 598

  Construction

-- 2,845 822 17,575 15,298

  Land loans

-- -- -- -- --

    Total real estate

55 2,889 822 17,575 15,896

Consumer:

  Home equity

-- 1 -- -- 15

  Credit cards

-- 137 -- -- --

  Automobile

-- -- -- -- --

  Other

-- 42 64 143 61

    Total consumer

-- 180 64 143 76

    Commercial business

-- 124 -- 586 --

Total of nonaccrual and 90 days past due

  loans

8,722 14,169 20,642 60,649 23,370

Real estate owned

6,708 12,597 14,570 2,990 1,524

Repossessed automobiles

-- 130 21 69 109

     Total non-performing assets

$ 15,430 $ 26,896 $ 35,233 $ 63,708 $ 25,003

Restructured loans

$ 15,112 $ 15,034 $ 13,491 $ 2,670 $ --

Allowance for loan loss as a percent of

  non-performing loans

80.9 % 51.1 % 81.3 % 40.3 % 32.0 %

Classified assets included in non-

  performing assets

$ 8,722 $ 14,169 $ 20,642 $ 60,649 $ 23,370

Nonaccrual and 90 days or more past due

  loans as a percentage of total loans

3.0 % 4.3 % 5.1 % 12.1 % 4.7 %

Nonaccrual and 90 days or more past due

  loans as a percentage of total assets

1.9 % 2.9 % 3.8 % 9.2 % 3.7 %

 Non-performing assets as a percentage of

    total assets

3.3 % 5.5 % 6.5 % 9.8 % 4.0 %

Nonaccrued interest (1)

$ 665 $ 783 $ 731 $ 2,664 $ 2,335

_______

(1)    Represents foregone interest on nonaccural loans.


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 With the exception of $3.4 million in construction and land loans that were past due 90 days at June 30, 2012, all of our construction loans from which repayment is delayed are a result of the slowdown in the real estate market and, in many cases, a corresponding decline in the value of the collateral. As a result of a decline in home sales and value, Anchor Bank has undertaken to re-evaluate the collectability of interest payments, the efficacy of collateral for these loans, including updated and/or new appraisals, identify additional collateral and or curtailment opportunities with borrowers, and update current and future exit strategies as part of its portfolio risk management.

 Real Estate Owned and Other Repossessed Assets.   As of June 30, 2012, we had 71 properties in real estate owned with an aggregate book value of $6.7 million.  The largest of these properties had an aggregate book value of  $746,000 and consisted of a commercial real estate property located in Bremerton, Washington.  At June 30, 2012, we had 18 one-to-four family properties with an aggregate book value of $3.4 million, two one-to-four family condominium units with an aggregate book value of $415,000, 41 residential building lots with an aggregate book value of $1.1 million, five vacant land parcels with an aggregate book value of $125,000, and five parcels of commercial real estate with an aggregate book value of $1.6 million.  The geographic distribution of our real estate owned is limited to southwest Washington and the greater Portland area of northwest Oregon, with 62 of the parcels in Washington and the remaining nine in Oregon.

 Restructured Loans. According to generally accepted accounting principles, we are required to account for certain loan modifications or restructurings as "troubled debt restructurings." Our policy is to track and report all loans modified to terms not generally available in the market, except for those outside of the materiality threshold established for such tracking and reporting.  Loans with principal balances of less than $50,000, and loans with temporary modifications of six months or less are deemed to be immaterial and not included within the tracking and reporting of troubled debt restructurings. In general, the modification or restructuring of a debt is considered a troubled debt restructuring if we, for economic or legal reasons related to a borrower's financial difficulties, grant a concession to the borrower that we would not otherwise consider.  We will modify the loan when upon completion of the residence the home is rented instead of sold, or when the borrower can continue to make interest payments and is unable to repay the loan until the property is sold as a result of current market conditions. In connection with a loan modification, we may lower the interest rate, extend the maturity date and require monthly payments when monthly payments are not otherwise required. We may also require additional collateral. All loans which are extended with rates and/or terms below market are identified as impaired loans and an appropriate allowance is established pursuant to generally accepted accounting principles.  A loan guarantee, in and by itself, is not considered in either the classification of an impaired loan, the determination of the amount of the allowance or the carrying value of the loan, unless the guarantor provides additional collateral which, when independently evaluated, reduces or eliminates the conditions which caused the loan to be determined as impaired. Accordingly, the existence of a loan guarantee does not result in the carrying value of an impaired loan at a value in excess of the appraised value of the collateral.  Loans which are placed in non-accrual status and subsequently modified are not returned to accruing status until there has been at least three months of consecutive satisfactory performance.  As of June 30, 2012, there were 30 loans with aggregate net principal balances of $15.1 million that we have identified as "troubled debt restructures."  In connection with these loans, a valuation allowance in the form of charged-off principal equal to $1.0 million has been taken.  Of these 30 loans, four loans totaling $1.2 million was not performing according to its modified repayment terms at June 30, 2012.

 The existence of a guarantor is an important factor that we consider in every deteriorating credit relationship and in our determination as to whether or not to restructure the loan.  Additional factors we consider include the cooperation we receive from the borrower and/or guarantor as determined by the timeliness and quality of their direct and indirect communication, including providing us with current financial information; their willingness to develop new, and report on, previously identified risk mitigation strategies; and whether we receive additional collateral.  The financial wherewithal of the borrower and/or guarantor is determined through a review and analysis of personal and business financial statements, tax return filings, liquidity verifications, personal and business credit reports, rent rolls, and direct reference checks.  The type of financial statements required of a borrower and/or guarantor varies based upon the credit risk and our aggregate credit exposure as it relates to the borrower and any guarantor. Audited financial statements are required for commercial business loans greater than $1.5 million and for commercial real estate loans greater than $10 million, with the level of outside independent accounting review decreasing as our risk exposure decreases.  We conduct

21

reviews of the financial condition of borrowers and guarantors at least annually for credits of $750,000 or more, and for aggregate relationships of $1.5 million or more.

 At both the time of loan origination and when considering a restructuring of a loan, we also assess the guarantor's character and reputation. This assessment is made by reviewing both the duration or length of time such guarantor has been providing credit guarantees, the aggregate of the contingent liabilities of such guarantor as it relates to guarantees of additional debt provided to other lenders, and the results of direct reference checks.  Cooperative and communicative borrowers and/or guarantors may create opportunities for restructuring a loan, however, this cooperation does not affect the amount of the allowance for loan losses recorded or the timing of charging off the loan.


 We pursue guarantees where the cost/benefit analysis results in the likelihood of some recovery.  Since 2008, we have pursued the guarantors on approximately 20 credit relationships, 15 of which have resulted in legal or negotiated guarantor settlements resulting in loss mitigation ranging from approximately 10% up to 100% of the potential unmitigated loan loss.  The other five guarantors we have pursued have not resulted, thus far, in any loss mitigation or recovery as a result of the guarantor's bankruptcy or ongoing litigation which has not yet been resolved.

 Classified Assets.   Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful or loss.  An asset is considered substandard if it is inadequately protected by the current net worth and repayment capacity of the borrower or of any collateral pledged.  Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

 When we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent and approved by senior management or the Classified Asset Committee 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. When an insured institution classifies problem assets as a loss, it is required to charge off such assets in the period in which they are deemed uncollectible.  Assets that do not currently expose us to sufficient risk to warrant classification as substandard or doubtful but possess identified weaknesses are considered either watch or special mention assets.  Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by our regulators, which can order the establishment of additional loss allowances.

 In connection with the filing of periodic reports with the FDIC  classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of our review of our assets, as of June 30, 2012, we had classified assets of $32.8 million.  The total amount classified represented 60.7% of equity capital and 7.0% of assets at June 30, 2012.




22

 The aggregate amounts of our classified loans at the date indicated (as determined by management), were as follows:

At June 30,

2012

2011

(In Thousands)

Classified Loans:

   Substandard

$ 30,471 $ 48,372

   Doubtful

2,316 --

   Loss

-- --

     Total

$ 32,787 $ 48,372

 Our $32.8 million of substandard loans at June 30, 2012, consisted primarily of $25.5 million of real estate secured loans and $7.3 million of consumer and commercial business loans.  Of the $25.5 million of substandard loans which were real estate secured, $5.1 million were construction and land loans secured by properties located in Washington.  Of the $5.1 million in substandard construction and land loans, $4.4 million consisted of loans made to builder/developers of which $3.4 million was on non-accrual status.  Additionally $754,000 were lot loans made to individuals which are not included in construction loans.  Also included in the total of substandard real estate secured loans at June 30, 2012 was $3.9 million of commercial real estate loans and $2.3 million of multi-family loans, secured by property located in Washington.  The balance of our substandard real estate secured loans at June 30, 2012 was $11.3 million, which consisted of loans secured by one-to-four family properties, and an additional $600,000 in home equity loans.

 Potential Problem Loans.   Potential problem loans are loans that do not yet meet the criteria for identification as classified assets graded as substandard or doubtful, but where known information about the borrower causes management to have serious concerns about the ability of the borrower to comply with present loan repayment terms and may result in the loan being included as a classified asset for future periods.  At June 30, 2012, we had $41.2 million, or 13.9% of our net loans that were identified as potential problem loans compared to $31.5 million or 9.4% of our net loans at June 30, 2011.

 Within these problem loans were the following lending relationships:



•  

a loan of $4.9 million secured by a church in Washington;


•  

a relationship of $4.2 million in two loans secured by commercial real estate in Washington;


•  

a relationship of $3.5 million in four loans secured by single family and multi-family rental property in Washington;


•  

a loan of $3.4 million in five loans secured by multi-family property in Washington;


•  

a loan of $2.5 million secured by multi-family real estate in Washington;


•  

a relationship of $2.2 million in two term loans secured by multi-family property in Oregon;


•  

a loan of $2.1 million secured by commercial real estate in Washington;


•  

a loan of $2.1 million secured by commercial real estate in Washington;


•  

a loan of $1.9 million secured by commercial real estate in Washington; and


•  

a loan of $1.4 million secured by multi-family property in Washington.


The 10 relationships described above comprise $28.2 million, or 68.5% of the potential problem loans that were identified as of June 30, 2012.  All of the loans identified above were in compliance with their repayment terms at June 30, 2012.

23

 Allowance for Loan Losses.   Management recognizes that loan losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio.   Our Chief Lending Officer assesses the allowance for loan and lease losses on a monthly basis and reports to the Board of Directors no less than quarterly.  The assessment includes analysis of several different factors, including delinquency, charge-off rates and the changing risk profile of our loan portfolio, as well as local economic conditions such as unemployment rates, bankruptcies and vacancy rates of business and residential properties.

 We believe that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period requiring management to make assumptions about probable losses inherent in the loan portfolio; and the impact of a sudden large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings.

 Our methodology for analyzing the allowance for loan losses consists of two components: formula and specific allowances.  The formula allowance is determined by applying an estimated loss percentage to various groups of loans.  The loss percentages are generally based on various historical measures such as the amount and type of classified loans, past due ratios and loss experience, which could affect the collectibility of the respective loan types.

 The specific allowance component is created when management believes that the collectibility of a specific large loan, such as a real estate, multi-family or commercial real estate loan, has been impaired and a loss is probable.

 The allowance is increased by the provision for loan losses, which is charged against current period earnings and decreased by the amount of actual loan charge-offs, net of recoveries.

 The provision for loan losses was $2.7 million and $8.1 million for the years ended June 30, 2012 and 2011, respectively.  We decreased the provision as a result of the decrease in loan delinquencies. The specific risks that are considered in our analysis for determining the provisions for loans losses include an automatic elevation in risk grade and corresponding reserve requirement based on loan payment and payment delinquencies, including debt to the borrower and related entities under loans to one borrower guidelines; and a qualitative analysis of the economic and portfolio trends.  The provision for loan losses for the year ended June 30, 2012, included an incremental increase component, a qualitative increase component, and specific reserve increase as a result of impairment analyses.  The total allowance for loan losses was $7.1 million and $7.2 million at June 30, 2012 and 2011, respectively.  Of the total allowance at June 30, 2012, specific reserves increased to $1.9 million and general reserves decreased to $5.2 million from specific reserves of $1.2 million and general reserves of $6.0 million, respectively, at June 30, 2011.  Included in the general reserve amount of $5.2 million at June 30, 2012 was $5.0 million based on incremental changes in asset quality and $200,000 based on qualitative analysis.

 The decrease in the provision for loan losses was a result of the decrease in classified loans, and loan charge-offs together with our recognition of qualitative factors.  We continually monitor the market conditions reported at national, regional, and local levels including those from the FDIC, Case-Schiller, and Realtor Boards. Delinquent residential construction and development loans decreased to $3.4 million, or 1.14% of total loans at June 30, 2012, compared to $7.8 million, or 2.3% of total loans at June 30, 2011.  Qualitative factors developed from this analysis along with the incremental changes discussed above resulted in an increase to the provision for the period.

 Levels and trends in delinquencies and non-performing loans have decreased. During the current economic cycle we have experienced changes in our portfolio with respect to delinquent, non-performing and impaired loans.  At June 30, 2012 and June 30, 2011 our total delinquent loans, including loans 30 or more days past due, were $14.2 million and $26.0 million, respectively, which included non-performing loans of $8.7 million and $14.2 million, respectively.  Net charge offs during the years ended June 30, 2012 and June 30, 2011 were $2.9 million and $17.6 million, respectively.

 For collateral dependent loans management utilizes the valuation from an appraisal obtained within the last six months in establishing the allowance for loan losses, unless additional information known to management results in management applying a downward adjustment to the valuation. Appraisals are updated subsequent to the time of origination when management identifies a loan as impaired or potentially being impaired, as indicated by the borrower's payment and loan covenant performance, an analysis of the borrower's financial condition, property tax and/or

24

assessment delinquency, increases in deferred maintenance or other information known to management.  Management identifies a loan as impaired when the source of repayment of the loan is recognized as being in jeopardy, such that economic or other changes have affected the borrower to the extent that it may not be able to meet repayment terms, and that resources available to the borrower, including the liquidation of collateral, may be insufficient.  Impairment is measured on a loan-by-loan basis for each loan based upon its source or sources of repayment.  For collateral dependent loans a current analysis of the net value of the collateral is determined utilizing the new appraisal.  Once an updated appraisal is obtained, our policy is to update this appraisal every nine months if the collateral is considered impaired, however, because of the current economic conditions, we have accelerated the appraisal cycle so that appraisals are updated every six months.  When the results of the impairment analysis indicate a potential loss, the loan is classified as substandard and a specific reserve is established for such loan in the amount determined.  Further, the specific reserve amount is adjusted to reflect any further deterioration in the value of the collateral that may occur prior to liquidation or reinstatement.  The impairment analysis takes into consideration the primary, secondary, and tertiary sources of repayment, whether impairment is likely to be temporary in nature or liquidation is anticipated.

 Our non-performing loans include collateral secured and unsecured loans, which totaled $8.7 million and $14.2 million at June 30, 2012 and 2011, respectively.  At June 30, 2012, our nonperforming loans secured by first mortgage liens consisted of one $3.4 million commercial real estate construction loan and $1.9 million of one-to-four family  mortgage loans.

 The remainder of our non-performing loans at June 30, 2012 and 2011, included secured and unsecured credits from our consumer and commercial business loan portfolios, totaling $3.2 million and $1.6 million, respectively.

 During the year ended June 30, 2012, we recorded a provision for loan losses which was significantly less than the provision for loan losses we recorded for the year ended June 30, 2011. The decreased provision for 2012 was primarily a result of decreased loan delinquencies and loan charge-off amounts.

 The allowance for loan losses was $7.1 million or 2.4% of total loans at June 30, 2012 as compared to $7.2 million or 2.2% of total loans outstanding at June 30, 2011.  The level of the allowance is based on estimates, and the ultimate losses may vary from the estimates.  Management will continue to review the adequacy of the allowance for loan losses and make adjustments to the provision for loan losses based on loan growth, economic conditions, charge-offs and portfolio composition.  For the years ended June 30, 2012 and 2011 the provision for loan losses was $2.7 million and $8.1 million, respectively.

 A loan is considered impaired when we have determined that we may be unable to collect payments of principal and/or interest when due under the terms of the loan. In the process of identifying loans as impaired, management takes into consideration factors which include payment history and status, collateral value, financial condition of the borrower, and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered by management on a case by case basis, after taking into consideration the totality of circumstances surrounding the loans and the borrowers, including payment history and amounts of any payment shortfall, length and reason for delay, and likelihood of return to stable performance.

 Impairment is measured on a loan by loan basis for all loans in the portfolio except for the smaller groups of homogeneous consumer loans in the portfolio.

 As of June 30, 2012 and 2011, we had impaired loans of $26.1 million and $34.5 million, respectively. Included within the impaired loan totals are loans identified as troubled debt restructures.  At June 30, 2012 and 2011, the aggregate amount of troubled debt restructure loans with valuation allowances were $15.1 million and $15.0 million, respectively.


25


The following table summarizes the distribution of the allowance for loan losses by loan category.


At June 30,

2012

2011

2010

2009

2008

Loan

Balance

Amount

 by Loan Category

Percent of

Loans

in Loan

Category to

total

Loans

Loan

Balance

Amount

 by Loan Category

Percent of

Loans

in Loan

Category to

total

Loans

Loan

Balance

Amount

 by Loan Category

Percent of

Loans

in Loan

Category to

total

Loans

Loan

Balance

Amount

 by Loan Category

Percent of

Loans

in Loan

Category to

total

Loans

Loan

Balance

Amount

 by Loan Category

Percent of

Loans

in Loan

Category to

total

Loans

(Dollars in Thousands)

Real estate:

  One-to-four family

$ 82,709 $ 1,659 28.0 % $ 97,133 $ 1,980 29.1 % $ 112,835 $ 2,975 27.7 % $ 114,823 $ 861 22.9 % $ 114,695 $ 229 23.0 %

  Multi-family

42,032 238 14.2 42,608 88 12.8 45,983 552 11.3 52,661 632 10.5 59,114 591 11.8

  Commercial

97,306 578 32.9 105,997 173 31.8 118,492 1,422 29.1 123,902 1,487 24.7 117,439 1,174 23.5

  Construction

6,696 148 2.3 11,650 1,163 3.5 36,812 7,952 9.0 106,163 16,558 21.2 103,924 4,309 20.8

  Land loans

7,062 368 2.4 6,723 191 2.0 7,843 157 1.9 9,211 184 1.8 6,957 139 1.4

    Total real estate

235,805 2,991 79.8 264,111 3,595 79.2 321,965 13,058 79.1 406,760 19,722 81.2 402,129 6,442 80.5

Consumer:

  Home equity

31,504 681 10.7 35,729 739 10.7 42,446 1,818 10.4 49,028 368 9.8 46,790 94 9.4

  Credit cards

5,180 328 1.8 7,101 568 2.1 7,943 477 2.0 8,617 517 1.7 7,989 240 1.6

  Automobile

3,342 373 1.1 5,547 675 1.7 8,884 533 2.2 14,016 841 2.8 18,095 241 3.6

  Other

2,968 126 1.0 3,595 153 1.1 4,160 250 1.0 5,142 309 1.0 5,757 283 1.2

    Total consumer

42,994 1,508 14.6 51,972 2,135 15.6 63,433 3,078 15.6 76,803 2,035 15.3 78,631 858 15.7

  Commercial

     business

16,618 2,558 5.6 17,268 1,509 5.2 21,718 652 5.3 17,172 206 3.4 18,507 185 3.7

Unallocated

-- -- -- -- -- -- -- -- -- -- 2,500 -- -- -- --

Total

$ 295,417 $ 7,057 100.0 % $ 333,351 $ 7,239 100.0 % $ 407,116 $ 16,788 100.0 % $ 500,735 $ 24,463 100.0 % $ 499,267 $ 7,485 100.0 %



26

Management believes that it uses the best information available to determine the allowance for loan losses.  However, unforeseen market conditions could result in adjustments to the allowance for loan losses and net income could be significantly affected, if circumstances differ substantially from the assumptions used in determining the allowance.


