LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio was as follows at December 31:



	2013			2012
REAL ESTATE LOANS
Commercial	$	32,970		$	33,250
Construction and development	41,633			31,893
Home equity	15,172			15,474
One-to-four-family	20,809			13,976
Multi-family	4,682			3,202
Total real estate loans	115,266			97,795
CONSUMER LOANS
Indirect home improvement	91,167			83,786
Solar	16,838			2,463
Marine	11,203			17,226
Automobile	1,230			2,416
Recreational	553			742
Home improvement	463			651
Other	1,252			1,386
Total consumer loans	122,706			108,670
COMMERCIAL BUSINESS LOANS	49,244			73,465
Total loans	287,216			279,930
Allowance for loan losses	(5,092		)	(4,698		)
Deferred costs, fees, and discounts, net	(1,043		)	(283		)
Total loans receivable, net	$	281,081		$	274,949

The Company defined its loan portfolio into three segments that reflect the structure of the lending function, the Company’s strategic plan and the manner in which management monitors performance and credit quality. The three loan portfolio segments are: (a) Real Estate Loans, (b) Consumer Loans and (c) Commercial Business Loans. Each of these segments is disaggregated into classes based on the risk characteristics of the borrower and/or the collateral type securing the loan. The following is a summary of each of the Company’s loan portfolio segments and classes:

Real Estate Loans

Commercial Lending. Loans originated by the Company primarily secured by income producing properties, including retail centers, warehouses and office buildings located in our market areas.

Construction and Development Lending. Loans originated by the Company for the construction of and secured by commercial real estate and one-to-four-family residences and tracts of land for development.

Home Equity Lending. Loans originated by the Company secured by second mortgages on one-to-four-family residences, primarily in our market area.

One-to-Four-Family Real Estate Lending. Loans originated by the Company secured by first mortgages on one-to-four-family residences, primarily in our market area.

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

Multi-family Lending. Apartment lending (more than four units) to current banking customers and community reinvestment loans for low to moderate income individuals in the Company's footprint.

Consumer Lending

Indirect Home Improvement. Fixture secured loans are originated by the Company for home improvement and are secured by the personal property installed in, on or at the borrower’s real property, and may be perfected with a UCC-2 financing statement filed in the county of the borrower’s residence. These indirect home improvement loans include replacement windows, siding, roofing, solar panels, and other home fixture installations.

Marine, Automobile and Recreational. Loans originated by the Company secured by boats, automobiles and RVs to borrowers in our Puget Sound market area.

Other Consumer Loans/Home Improvement. Loans originated by the Company, including direct home improvement loans, loans on deposits and other consumer loans.

Commercial Business Loans

Commercial Business Lending. Commercial business loans originated by the Company to local small and mid-sized businesses in our Puget Sound market area are secured by accounts receivable, inventory or property, plant and equipment. Commercial business loans are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following tables detail activities in the allowance for loan losses by loan categories:



	December 31, 2013
ALLOWANCE FOR LOAN LOSSES	Real Estate			Consumer			Commercial Business			Unallocated			Total
Beginning balance	$	1,690		$	2,158		$	815		$	35		$	4,698
Provision for loan loss	991			365			32			782			2,170
Charge-offs	(809		)	(1,757		)	(63		)	—			(2,629		)
Recoveries	91			746			16			—			853
Net charge-offs	(718		)	(1,011		)	(47		)	—			(1,776		)
Ending balance	$	1,963		$	1,512		$	800		$	817		$	5,092
Year-end amount allocated to:
Loans individually evaluated for impairment	$	85		$	—		$	6		$	—		$	91
Loans collectively evaluated for impairment	1,878			1,512			794			817			5,001
Ending balance	$	1,963		$	1,512		$	800		$	817		$	5,092
LOANS RECEIVABLES
Loans individually evaluated for impairment	$	1,649		$	—		$	54		$	—		$	1,703
Loans collectively evaluated for impairment	113,617			122,706			49,190			—			285,513
Ending balance	$	115,266		$	122,706		$	49,244		$	—		$	287,216

	December 31, 2012
ALLOWANCE FOR LOAN LOSSES	Real Estate			Consumer			Commercial Business			Unallocated			Total
Beginning balance	$	803		$	2,846		$	511		$	185		$	4,345
Provision for loan loss	1,658			941			464			(150		)	2,913
Charge-offs	(780		)	(2,581		)	(179		)	—			(3,540		)
Recoveries	9			952			19			—			980
Net charge-offs	(771		)	(1,629		)	(160		)	—			(2,560		)
Ending balance	$	1,690		$	2,158		$	815		$	35		$	4,698
Year-end amount allocated to:
Loans individually evaluated for impairment	$	118		$	—		$	7		$	—		$	125
Loans collectively evaluated for impairment	1,572			2,158			808			35			4,573
Ending balance	$	1,690		$	2,158		$	815		$	35		$	4,698
LOANS RECEIVABLES
Loans individually evaluated for impairment	$	3,606		$	—		$	194		$	—		$	3,800
Loans collectively evaluated for impairment	94,189			108,670			73,271			—			276,130
Ending balance	$	97,795		$	108,670		$	73,465		$	—		$	279,930