The following table sets forth an analysis of our allowance for loan losses at the dates and for the periods indicated.

Year Ended June 30,

2012

2011

2010

2009

2008

(Dollars in Thousands)

Allowance at beginning of period

$ 7,239 $ 16,788 $ 24,463 $ 7,485 $ 4,644

Provision for loan losses

2,735 8,078 2,615 20,263 3,545

Recoveries:

Real Estate loans:

  One-to-four family

498 238 146 3 1

  Multi-family

-- -- -- 20 --

  Commercial

18 5 -- -- 112

  Construction

271 502 -- -- --

  Land loans

-- -- -- -- --

    Total real estate

787 745 146 23 113

Consumer:

  Home equity

20 9 1 3 1

  Credit cards

121 98 55 45 --

  Automobile

20 62 95 33 --

  Other

22 27 39 -- 18

    Total consumer

183 196 190 81 19

  Commercial business

131 3 -- -- 6

Total recoveries

1,101 944 336 104 138

Charge-offs:

Real Estate loans:

  One-to-four family

1,465 3,003 747 283 10

  Multi-family

-- -- -- -- --

  Commercial

571 584 31 -- --

  Construction

561 8,915 4,970 2,086 259

  Land loans

-- -- 2,836 -- --

    Total real estate

2,597 12,502 8,584 2,369 269

Consumer:

  Home equity

337 465 847 222 --

  Credit cards

492 591 605 374 --

  Automobile

59 55 254 17 --

  Other

470 777 336 407 568

    Total consumer

1,358 1,888 2,042 1,020 568

  Commercial business

63 4,181 -- -- 5

Total charge-offs

4,018 18,571 10,626 3,389 842

Net charge-offs

2,917 17,627 10,290 3,285 704

Balance at end of period

$ 7,057 $ 7,239 $ 16,788 $ 24,463 $ 7,485

Allowance for loan losses as a percentage

 of total loans outstanding at the end of

 the period

2.4 % 2.2 % 4.1 % 4.9 % 1.5 %

Net charge-offs as a percentage of average

  total loans outstanding during the period

0.9 % 4.7 % 2.3 % 0.6 % 0.1 %

Allowance for loan losses as a percentage

 of non-performing loans at end of period

80.9 % 51.1 % 81.3 % 40.3 % 32.0 %




27



Our Executive Loan Committee reviews the appropriate level of the allowance for loan losses on a quarterly basis and establishes the provision for loan losses based on the risk composition of our loan portfolio, delinquency levels, loss experience, economic conditions, bank regulatory examination results, seasoning of the loan portfolios and other factors related to the collectibility of the loan portfolio as detailed further under "Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Allowance for Loan Losses." The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual loan charge-offs, net of recoveries.


Management believes that our allowance for loan losses as of June 30, 2012 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provision that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.

The following table provides certain information with respect to our allowance for loan losses, including  charge-offs, recoveries and selected ratios for the periods indicated.

Year Ended June 30,

2012

2011

2010

2009

2008

(Dollars in Thousands)

Provisions for loan losses

$ 2,735 $ 8,078 $ 2,615 $ 20,263 $ 3,545

Allowance for loan losses

7,057 7,239 16,788 24,463 7,485

Allowance for loan losses as a

  percentage of total loans

  outstanding at the end of the

  period

2.4 % 2.2 % 4.1 % 4.9 % 1.5 %

Net charge-offs

2,917 17,627 10,290 3,285 704

Total of nonaccrual and 90

  days past due loans

8,722 14,169 20,642 60,649 23,370

Allowance for loan losses as a

   percentage of non-performing loans at

   end of period

80.9 % 51.1 % 81.3 % 40.3 % 32.0 %

Nonaccrual and 90 days or more

  past due loans as a percentage of

  loans receivable

3.0 % 4.3 % 5.1 % 12.1 % 4.7 %

Total loans

$ 295,417 $ 333,351 $ 407,116 $ 500,735 $ 499,267

Investment Activities


General.   Under Washington law, savings banks are permitted to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, banker's acceptances, repurchase agreements, federal funds, commercial paper, investment grade corporate debt securities, and obligations of states and their political sub-divisions.


The investment committee, consisting of Directors Ruecker, Shaw and Degner, have the authority and responsibility to administer our investment policy, monitor portfolio strategies, and recommend appropriate changes to policy and strategies to the board.  On a monthly basis, our management reports to the board a summary of investment holdings with respective market values, and all purchases and sales of investments.  The Chief Financial Officer has the primary responsibility for the management of the investment portfolio.  The Chief Financial Officer considers various

28

factors when making decisions, including the marketability, maturity and tax consequences of proposed investments.  The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.


The general objectives of the investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk.


At June 30, 2012, our investment portfolio consisted principally of mortgage-backed securities, U.S. Government Agency obligations, municipal bonds and mutual funds consisting of mortgage-backed securities.  From time to time, investment levels may increase or decrease depending upon yields available on investment opportunities and management's projected demand for funds for loan originations, deposits and other activities.


Mortgage-Backed Securities .  The mortgage-backed securities in our portfolios were comprised of Freddie Mac mortgage-backed securities.  At June 30, 2012 the amortized cost was $46.5 million of mortgage-backed securities held in the available for sale category with a weighted average yield of 4.02%, while the mortgage-backed securities in the held to maturity portfolio was $7.0 million with a weighted average yield of 5.02%.


Municipal Bonds .  The tax-exempt and taxable municipal bond portfolios were comprised of general obligation bonds ( i.e. , backed by the general credit of the issuer) and revenue bonds ( i.e. , backed by revenues from the specific project being financed) issued by various municipal corporations.   All bonds are rated "A" or better and are from issuers located within the State of Washington. The weighted average yield on the tax exempt bonds (on a tax equivalent basis) was 4.83% at June 30, 2012, and the total amount of our municipal bonds was $1.8 million at that date, of which $1.7 million was available for sale.


Federal Home Loan Bank Stock.   As a member of the FHLB of Seattle, we are required to own capital stock in the FHLB of Seattle.  The amount of stock we hold is based on guidelines specified by the FHLB of Seattle.  The redemption of any excess stock we hold is at the discretion of the FHLB of Seattle.  The carrying value of FHLB stock was $6.5 million at June 30, 2012.


Our investment in  FHLB stock is carried at cost, which approximates fair value.  As a member of the FHLB System, we are required to maintain a minimum level of investment in FHLB stock based on specific percentages of our outstanding mortgages, total assets, or FHLB advances.  At June 30, 2012 and 2011, our minimum investment requirement was approximately $2.9 million and $3.8 million, respectively.  We were in compliance with the FHLB minimum investment requirement at June 30, 2012 and 2011.  For the year ended June 30, 2012, we did not receive any dividends from the FHLB.


Bank-Owned Life Insurance.   We purchase bank-owned life insurance policies ("BOLI") to offset future employee benefit costs.  At June 30, 2012, we had a $18.3 million investment in life insurance contracts.  The purchase of BOLI policies, and its increase in cash surrender value, is classified as "Investment in life insurance contracts" in our consolidated statement of operations.  The income related to the BOLI, which is generated by the increase in the cash surrender value of the policy, is classified in "increase in cash surrender value of life insurance" in our consolidated statement of operations.




29


The following table sets forth the composition of our securities portfolios at the dates indicated.  The amortized cost of the available for sale investments is their net book value before the mark-to-market fair value adjustment.


At June 30,

2012

2011

2010

Amortized

Cost

Fair

Value

Amortized

Cost

Fair

Value

Amortized

Cost

Fair

Value

(Dollars in Thousands)

Available for sale:

  Securities:

    U.S. Government Agencies

       obligations

$ -- $ -- $ 3,000 $ 3,045 $ 2,999 $ 3,151

    Municipal bonds

1,623 1,656 2,355 2,400 3,372 3,431

Mortgage-backed securities:

  Freddie Mac

46,547 47,061 30,459 32,718 39,440 42,197

    Total available for sale

48,170 48,717 35,814 38,163 45,811 48,779

Held to maturity:

  Securities:

    Municipal bonds

142 142 149 149 155 155

Mortgage-backed securities:

  Freddie Mac

7,037 7,548 7,438 8,008 9,880 10,555

  Total held to maturity

7,179 7,690 7,587 8,157 10,035 10,710

Total securities

$ 55,349 $ 56,407 $ 43,401 $ 46,320 $ 55,846 $ 59,489






30


The table below sets forth information regarding the amortized cost, weighted average yields and maturities or call dates of Anchor Bank's investment portfolio at June 30, 2012.

At

At June 30, 2012

June 30,

Over One to

Over Five to

Mortgage-Backed

2012

One Year or Less

Five Years

Ten Years

Over Ten Years

Securities

Totals

Weighted

Weighted

Weighted

Weighted

Weighted

MBS

Securities

Weighted

Weighted

Amortized

Average

Amortized

Average

Amortized

Average

Amortized

Average

Amortized

Average

Amortized

Average

Amortized

Average

Cost

Yield

Cost

Yield

Cost

Yield

Cost

Yield

Cost

Yield

Cost

Yield

Cost

Yield

(Dollars in Thousands)

Available for sale:

     Securities:

          Municipal

             bonds (1)

$ 1,623 4.83 % $ 170 3.85 % $ 600 4.17 % $ -- -- % $ 853 5.49 % $ -- -- % $ 1,623 4.83 %

     Mortgage-backed

     securities:

          Freddie Mac

46,547 4.02 -- -- -- -- -- -- -- -- 46,547 4.02 46,547 4.02

      Total available for

         sale

48,170 -- 170 -- 600 -- -- -- 853 -- 46,547 -- 48,170 --

Held to maturity:

     Securities:

          Municipal

              bonds  (1)

142 6.38 -- -- -- -- -- -- 142 6.38 -- -- 142 6.38

     Mortgage-backed

     securities:

          Freddie Mac

7,037 5.02 -- -- -- -- -- -- -- -- 7,037 5.02 7,037 5.02

    Total held to maturity

7,179 -- -- -- 142 7,037 7,179

Total

$ 55,349 $ 170 $ 600 $ -- $ 995 $ 53,584 $ 55,349

__________

(1)       Yields on tax exempt obligations are computed on a tax equivalent basis.


31


Deposit Activities and Other Sources of Funds


General .   Deposits and loan repayments are the major sources of our funds for lending and other investment purposes.  Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions.  Borrowings from the FHLB of Seattle are used to supplement the availability of funds from other sources and also as a source of term funds to assist in the management of interest rate risk.


Our deposit composition reflects a mixture with certificates of deposit accounting for approximately one-half of the total deposits and interest and non-interest-bearing checking, savings and money market accounts comprising the balance of total deposits.  We rely on marketing activities, convenience, customer service and the availability of a broad range of deposit products and services to attract and retain customer deposits.


Deposits.   Substantially all of our depositors are residents of Washington State.  Deposits are attracted from within our market area through the offering of a broad selection of deposit instruments, including checking accounts, money market deposit accounts, savings accounts and certificates of deposit with a variety of rates.  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 our deposit accounts, we consider the development of long term profitable customer relationships, current market interest rates, current maturity structure and deposit mix,  our customer preferences and the profitability of acquiring customer deposits compared to alternative sources.


At June 30, 2012, we had $74.3 million of jumbo ($100,000 or more) retail certificates of deposit.  We also had $8.0 million in public funds, which represented 2.3% of total deposits at June 30, 2012.  Anchor Bank had no brokered deposits at June 30, 2012.  Pursuant to the Order we may not accept brokered deposits without regulatory approval.


In the unlikely event we are liquidated, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to Anchor Bancorp, as the sole shareholder of Anchor Bank.


Deposit Activities.   The following table sets forth our total deposit activities for the periods indicated.

Year Ended June 30,

2012

2011

2010

(In Thousands)

Beginning balance

$ 339,474 $ 355,788 $ 471,713

Net deposits (withdrawals) before

   interest credited

1,606 (22,144 ) (125,473 )

Interest credited

4,718 5,830 9,548

      Net increase (decrease) in deposits

6,324 (16,314 ) (115,925 )

          Ending balance

$ 345,798 $ 339,474 $ 355,788



32


The following table sets forth information concerning our time deposits and other deposits at June 30, 2012.


Weighted

Average

Percentage

Interest

Minimum

of Total

Rate

Term

Category

Amount

Balance

Deposits

(In Thousands)

N/A

Savings accounts

$ 36,475 10.5 %
N/A

Demand deposit accounts

54,375 15.7
N/A

Money market accounts

83,750 24.2

Certificates of Deposit

2.01 %

6 month

Fixed-term, fixed rate

8,120 500 2.3
3.14

9-12 month

Fixed-term, fixed rate

16,355 500 4.7
3.46

13-16 month

Fixed-term, fixed rate

4,072 500 1.2
5.20

18-20 month

Fixed term-fixed or variable rate

15,493 500 4.5
2.50

24 month

Fixed term-fixed or variable rate

35,485 2,000 10.3
3.80

30-36 month

Fixed term-fixed or variable rate

8,899 500 2.6
3.78

48 month

Fixed term-fixed or variable rate

3,939 500 1.1
2.58

60 month

Fixed term-fixed or variable rate

7,897 500 2.3
2.01

96 month

Fixed term-fixed or variable rate

70,213 500 20.3
0.83

Other

Fixed term-fixed or variable rate

725 500 0.2

   TOTAL

$ 171,198 100.0 %


Time Deposits by Rate.   The following table sets forth our time deposits classified by rates as of the dates indicated.


At June 30,

2012

2011

2010

(In Thousands)

0.00 - 0.99 % $ 40,996 $ 22,996 $ 2,157
1.00 - 1.99 % 51,994 71,215 68,318
2.00 - 2.99 % 23,898 26,068 24,345
3.00 - 3.99 % 46,364 50,615 53,847
4.00 - 4.99 % 7,555 9,932 46,217
5.00 - 5.99 % 391 693 6,580
6.00 - 6.99 % -- -- --
7.00 - 7.99 % -- -- --
8.00 - 8.99 % -- -- --

Total

$ 171,198 $ 181,519 $ 201,464


33


Time Deposit Certificates.   The following table sets forth the amount and maturities of time deposit certificates at June 30, 2012.


Amount Due

After 1 Year

After 2 Years

After 3 Years

Within

Through

Through

Through

Beyond

1 Year

2 Years

3 Years

4 Years

4 Years

Total

(In Thousands)

0.00 - 0.99 % $ 29,784 $ 10,813 $ 299 $ -- $ 100 $ 40,996
1.00 - 1.99 % 35,761 8,471 1,772 973 5,017 51,994
2.00 - 2.99 % 2,544 1,131 1,567 2,056 16,600 23,898
3.00 - 3.99 % 1,606 964 -- 863 42,931 46,364
4.00 - 4.99 % 1,297 1,102 486 4,159 511 7,555
5.00 - 5.99 % -- 252 -- 139 -- 391

Total

$ 70,992 $ 22,733 $ 4,124 $ 8,190 $ 65,159 $ 171,198

The following table indicates the amount of our jumbo certificates of deposit by time remaining until maturity as of June 30, 2012.  Jumbo certificates of deposit are certificates in amounts of $100,000 or more.


Time Deposit

Maturity Period

Certificates

(In Thousands)

Three months or less

$ 11,502

Over three through six months

8,315

Over six through twelve months

8,828

Over twelve months

45,653

    Total

$ 74,298



34


Deposit Flow.   The following table sets forth the balances of deposits in the various types of accounts we offered  at the dates indicated.


At June 30,

2012

2011

2010

Percent

Percent

Percent

of

Increase/

of

Increase/

of

Amount

Total

(Decrease)

Amount

Total

(Decrease)

Amount

Total

(Dollars in Thousands)

Savings deposits

$ 36,475 10.5 % $ 4,212 $ 32,263 9.5 % $ 2,507 $ 29,756 8.4 %

Demand deposit accounts

54,375 15.7 6,700 47,675 14.0 (6,526 ) 54,201 15.2

Money market accounts

83,750 24.2 5,733 78,017 23.0 7,650 70,367 19.8

Fixed-rate certificates which

  mature in the year ending:

  Within 1 year

46,820 13.5 (5,007 ) 51,827 15.3 (32,809 ) 84,636 23.8

  After 1 year, but within 2 years

15,441 4.5 2,029 13,412 4.0 (5,384 ) 18,796 5.3

  After 2 years, but within 5 years

21,294 6.2 5,083 16,211 4.8 5,309 10,902 3.1

  Certificates maturing thereafter

56,172 16.2 1,186 54,986 16.2 25,081 29,905 8.4

Variable rate certificates

31,471 9.1 (13,612 ) 45,083 13.3 (12,142 ) 57,225 16.1

     Total

$ 345,798 $ 6,324 $ 339,474 $ (16,314 ) $ 355,788




35


Borrowings.   Customer deposits are the primary source of funds for our lending and investment activities.  We do, however, use advances from the FHLB of Seattle to supplement our supply of lendable funds, to meet short-term deposit withdrawal requirements and also to provide longer term funding to better match the duration of selected loan and investment maturities.


As one of our capital management strategies, we have used advances from the FHLB of Seattle to fund loan originations in order to increase our net interest income.  Depending upon the retail banking activity and the availability of excess capital, we will consider and undertake additional leverage strategies within applicable regulatory requirements or restrictions.  Such borrowings would be expected to primarily consist of FHLB of Seattle advances.


As a member of the FHLB of Seattle, we are required to own capital stock in the FHLB of Seattle and are authorized to apply for advances on the security of that stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met.  Advances are individually made under various terms pursuant to several different credit programs, each with its own interest rate and range of maturities.  Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit.  We also maintain a committed credit facility with the FHLB of Seattle that provides for immediately available advances up to an aggregate of 25% of the prior quarter's total assets of Anchor Bank. At June 30, 2012, outstanding advances to Anchor Bank from the FHLB of Seattle totaled $64.9 million.


The following table sets forth information regarding FHLB of Seattle advances by us at the end of and during the periods indicated.  The table includes both long- and short-term borrowings.


Year Ended

June 30,

2012

2011

2010

(Dollars in Thousands)

Maximum amount of borrowing outstanding

  at any month end:

     Federal Home Loan Bank advances

$ 74,900 $ 121,900 $ 136,900

Approximate average borrowing outstanding:

     Federal Home Loan Bank advances

73,242 104,408 135,975

Approximate weighted average rate paid on:

     Federal Home Loan Bank advances

1.87 % 2.08 % 3.75 %

At June 30,

2012

2011

2010

(Dollars in Thousands)

Balance outstanding at end of period:

     Federal Home Loan Bank advances

$ 64,900 $ 85,900 $ 136,900

Weighted average rate paid on:

     Federal Home Loan Bank advances

1.90 % 1.75 % 3.07 %



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Subsidiaries and Other Activities


Anchor Bank.   Anchor Bank has one wholly-owned subsidiary, Anchor Financial Services, Inc., that is currently inactive.   At June 30, 2012, Anchor Bank's equity investment in Anchor Financial Services, Inc. was $303,000.


Competition


Anchor Bank operates in an intensely competitive market for the attraction of deposits (generally its primary source of lendable funds) and in the origination of loans.  Historically, its most direct competition for deposits has come from large commercial banks, thrift institutions and credit unions in its primary market area.  In times of high interest rates, Anchor Bank experiences additional significant competition for investors' funds from short-term money market securities and other corporate and government securities.  Anchor Bank's competition for loans comes principally from mortgage bankers, commercial banks and other thrift institutions.  Such competition for deposits and the origination of loans may limit Anchor Bank's future growth and earnings prospects.


Natural Disasters


Grays Harbor, Thurston, Lewis, Pierce, Mason and King counties, where substantially all of the real and personal properties securing our loans are located, is an earthquake-prone region.  We have not suffered any losses in the last fifteen years from earthquake damage to collateral secured loans, which include the July 1999 and February 2001 major earthquakes in the region.  Although we have experienced no losses related to earthquakes, a major earthquake could result in material loss to us in two primary ways.  If an earthquake damages real or personal properties collateralizing outstanding loans to the point of insurable loss, material loss would be suffered to the extent that the properties are uninsured or inadequately insured.  A substantial number of our borrowers do not have insurance which provides for coverage as a result of losses from earthquakes.  Earthquake insurance is generally not required by other lenders in the market area, and as a result in order to remain competitive in the marketplace, we do not require earthquake insurance as a condition of making a loan.  Earthquake insurance is also not always available at a reasonable coverage level and cost because of changing insurance underwriting practices in our market area resulting from past earthquake activity and the likelihood of future earthquake activity in the region.  In addition, if the collateralized properties are only damaged and not destroyed to the point of total insurable loss, borrowers may suffer sustained job interruptions or job loss, which may materially impair their ability to meet the terms of their loan obligations.  While risk of credit loss can be insured against by, for example, job interruption insurance or "umbrella" insurance policies, such forms of insurance often are beyond the financial means of many individuals.  Accordingly, for most individuals, sustained job interruption or job loss would likely result in financial hardship that could lead to delinquency in their financial obligations or even bankruptcy.  Accordingly, no assurances can be given that a major earthquake in our primary market area will not result in material losses to us.


Employees


At June 30, 2012, we had 140 full-time equivalent employees.  Our employees are not represented by any collective bargaining group.  We consider our employee relations to be good.




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


Age at

June 30,

Position

Name

2012

Company

Bank

Jerald L. Shaw

66

President and Chief Executive

    Officer

President and Chief Executive

    Officer

Terri L. Degner

49

Chief Financial Officer

Chief Financial Officer

Gregory H. Schultz

58

Executive Vice President

Executive Vice President and Chief Lending

Officer


Biographical Information .  The following is a description of the principal occupation and employment of the executive officers of the Company and the Bank during at least the past five years:


Jerald L. Shaw is the President and Chief Executive Officer of Anchor Bank, positions he has held since July 2006.  He has also served in those capacities for Anchor Bancorp since its formation in September 2008.  Prior to serving as President and Chief Executive Officer, he served as Chief Operating Officer from 2004 to 2006 and as Chief Financial Officer from 1988 to 2002.  Prior to that, he served Anchor Bank and its predecessor, Aberdeen Federal Savings and Loan Association, in a variety of capacities since 1976.   Mr. Shaw has been with Anchor Bank and its predecessor, Aberdeen Federal Savings and Loan Association, since 1976.  Prior to that time, Mr. Shaw piloted C-130 aircraft for the U.S. Air Force, including combat missions during the Vietnam War.  Having performed or directly supervised virtually every position at Anchor Bank, he has extensive knowledge of our operations.  He is a distinguished graduate of the School for Executive Development of the U.S. League of Savings Institution at the University of Washington.  He has also attended asset-liability management training, directors' colleges, and other banking-related training.  He is an active in the Thurston County Chamber of Commerce and American Bankers Association, and is a board member of the Washington Financial League.  Mr. Shaw is on the Aberdeen Rotary Club and the Aberdeen Lions Club, and volunteers for Habitat for Humanity.


Terri L. Degner is the Executive Vice President, Chief Financial Officer and Treasurer of Anchor Bank, positions she has held since 2004.  She has also served in those capacities for Anchor Bancorp since its formation in September 2008.  Prior to serving as Executive Vice President, Chief Financial Officer and Treasurer, Ms. Degner has served Anchor Bank in a variety of capacities since 1990, including as Senior Vice President and Controller from 1994 to 2004.  Ms. Degner has been in banking since high school.  She has worked in multiple lending positions in various size institutions.  Since 1990, she has held a variety of positions in the finance area of Anchor Bank.  Ms. Degner demonstrated her determination to succeed when she worked full time in Anchor's Accounting Department and commuted 60 miles to evening classes at St. Martin's College where she received her Bachelor's Degree in Accounting.  At the same time she worked full days and met all expectations for performance.  In 2000, she graduated from the Pacific Coast Banking School at the University of Washington in the top 10% of her class and her thesis was published in the University's library.  She has become the management expert on issues ranging from information technology to asset-liability management.  Ms. Degner also serves on the board of directors and finance committee of NeighborWorks of Grays Harbor.


Gregory H. Schultz , is an Executive Vice President of Anchor Bancorp, a position he has held since January 2011.  Mr. Schultz also is an Executive Vice President and Chief Lending Officer of Anchor Bank,  positions he has held since October 2010 and May 2008, respectively.  Prior to his appointment as Executive Vice President of Anchor Bank, Mr. Schultz had served as Senior Vice President since joining Anchor Bank in February 2008.  In his current capacity, Mr. Schultz serves on many Bank committees, including Chair of the Executive Loan and Problem Asset committees, and  as a member of the Executive Management, Senior Management, Risk Management, ALCO, IT, and Loan Policy committees.  Mr. Schultz has more than 37 years of experience in banking and finance, beginning as a collector in 1974 with a subsidiary of Bank of America.  His career includes three years in consumer lending, four years in the thrift

38

industry, and 30 years in community and regional commercial banking, working in Utah, Idaho, Nevada and Washington. Prior to joining Anchor Bank in February 2008, Mr. Schultz was the Senior Commercial Lending Officer for Silverstate Bank from May 2007 through January 2008, and was previously employed by Community Bank of Nevada for ten years in a variety of positions, including most recently as Chief Lending Officer.  Mr. Schultz earned an Associate of Arts Degree in Speech and Drama from Treasure Valley Community College and has extensive training in most aspects of banking including accounting, credit, law, sales, marketing, valuation, management and administration.  Mr. Schultz also participates as a volunteer for charitable organizations, including Relay for Life and Rebuilding Together, and participates in community fund raising activities for Habitat for Humanity, the Kiwanis Club and the Chamber of Commerce.


How We Are Regulated

The following is a brief description of certain laws and regulations applicable to Anchor Bancorp and Anchor Bank. Descriptions of laws and regulations here and elsewhere in this report do not purport to be complete and are qualified in their entirety by reference to the actual laws and regulations. Legislation is introduced from time to time in the United States Congress or the Washington State Legislature that may affect the operations of Anchor Bancorp and Anchor Bank.  In addition, the regulations governing us may be amended from time to time by our regulators.  Any such legislation or regulatory changes in the future could adversely affect us.  We cannot predict whether any such changes may occur.


Anchor Bancorp is registered as a bank holding company under the Bank Holding Company Act and is subject to regulation and supervision by the Federal Reserve Board and the DFI.  Anchor Bancorp is also required to file annually a report of operations with, and is subject to examination by, the Federal Reserve and the DFI.  This regulation and oversight is generally intended to ensure that Anchor Bancorp limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of Anchor Bank.


New Legislation. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. The following discussion summarizes significant aspects of the Dodd-Frank Act that may affect Anchor Bank and Anchor Bancorp. For certain of these changes, implementing regulations have not been promulgated, so we cannot determine the full impact of the Dodd-Frank Act on our business and operations at this time.


The following aspects of the Dodd-Frank Act are related to the operations of Anchor Bank:


The Consumer Financial Protection Bureau ("CFPB"), an independent consumer compliance regulatory agency within the Federal Reserve has been established. The CFPB is empowered to exercise broad regulatory, supervisory and enforcement authority over financial institutions with total assets of over $10 billion with respect to both new and existing consumer financial protection laws. Financial institutions with assets of less than $10 billion, like Anchor Bank, will continue to be subject to supervision and enforcement by their primary federal banking regulator with respect to federal consumer financial protection laws.  The CFPB also has authority to promulgate new consumer financial protection regulations and amend existing consumer financial protection regulations;


The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution  subsidiaries;


The prohibition on payment of interest on demand deposits was repealed, effective July 21, 2011;


Deposit insurance is permanently increased to $250,000 and unlimited deposit insurance for  noninterest-bearing transaction accounts is extended through December 31, 2013;

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The deposit insurance assessment base for FDIC insurance is the depository institution's average consolidated total assets less the average tangible equity during the assessment period; and

The minimum reserve ratio of the FDIC's Deposit Insurance Fund ("DIF") increased to 1.35 percent of estimated annual insured deposits or the comparable percentage of the assessment  base; however, the FDIC is directed to "offset the effect" of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion. Pursuant to the Dodd-Frank Act, the FDIC recently issued a rule setting a designated reserve ratio at 2.0% of insured deposits.


The following aspects of the Dodd-Frank Act are related to the operations of Anchor Bancorp:


Tier 1 capital treatment for "hybrid" capital items like trust preferred securities is eliminated subject to various grandfathering and transition rules. The federal banking agencies must promulgate new rules on regulatory capital within 18 months from July 21, 2010, for both depository institutions and their holding companies, to include leverage capital and risk-based capital measures at least as stringent as those now applicable to Anchor Bank under the prompt corrective action regulations;


Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have a "say on pay" vote every one, two or three years;


A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments;


Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain "significant" matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be significant;


Stock exchanges are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation payable on the basis of financial information reportable under the securities laws, and (ii) the recovery from current or former executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information;


Disclosure in annual proxy materials is required concerning the relationship between the executive compensation paid and the financial performance of the issuer;


Item 402 of Regulation S-K is amended to require companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees; and


Smaller reporting companies are exempt from complying with the internal control auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act.


Regulation and Supervision of Anchor Bank


General. Anchor Bank, as a state-chartered savings bank, is subject to applicable provisions of Washington law and to regulations and examinations of the DFI. As an insured institution, it also is subject to examination and regulation by the FDIC, which insures the deposits of Anchor Bank to the maximum permitted by law. During these state or federal regulatory examinations, the examiners may require Anchor Bank to provide for higher general or specific loan

40

loss reserves, which can impact our capital and earnings. This regulation of Anchor Bank is intended for the protection of depositors and the Deposit Insurance Fund of the FDIC and not for the purpose of protecting shareholders of Anchor Bank or Anchor Bancorp. Anchor Bank is required to maintain minimum levels of regulatory capital and is subject to some limitations on the payment of dividends to Anchor Bancorp. See "- Regulatory Capital Requirements" and "- Limitations on Dividends and Stock Repurchases."


Federal and State Enforcement Authority and Actions. As part of its supervisory authority over Washington-chartered savings banks, the DFI may initiate enforcement proceedings to obtain a cease-and-desist order against an institution believed to have engaged in unsafe and unsound practices or to have violated a law, regulation, or other regulatory limit, including a written agreement. The FDIC also has the authority to initiate enforcement actions against insured institutions for similar reasons and may terminate the deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. Both these agencies may utilize less formal supervisory tools to address their concerns about the condition, operations or compliance status of a savings bank.


Regulation by the Washington Department of Financial Institutions. State law and regulations govern Anchor Bank's ability to take deposits and pay interest, to make loans on or invest in residential and other real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers, and to establish branch offices. As a state savings bank, Anchor Bank must pay semi-annual assessments, examination costs and certain other charges to the DFI.


Washington law generally provides the same powers for Washington savings banks as federally and other-state chartered savings institutions and banks with branches in Washington, subject to the approval of the DFI. Washington law allows Washington savings banks to charge the maximum interest rates on loans and other extensions of credit to Washington residents which are allowable for a national bank in another state if higher than Washington limits. In addition, the DFI may approve applications by Washington savings banks to engage in an otherwise unauthorized activity, if the DFI determines that the activity is closely related to banking, and Anchor Bank is otherwise qualified under the statute. This additional authority, however, is subject to review and approval by the FDIC if the activity is not permissible for national banks.


Insurance of Accounts and Regulation by the FDIC. The Deposit Insurance Fund ("DIF") of the FDIC insures deposit accounts in Anchor Bank up to $250,000 per separately insured depositor. Noninterest bearing transaction accounts have unlimited coverage until December 31, 2012.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. Our deposit insurance premiums for the year ended June 30, 2012, were $1.0 million.  Those premiums have increased in recent years due to recent strains on the FDIC deposit insurance fund due to the cost of large bank failures and increases in the number of troubled banks.


The Dodd-Frank Act requires the FDIC's deposit insurance assessments to be based on assets instead of deposits.  The FDIC has issued rules, effective as of the second quarter of 2011, which specify that the assessment base for a bank is equal to its total average consolidated assets less average tangible capital. The FDIC assessment rates range from approximately 2.5 basis points to 45 basis points, depending on applicable adjustments for unsecured debt issued by an institution and brokered deposits (and to further adjustment for institutions that hold unsecured debt of other FDIC-insured institutions), until such time as the FDIC's reserve ratio equals 1.15%. Once the FDIC's reserve ratio reaches 1.15% and the reserve ratio for the immediately prior assessment period is less than 2.0%, the applicable assessment rates may range from 1.5 basis points to 40 basis points (subject to adjustments as described above). If the reserve ratio for the prior assessment period is equal to, or greater than 2.0% and less than 2.5%, the assessment rates may range from one basis point to 38 basis points and if the prior assessment period is greater than 2.5%, the assessment rates may range from a half basis point to 35 basis points (in each case subject to adjustments as described above. No institution may pay a dividend if it is in default on its federal deposit insurance assessment.


The FDIC conducts examinations of and requires reporting by state non-member banks, such as Anchor Bank. The FDIC also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the deposit insurance fund.  The FDIC may terminate the deposit insurance of any insured

41

depository institution, including Anchor Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of Anchor Bank's deposit insurance.


Prompt Corrective Action.   Federal statutes establish a supervisory framework based on five capital categories:  well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.  An institution's category depends upon where its capital levels are in relation to relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain other factors.  The federal banking agencies have adopted regulations that implement this statutory framework.  Under these regulations, an institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its ratio of core capital to adjusted total assets (leverage ratio) is 5% or more, and it is not subject to any federal supervisory order or directive to meet a specific capital level.  In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%, a Tier 1 risk-based capital ratio of not less than 4%, and a leverage ratio of not less than 4%.  An institution that is not well capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits generally. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.


Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become more extensive as an institution becomes more severely undercapitalized.  Failure by an institution to comply with applicable capital requirements would, if unremedied, result in progressively more severe restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator.  Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements.  Additionally, approval of any regulatory application filed for their review may be dependent on compliance with capital requirements.


At June 30, 2012, Anchor Bank was categorized as "well capitalized" under the prompt corrective action regulations of the FDIC.  Although we were "well capitalized" at June 30, 2012 based on financial statements prepared in accordance with generally accepted accounting principles in the United States and the general percentages in the regulatory guidelines, we were no longer regarded as "well capitalized" for federal regulatory purposes as a result of the deficiencies cited in the Supervisory Directive.  As a result of this reclassification, our borrowing costs and terms from the Federal Reserve and the FHLB, as well as our FDIC deposit insurance premiums, increased.


Capital Requirements. Anchor Bank is required by FDIC regulations to maintain minimum levels of regulatory capital consisting of core (Tier 1) capital and supplementary (Tier 2) capital. Tier 1 capital generally includes common shareholders' equity and noncumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, which is limited to 100 percent of Tier 1 capital, includes such items as qualifying general loan loss reserves, cumulative perpetual preferred stock, mandatory convertible debt, term subordinated debt and limited life preferred stock; however, the amount of term subordinated debt and intermediate term preferred stock (original maturity of at least five years but less than 20 years) that may be included in Tier 2 capital is limited to 50 percent of Tier 1 capital.


The FDIC currently measures an institution's capital using a leverage limit together with certain risk-based ratios.  The FDIC's minimum leverage capital requirement specifies a minimum ratio of Tier 1 capital to average total assets.  Most banks are required to maintain a minimum leverage ratio of at least 4% to 5% of total assets.  At June 30, 2012, Anchor Bank had a Tier 1 leverage capital ratio of 10.9%.  The FDIC retains the right to require a particular institution to maintain a higher capital level based on its particular risk profile.


FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets.  Assets are placed in one of four categories and given a percentage weight based on the relative risk of that category.  In addition, certain off-balance-sheet items are converted to balance-sheet credit equivalent amounts,

42

and each amount is then assigned to one of the four categories.  Under the guidelines, for a bank to be considered adequately capitalized the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to risk-weighted assets (the Tier 1 risk based capital ratio) must be at least 4%.  In evaluating the adequacy of a bank's capital, the FDIC may also consider other factors that may affect a bank's financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market risks, the quality and level of earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the effectiveness of loan and investment policies, and management's ability to monitor and control financial operating risks.


The DFI requires that net worth equal at least five percent of total assets.  At June 30, 2012, Anchor Bank had Tier 1 risk-based capital of 17.0%.


The table below sets forth Anchor Bank's capital position under the prompt corrective action regulations of the FDIC at June 30, 2012 and 2011 and the requirements pursuant to the Order. The Bank's Tier 1 capital ratio was 10.9% and our total risk-based capital ratio was 18.2% at June 30, 2012, which exceeded the requirements of the Order of 10% and 12%, respectively.

At June 30,

2012

2011

Amount

Ratio

Amount

Ratio

(Dollars in Thousands)

Bank equity capital under GAAP

$ 54,024 $ 57,452

Total risk-based capital

$ 56,143 18.2 % $ 57,812 17.1 %

Total risk-based capital requirement

24,634 8.0 27,085 8.0

Excess

$ 31,509 10.2 % $ 30,727 9.1 %

Tier 1 risk-based capital

$ 52,254 17.0 % $ 53,543 15.8 %

Tier 1 risk-based capital requirement

12,317 4.0 13,543 4.0

Excess

$ 39,937 13.0 % $ 40,000 11.8 %

Tier 1 leverage capital

$ 52,254 10.9 % $ 53,543 10.7 %

Tier 1 leverage capital requirement

19,094 4.0 20,093 4.0

Excess

$ 33,160 6.9 % $ 33,450 6.7 %

Pursuant to minimum capital requirements of the FDIC, Anchor Bank is required to maintain a leverage ratio (capital to assets ratio) of 4% and risk-based capital ratios of Tier 1 capital and total capital (to total risk-weighted assets) of 4% and 8%, respectively.  The Order required Anchor Bank to maintain Tier 1 capital and total risk-based capital ratios at a minimum of 10% and 12%, respectively.  The Supervisory Directive requires Anchor Bank to maintain a Tier 1 capital ratio of at least 10%) As of June 30, 2012 and  2011, the Bank was classified as an "adequately capitalized" institution under the criteria established by the FDIC.


Anchor Bank's management believes that, under the current regulations, Anchor Bank will continue to meet its minimum capital requirements in the foreseeable future.  However, events beyond the control of Anchor Bank, such as a downturn in the economy in areas where it has most of its loans, could adversely affect future earnings and, consequently, the ability of Anchor Bank to meet its capital requirements.