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

Information pertaining to aging analysis of past due loans are summarized as follows:



	December 31, 2013
	Loans Past Due and Still Accruing
	30-59 Days		60-89 Days		90 Days or More Past Due		Total Past Due		Non-Accrual		Current		Total Loans Receivable
REAL ESTATE LOANS
Commercial	$	—	$	—	$	—	$	—	$	567	$	32,403	$	32,970
Construction and development	—		—		—		—		—		41,633		41,633
Home equity	63		146		—		209		172		14,791		15,172
One-to-four-family	—		—		—		—		104		20,705		20,809
Multi-family	—		—		—		—		—		4,682		4,682
Total real estate loans	63		146		—		209		843		114,214		115,266
CONSUMER
Indirect home improvement	533		218		—		751		258		90,158		91,167
Solar	—		—		—		—		—		16,838		16,838
Marine	33		—		—		33		—		11,170		11,203
Automobile	34		13		—		47		—		1,183		1,230
Recreational	39		—		—		39		—		514		553
Home improvement	7		—		—		7		—		456		463
Other	15		6		—		21		—		1,231		1,252
Total consumer loans	661		237		—		898		258		121,550		122,706
COMMERCIAL BUSINESS LOANS	54		—		—		54		—		49,190		49,244
Total	$	778	$	383	$	—	$	1,161	$	1,101	$	284,954	$	287,216

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)



	December 31, 2012
	Loans Past Due and Still Accruing
	30-59 Days		60-89 Days		90 Days or More Past Due		Total Past Due		Non-Accrual		Current		Total Loans Receivable
REAL ESTATE LOANS
Commercial	$	—	$	—	$	—	$	—	$	783	$	32,467	$	33,250
Construction and development	—		—		—		—		—		31,893		31,893
Home equity	192		484		—		676		248		14,550		15,474
One-to-four-family	—		—		—		—		344		13,632		13,976
Multi-family	—		—		—		—		—		3,202		3,202
Total real estate loans	192		484		—		676		1,375		95,744		97,795
CONSUMER
Indirect home improvement	653		300		—		953		295		82,538		83,786
Solar	—		—		—		—		—		2,463		2,463
Marine	84		2		—		86		—		17,140		17,226
Automobile	68		1		—		69		10		2,337		2,416
Recreational	44		—		—		44		—		698		742
Home improvement	—		—		—		—		32		619		651
Other	8		11		—		19		—		1,367		1,386
Total consumer loans	857		314		—		1,171		337		107,162		108,670
COMMERCIAL BUSINESS LOANS	—		—		—		—		194		73,271		73,465
Total	$	1,049	$	798	$	—	$	1,847	$	1,906	$	276,177	$	279,930

The following tables provide additional information about our impaired loans that have been segregated to reflect loans for which an allowance for credit losses has been provided and loans for which no allowance has been provided:

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)



	At or For the Year Ended December 31, 2013
	Unpaid Principal Balance		Write- downs			Recorded Investment		Specific Reserve			Adjusted Recorded Investment		YTD Average Recorded Investment		YTD Interest Income Recognized
WITH NO RELATED ALLOWANCE RECORDED
Commercial	$	—	$	—		$	—	$	—		$	—	$	—	$	—
Construction and development	—		—			—		—			—		—		—
Home equity	39		—			39		—			39		39		—
One-to-four-family	1,212		(169		)	1,043		—			1,043		1,041		59
Multi-family	—		—			—		—			—		—		—
Indirect home improvement	—		—			—		—			—		—		—
Solar	—		—			—		—			—		—		—
Marine	—		—			—		—			—		—		—
Automobile	—		—			—		—			—		—		—
Recreational	—		—			—		—			—		—		—
Home improvement	—		—			—		—			—		—		—
Other	—		—			—		—			—		—		—
Commercial business loans	—		—			—		—			—		—		—
Subtotal loans	1,251		(169		)	1,082		—			1,082		1,080		59
WITH AN ALLOWANCE RECORDED
Commercial	731		(164		)	567		(85		)	482		622		15
Construction and development	—		—			—		—			—		—		—
Home equity	—		—			—		—			—		—		—
One-to-four-family	—		—			—		—			—		—		—
Multi-family	—		—			—		—			—		—		—
Indirect home improvement	—		—			—		—			—		—		—
Solar	—		—			—		—			—		—		—
Marine	—		—			—		—			—		—		—
Automobile	—		—			—		—			—		—		—
Recreational	—		—			—		—			—		—		—
Home improvement	—		—			—		—			—		—		—
Other	—		—			—		—			—		—		—
Commercial business loans	56		(2		)	54		(6		)	48		59		—
Subtotal loans	787		(166		)	621		(91		)	530		681		15
Total	$	2,038	$	(335	)	$	1,703	$	(91	)	$	1,612	$	1,761	$	74



NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)
	At or For the Year Ended December 31, 2012
	Unpaid Principal Balance		Write- downs			Recorded Investment		Specific Reserve			Adjusted Recorded Investment		YTD Average Recorded Investment		YTD Interest Income Recognized
WITH NO RELATED ALLOWANCE RECORDED
Commercial	$	—	$	—		$	—	$	—		$	—	$	—	$	—
Construction and development	—		—			—		—			—		—		—
Home equity	111		—			111		—			111		112		3
One-to-four-family	1,295		(170		)	1,125		—			1,125		1,172		30
Multi-family	—		—			—		—			—		—		—
Indirect home improvement	—		—			—		—			—		—		—
Solar	—		—			—		—			—		—		—
Marine	—		—			—		—			—		—		—
Automobile	—		—			—		—			—		—		—
Recreational	—		—			—		—			—		—		—
Home improvement	—		—			—		—			—		—		—
Other	—		—			—		—			—		—		—
Commercial business loans	241		(111		)	130		—			130		172		—
Subtotal loans	1,647		(281		)	1,366		—			1,366		1,456		33
WITH AN ALLOWANCE RECORDED
Commercial	950		(167		)	783		(39		)	744		893		7
Construction and development	1,625		(38		)	1,587		(79		)	1,508		1,616		68
Home equity	—		—			—		—			—		—		—
One-to-four-family	—		—			—		—			—		—		—
Multi-family	—		—			—		—			—		—		—
Indirect home improvement	—		—			—		—			—		—		—
Solar	—		—			—		—			—		—		—
Marine	—		—			—		—			—		—		—
Automobile	—		—			—		—			—		—		—
Recreational	—		—			—		—			—		—		—
Home improvement	—		—			—		—			—		—		—
Other	—		—			—		—			—		—		—
Commercial business loans	67		(3		)	64		(7		)	57		68		5
Subtotal loans	2,642		(208		)	2,434		(125		)	2,309		2,577		80
Total	$	4,289	$	(489	)	$	3,800	$	(125	)	$	3,675	$	4,033	$	113

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The average recorded investment in impaired loans was $1.8 million and $4.0 million for the years ended December 31, 2013, and 2012, respectively. For the years ended December 31, 2013 and 2012, the Company recognized interest income on impaired loans of $74,000 and $113,000, respectively.

Credit Quality Indicators

As part of the Company’s on-going monitoring of credit quality of the loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grading of loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) non-performing loans and (v) the general economic conditions in the Company’s market.

The Company utilizes a risk grading matrix to assign a risk grade to its real estate and commercial business loans. Loans are graded on a scale of 1 to 10, with loans in risk grades 1 to 6 considered “Pass” and loans in risk grades 7 to 10 are reported as classified loans in the Company's allowance for loan loss analysis.

A description of the 10 risk grades is as follows:


•	Grades 1 and 2 – These grades include loans to very high quality borrowers with excellent or desirable business credit.


•	Grade 3 – This grade includes loans to borrowers of good business credit with moderate risk.


•	Grades 4 and 5 – These grades include “Pass” grade loans to borrowers of average credit quality and risk.


•	Grade 6 – This grade includes loans on management’s “Watch” list and is intended to be utilized on a temporary basis for “Pass” grade borrowers where frequent and thorough monitoring is required due to credit weaknesses and where significant risk-modifying action is anticipated in the near term.


•	Grade 7 – This grade is for “Other Assets Especially Mentioned (OAEM)” in accordance with regulatory guidelines and includes borrowers where performance is poor or significantly less than expected.


•	Grade 8 – This grade includes “Substandard” loans in accordance with regulatory guidelines which represent an unacceptable business credit where a loss is possible if loan weakness is not corrected.


•	Grade 9 – This grade includes “Doubtful” loans in accordance with regulatory guidelines where a loss is highly probable.


•	Grade 10 – This grade includes “Loss” loans in accordance with regulatory guidelines for which total loss is expected and when identified are charged-off.

Consumer, Home Equity and One-to-Four-Family Real Estate Loans

Homogeneous loans are risk rated based upon the Uniform Retail Credit Classification Policy and Account Management Policy. Loans classified under these policies at the Company are consumer loans which include indirect home improvement, solar, marine, automobile, recreational, home improvement and other, and one-to-four family first and second liens. Under the Uniform Retail Credit Classification Policy, loans that are current or less than 90 days past due are graded “Pass” and risk graded "4" internally. Loans that are past due more than 90 days are classified “Substandard” risk graded "8" internally. At 120 days past due, homogeneous loans are charged off based on the value of the collateral less cost to sell.