New Proposed Capital Rules. On June 7, 2012, the Federal Reserve approved proposed rules that would substantially amend the regulatory risk-based capital rules applicable to Anchor Bancorp and Anchor Bank. The FDIC subsequently approved these proposed rules on June 12, 2012. The proposed rules implement the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act. "Basel III" refers to various documents released by the Basel Committee on Banking Supervision.  The proposed rules are subject to a public comment period prior to adoption of final rules.

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The proposed rules include new minimum risk-based capital and leverage ratios, which would be phased in during 2013 and 2014, and would refine the definitions of what constitutes "capital" for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to Anchor Bancorp and Anchor Bank under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4%. The proposed rules would also establish a "capital conservation buffer" of 2.5% above each of the new regulatory minimum capital ratios would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

The proposed rules also implement other revisions to the current capital rules such as recognition of all unrealized gains and losses on available for sale debt and equity securities, and provide that instruments that will no longer qualify as capital would be phased out over time.

 The federal bank regulatory agencies also proposed revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including Anchor Bank, if their capital levels begin to show signs of weakness. These revisions would take effect January 1, 2015. Under the prompt corrective action requirements, insured depository institutions would be required to meet the following increased capital level requirements in order to qualify as "well capitalized":  (i) a new common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from the current rules).

 The proposed rules set forth certain changes for the calculation of risk-weighted assets, which we would be required to utilize beginning January 1, 2015. The proposed rule utilizes an increased number of credit risk and other exposure categories and risk weights, and also addresses: (i) a proposed alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; and (iv) revised capital treatment for derivatives and repo-style transactions.

 In particular, the proposed rules would expand the risk-weighting categories from the current four categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures. Higher risk weights would apply to a variety of exposure categories. Specifics include, among others:

Applying a 150% risk weight instead of a 100% risk weight for certain high volatility commercial real estate acquisition, development and construction loans.

For residential mortgage exposures, the current approach of a 50% risk weight for high-quality seasoned mortgages and a 100% risk-weight for all other mortgages is replaced with a risk weight of between 35% and 200% depending upon the mortgage's loan-to-value ratio and whether the mortgage is a "category 1" or "category 2" residential mortgage exposure (based on eight criteria that include, among others, the term, seniority of the lien, use of negative amortization, balloon payments and certain rate increases).

Assigning a 150% risk weight to exposures (other than residential mortgage exposures) that are 90 days past due.

Providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (currently set at 0%).

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Providing for a 100% risk weight for claims on securities firms.

Eliminating the current 50% cap on the risk weight for OTC derivatives.


Federal Home Loan Bank System.   Anchor 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.


As a member, Anchor Bank is required to purchase and maintain stock in the FHLB of Seattle.  At June 30, 2012, Anchor Bank had $6.5 million in FHLB stock, which was in compliance with this requirement.  Anchor Bank did not receive any dividends from the FHLB of Seattle for the year ended June 30, 2012. Subsequent to December 31, 2008, the FHLB of Seattle announced that it was below its regulatory risk-based capital requirement and it is now precluded from paying dividends or repurchasing capital stock. The FHLB of Seattle is not anticipated to resume dividend payments until its financial results improve. The FHLB of Seattle has not indicated when dividend payments may resume.


The FHLBs 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 affected adversely the level of FHLB dividends paid and could continue to do so in the future.  These contributions could also have an adverse effect on the value of FHLB stock in the future.  A reduction in value of Anchor Bank's FHLB stock may result in a corresponding reduction in its capital.


Standards for Safety and Soundness.   The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository institutions relating to: internal controls, information systems and internal audit systems; loan documentation; credit underwriting; interest rate risk exposure; asset growth; asset quality; earnings and compensation, fees and benefits. 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.  Each insured depository institution must implement a comprehensive written information security program that includes administrative, technical, and physical safeguards appropriate to the institution's size and complexity and the nature and scope of its activities.  The information security program also must be designed to ensure the security and confidentiality of customer information, protect against any unanticipated threats or hazards to the security or integrity of such information, protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer, and ensure the proper disposal of customer and consumer information.  Each insured depository institution must also develop and implement a risk-based response program to address incidents of unauthorized access to customer information in customer information systems.  If the FDIC determines that Anchor Bank fails to meet any standard prescribed by the guidelines, it may require Anchor Bank to submit an acceptable plan to achieve compliance with the standard.  FDIC regulations establish deadlines for the submission and review of such safety and soundness compliance plans.  Management of Anchor Bank is not aware of any conditions relating to these safety and soundness standards which would require submission of a plan of compliance.


Real Estate Lending Standards. FDIC regulations require Anchor Bank to adopt and maintain written policies that establish appropriate limits and standards for real estate loans.  These standards, which must be consistent with safe and sound banking practices, must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value ratio limits) that are clear and measurable, loan administration procedures, and documentation, approval and reporting requirements.  Anchor Bank is obligated to monitor conditions in its real estate markets to ensure that its standards continue to be appropriate for current market conditions.  Anchor Bank's Board of Directors is required to review and approve Anchor Bank's standards at least annually.  The FDIC has published guidelines for compliance with these regulations, including supervisory limitations on loan-to-value ratios for different categories of real estate loans.  Under the guidelines, the aggregate amount of all loans in excess of the supervisory loan-to-value ratios should

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not exceed 100% of total capital, and the total of all loans for commercial, agricultural, multifamily or other non-one-to-four-family properties should not exceed 30% of total capital.  Loans in excess of the supervisory loan-to-value ratio limitations must be identified in Anchor Bank's records and reported at least quarterly to Anchor Bank's Board of Directors.  Anchor Bank is in compliance with the record and reporting requirements.  As of June 30, 2012, Anchor Bank's aggregate loans in excess of the supervisory loan-to-value ratios were 13.34% and Anchor Bank's loans on commercial, agricultural, multifamily or other non-one-to-four-family properties in excess of  the supervisory loan-to-value ratios were 11.74%.  Based on strong risk management practices, Anchor Bank has consistently operated above the aggregate 100% of capital guideline limit since these standards were imposed.


Activities and Investments of Insured State-Chartered Financial Institutions.   Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks.  An insured state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's total assets, (3) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors', directors' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, and (4) acquiring or retaining the voting shares of a depository institution owned by another FDIC-insured institution if certain requirements are met.


Washington State has enacted a law regarding financial institution parity.  Primarily, the law affords Washington-chartered commercial banks the same powers as Washington-chartered savings banks.  In order for a bank to exercise these powers, it must provide 30 days notice to the Director of Financial Institutions and the Director must authorize the requested activity.  In addition, the law provides that Washington-chartered savings banks may exercise any of the powers of Washington-chartered commercial banks, national banks and federally-chartered savings banks, subject to the approval of the Director in certain situations.  Finally, the law provides additional flexibility for Washington-chartered commercial and savings banks with respect to interest rates on loans and other extensions of credit.  Specifically, they may charge the maximum interest rate allowable for loans and other extensions of credit by federally-chartered financial institutions to Washington residents.


Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") is a federal statute that 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.  To the extent that legal uncertainty exists in this area, all creditors, including Anchor 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 costs often substantially exceed the value of the collateral property.


Federal Reserve System.   The Federal Reserve Board requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits.  These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank.  Negotiable order of withdrawal (NOW) accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to the reserve requirements, as are any non-personal time deposits at a savings bank.  As of June 30, 2012, Anchor Bank's deposit with the Federal Reserve Bank and vault cash exceeded its reserve requirements.


Affiliate Transactions.   Federal laws strictly limit the ability of banks to engage in certain transactions with their affiliates, including their bank holding companies.  Transactions deemed to be a "covered transaction" under Section 23A of the Federal Reserve Act and between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company are limited to 10% of the bank subsidiary's capital and surplus and, with respect to the parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiary's capital and surplus.  Further, covered transactions that are loans and extensions of credit generally are required to be secured

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by eligible collateral in specified amounts.  Federal law also requires that covered transactions and certain other transactions listed in Section 23B of the Federal Reserve Act between a bank and its affiliates be on terms as favorable to the bank as transactions with non-affiliates.


Community Reinvestment Act.   Anchor Bank is subject to the provisions of the Community Reinvestment Act of 1977 ("CRA"), which requires the appropriate federal bank regulatory agency to assess a bank's performance under the CRA in meeting the credit needs of the community serviced by the bank, including low and moderate income neighborhoods.  The regulatory agency's assessment of the bank's record is made available to the public.  Further, a bank's CRA performance must be considered in connection with a bank's application to, among other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution.  Anchor Bank received a "satisfactory" rating during its most recent examination.


Dividends. The amount of dividends payable by Anchor Bank to Anchor Bancorp depends upon Anchor Bank's earnings and capital position, and is limited by federal and state laws, regulations and policies.  According to Washington law, Anchor Bank may not declare or pay a cash dividend on its capital stock if it would cause its net worth to be reduced below (1) the amount required for liquidation accounts or (2) the net worth requirements, if any, imposed by the Director of the DFI.  Dividends on Anchor Bank's capital stock may not be paid in an aggregate amount greater than the aggregate retained earnings of Anchor Bank, without the approval of the Director of the DFI.


The amount of dividends actually paid during any one period is strongly affected by Anchor Bank's policy of maintaining a strong capital position.  Federal law further provides that no insured depository institution may pay a cash dividend if it would cause the institution to be "undercapitalized," as defined in the prompt corrective action regulations.  Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments are deemed to constitute an unsafe and unsound practice.


Under the Supervisory Directive, Anchor Bank is not able to pay dividends to Anchor Bancorp without the prior approval of the DFI and the FDIC and we do not expect to be permitted to pay dividends as long as the Supervisory Directive remains in effect. In addition, we are restricted by the FDIC from making any distributions to stockholders that represent a return of capital without the written non-objection of the FDIC Regional Director.


Other Consumer Protection Laws and Regulations.   Anchor Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers.  While the list set forth below is not exhaustive, these include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing.  These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services.  Failure to comply with these laws and regulations can subject Anchor Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.


Regulation and Supervision of Anchor Bancorp


General .  Anchor Bancorp is a bank holding company registered with the Federal Reserve and the sole shareholder of Anchor Bank.  Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended, ("BHCA"), and the regulations promulgated thereunder.  This regulation and oversight is generally intended to ensure that Anchor Bancorp limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of Anchor Bank.

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As a bank holding company, Anchor Bancorp is required to file quarterly reports with the Federal Reserve and any additional information required by the Federal Reserve and will be subject to regular examinations by the Federal Reserve.  The Federal Reserve also has extensive enforcement authority over bank holding companies, including the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries).  In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.


The Bank Holding Company Act.   Under the BHCA, Anchor Bancorp is supervised by the Federal Reserve.  The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner.  In addition, the Federal Reserve provides that bank holding companies should serve as a source of strength to its subsidiary banks by being prepared to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks.  A bank holding company's failure to meet its obligation to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve's regulations or both.


Under the BHCA, the Federal Reserve may approve the ownership of shares by a bank holding company in any company the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto.  These activities generally include, among others, operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit related insurance; leasing property on a full payout, non-operating basis; selling money orders, travelers' checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.


Sarbanes-Oxley Act of 2002 .  As a public company, Anchor Bancorp is subject to the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing.  The Sarbanes-Oxley Act was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with various 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 includes very specific additional disclosure requirements and corporate governance rules and required the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other 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.


Acquisitions .  The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries.  A bank holding company that meets certain supervisory and financial standards and elects to be designed as a financial holding company may also engage in certain securities, insurance and merchant banking activities and other activities determined to be financial in nature or incidental to financial activities.  The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries.

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Interstate Banking .  The Federal Reserve must approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than the holding company's home state, without regard to whether the transaction is prohibited by the laws of any state.  The Federal Reserve may not approve the acquisition of a bank that has not been in existence for the minimum time period, not exceeding five years, specified by the law of the host state.  Nor may the Federal Reserve approve an application if the applicant controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch.  Federal law does not affect the authority of states to limit the percentage of total insured deposits in the state that may be held or controlled by a bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies.  Individual states may also waive the 30% state-wide concentration limit contained in the federal law.


The federal banking agencies are authorized to approve interstate merger transactions without regard to whether the transaction is prohibited by the law of any state, unless the home state of one of the banks adopted a law prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks.  Interstate acquisitions of branches will be permitted only if the law of the state in which the branch is located permits such acquisitions.  Interstate mergers and branch acquisitions will also be subject to the nationwide and statewide insured deposit concentration amounts described above.


Regulatory Capital Requirements.   The Federal Reserve Board has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the Bank Holding Company Act.  These guidelines apply on a consolidated basis to bank holding companies with $500 million or more in assets or with less assets but certain risky activities, and on a bank-only basis to other companies. These bank holding company capital adequacy guidelines are similar to those imposed on Anchor Bank by the FDIC. For a bank holding company with less than $500 million in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations.


Restrictions on Dividends .  Anchor Bancorp's ability to declare and pay dividends may depend in part on dividends received from Anchor Bank.  The Revised Code of Washington regulates the distribution of dividends by savings banks and states, in part, that dividends may be declared and paid out of accumulated net earnings, provided that the bank continues to meet its surplus requirements.  In addition, dividends may not be declared or paid if Anchor Bank is in default in payment of any assessment due the FDIC.


A policy of the Federal Reserve limits the payment of a cash dividend by a bank holding company if the holding company's net income for the past year is not sufficient to cover both the cash dividend and a rate of earnings retention that is consistent with capital needs, asset quality and overall financial condition. A bank holding company that does not meet any applicable capital standard would not be able to pay any cash dividends under this policy. A bank holding company not subject to consolidated capital requirements is expected not to pay dividends unless its debt-to-equity ratio is less than 1:1, and it meets certain additional criteria. The Federal Reserve also has indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends.


Except for a company that meets the well-capitalized standard for bank holding companies, is well managed, and is not subject to any unresolved supervisory issues, a bank holding company is required to give  the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company's consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation or regulatory order, condition, or written agreement. A bank holding company is considered well-capitalized if on a consolidated basis it has a total risk-based capital ratio of at least 10.0% and a Tier 1 risk-based capital ratio of 6.0% or more, and is not subject to an agreement, order, or directive to maintain a specific level for any capital measure.

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Stock Repurchases .  Bank holding companies, except for certain "well-capitalized" and highly rated bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth.  The Federal Reserve may disapprove a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.


TAXATION


Federal Taxation


General. Anchor Bancorp and Anchor Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Anchor Bancorp or Anchor Bank. Anchor Bank's federal income tax returns have never been audited.


Anchor Bancorp files a consolidated federal income tax return with Anchor Bank. Any cash distributions made by Anchor Bancorp to its shareholders would be considered to be taxable dividends and not as a non-taxable return of capital to shareholders for federal and state tax purposes.


Method of Accounting. For federal income tax purposes, Anchor Bank currently reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on June 30 for filing its federal income tax return.


Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income.  The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years.


Net Operating Loss Carryovers . A financial institution may carryback net operating losses to the preceding five taxable years and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after August 6, 1997.


Corporate Dividends-Received Deduction. Anchor Bancorp may eliminate from its income dividends received from Anchor Bank as a wholly-owned subsidiary of Anchor Bancorp if it elects to file a consolidated return with Anchor Bank.  The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payor of the dividend.  Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.


Washington Taxation


Anchor Bank is subject to a business and occupation tax imposed under Washington law at the rate of 1.8% of gross receipts.  Interest received on loans secured by mortgages or deeds of trust on residential properties and certain securities are exempt from this tax.




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Item 1A.  Risk Factors.


An investment in our common stock involves various risks which are particular to Anchor Bancorp, our industry, and our market area.  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.


Risks Related to Our Business


We are subject to increased regulatory scrutiny and are subject to certain business limitations. Further, we may be subject to more severe future regulatory enforcement actions if our financial condition or performance weakens.


Primarily because of its increased level of non-performing assets, on August 12, 2009, Anchor Bank became subject to the Order, issued with its consent, by the FDIC and DFI because they had reason to believe that Anchor Bank had engaged in unsafe and unsound banking practices and violations of law and/or regulations.  The Order was terminated on September 5, 2012 as a result of the steps Anchor Bank took in complying with the Order and reducing its level of classified assets, augmenting management and improving the overall condition of Anchor Bank. In place of the Order, Anchor Bank entered into a Supervisory Directive with the DFI. The Supervisory Directive contains provisions concerning (i) the management and directors of Anchor Bank; (ii) restrictions on paying dividends; (iii) reductions of classified assets; (iv) maintaining  Tier 1 capital in an amount equal to or exceeding 10% of Anchor Bank's total assets; (v) policies concerning the allowance for loan and lease losses ("ALLL"); and (vi) requirements to furnish a revised three-year business plan to improve Anchor Bank's profitability and progress reports to the FDIC and DFI. The Supervisory Directive will remain in effect until modified or terminated by the FDIC and DFI.


Management has been taking action and implementing programs to comply with the requirements of the Supervisory Directive.  Compliance with the Supervisory Directive, however, is subject to a determination by the FDIC and DFI.  The FDIC or DFI may determine, in its sole discretion, that we have not addressed the issues raised by the Supervisory Directive satisfactorily, or that any current or past actions, violations or deficiencies could be the subject of further regulatory enforcement actions taken by it.  Such enforcement actions could involve penalties or limitations on our business and negatively affect our ability to implement our business plan, the value of our common stock as well as our financial condition and results of operations.


The current weak economic conditions 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 five counties in which we operate, including the Portland, Oregon metropolitan area, which we consider to be our primary market areas could have a material adverse effect on our business, financial condition, results of operations and prospects.  In particular, in the current economic downturn, Washington and Oregon have experienced substantial home price declines and increased foreclosures and have experienced above average unemployment rates.


Continued weakness or 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, possibly resulting in a decrease in our total loans or assets;

•  

collateral for loans made may decline further in value, exposing us to increased risk of loss on existing loans, reducing customers' borrowing power, and reducing the value of assets and collateral associated with existing loans; and

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•  

the amount of our low-cost or noninterest bearing deposits may decrease and the composition of our deposits may be adversely affected.

Our business may be adversely affected by credit risk associated with residential property.


At June 30, 2012, $82.7 million, or 28.0% of our total loan portfolio, was secured by one-to-four single-family  real property. This type of lending is generally sensitive to regional and local economic conditions that  significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in the Washington housing market has reduced the value of the real estate collateral securing these types of loans and increased the risk that we would incur losses if borrowers default on their loans reflected in our  recent charge-off experience on these loans. These declines may have a greater effect on our earnings and capital than on the earnings and capital of financial institutions whose loan portfolios are more diversified.


Many of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because either we originated the loan with a relatively high combined loan-to-value ratio or because of the decline in home values in our market areas.  Residential loans with combined higher loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, such borrowers may be unable to repay their loans in full from the sale proceeds.  Further, a significant amount of our home equity lines of credit consist of second mortgage loans. For those home equity lines secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.  For these reasons, we may experience higher rates of delinquencies, default and losses on our residential loans.


Our loan portfolio is concentrated in loans with a higher risk of loss.


In addition to residential mortgage loans, we originate construction and land loans, commercial and multi- family mortgage loans, commercial business loans, and consumer loans primarily within our market areas.  At June 30, 2012, we had $212.7 million outstanding in non-residential loans, a decrease of $23.5 million compared to $236.2 million outstanding at June 30, 2011.  For the year ended June 30, 2012, loans delinquent 30 days or more, including non-performing loans, decreased to $14.2 million, compared to $26.0 million at June 30, 2011.  At June 30, 2012, delinquent loans represented 4.8% of total loans, including construction loans which represented 1.1% of total loans.  For the comparable period in 2011, delinquent loans represented 7.8% of total loans, including construction loans which represented 2.3% of total loans.  Many of these loans are perceived to have greater credit risk than residential real estate loans for a number of reasons, including those described below:


Construction and Land Loans. At June 30, 2012, we had $13.8 million or 4.7% of total loans in construction and land loans.  Included in this amount are $7.1 million of land loans to individuals at June 30, 2012. Since 2008, and as required by the Order, we have significantly decreased our origination of construction and land acquisition and development loans.  Construction and land lending includes the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost (including interest) of the project.  If the estimate of construction cost proves to be inaccurate, we may advance funds beyond the amount originally committed to permit completion of the project.  If the estimate of value upon completion proves to be inaccurate, we may be confronted at, or prior to, the maturity of the loan with a project the value of which is insufficient to assure full repayment.  In addition, speculative construction loans to a builder are for homes that are not pre-sold, and thus pose a greater potential risk to us than construction loans to individuals on their personal residences.  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 affected by supply and demand conditions.  As a result, this type of lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to sell the property, rather than the ability of the borrower or guarantor to independently repay principal and

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interest.  At June 30, 2012, $308,000 of our construction loans were to a builder for speculative residential construction.  Speculative construction loans are loans made to builders who have not identified a buyer for the completed property at the time of origination. At June 30, 2012, $3.5 million or 39.9% of our total construction and land loans were non-performing.


Commercial and Multi-family Mortgage Loans.   These loans typically involve higher principal amounts than other types of loans. Repayment is dependent upon income being generated from the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions.  Commercial and multi-family mortgage loans also expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate.  In addition, many of our commercial and multi-family real estate loans are not fully amortizing and contain large balloon payments upon maturity.  Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment.  This risk is exacerbated in this current environment.  As required by the Order, we implemented a plan to reduce the balance of these loans.  At June 30, 2012, we had $139.3 million or 47.2% of total loans in commercial and multi-family mortgage loans.


Commercial Business Loans. At June 30, 2012, we had $16.6 million or 5.6% of total loans in commercial business loans, however, we are currently planning on expanding our commercial business lending, subject to market conditions.  Commercial business  lending 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 being viewed as the primary source of repayment in the event of borrower default. Our 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 creditworthiness of the borrower and secondarily on the underlying collateral provided by the borrower.  For more information about the credit risk we face with respect to these types of loans, see Item 1., "Business  – Lending Activities – Commercial Business Lending."

Consumer Loans.   We make secured and unsecured consumer loans.  Our secured consumer loans are collateralized with assets that may not provide an adequate source of payment of the loan due to depreciation, damage, or loss.  In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans.   At June 30, 2012, we had $43.0 million or 14.6% of total loans in consumer loans.  Of this amount, $31.5 million were in home equity loans, some of which are loans in amounts for up to 100% of collateral value.  For more information about the credit risk, we face with respect to these types of loans, see "Our business may be adversely affected by credit risk associated with residential property."


Our loan portfolio possesses increased risk as the result of subprime loans.

As of June 30, 2012, we held in our loan portfolio $6.4 million in one- to four-family mortgage loans ($4.5 million of which were fixed rate), $500,000 of automobile loans (all of which were fixed rate), $3.5 million of home equity loans (of which $3.0 million were fixed rate) and $200,000 of other types of consumer loans (all of which were fixed rate), which are considered "subprime" by federal banking regulators.  The aggregate amount of loans considered subprime at June 30, 2012 was $10.5 million or 3.6% of our total loan portfolio. In exchange for the additional lender risk associated with these loans, these borrowers generally are required to pay a higher interest rate, and depending on the severity of the credit history, a lower loan-to-value ratio may be required than for a conforming loan borrower. At the time of loan origination, our subprime borrowers had an average Fair Isaac and Company, Incorporated, or FICO, credit score of 622 and a weighted average loan-to-value ratio of 63%, which may be significantly understated if current

53

market values are used. A FICO score is a principal measure of credit quality and is one of the significant criteria we rely upon in our underwriting. Generally, a FICO score of 660 or higher indicates the borrower has an acceptable credit reputation. At June 30, 2012, $800,000 of our subprime loans was categorized as non-performing assets and all of these loans were categorized as nonaccrual. Subprime loans are generally considered to have an increased risk of delinquency and foreclosure than do conforming loans, especially when adjustable rate loans adjust to a higher interest rate.  We had not experienced such increased delinquencies or foreclosures at June 30, 2012, however, our subprime loan portfolio will be adversely affected in the event of a further downturn in regional or national economic conditions. In addition, we may not recover funds in an amount equal to any remaining loan balance. Consequently, we could sustain loan losses and potentially incur a higher provision for loan loss expense.


Our concentration in non-owner occupied residential real estate loans may expose us to increased credit risk.


At June 30, 2012, $20.6 million, or 24.9% of our residential mortgage loan portfolio and 7.0% of our total loan portfolio, consisted of loans secured by non-owner occupied residential properties. Loans secured by non-owner occupied properties generally expose a lender to greater risk of non-payment and loss than loans secured by owner occupied properties because repayment of such loans depend primarily on the tenant's continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner's ability to repay the loan without the benefit of a rental income stream. In addition, the physical condition of non-owner occupied properties is often below that of owner occupied properties due to lax property maintenance standards, which has a negative impact on the value of the collateral properties. Furthermore, some of our non-owner occupied residential loan borrowers have more than one loan outstanding with us. At June 30, 2012, we had 17 non-owner occupied residential loan relationships, with aggregate outstanding balances of $11.0 million, of which four loan relationships had an aggregate outstanding balance over $500,000. Consequently, an adverse development with respect to one credit relationship may expose us to a greater risk of loss compared to an adverse development with respect to an owner occupied residential mortgage loan.  At June 30, 2012, all of our non-owner occupied residential mortgage loans were complying with their loan repayment terms, except for two loans which totaled $300,000 at that date.


The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.


The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency, have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending.  Under the guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors, (i) total reported loans for construction, land acquisition and development, and other land represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm residential properties, loans for construction, land acquisition and development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial  real estate related entities, represent 300% or more of total capital.  The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution).  The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations.  The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing.  Our total non-owner occupied commercial real estate loans were $113.1 million or 38.3% of total capital at June 30, 2012 compared to $144.3 million or 246.5% of total capital at June 30, 2011.  While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.




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Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.


Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms, or that any underlying collateral will not be sufficient to assure repayment.  This risk is affected by, among other things:


•  

cash flow of the borrower and/or the project being financed;


•  

the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;


•  

the duration of the loan;


•  

the character and creditworthiness of a particular borrower; and


•  

changes in economic and industry conditions.


We maintain an allowance for loan losses, which we believe is an appropriate reserve to provide for probable losses in our loan portfolio.  The allowance is funded by provisions for loan losses charged to expense.  The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:


•  

our general reserve, based on our historical default and loss experience, certain macroeconomic factors, and management's expectations of future events;


•  

our specific reserve, based on our evaluation of non-performing loans and their underlying collateral; and


•  

an unallocated reserve to provide for other credit losses inherent in our portfolio that may not have been contemplated in the other loss factors.


The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.  In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management.  In addition, if charge-offs in future periods exceed the allowance for loan losses we will need additional provisions to replenish the allowance for loan losses.  Any additional provisions will result in a decrease in net income and possibly capital, and may have a material adverse effect on our financial condition and results of operations.


Our provision for loan losses and net loan charge-offs have increased significantly in recent years and we may be required to make further increases in our provision for loan losses and to charge-off additional loans in the future, which could adversely affect our results of operations.


For the year ended June 30, 2012 we recorded a provision for loan losses of $2.7 million compared to $8.1 million for the year ended June 30, 2011.  We also recorded net loan charge-offs of $2.9 million for the year ended June 30, 2012 compared to $17.6 million for the comparable period in 2011.  Since 2007 we have experienced significant loan delinquencies and credit losses.  However, at June 30, 2012, our total non-performing assets had decreased to $15.4 million compared to $26.9 million at June 30, 2011.  We have also extended $1.8 million in construction loans that were otherwise due to permit completion of the project or to provide the borrower additional time to market the underlying

55

collateral.  Most of these loans mature within 24 months.  To the extent these loans are not further extended or the borrower cannot otherwise refinance with a third party lender our non-performing assets may increase further.


If current weak conditions in the housing and real estate markets continue, we expect that we will continue to experience further delinquencies and credit losses.  As a result, we could be required to make further increases in our provision for loan losses to increase our allowance for loan losses.  Our allowance for loan losses was 2.4% of total loans held for investment and 80.9% of non-performing loans at June 30, 2012. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and our capital.


In addition, Western Washington and the Portland, Oregon metropolitan area, where substantially all of the real and personal property securing our loans is located, is an earthquake-prone region.  A major earthquake could result in our significantly increasing our allowance for loan losses resulting in material losses to us, although we have not experienced any losses in the past ten years as a result of earthquake damage to collateral securing loans. See Item 1., "Business – Natural Disasters."


If our nonperforming assets increase, our earnings will be adversely affected.


At June 30, 2012, our nonperforming assets which consist of nonaccruing loans and real estate owned, were $15.4 million, or 3.3% of total assets.  Our nonperforming assets adversely affect our net income in various ways:


we record interest income only on a cash basis for nonaccrual loans and any nonperforming securities and we do not record interest income for real estate owned;


we must provide for probable loan losses through a current period charge to the provision for loan losses;


noninterest expense increases when we write down the value of properties in our real estate owned portfolio to reflect changing market values or recognize other-than-temporary impairment on nonperforming securities;


there are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to our real estate owned; and


the resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity.


If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our financial condition and results of operations.


We are subject to interest rate risk which could adversely affect our results of operations and financial condition.


Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities and (iii) the average duration of our mortgage-backed securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

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Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.


Decreases in noninterest income could adversely affect our return to profitability and if we cannot generate and increase our income our stock price may be adversely affected.


Our net interest income has decreased steadily in recent years. We also face significant challenges that will hinder our ability to generate competitive returns. Our most significant challenge has been our low interest rate spread and margin during recent periods. As a result, we have become even more reliant on our noninterest income and have relied on significant gains on sales of assets in order to generate net income.  We cannot continue to rely on these significant gains as these gains are subject to market and other risks.  During the years ended June 30, 2012 and 2011 net interest income before provision for loan losses exceeded noninterest expense by $5.7 million and $6.5 million, respectively. While we have identified various strategic initiatives that we will pursue in our efforts to overcome these  challenges and improve earnings, our strategic initiatives may not succeed in generating and increasing income. If we are unable to generate or increase income, our stock price may be adversely affected.


In addition, we originate and sell residential mortgage loans. Changes in interest rates affect demand for our residential loan products and the revenue realized on the sale of loans. A decrease in the volume of loans sold can decrease our revenues and net income.  Further, recent regulatory changes to the rules for overdraft fees for debit transactions and interchange fees have reduced our fee income, resulting in a reduction of our noninterest income.


Increases in deposit insurance premiums and special FDIC assessments will hurt our earnings.


The Dodd-Frank Act established 1.35% of total insured deposits as the minimum reserve ratio.  The FDIC has adopted a plan under which it will meet this ratio by the statutory deadline of September 30, 2020, which has increased assessments. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the minimum reserve ratio to 1.35% from the former minimum of 1.15%.  The FDIC has not announced how it will implement this offset.  In addition to the statutory minimum ratio, the FDIC must set a designated reserve ratio or DRR, which may exceed the statutory minimum.  The FDIC has set 2.0% as the DRR.


As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution's total assets minus its tangible equity instead of its deposits.  While our FDIC insurance premiums initially mayl be reduced by these regulations, it is possible that our future insurance premiums will increase under the final regulations.


Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.


Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and advances from the Federal Home Loan Bank of Seattle ("FHLB") and other borrowings to fund our operations.  At June 30, 2012, we had $64.9 million of FHLB advances outstanding with an additional $43.2 million of available borrowing capacity.  Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB, or market conditions change. Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Washington or Oregon markets where our loans are concentrated, or adverse regulatory action against us.  Our ability to borrow could also be impaired by factors that are not specific to us,  such as a disruption in the financial markets or negative views and expectations about the prospects for the financial

57

services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. In addition, under the Order our ability to use brokered deposits as a source of liquidity is limited.


Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected.  Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs.  In this case, our operating margins and profitability would be adversely affected.


We operate in a highly competitive industry.


We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources.  These competitors primarily include national, regional and internet banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, mortgage banking finance companies, brokerage firms, insurance companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation.  Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking.  Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.  Many of our competitors in these sectors have fewer regulatory constraints and may have lower cost structures.  Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.


Our ability to compete successfully depends on a number of factors including the following:


the ability to develop, maintain and build upon long-term customer relationships;


the ability to expand our market position;


the scope, relevance and pricing of products and services offered to meet customer needs and demands;


the rate at which we introduce new products and services relative to our competitors;


customer satisfaction with our products and service; and


industry and general economic trends.


Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.




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We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations, that are expected to increase our costs of operations.


Anchor Bank is subject to extensive examination, supervision and comprehensive regulation by the FDIC and the DFI, and Anchor Bancorp is subject to examination and supervision by the Federal Reserve.  The FDIC, DFI and the Federal Reserve govern the activities in which we may engage, primarily for the protection of depositors and the Deposit Insurance Fund.  These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on an institution's operations, reclassify assets, determine the adequacy of an institution's allowance for loan losses and determine the level of deposit insurance premiums assessed.


Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") has significantly changed the bank regulatory structure and will affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress.  The federal agencies are given significant discretion in drafting and implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.


Certain provisions of the Dodd-Frank Act are expected to have a near term impact on Anchor Bank.  For example, a provision of the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts.  Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.


The Dodd-Frank Act also broadens the base for FDIC insurance assessments.  Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, and noninterest-bearing transaction accounts have unlimited deposit insurance through December 31, 2012.


The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called "golden parachute" payments and authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidate using a company's proxy materials.  The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.


The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit "unfair, deceptive or abusive" acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Financial institutions such as Anchor Bank with $10 billion or less in assets will continue to be examined for compliance with the consumer laws by their primary bank regulators.


On June 7, 2012, the Federal Reserve approved proposed rules, subsequently approved by the FDIC on June 12, 2012, that would substantially amend the regulatory risk-based capital rules applicable to us. The proposed rules implement the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act. The proposed rules include new higher minimum risk-based capital and leverage ratios, which would be phased in during 2013 and 2014, and would limit the definition of what constitutes "capital" for purposes of calculating those ratios. The proposed new minimum capital level requirements under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a "capital conservation buffer" of 2.5% above the new regulatory minimum capital ratios.

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While the proposed Basel III changes and other regulatory capital requirements will likely result in generally higher regulatory capital standards, it is difficult at this time to predict when or how any new standards will ultimately be applied to us or what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks.  However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.


The application of more stringent capital requirements could, among other things, result in lower returns on invested capital, over time require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements.  Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy and could limit our ability to make distributions, including paying out dividends or buying back shares.  Any additional changes in our regulation and oversight, in the form of new laws, rules and regulations could make compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects.


Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.


We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.  At some point, we may need to raise additional capital to support continued growth.


Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance.  Accordingly, we may not be able to raise additional capital if needed on terms that are acceptable to us, or at all.  If we cannot raise additional capital when needed, our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected.  In addition, if we are unable to raise additional capital when required by the FDIC and DFI, we may be subject to additional adverse regulatory action. See "– We are subject to increased regulatory scrutiny and are subject to certain business limitations.  Further, we may be subject to more severe future regulatory enforcement actions if our financial condition or performance weakens further." above.


If our investment in the Federal Home Loan Bank of Seattle becomes impaired, our earnings and shareholders' equity could decrease.


At June 30, 2012, we owned $6.5 million in FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the FHLB's Capital Plan. Our FHLB stock has a par value of $100, is carried at cost, and it is subject to recoverability testing per applicable accounting standards. The FHLB has announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency, its primary regulator, as of December 31, 2008, and that it would suspend future dividends and the repurchase and redemption of outstanding common stock. As a result, the FHLB has not paid a dividend since the fourth quarter of 2008. In August 2009, under the Federal Housing Finance Agency's prompt corrective action regulations, the FHLB received a capital classification of "undercapitalized" and has subsequently remained so classified, due to, among other things, risk-based capital deficiencies as of March 31, 2009 and June 30, 2009, the deterioration in the value of its private-label mortgage-backed securities and the amount of accumulated unrealized losses stemming from that deterioration, and the amount of its retained earnings. On October 25, 2010, the FHLB entered into a consent order with the Federal Housing Finance Agency.  The consent order required, among other matters, the FHLB meet and maintain 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, we have not recorded an impairment on our investment in FHLB stock.  Further deterioration in the FHLB's financial position may, however, result in future impairment in the value of those

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securities.  We will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.


New or changes in existing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.


The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit our shareholders.  Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. Additionally, actions by regulatory agencies or significant litigation against us could require us to devote significant time and resources to defending our business and may lead to penalties that materially affect us.  These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.

If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.


We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed upon and the property taken in as real estate owned and at certain other times during the assets holding period.  Our net book value ("NBV") in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs ("fair value"). A charge-off is recorded for any excess in the asset's NBV over its fair value.  If our valuation process is incorrect, the fair value of the investments in real estate may not be sufficient to recover our NBV in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in real estate could have a material adverse effect on our financial condition and results of operations.


In addition, bank regulators periodically review our real estate owned and may require us to recognize further charge-offs.  Any increase in our charge-offs, as required by the bank regulators, may have a material adverse effect on our financial condition and results of operations.


You may not receive dividends on our common stock.


It is not expected that we will pay cash dividends on our common stock in the near future. Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments.  Under the Supervisory Directive, Anchor Bank is not able to pay dividends to Anchor Bancorp without the prior approval of the DFI and the FDIC and we do not expect to pay dividends as long as the Supervisory Directive remains in effect. In addition, we are restricted by the FDIC from making any distributions to stockholders that represent a return of capital without the written non-objection of the FDIC Regional Director. The declaration and payment of future cash dividends will be subject to, among other things, our then current and projected consolidated operating results, financial condition, tax considerations, statutory and regulatory restrictions, future growth plans, general economic conditions, and other factors the board deems relevant.







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Item 2.  Properties


At June 30, 2012, we had one administrative office, 13 full service banking offices and one loan center of which 11 of the locations are owned and five locations are leased.  At June 30, 2012, the net book value of our investment in premises, equipment and leaseholds was $12.2 million.  The net book value of our data processing and computer equipment at June 30, 2012 was $169,000.