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following tables summarize risk rated loan balances by category:



	December 31, 2013
	Pass (1 - 5)		Watch (6)		Special Mention (7)		Substandard (8)		Doubtful(9)		Total
REAL ESTATE LOANS
Commercial	$	31,500	$	903	$	—	$	567	$	—	$	32,970
Construction and development	41,633		—		—		—		—		41,633
Home equity	15,000		—		—		172		—		15,172
One-to-four-family	19,766		—		—		1,043		—		20,809
Multi-family	4,682		—		—		—		—		4,682
Total real estate loans	112,581		903		—		1,782		—		115,266
CONSUMER
Indirect home improvement	90,909		—		—		258		—		91,167
Solar	16,838		—		—		—		—		16,838
Marine	11,203		—		—		—		—		11,203
Automobile	1,230		—		—		—		—		1,230
Recreational	553		—		—		—		—		553
Home improvement	463		—		—		—		—		463
Other	1,252		—		—		—		—		1,252
Total consumer loans	122,448		—		—		258		—		122,706
COMMERCIAL BUSINESS LOANS	38,492		10,698		—		54		—		49,244
Total	$	273,521	$	11,601	$	—	$	2,094	$	—	$	287,216

	December 31, 2012
	Pass (1 - 5)		Watch (6)		Special Mention (7)		Substandard (8)		Doubtful(9)		Total
REAL ESTATE LOANS
Commercial	$	29,145	$	3,322	$	—	$	783	$	—	$	33,250
Construction and development	30,306		—		—		1,587		—		31,893
Home equity	15,226		—		—		248		—		15,474
One-to-four-family	12,851		—		—		1,125		—		13,976
Multi-family	3,202		—		—		—		—		3,202
Total real estate loans	90,730		3,322		—		3,743		—		97,795
CONSUMER
Indirect home improvement	83,491		—		—		295		—		83,786
Solar	2,463		—		—		—		—		2,463
Marine	17,226		—		—		—		—		17,226
Automobile	2,406		—		—		10		—		2,416
Recreational	742		—		—		—		—		742
Home improvement	619		—		—		32		—		651
Other	1,386		—		—		—		—		1,386
Total consumer loans	108,333		—		—		337		—		108,670
COMMERCIAL BUSINESS LOANS	72,596		—		675		194		—		73,465
Total	$	271,659	$	3,322	$	675	$	4,274	$	—	$	279,930

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

Troubled Debt Restructured Loans

The Company had four troubled debt restructured ("TDR") loans still on accrual and included in impaired loans for both years at December 31, 2013 and 2012. In addition, the Company had $0 and $892,000, loans on non-accrual at December 31, 2013 and 2012, respectively. The Company had no commitments to lend additional funds on impaired loans.

A summary of TDR loans is as follows:



	2013		2012
Troubled debt restructured loans still on accrual	$	815	$	2,368
Troubled debt restructured loans on non-accural	—		892
Total troubled debt restructured loans	$	815	$	3,260

The following tables present TDR loans that occurred during the years ended December 31, 2013 and 2012:



	At or For the Year Ended December 31, 2013
	Number of Contracts	Recorded Investment		Increase in the Allowance		Charge-offs to the Allowance

Commercial business loans	1	$	35	$	—	$	35
Total	1	$	35	$	—	$	35



	At or For the Year Ended December 31, 2012
	Number of Contracts	Recorded Investment		Increase in the Allowance		Charge-offs to the Allowance
Real estate - one-to-four-family	2	$	237	$	—	$	60
Commercial business loans	1	64		7		3
Total	3	$	301	$	7	$	63

The recorded investments in the tables above are year end balances that are inclusive of all partial pay-downs and charge-offs since the modification date. Loans modified in a TDR that were fully paid down, charged-off, or foreclosed upon by year end are not reported.

TDRs in the tables above were the result of interest rate modifications and extended payment terms. The Company has not forgiven any principal on the above loans. For the years ended December 31, 2013 and 2012 there were no reported TDR loans that were modified in the previous 12 months that subsequently defaulted in the reporting year.

Related Party Loans

Certain directors and executive officers or their related affiliates are customers of and have had banking transactions with the Company. As of December 31, 2013, there were no new loans or activity, however there was one existing loan

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

to a newly appointed director with an outstanding balance of $5,000 and an unfunded commitment of $45,000. As of December 31, 2012 there were no loans or activity outstanding to directors, executive officers, and related business entities with which they are associated. All loans and commitments included in such transactions were made in compliance with applicable laws on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons and do not involve more than the normal risk of collectability or present any other unfavorable features.