The following table provides a list of our main and branch offices and indicates whether the properties are owned or leased:

Location

Leased or

Owned

Lease

Expiration

Date

Square

Footage

Net Book Value

at June 30,

2012

(In Thousands)

ADMINISTRATIVE OFFICE

100 West First

Aberdeen, Washington 98520

Owned

-- 7,410 $ 2,197

BRANCH OFFICES:

Aberdeen (1) (2)

120 N. Broadway

Aberdeen, Washington 98520

Owned

-- 17,550 1,320

Centralia (2)

604 S. Tower

Centralia, Washington 98531

Owned

-- 3,000 658

Chehalis (3)

1601 NW Louisiana Avenue

Chehalis, Washington 98532

Leased

4/30/13

683 152

Elma (2)

216 S. Third Street

Elma, Washington 98541

Owned

-- 2,252 289

Hoquiam

701 Simpson Avenue

Hoquiam, Washington 98550

Leased

3/31/12

550 6

Lacey (4)

601 Woodland Square Loop SE

Lacey, Washington 98503

Owned

-- 13,505 1,992

Martin Way

4250 Martin Way E.

Building 4, Suite 107

Olympia, Washington 98516

Leased

6/30/13

1,813 79

(table continued on following page)

62

Location

Leased or

Owned

Lease

Expiration

Date

Square

Footage

Net Book Value

at June 30,

2012

Montesano

301 Pioneer Avenue East

Montesano, Washington 98563

Owned

-- 2,125 3,004

Ocean Shores (2)

795 Pt. Brown Avenue NW

Ocean Shores, Washington 98569

Owned

-- 2,550 633

Olympia (2)

2610 Harrison Avenue West

Olympia, Washington 98507

Owned

-- 1,882 463

Puyallup (3)

16502 Meridian Avenue E, Suite B

Puyallup, Washington 98375

Leased

1/31/15

982 109

Shelton (3)

100 E. Wallace Kneeland Boulevard

Shelton, Washington 98584

Leased

5/31/13

673 23

Westport (2)

915 N. Montesano

Westport, Washington 98595

Owned

-- 3,850 1,051

LOAN OFFICES:

Aberdeen

211 E. Market Street

Aberdeen, Washington 98520

Owned

-- 12,825 18

Aberdeen

215 E. Market Street

Aberdeen, Washington 98520

Owned

-- 12,000 197

________

(1)  Includes our home branch. 

(2)

Drive-up ATM available.

(3)  Wal-Mart locations. 
(4)  Includes space leased. 

Item 3.      Legal Proceedings


Anchor Bank from time to time is involved in various claims and legal actions arising in the ordinary course of business.  There are currently no matters that in the opinion of management, would have material adverse effect on our consolidated financial position, results of operation, or liquidity.


Item 4. Mine Safety Disclosu res


    Not applicable.


63



PART II


Item 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities


Our common stock is traded on The Nasdaq Stock Market LLC's Global Market, under the symbol "ANCB."  As of June 30, 2012, there were 2,550,000 shares of common stock issued and outstanding and we had approximately 225 shareholders of record, excluding persons or entities who hold stock in nominee or "street name" accounts with brokers.  The Company has not paid any dividends to shareholders since its formation.


Stock Repurchases.   The Company had no stock repurchases of its outstanding common stock during the fourth quarter of the year ended June 30, 2012.


Equity Compensation Plan Information.   The equity compensation plan information presented under subparagraph (d) in Part III, Item 12 of this report is incorporated herein by reference.


Performance Graph.   The following graph compares the cumulative total shareholder return on the Company's Common Stock with the cumulative total return on the NASDAQ Composite Index and a peer group of the SNL All Thrift Index.  Total return assumes the reinvestment of all dividends and that the value of Common Stock and each index was $100 on January 26, 2012.


Period Ending

Index

1/26/11

3/31/11

6/30/11

09/30/11

12/31/11

3/31/12

6/30/12

Anchor Bancorp

$100.00

$107.00

$  92.00

$62.10

$62.00

$85.00

$103.40

NASDAQ Composite

100.00

101.71

101.67

88.76

96.05

114.29

108.85

SNL Thrift Index

100.00

100.08

  94.32

77.92

85.43

94.66

  92.20



Source: SNL Financial LC, Charlottesville, VA


64



Item 6.

Selected Financial Data


The following table sets forth certain information concerning our consolidated financial position and results of operations at and for the dates indicated and have been derived from our audited consolidated financial statements.  The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data."


At June 30,

2012

2011

2010

2009

2008

FINANCIAL CONDITION DATA:

(In Thousands)

Total assets

$ 470,815 $ 488,935 $ 544,829 $ 652,435 $ 626,445

Securities

1,798 5,594 6,737 9,337 26,643

Mortgage-backed securities

54,098 40,156 52,077 70,530 51,023

Loans receivable, net (1)

287,755 325,464 389,411 474,957 490,515

Deposits

345,798 339,474 355,788 471,713 389,949

Federal Home Loan Bank advances

64,900 85,900 136,900 129,500 165,165

Total equity

54,024 57,452 44,670 42,914 62,362

Year Ended June 30,

OPERATING DATA:

2012

2011

2010

2009

2008

(In Thousands)

Total interest income

$ 22,464 $ 25,969 $ 32,503 $ 37,050 $ 40,131

Total interest expense

6,090 8,002 14,650 20,748 22,665

Net interest income before provision

   for loan losses

16,374 17,967 17,853 16,302 17,466

Provision for loan losses

2,735 8,078 2,615 20,263 3,545

Net interest income (loss) after

   provision for loan losses

13,639 9,889 15,238 (3,961 ) 13,921

Noninterest income

6,674 5,752 6,807 5,777 5,652

Noninterest expense

22,025 24,461 24,583 24,992 18,789

Income (loss) before provision (benefit)

   for income tax

(1,712 ) (8,820 ) (2,538 ) (23,176 ) 784

Total benefit for income tax

-- -- (2,958 ) (2,923 ) (2 )

Net income (loss)

$ (1,712 ) $ (8,820 ) $ 420 $ (20,253 ) $ 786

___________________

(1)           Net of allowances for loan losses, loans in process and deferred loan fees.

65

At June 30,

OTHER DATA:

2012

2011

2010

2009

2008

Number of:

  Real estate loans outstanding

2,500 2,222 2,463 2,499 2,398

  Deposit accounts

25,411 26,837 29,035 31,951 31,613

  Full-service offices

13 14 16 16 20

At or For the

Year Ended June 30,

KEY FINANCIAL RATIOS:

2012

2011

2010

2009

2008

Performance Ratios:

Return on assets (1)

(0.36 )% (1.72 )% 0.07 % (3.02 )% 0.13 %

Return on equity (2)

(3.13 ) (16.66 ) 0.86 (34.70 ) 1.27

Equity to total assets ratio (3)

11.36 10.32 8.07 8.72 9.90

Interest rate spread (4)

3.43 3.57 3.00 2.17 2.48

Net interest margin (5)

3.65 3.78 3.22 2.58 2.97

Average interest-earning assets to

  average interest-bearing liabilities

116.4 112.3 108.5 112.5 112.6

Efficiency ratio (6)

95.6 103.1 99.7 113.2 81.4

Other operating expenses as a

  percent of average total assets

4.6 4.8 4.1 3.7 3.0

Capital Ratios:

Tier I leverage

10.9 10.7 7.6 6.2 10.1

Tier I risk-based

17.0 15.8 10.5 8.9 12.6

Total risk-based

18.2 17.1 11.8 10.1 13.6

Asset Quality Ratios:

Non-accrual and 90 days or

  more past due loans as a

  percent of total loans

3.0 4.3 5.1 12.1 4.7

Non-performing assets as a

  percent of total assets

3.3 5.5 6.5 9.8 4.0

Allowance for loan losses as a percent

  of total loans

2.4 2.2 4.1 4.9 1.5

Allowance for loan losses as a percent

  of non-performing loans

80.9 51.1 81.3 40.3 32.0

Net charge-offs to average

  outstanding loans

0.9 4.7 2.3 0.6 0.1

_______________________

(1)

Net income (loss) divided by average total assets.

(2)

Net income (loss) divided by monthly average equity.

(3)

Average equity divided by average total assets.

(4)

Difference between weighted average yield on interest-earning assets and weighted average rate on interest-bearing liabilities.

(5)

Net interest income as a percentage of average interest-earning assets.

(6)

The efficiency ratio represents the ratio of noninterest expense divided by the sum of net interest income and noninterest income (expense).



66


Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations


This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial conditions and results of operations. The information in this section has been derived from the Consolidated Financial Statements and footnotes thereto, which are included in Item 8 of this Form 10-K.  You should read the information in this section in conjunction with the business and financial information regarding us as provided in this Form 10-K.  Unless otherwise indicated, the financial information presented in this section reflects the consolidated financial condition and results of operations of Anchor Bancorp and its subsidiary.


Overview


Anchor Bancorp is a bank holding company which primarily engages in the business activity of its subsidiary, Anchor Bank.  Anchor Bank is a community-based savings bank primarily serving Western Washington through our 13 full-service banking offices (including three Wal-Mart store locations) and one loan production office located within Grays Harbor, Thurston, Lewis, Pierce, and Mason counties, Washington. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans. We offer a wide range of loan products to meet the demands of our customers. Historically, lending activities have been primarily directed toward the origination of one- to four-family construction, commercial real estate and consumer loans.  Since 1990, we have also offered commercial real estate loans and multi-family loans primarily in Western Washington. To an increasing extent in recent years, lending activities have also included the origination of residential construction loans through brokers, in particular within the Portland, Oregon metropolitan area and increased reliance on non-deposit sources of funds.


Historically we used wholesale sources to fund wholesale loan growth; typically FHLB advances or brokered certificates of deposit depending on the relative cost of each and our interest rate position.  Under the Order, however, we were not permitted to increase our brokered deposits.  Our current strategy is to utilize FHLB advances consistent with our asset liability objectives and replace brokered deposits with retail deposits while limiting loan growth consistent with our regulatory and capital objectives.  While continuing our commitment to all real estate lending, management expects to continue to reduce our exposure to construction loans while commercial business lending becomes increasingly more important for us.


Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings.  Changes in levels of interest rates also affect our net interest income.  Additionally, to offset the impact of the current interest rate environment, we are seeking to find means of increasing interest income while controlling expenses. We intend to enhance the mix of our assets by increasing commercial business relationships which have higher risk-adjusted returns as well as deposits.  A secondary source of income is noninterest income, which includes gains on sales of assets, and revenue we receive from providing products and services. From time to time,  our  noninterest  expense has exceeded our net interest income after provision for loan losses and we have relied primarily upon gains on sales of assets  (primarily  sales of mortgage loans to Freddie Mac) to supplement our net interest income and to improve earnings.


Our operating expenses consist primarily of compensation and benefits, general and administrative, information technology, occupancy and equipment, deposit services and marketing expenses. Compensation and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.


Compliance With Regulatory Restrictions


Correcting the problems identified in the Order has caused us to revise our operating strategy and has had a resulting impact on our financial condition and results of operations.  We have reduced our asset size from $652.4 million at June 30, 2009 to $470.8 million at June 30, 2012 as we have sought to reduce our commercial real estate loans,

67

specifically our concentration in construction lending to preserve our capital and maximize our regulatory capital ratios.  In particular, in fiscal 2010 we sold relatively high yielding performing loans which has reduced our net interest income in recent periods.  Also, because of the reduced demand for commercial real estate loans, we have sold these loans at a discount which has negatively impacted our operating results. Compliance with the Order has also increased our non-interest expense from $18.9 million for the year ended June 30, 2008 to $22.0 million for the year ended June 30, 2012 as we have increased our use of third party consultants.  The reduction in asset size has helped us preserve our capital and maximize our regulatory capital ratios as we took action to achieve compliance with the requirements of the Order.

In addition to the reduction in assets we also reduced certain types of liabilities.  We had relied on wholesale funds such as brokered deposits in some cases to fund lending transactions and as a result of the Order these funding sources are no longer available to us.  For example, in the past Anchor Bank had used wholesale funds as an additional funding source, in many cases they were used to "match" fund loan purchases, or in other words to provide the specific source funds to purchase loans.  The majority of these purchases were commercial real estate or multi-family loans.  As a result of the Order we significatnly reduced brokered certificates and our reliance on wholesale funds and have increased our reliance on core deposits which has decreased our cost of funds.  At June 30, 2012, we had eliminated all brokered deposits as compared to $84.7 million of brokered deposits at June 30, 2009.

The Order was terminated on September 5, 2012 as a result of the steps Anchor Bank took in complying with the Order and reducing its level of classified assets, augmenting management and improving the overall condition of Anchor Bank. In place of the Order, Anchor Bank entered into a Supervisory Directive with the DFI.

The Supervisory Directive contains provisions concerning (i) the management and directors of Anchor Bank; (ii) restrictions on paying dividends; (iii) reductions of classified assets; (iv) maintaining  Tier 1 capital in an amount equal to or exceeding 10% of Anchor Bank's total assets; (v) policies concerning the allowance for loan and lease losses ("ALLL"); and (vi) requirements to furnish a revised three-year business plan to improve Anchor Bank's profitability and progress reports to the FDIC and DFI.

Management and the Board of Directors have and will be taking action and implementing programs to comply with the requirements of the Supervisory Directive.


Operating Strategy


Our focus is on managing our problem assets, increasing our higher-yielding assets (in particular commercial business loans), increasing our core deposit balances, reducing expenses, and retaining experienced employees with a commercial lending focus.  We seek to achieve these results by focusing on the following objectives:


Focusing on Asset Quality.   We have de-emphasized new loan originations for investment purposes to focus on monitoring existing performing loans, resolving non-performing loans and selling foreclosed assets.   We have aggressively sought to reduce our level of non-performing assets through write-downs, collections, modifications and sales of non-performing loans and the sale of properties once they become real estate owned.  We have taken proactive steps to resolve our non-performing loans, including negotiating repayment plans, forbearances, loan modifications and loan extensions with our borrowers when appropriate, and accepting short payoffs on delinquent loans, particularly when such payoffs result in a smaller loss to us than foreclosure.  We also have added experienced personnel to the department that monitors our loans to enable us to better identify problem loans in a timely manner and reduce our exposure to a further deterioration in asset quality, including a new Chief Lending Officer in 2008 and a new Credit Administration Officer in 2009.  During the latter part of fiscal 2007, as part of management's decision to reduce the risk profile of our loan portfolio, we implemented more stringent underwriting guidelines and procedures.  Prior to this time our underwriting emphasis with respect to commercial real estate, multi-family and construction loans focused heavily on the value of the collateral securing the loan, with less emphasis placed on the borrower's debt servicing capacity or other credit factors.  Our revised underwriting guidelines place greater emphasis on the borrower's credit, debt service coverage and cash flows as well as on collateral appraisals.  Additionally, our policies with respect to loan extensions became more conservative than our previous policies, and now require that a review of all relevant factors, including loan terms, the condition of the security property, market changes and trends that may affect the security property and

68

financial condition of the borrower conform to our revised underwriting guidelines and that the extension be in our best interest.


Improving our Earnings by Expanding Our Product Offerings .  We intend, subject to market conditions, to prudently increase the percentage of our assets consisting of higher-yielding commercial business loans, which offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations.  At June 30, 2012 our commercial business loans totaled $16.6 million, or 5.6% of our total loan portfolio.  We also intend to selectively add additional products to further diversify revenue sources and to capture more of each customer's banking relationship by cross selling our loan and deposit products and additional services to our customers such as electronic invoicing and payroll services for our business customers.


Attracting Core Deposits and Other Deposit Products.   Our strategic focus is to emphasize total relationship banking with our customers to increase core deposits to internally fund our loan growth.  We believe that by focusing on customer relationships, our level of core deposits and locally-based retail certificates of deposit will increase.


As a result of the Order and Supervisory Directive, we are focused on reducing our reliance on other wholesale funding sources such as brokered deposits and reducing  our asset size for the purpose of preserving capital and to facilitate our efforts in complying with the requirements of the Supervisory Directive.  During the year ended June 30, 2012, our deposits increased by $6.3 million.  This increase was primarily as a result of our strategy to increase core deposits.


Continued Expense Control.   Beginning in fiscal 2009 and continuing into fiscal 2012, management has undertaken several initiatives to reduce noninterest expense and will continue to make it a priority to identify cost savings opportunities throughout all phases of our operations.  Beginning in fiscal 2009, we instituted expense control measures such as reducing staff, eliminating Anchor Bank's discretionary matching contribution to its 401(k) plan, reducing most marketing expenses and charitable contributions, cancelling certain projects and capital purchases, and reducing travel and entertainment expenditures.  We have also reduced our number of full-time equivalent employees from 194 at September 30, 2008 to 140 at June 30, 2012.  During fiscal 2009, four in store Wal-Mart branch offices were closed as a result of their failure to meet our required growth standards.  During fiscal 2010, two additional in store Wal-Mart branch offices were closed.  The reduction in personnel, cost savings and closure of offices, resulted in savings of approximately $1.8 million per year from the closure of these six offices.  Notwithstanding these initiatives, our efforts to reduce non-interest expense have been adversely affected by the $1.0 million increase in our FDIC insurance premiums beginning in fiscal 2009 and cost associated with  real estate owned which has been significant in recent years.  Despite these significant costs, non-interest expense decreased by $2.4 million or 10.0% during fiscal 2012.


Retaining Experienced Personnel with a Focus on Relationship Banking.   Our ability to continue to retain banking professionals with strong community relationships and significant knowledge of our markets will be a key to our success.  We believe that we enhance our market position and add profitable growth opportunities by focusing on retaining experienced bankers who are established in their communities.  We emphasize to our employees the importance of delivering exemplary customer service and seeking opportunities to build further relationships with our customers.  Our goal is to compete with other financial service providers by relying on the strength of our customer service and relationship banking approach.


Disciplined Franchise Expansion.   Currently we cannot increase our asset size because of the capital and other requirements of the Supervisory Directive.   As a result of these requirements, we have instead reduced our asset size to facilitate our efforts to comply with the Order and to preserve our capital, which we expect to continue to ensure compliance with the Supervisory Directive.  Once the Supervisory Directive is lifted and general economic conditions improve, we anticipate modest organic growth. We will seek to increase our loan originations and core deposits through targeted marketing efforts designed to take advantage of the opportunities being created as a result of the consolidation of financial institutions that is occurring in our market area.




69

Critical Accounting Policies


We use estimates and assumptions in our financial statements in accordance with generally accepted accounting principles. Management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to the determination of the allowance for loan losses and the associated provision for loan losses, the valuation of capitalized mortgage servicing rights, deferred income taxes and the associated income tax expense, as well as valuation of real estate owned. Management reviews the allowance for loan losses for adequacy on a monthly basis and establishes a provision for loan losses that it believes is sufficient for the loan portfolio growth expected and the loan quality of the existing portfolio. The carrying value of the capitalized mortgage servicing rights are evaluated annually and the carrying value of real estate owned is assessed on a quarterly basis. Income tax expense and deferred income taxes are calculated using an estimated tax rate and are based on management's understanding of our effective tax rate and the tax code.

Allowance for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the allowance for loan losses must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our Board of Directors and management assesses the allowance for loan losses on a quarterly basis. The Executive Loan Committee analyzes several different factors including delinquency rates, charge-off rates and the changing risk profile of our loan portfolio, as well as local economic conditions such as unemployment rates, bankruptcies and vacancy rates of business and residential properties.

We believe that the accounting estimate related to the allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period,  requiring management to make assumptions about future losses on loans. The impact of a  sudden large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings.


Our methodology for analyzing the allowance for loan losses consists of specific allocations on significant individual credits that meet the definition of impaired and a general allowance amount.  The specific allowance component is determined when management believes that the collectibility of a specifically identified large loan has been impaired and a loss is probable. The general allowance component relates to assets with no well-defined deficiency or weakness and takes into consideration loss that is inherent within the portfolio but has not been realized. The general allowance is determined by applying an expected loss percentage to various types of loans with similar characteristics and classified loans that are not analyzed specifically for impairment.  Because of the imprecision in calculating inherent and potential losses, the national and local economic conditions are also assessed to determine if the general allowance is adequate to cover losses.  We factored in an unallocated portion for market risk.

The allowance is increased by the provision for loan losses, which is charged against current period operating results and decreased by the amount of actual loan charge-offs, net of recoveries.


Deferred Income Taxes. Deferred income taxes are reported for temporary differences between items of income or expense reported in the financial statements and those reported for income tax purposes. Deferred taxes are computed using the asset and liability.  Under this method, a deferred tax asset or liability is determined based on the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in an institution's income tax returns.  Deferred tax assets are deferred tax consequences attributable to deductible temporary differences and carryforwards.  After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance.  A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized.  As required by GAAP, available evidence is weighted heavily on cumulative losses with less weight placed on future projected profitability.  Realization of the deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character in the period during which deductible temporary differences reverse or within the carryback and carryforward periods available under tax law.  Based upon the available evidence, we recorded a valuation allowance of $7.9 million and $6.4 million at June 30, 2012 and 2011, respectively.  The deferred tax provision for the year is equal to the net change in the net deferred tax asset from the beginning to the end of the year, less amounts

70

applicable to the change in value related to investments available for sale. The effect on deferred taxes of a change in tax rates is recognized as income in the period that includes the enactment date. The primary differences between financial statement income and taxable income result from deferred loan fees and costs, mortgage servicing rights, loan loss reserves and dividends received from the FHLB of Seattle.  Deferred income taxes do not include a liability for pre-1988 bad debt deductions allowed to thrift institutions that may be recaptured if the institution fails to qualify as a bank for income tax purposes in the future.


Real Estate Owned.   Real estate acquired through foreclosure is transferred to the real estate owned asset classification at the lesser of "cost" (principal balance less unearned loan fees, plus capitalized expenses of acquisition, if any) or "fair value" (estimated fair market value less estimated costs of disposal).  Costs associated with real estate owned for maintenance, repair, property tax, etc., are expensed during the period incurred. Assets held in real estate owned are reviewed monthly for potential impairment.  When impairment is indicated the impairment is charged against current period operating results and netted against the real estate owned to reflect a net book value.  At disposition any residual difference is either charged to current period earnings as a loss on sale or reflected as income in a gain on sale.


Comparison of Financial Condition at June 30, 2012 and June 30, 2011


General. Total assets decreased $18.1 million, or 3.7%, to $470.8 million at June 30, 2012 from $488.9 million at June 30, 2011.  The decrease in assets during this period was primarily a result of a $37.7 million or 11.6% decrease in loans receivable.  In addition, total real estate owned decreased $5.9 million, or 46.7%, to $6.7 million at June 30, 2012 from $12.6 million at June 30, 2011.  Total liabilities decreased $14.7 million or 3.4% to $416.8 million at June 30, 2012 compared to $431.5 million at June 30, 2011.  The decrease in our balance sheet facilitated our efforts to comply with the regulatory capital requirements under the Order.  Total deposits increased $6.3 million, or 1.9%, to $345.8 million at June 30, 2012 from $339.5 million at June 30, 2011 primarily as a result of an increase of $5.7 million or 7.3% in money market deposits and $7.7 million or 25.3% in non-interest bearing deposits partially offset by a $10.3 million decline in certificate of deposits.  Our total borrowings, which consisted of FHLB advances, decreased $21.0 million from June 30, 2011 to June 30, 2012. The average cost of advances decreased from 2.08% during the year ended June 30, 2011 to 1.87% during the year ended June 30, 2012.


Assets.   For the year ended June 30, 2012, total assets decreased $18.1 million. The following table details the increases and decreases in the composition of our assets from June 30, 2011 to June 30, 2012:

Balance at

Balance at

Increase (Decrease)

June 30, 2012

June 30, 2011

Amount

Percent

(Dollars in Thousands)

Cash and due from banks

$ 78,673 $ 63,757 $ 14,916 23.4 %

Mortgage-backed securities,

  available for sale

47,061 32,718 14,343 43.8

Mortgage-backed securities, held to

  maturity

7,037 7,438 (401 ) (5.4 )

Loans receivable, net of allowance

  for loan losses

287,755 325,464 (37,709 ) (11.6 )

Real estate owned

6,708 12,597 (5,889 ) (46.7 )

From June 30, 2011 to June 30, 2012, cash and due from banks increased $14.9 million.  This increase was primarily a result of funds received from normal operations.


Mortgage-backed securities increased $13.9 million to $54.1 million at June 30, 2012 from $40.2 million at June 30, 2011. During the year ended June 30, 2012, we securitized $4.7 million of fixed rate mortgage-backed securities through Freddie Mac.  We securitize and sell mortgage loans to manage interest rate sensitivity and capital requirements, supplement loan originations and provide liquidity.  During the year ended June 30, 2012, we sold $24.4 million in securities compared to $3.4 million in securities for the year ended June 30, 2011.

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Loans receivable, net, decreased $37.7 million to $287.8 million at June 30, 2012 from $325.5 million at June 30, 2011 primarily as a result of lower loan demand from creditworthy borrowers, charge-offs, and transfers of nonperforming loans to real estate owned, as well as pay downs due to normal borrower activity.  During the year ended June 30, 2012, $11.8 million of non-performing loans were transferred to real estate owned. We continued to reduce our exposure to construction and land loans during the year ended June 30, 2012. The total construction and land loan portfolios declined to $13.8 million or 4.7% of the total loan portfolio at June 30, 2012 compared to $18.4 million or 5.5% of the total loan portfolio a year ago.  In addition to the significant decline in the construction and land loan portfolios, our commercial real estate loan portfolio decreased $8.7 million. One- to- four family loans decreased $14.4 million primarily due to repayments and lower loan demand. Consumer loans decreased $9.0 million primarily due to a $4.2 million decrease in home equity loans and a $2.2 million reduction in automobile loans.


Real estate owned, net decreased $5.9 million as a result of ongoing sales to reduce our non-performing assets.


Deposits.   Deposits increased $6.3 million, or 1.9%, to $345.8 million at June 30, 2012 from $339.5 million at June 30, 2011.  The increase in money market deposits was due in part to our ongoing marketing strategy to focus on core deposits.


The following table details the changes in deposit accounts:

Balance at

Balance at

Increase (Decrease)

June 30, 2012

June 30, 2011 Amount Percent

(Dollars in Thousands)

Noninterest-bearing demand

  deposits

$ 37,941 $ 30,288 $ 7,653 25.3 %

Interest-bearing demand deposits

16,434 17,387 (953 ) (5.5 )

Money market accounts

83,750 78,017 5,733 7.3

Savings deposits

36,475 32,263 4,212 13.1

Certificates of deposit

  Retail certificates

171,198 181,519 (10,321 ) (5.7 )

  Brokered certificates

-- -- -- --

     Total deposit accounts

$ 345,798 $ 339,474 6,324 1.9 %

Borrowings. FHLB advances decreased $21.0 million, or 24.7%, to $64.9 million at June 30, 2012 from $85.9 million at June 30, 2011.  The decrease in borrowing was related to our continuing focus on reducing wholesale funds.


Equity.   Total equity decreased $3.4 million, or 6.0%, to $54.0 million at June 30, 2012 from $57.5 million at June 30, 2011.  The decrease was due to a $1.7 million loss as well as a change in other comprehensive income.


Comparison of Operating Results for the Years Ended June 30, 2012 and June 30, 2011


General.   Net loss for the year ended June 30, 2012 was $1.7 million compared to a net loss of $8.8 million for the year ended June 30, 2011.

Net Interest Income.   Net interest income decreased $1.6 million, or 16.4%, to $16.4 million for the year ended June 30, 2012, from $18.0 million for the year ended June 30, 2011. The decrease in net interest income was primarily attributable to the decrease in our net loans receivable.


Our net interest margin decreased 13 basis points to 3.65% for the year ended June 30, 2012, from 3.78% for the same period of the prior year.  Over the last year, our net interest margin declined as a result of the decline in our cost of funds not exceeding the reduction in yield on interest-earning assets.  Our yield on earnings assets decreased to 5.01% for the year ended June 30, 2012 from 5.46% for the year ended June 30, 2011.  Our funding costs have decreased from 1.89% during the year ended June 30, 2011 to 1.58% during the year ended June 30, 2012.  The decline was related to

72

the repricing of our FHLB borrowings and certificates of deposit to lower current rates.  We expect further declines in our funding costs as our certificates of deposit mature and reprice to current market rates.  Our net interest rate spread decreased to 3.43% for the year ended June 30, 2012 as compared to 3.57% for the year ended June 30, 2011.


The cost of borrowed funds from the FHLB and certificates of deposit decreased to 1.87% and 2.19%, respectively during the year ended June 30, 2012 from 2.08% and 2.51% for the prior year.  The following table sets forth the results of balance sheet growth and changes in interest rates to our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.


Year Ended June 30, 2012

Compared to June 30, 2011

Increase (Decrease)

Due to

Rate

Volume

Total

(In Thousands)

Interest-earning assets:

  Loans receivable, net

$ 164 $ (3,442 ) $ (3,278 )

  Mortgage-backed securities

(290 ) 110 (180 )

  Securities, FHLB and cash and due from banks

(204 ) 157 (47 )

     Total net change in income on interest-earning assets

(330 ) (3,175 ) (3,505 )

Interest-bearing liabilities:

  Savings deposits

(58 ) 31 (27 )

  Interest bearing demand deposits

8 (18 ) (10 )

  Money market accounts

(243 ) 65 (178 )

  Certificates of deposit

(576 ) (321 ) (897 )

  FHLB advances

(152 ) (648 ) (800 )

Total net change in expense on interest-bearing liabilities

(1,021 ) (891 ) (1,912 )

Net change in net interest income

$ 691 $ (2,284 ) $ (1,593 )

Interest Income. Total interest income for the year ended June 30, 2012 decreased $3.5 million, or 13.5%, to $22.5 million, from $26.0 million for the year ended June 30, 2011. The decrease during the period was primarily attributable to the decline in net loans receivable over the last year.


The following table compares detailed average earning asset balances, associated yields, and resulting changes in interest income for the years ended June 30, 2012 and 2011:


Year Ended June 30,

2012

2011

Increase/

Average

Balance

Yield

Average

Balance

Yield

(Decrease) in

Interest

Income from

2011

(Dollars in Thousands)

Loans receivable, net

$ 318,366 6.34 % $ 373,099 6.29 % $ (3,278 )

Mortgage-backed securities

47,622 4.13 45,271 4.74 (180 )

Securities

3,331 4.41 6,259 4.25 (119 )

FHLB stock

6,510 -- 6,510 -- --

Cash and due from banks

72,698 0.23 44,602 0.21 72

Total interest-earning assets

$ 448,527 5.01 % $ 475,741 5.46 % $ (3,505 )


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Interest Expense.   Interest expense decreased $1.9 million, or 23.9%, to $6.1 million for the year ended June 30, 2012 from $8.0 million for the year ended June 30, 2011 primarily due to a decline in our cost of funds.  In addition, the average balance of total interest-bearing liabilities decreased $38.4 million, or 9.1%, to $385.2 million for the year ended June 30, 2012 from $423.7 million for the year ended June 30, 2011. The decrease was primarily a result of our managed decline in certificates of deposit and continued focus on reducing FHLB advances and increasing core deposits.


As a result of general market rate decreases along with the reduction in outstanding brokered certificates of deposits, the average cost of funds for total interest-bearing liabilities decreased 31 basis points to 1.58% for the year ended June 30, 2012 compared to 1.89% for the year ended June 30, 2011.


The following table details average balances, cost of funds and the change in interest expense for the years  ended June 30, 2012 and 2011:

Year Ended June 30,

2012

2011

Increase/

Average

Balance

Yield

Average

Balance

Yield

(Decrease) in

Interest

Expense from

2011

(Dollars in Thousands)

Savings deposits

$ 35,153 0.56 % $ 30,864 0.72 % (27 )

Interest-bearing demand deposits

14,823 0.33 20,423 0.29 (10 )

Money market accounts

82,476 0.66 75,661 0.95 (178 )

Certificates of deposit

179,555 2.19 192,334 2.51 (897 )

FHLB advances

73,242 1.87 104,408 2.08 (800 )

Total interest-bearing liabilities

$ 385,249 1.58 % $ 423,695 1.89 % (1,912 )

Provision for Loan Losses.   In connection with our analysis of the loan portfolio for the year ended June 30, 2012, management determined that a provision for loan losses of $2.7 million was required for the year ended June 30, 2012, compared to a provision for loan losses of $8.1 million established for the year ended June 30, 2011. The $5.3 million decrease in the provision primarily reflects a decrease in charge-offs to $4.0 million for year ended June 30, 2012 as compared to $18.6 million for the last fiscal year.  The $4.0 million of loans charged off during the fiscal year included $1.5 million of one-four family mortgage loans, $571,000 of commercial real estate loans, $561,000 of construction loans, $337,000 of home equity loans, $1.0 million of direct consumer loans, including credit cards and $63,000 of commercial business loans.  Non-performing assets were $15.4 million or 3.3% of total assets at June 30, 2012, compared to $26.9 million, or 5.5% of total assets at June 30, 2011.  Management considers the allowance for loan losses at June 30, 2012 to be adequate to cover probable losses inherent in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.




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The following table details activity and information related to the allowance for loan losses for the year ended June 30, 2012 and 2011:

At or For the Year

Ended June 30,

2012

2011

(Dollars in Thousands)

Provision for loan losses

$ 2,735 $ 8,078

Net charge-offs

2,917 17,627

Allowance for loan losses

7,057 7,239

Allowance for losses as a percentage of total loans

  receivable at the end of this period

2.4 % 2.2 %

Nonaccrual and 90 days or more past due loans

$ 8,722 $ 14,169

Allowance for loan losses as a percentage of

  non-performing loans at end of period

80.9 % 51.1 %

Nonaccrual and 90 days or more past due loans as a

  percentage of loans receivable at the end of the period

3.0 % 4.3 %

Total loans

$ 295,417 $ 333,351

Noninterest Income.   Noninterest income decreased $922,000, or 16.0%, to $6.7 million for the year ended June 30, 2012 from $5.8 million for the year ended June 30, 2011.  The following table provides a detailed analysis of the changes in the components of noninterest income:


Year Ended

June 30

Increase (Decrease)

2012

2011

Amount

Percent

(Dollars in Thousands)

Deposit services fees

$ 1,900 $ 2,288 $ (388 ) (17.0 )%

Other deposit fees

798 860 (62 ) (7.2 )

Loan fees

955 971 (16 ) (1.6 )

Gain on sale of investments

1,536 135 1,401 1,037.8

Gain on sale of loans

259 174 85 48.9

Other income

1,226 1,324 (98 ) (7.4 )

Total noninterest income

$ 6,674 $ 5,752 $ 922 16.0 %

Noninterest income increased during the year ended June 30, 2012, primarily as a result of increased gains on sale of investments partially offset by a decline in deposit service fees due.  Deposit service fees decreased as a result of prior branch closures as well as reductions in overdraft fees.


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Noninterest Expense.   Noninterest expense decreased $2.4 million, or 10.0%, to $22.0 million for the year ended June 30, 2012 from $24.5 million for the year ended June 30, 2011.  The following table provides an analysis of the changes in the components of noninterest expense:


At or For the Year

Ended June 30,

Increase (Decrease)

2012

2011

Amount

Percent

(Dollars in Thousands)

Compensation and benefits

$ 8,447 $ 8,365 $ 82 1.0 %

General and administrative expenses

3,644 3,733 (89 ) (2.4 )

Real estate owned reserve

2,494 4,624 (2,130 ) (46.1 )

Real estate holding cost

862 1,094 (232 ) (21.2 )

FDIC insurance premium

1,016 1,164 (148 ) (12.7 )

Information technology

2,271 2,049 222 10.8

Occupancy and equipment

2,192 2,337 (145 ) (6.2 )

Deposit services

771 708 63 8.9

Marketing

653 543 110 20.3

Loss on sale of premises and equipment

129 168 (39 ) (23.2 )

Net (gain) loss on sale of REO

(454 ) (324 ) (130 ) 40.1

     Total noninterest expense

$ 22,025 $ 24,461 $ (2,436 ) (10.0 )%

Major components of the increase in noninterest expense include:


Noninterest expense decreased $2.4 million or 10.0% in the year ended June 30, 2012 to $22.0 million from $24.5 million for the year ended June 30, 2011.  The decrease was primarily due to a decreased of $2.1 million to REO impairment charges and $232,000 in REO holding costs for the year ended June 30, 2012.


Our efficiency ratio, which is the percentage of noninterest expense to net interest income plus noninterest income, was 95.6% for the year ended June 30, 2012 compared to 103.1% for the year ended June 30, 2011. The decrease in efficiency ratio was primarily attributable to the decrease in noninterest expense.  By definition, a lower efficiency ratio would be an indication that we are more efficiently utilizing resources to generate net interest income and other fee income.


Provision (benefit) for Income Tax.   The benefit for income tax for the years ended June 30, 2012 and 2011, respectively, is zero as a result of the net operating loss in both years.  Our combined federal and state effective income tax rate for the current period was a tax benefit of (0%), as compared to (0%) for the same period a year ago.


Deferred tax assets are deferred tax consequences attributable to deductible temporary differences and carryforwards.  After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance.  A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized.  As required by generally accepted accounting principles, available evidence is weighted heavily on cumulative losses with less weight placed on future projected profitability.  Realization of the deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character in the period during which deductible temporary differences reverse or within the carryback and carryforward periods available under tax law.  Based upon the available evidence, we recorded a valuation allowance of $7.9 million, $6.4 million and $3.0 million at June 30, 2012, June 30, 2011 and 2010, respectively.




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Comparison of Financial Condition at June 30, 2011 and June 30, 2010


General. Total assets decreased $55.9 million, or 10.3%, to $488.9 million at June 30, 2011 from $544.8 million at June 30, 2010.  The decrease in assets during this period was primarily a result of a $63.9 million or 16.4% decrease in loans receivable.  Total real estate owned decreased $2.0 million, or 13.5%, to $12.6 million at June 30, 2011 from $14.6 million at June 30, 2010.  Total liabilities decreased $68.7 million or 13.7% to $431.5 million at June 30, 2011 compared to $500.2 million at June 30, 2010.  The decrease in our balance sheet facilitated our efforts to comply with the regulatory capital requirements under the Order.  Total deposits decreased $16.3 million, or 4.6%, to $339.5 million at June 30, 2011 from $355.8 million at June 30, 2010 primarily as a result of our elimination of $21.7 million in brokered deposits partially offset by an increase of $7.7 million or 10.9% in money market deposits.  Our total borrowings, which consisted of FHLB advances, decreased $51.0 million from June 30, 2010 to June 30, 2011. The average cost of advances decreased from 3.75% during the year ended June 30, 2010 to 2.08% during the year ended June 30, 2011.


Assets.   For the year ended June 30, 2011, total assets decreased $55.9 million. The following table details the increases and decreases in the composition of our assets from June 30, 2010 to June 30, 2011:

Balance at

Balance at

Increase (Decrease)

June 30, 2011

June 30, 2010

Amount

Percent

(Dollars in Thousands)

Cash and due from banks

$ 63,757 $ 32,831 $ 30,926 94.2 %

Mortgage-backed securities,

  available for sale

32,718 42,197 (9,479 ) (22.5 )

Mortgage-backed securities,

  held to maturity

7,438 9,880 (2,442 ) (24.7 )

Loans receivable, net of

  allowance for loan losses

325,464 389,411 (63,947 ) (16.4 )

From June 30, 2010 to June 30, 2011, cash and due from banks increased $30.9 million.  This increase was primarily a result of our public offering in January 2011 as well as funds received from normal operations.


Mortgage-backed securities decreased $11.9 million to $40.2 million at June 30, 2011 from $52.1 million at June 30, 2010. During the year ended June 30, 2010, we did not securitize any fixed rate mortgage-backed securities through Freddie Mac. We securitize and sell mortgage loans to manage interest rate sensitivity and capital requirements, supplement loan originations and provide liquidity.  During the year ended June 30, 2011, we sold $3.3 million in securities compared to $5.0 million in securities for the year ended June 30, 2010.


Loans receivable, net, decreased $63.9 million to $325.5 million at June 30, 2011 from $389.4 million at June 30, 2010 primarily as a result of lower loan demand from creditworthy borrowers, charge-offs, and transfers of nonperforming loans to real estate owned, as well as pay downs due to normal borrower activity.  During the year ended June 30, 2011, $11.6 million of non-performing loans were transferred to real estate owned. During the year ended June 30, 2011, we continued to reduce our exposure to construction and land loans. The total construction and land loan portfolios declined to $18.4 million or 5.5% of the total loan portfolio at June 30, 2011 compared to $44.7 million or 11.0 % of the total loan portfolio a year ago.  In addition to the significant decline in the construction and land loan portfolios, our commercial real estate loan portfolio decreased $12.5 million as a result of our continued focus on reducing the overall risk profile of our loan portfolio. One- to- four family loans decreased $15.7 million primarily due to repayments and lower loan demand. Consumer loans decreased $11.5 million primarily due to a $6.7 million decrease in home equity loans and a $3.3 million reduction in automobile loans.


Deposits.   Deposits decreased $16.3 million, or 4.6%, to $339.5 million at June 30, 2011 from $355.8 million at June 30, 2010.  We reduced brokered deposits $21.7 million in order to comply with the Order and as part of our strategy to reduce outstanding brokered deposits.  The increase in money

77

market deposits was due in part to our ongoing marketing strategy to focus on core deposits, as well as customer preference between demand deposits and money market accounts.


The following table details the changes in deposit accounts:

Balance at

Balance at

Increase (Decrease)

June 30, 2011

June 30, 2010

Amount Percent

(Dollars in Thousands)

Noninterest-bearing demand

  deposits

$ 30,288 $ 28,718 $ 1,570 5.5 %

Interest-bearing demand deposits

17,387 25,483 (8,096 ) (31.8 )

Money market accounts

78,017 70,367 7,650 10.9

Savings deposits

32,263 29,756 2,507 8.4

Certificates of deposit

  Retail certificates

181,519 179,739 1,780 1.0

  Brokered certificates

-- 21,725 (21,725 ) (100.0 )

     Total deposit accounts

$ 339,474 $ 355,788 $ (16,314 ) (4.6 )

Borrowings. FHLB advances decreased $51.0 million, or 37.3%, to $85.9 million at June 30, 2011 from $136.9 million at June 30, 2010.  The decrease in borrowing was related to our continuing focus on reducing wholesale funds.


Equity.   Total equity increased $12.8 million, or 28.6%, to $57.5 million at June 30, 2011 from $44.7 million at June 30, 2010.  The increase was due to our public offering which increased equity by $22.2 million, an $8.8 million net loss and an $600,000 decrease in other comprehensive income.


Comparison of Operating Results for the Years Ended June 30, 2011 and June 30, 2010


General.   Net loss for the year ended June 30, 2011 was $8.8 million compared to net income of $420,000 for the year ended June 30, 2010.

Net Interest Income.   Net interest income increased $114,000, or 0.64%, to $18.0 million for the year ended June 30, 2011, from $17.9 million for the year ended June 30, 2010. The increase in net interest income was primarily attributable to the increase in our net interest margin.


Our net interest margin increased 56 basis points to 3.78% for the year ended June 30, 2011, from 3.22% for the same period of the prior year.  Over the last year, our net interest margin has improved as a result of the decrease in our non-performing loans and the decline in our cost of funds exceeding the reduction in yield on interest-earning assets.  Our yield on earnings assets decreased to 5.46% for the year ended June 30, 2011 from 5.87% for the year ended June 30, 2010.  Our funding costs have decreased from 2.87% during the year ended June 30, 2010 to 1.89% during the year ended June 30, 2011.  The decline was related to the repricing of our FHLB borrowings certificates of deposit to lower current rates and a $21.7 million decline in brokered certificates of deposit during the year ended June 30, 2011.  Our net interest rate spread increased to 3.57% for the year ended June 30, 2011 as compared to 3.00% for the year ended June 30, 2010.




78


The cost of borrowed funds from the FHLB decreased to 2.08% during the year ended June 30, 2011 from 3.75% for the same period of the prior year.  The following table sets forth the results of balance sheet growth and changes in interest rates to our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.


Year Ended June 30, 2011

Compared to June 30, 2010

Increase (Decrease)

Due to

Rate

Volume

Total

(In Thousands)

Interest-earning assets:

  Loans receivable, net

$ (695 ) $ (4,949 ) $ (5,644 )

  Mortgage-backed securities

(133 ) (713 ) (846 )

  Securities, FHLB and

    cash and due from banks

(155 ) 171 (44 )

     Total net change in income on interest-earning assets

(983 ) (5,551 ) (6,534 )

Interest-bearing liabilities:

  Savings deposits

(12 ) 15 3

  Interest bearing demand deposits

(54 ) (25 ) (79 )

  Money market accounts

(385 ) (135 ) (520 )

  Certificates of deposit

(1,657 ) (1,465 ) (3,122 )

  FHLB advances

(1,746 ) (1,184 ) (2,930 )

Total net change in expense on interest-bearing liabilities

(3,854 ) (2,794 ) (6,648 )

Net change in net interest income

$ 2,871 $ (2,757 ) $ 114

Interest Income. Total interest income for the year ended June 30, 2011 decreased $6.5 million, or 20.1%, to $26.0 million, from $32.5 million for the year ended June 30, 2010. The decrease during the period was primarily attributable to the decline in net loans receivable over the last year.


The following table compares detailed average earning asset balances, associated yields, and resulting changes in interest income for the years ended June 30, 2011 and 2010:


Year Ended June 30,

2011

2010

Increase/

Average

Balance

Yield

Average

Balance

Yield

(Decrease) in

Interest

Income from

2010

(Dollars in Thousands)

Loans receivable, net

$ 373,099 6.29 % $ 449,527 6.48 % $ (5,644 )

Mortgage-backed securities

45,271 4.74 59,436 5.03 (846 )

Securities

6,259 4.25 7,966 4.27 (74 )

FHLB stock

6,510 -- 6,510 -- --

Cash and due from banks

44,602 0.21 30,492 0.20 30

Total interest-earning assets

$ 475,741 5.46 % $ 553,931 5.87 % $ (6,534 )


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Interest Expense.   Interest expense decreased $6.6 million, or 45.4%, to $8.0 million for the year ended June 30, 2011 from $14.7 million for the year ended June 30, 2010 primarily due to a decline in our cost of funds.  In addition, the average balance of total interest-bearing liabilities decreased $87.0 million, or 17.0%, to $423.7 million for the year ended June 30, 2011 from $510.7 million for the year ended June 30, 2010. The decrease was primarily a result of a decline in FHLB advances of $51.0 million and $21.7 million in brokered certificates of deposit.


As a result of general market rate decreases along with the reduction in outstanding brokered certificates of deposits, the average cost of funds for total interest-bearing liabilities decreased 98 basis points to 1.89% for the year ended June 30, 2011 compared to 2.87% for the year ended June 30, 2010.

The following table details average balances, cost of funds and the change in interest expense for the years  ended June 30, 2011 and 2010:

Year Ended June 30,

2011

2010

Increase/

Average

Balance

Yield

Average

Balance

Yield

(Decrease) in

Interest

Expense from

2010

(Dollars in Thousands)

Savings deposits

$ 30,864 0.72 % $ 28,954 0.76 % $ 3

Interest-bearing demand deposits

20,423 0.29 25,033 0.55 (79 )

Money market accounts

75,661 0.95 84,933 1.46 (520 )

Certificates of deposit

192,334 2.51 235,785 3.37 (3,122 )

FHLB advances

104,408 2.08 135,975 3.75 % (2,930 )

Total interest-bearing liabilities

$ 423,690 1.89 % $ 510,680 2.87 % $ (6,648 )

Provision for Loan Losses.   In connection with our analysis of the loan portfolio for the year ended June 30, 2011, management determined that a provision for loan losses of $8.1 million was required for the year ended June 30, 2011, compared to a provision for loan losses of $2.6 million established for the year ended June 30, 2010. The $5.5 million increase in the provision primarily reflects an increase in charge-offs to $18.6 million for year ended June 30, 2011 as compared to $10.6 million for the last fiscal year.  The $18.6 million of loans charged off during the fiscal year included $8.9 million of construction loans, $3.0 million of one-four family mortgage loans, $4.2 million of commercial business loans, $584,000 of commercial real estate loans, $465,000 of consumer home equity loans, and  $1.4 million of direct consumer loans, including credit cards.  Non-performing assets were $26.9 million or 5.5% of total assets at June 30, 2011, compared to $35.2 million, or 6.5% of total assets at June 30, 2010.


The following table details activity and information related to the allowance for loan losses for the year ended June 30, 2011 and 2010:

At or For the Year

Ended June 30,

2011

2010

(Dollars in Thousands)

Provision for loan losses

$ 8,078 $ 2,615

Net charge-offs

17,627 10,290

Allowance for loan losses

7,239 16,788

Allowance for losses as a percentage of total loans

  receivable at the end of this period

2.2 % 4.1 %

Nonaccrual and 90 days or more past due loans

14,169 20,642

Allowance for loan losses as a percentage of

  non-performing loans at end of period

51.1 % 81.3 %

Nonaccrual and 90 days or more past due loans as a

  percentage of loans receivable at the end of the period

4.3 % 5.1 %

Total loans

$ 333,351 $ 407,116

80

 Noninterest Income.   Noninterest income decreased $1.1 million, or 15.5%, to $5.8 million for the year ended June 30, 2011 from $6.8 million for the year ended June 30, 2010.  The following table provides a detailed analysis of the changes in the components of noninterest income:


Year Ended

June 30

Increase (Decrease)

2011

2010

Amount

Percent

(Dollars in Thousands)

Deposit services fees

$ 2,288 $ 2,719 $ (431 ) (15.9 )%

Other deposit fees

860 816 44 5.4

Loan fees

971 913 58 6.4

Gain (loss) on sale of investments

135 956 (821 ) (85.9 )

Gain on sale of loans

174 -- 174

Other income

1,324 1,403 (79 ) (5.6 )

Total noninterest income

$ 5,752 $ 6,807 $ 1,055 (15.5 )

Noninterest income decreased during the year ended June 30, 2011, primarily as a result of reduced gains on sale of investments and a decline in deposit service fees.  Deposit service fees decreased as a result of the six branch closures as well as reductions in overdraft fees.


Noninterest Expense.   Noninterest expense decreased $122,000, or 0.5%, to $24.5 million for the year ended June 30, 2011 from $24.6 million for the year ended June 30, 2010.  The following table provides an analysis of the changes in the components of noninterest expense:


At or For the Year

Ended June 30,

Increase (Decrease)

2011

2010

Amount

Percent

(Dollars in Thousands)

Compensation and benefits

$ 8,365 $ 8,973 $ (608 ) (6.8 )%

General and administrative expenses

4,827 5,036 (209 ) (4.2 )

Real estate owned reserve

4,624 3,143 1,481 47.1

FDIC insurance premium

1,164 1,414 (250 ) (17.7 )

Information technology

2,049 1,952 97 5.0

Occupancy and equipment

2,337 2,581 (244 ) (9.5 )

Deposit services

708 885 (177 ) (20.0 )

Marketing

543 474 69 14.6

Net (gain) loss on sale of REO

(324 ) 10 (334 ) (3,340.0 )

Loss on sale of property, premises and

   equipment

168 115 53 46.1

     Total noninterest expense

$ 24,461 $ 24,583 $ 122 (0.5 )%

Major components of the increase in noninterest expense include:


Compensation and benefits decreased $608,000, or 6.8%, to $8.4 million for the year ended June 30, 2011 from $9.0 million for the same period a year ago as a result of the closure of one branch in June 2010 and one in January 2011 which resulted in a reduction of employees as well as a $244,000 reduction in occupancy and equipment expense.  At June 30, 2011 we employed 138 full-time equivalent employees compared to 157 at June 30, 2010.  In addition, we realized a $324,000 gain on sale of real estate owned during fiscal 2011.  These reductions in non-interest expenses were partially offset by a $1.5 million increase in our real estate owned reserve for the year ended June 30, 2011 as a result of the decline in real estate owned values.

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Our efficiency ratio, which is the percentage of noninterest expense to net interest income plus noninterest income, was 103.1% for the year ended June 30, 2011 compared to 99.7% for the year ended June 30, 2010. The increase in efficiency ratio was primarily attributable to the decrease in noninterest income. By definition, a lower efficiency ratio would be an indication that we are more efficiently utilizing resources to generate net interest income and other fee income.


Provision (benefit) for Income Tax.   The benefit for income tax for the year ended June 30, 2011 as compared to a benefit for income tax of $(3.0 million) for the same period a year ago as a result of the net operating loss for the year ended June 30, 2010. Our combined federal and state effective income tax rate for the current period was a tax benefit of (0%), as compared to (116.5%) for the same period a year ago.


Deferred tax assets are deferred tax consequences attributable to deductible temporary differences and carryforwards.  After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance.  A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized.  As required by generally accepted accounting principles, available evidence is weighted heavily on cumulative losses with less weight placed on future projected profitability.  Realization of the deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character in the period during which deductible temporary differences reverse or within the carryback and carryforward periods available under tax law.  Based upon the available evidence, we recorded a valuation allowance of $6.4 million, $3.0 million and $5.2 million at June 30, 2011, June 30, 2010 and 2009, respectively.


Average Balances, Interest and Average Yields/Cost


The following table sets forth for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin, and the ratio of average interest-earning assets to average interest-bearing liabilities. Average balances have been calculated using the average of weekly interest-earning assets and interest-bearing liabilities.  Noninterest-earning assets and noninterest-bearing liabilities have been computed on a monthly basis.


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Year Ended June 30,

2012

2011

2010

Average

Balance (1)

Interest

and

 Dividends

Yield/

Cost

Average

Balance (1)

Interest

and

 Dividends

Yield/

Cost

Average

Balance (1)

Interest

and

 Dividends

Yield/

Cost

(Dollars in Thousands)

Interest-earning assets:

  Loans receivable, net (1)

$ 318,366 $ 20,187 6.34 % $ 373,099 $ 23,465 6.29 % $ 449,527 $ 29,109 6.48 %

  Mortgage-backed securities

47,622 1,966 4.13 45,271 2,146 4.74 59,436 2,992 5.03

  Securities

3,331 147 4.41 6,259 266 4.25 7,966 340 4.27

  FHLB stock

6,510 -- -- 6,510 -- -- 6,510 -- --

  Cash and due from banks

72,698 164 0.23 44,602 92 0.21 30,492 62 0.20

      Total interest-

         earning assets

448,527 22,464 5.01 475,741 25,969 5.46 553,931 32,503 5.87

Noninterest earning assets

32,581 37,014 50,024

  Total average assets

$ 481,108 $ 512,755 $ 603,955

Interest-bearing liabilities:

  Savings deposits

$ 35,153 196 0.56 $ 30,864 223 0.72 $ 28,954 220 0.76

  Interest-bearing demand deposits

14,823 49 0.33 20,428 59 0.29 25,033 138 0.55

  Money market accounts

82,476 542 0.66 75,661 720 0.95 84,933 1,240 1.46

  Certificates of deposit

179,555 3,931 2.19 192,334 4,828 2.51 235,785 7,950 3.37

    Total deposits

312,007 4,718 1.51 319,287 5,830 1.83 374,705 9,548 2.55

FHLB advances

73,242 1,372 1.87 104,408 2,172 2.08 135,975 5,102 3.75

    Total interest-bearing liabilities

385,249 6,090 1.58 423,695 8,002 1.89 510,680 14,650 2.87

Noninterest-bearing liabilities

41,088 36,121 44,557

  Total average liabilities

426,337 459,816 555,237

Average equity

54,771 52,939 48,718

  Total liabilities and equity

$ 481,108 $ 512,755 $ 603,955

Net interest income

$ 16,374 $ 17,967 $ 17,853

Interest rate spread

3.43 % 3.57 % 3.00 %

Net interest margin

3.65 % 3.78 % 3.22 %

Ratio of average interest-earning assets to

  average interest-bearing liabilities

116.4 % 112.3 % 108.5 %


___________________

(1)           Average loans receivable includes non-performing loans and does not include net deferred loan fees.  Interest income does not include non-accrual loans.




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Yields Earned and Rates Paid


The following table sets forth (on a consolidated basis) for the periods and at the dates indicated, the  weighted average yields earned on our assets, the weighted average interest rates paid on our liabilities, together with the net yield on interest-earning assets.


At

June 30,

Year Ended June 30,

2012

2012

2011

2010

Weighted average yield on:

  Loans receivable, net

6.33 % 6.34 % 6.29 % 6.48 %

  Mortgage-backed securities

4.15 4.13 4.74 5.03

  Securities

4.51 4.41 4.25 4.27

  FHLB stock

-- -- -- --

  Cash and due from banks

0.21 0.23 0.21 0.20

    Total interest-earning assets

5.33 5.01 5.46 5.87

Weighted average rate paid on:

  Savings accounts

0.40 0.56 0.72 0.76

  Interest-bearing demand deposits

0.29 0.33 0.29 0.55

  Money market accounts

0.43 0.66 0.95 1.46

  Certificates of deposit

2.10 2.19 2.51 3.37

    Total average deposits

1.35 1.51 1.83 2.55

  FHLB advances

1.90 1.87 2.08 3.75

    Total interest-bearing liabilities

1.31 1.58 1.89 2.87

Interest rate spread (spread between

   weighted average rate on all

   interest-earning assets and all

   interest-bearing liabilities)

4.02 3.43 3.57 3.00

Net interest margin (net interest

   income (expense) as a percentage

   of average interest-earning assets)

NA

3.65 3.78 3.22



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Rate/Volume Analysis


The following table sets forth the effects of changing rates and volumes on our net interest income. Information is provided with respect to: (1) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (2) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.


Year Ended June 30, 2012

Compared to June 30, 2011

Increase (Decrease) Due to

Year Ended June 30, 2011

Compared to June 30, 2010

Increase (Decrease) Due to

Rate

Volume

Total

Rate

Volume

Total

(In Thousands)

Interest-earning assets:

  Loans receivable, net

$ 164 $ (3,442 ) $ (3,278 ) $ (695 ) $ (4,949 ) $ (5,644 )

  Mortgage-backed securities

(290 ) 110 (180 ) (133 ) (713 ) (846 )

  Securities, Federal

    Home Loan Bank stock and

    cash due from banks

(204 ) 157 (47 ) (155 ) 111 (44 )

Total net change in income on

  interest-earning assets

$ (330 ) $ (3,175 ) $ (3,505 ) $ (983 ) $ (5,551 ) $ (6,534 )