UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018



[ ]	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	(I.R.S. Employer
or organization)	I.D. Number)

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

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, every Interactive Data File required to be submitted 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 such files).

Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☒ Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

Table of Contents

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of November 5, 2018, there were 2,484,030 shares of common stock, $0.01 par value per share, outstanding.

Table of Contents

ANCHOR BANCORP

FORM 10-Q

TABLE OF CONTENTS



PART 1 - FINANCIAL INFORMATION
	Page
Item 1 - Financial Statements	1

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	32

Item 3 - Quantitative and Qualitative Disclosures About Market Risk	45

Item 4 - Controls and Procedures	47

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings	47

Item 1A - Risk Factors	47

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds	48

Item 3 – Defaults Upon Senior Securities	48

Item 4 – Mine Safety Disclosures	48

Item 5 - Other Information	48

Item 6 - Exhibits	49

SIGNATURES	50

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

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements



ANCHOR BANCORP AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands, except share data) (Unaudited)	September 30, 2018			June 30, 2018
ASSETS
Cash and cash equivalents	$	50,546		$	17,568
Securities available-for-sale, at fair value, amortized cost of $17,586 and $18,407	16,817			17,725
Securities held-to-maturity, at amortized cost, fair value of $3,188 and $3,500	3,287			3,584
Loans held for sale	999			98
Loans receivable, net of allowance for loan losses of $4,420 and $4,370	369,291			392,044
Bank owned life insurance investment, net of surrender charges	20,675			20,546
Accrued interest receivable	1,424			1,423
Real estate owned ("REO"), net	742			737
Federal Home Loan Bank ("FHLB") stock, at cost	2,047			2,047
Property, premises, and equipment, at cost, less accumulated depreciation of $12,390 and $12,243	8,515			8,664
Deferred tax asset, net	3,187			3,585
Prepaid expenses and other assets	1,350			1,633
Total assets	$	478,880		$	469,654
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits:
Noninterest-bearing	$	59,725		$	55,381
Interest-bearing	305,932			303,640
Total deposits	365,657			359,021

FHLB advances	37,000			37,000
Advance payments by borrowers for taxes and insurance	1,975			1,077
Supplemental Executive Retirement Plan liability	1,746			1,738
Accounts payable and other liabilities	3,826			3,374
Total liabilities	410,204			402,210
STOCKHOLDERS’ EQUITY
Preferred stock, $0.01 par value per share authorized 5,000,000 shares; no shares issued or outstanding	—			—
Common stock, $0.01 par value per share, authorized 45,000,000 shares; 2,484,030 issued and outstanding at September 30, 2018 and 2,484,030 issued and outstanding at June 30, 2018, respectively	25			25
Additional paid-in capital	22,343			22,298
Retained earnings	48,063			46,776
Unearned Employee Stock Ownership Plan ("ESOP") shares	(523		)	(540		)
Accumulated other comprehensive loss, net of tax	(1,232		)	(1,115		)
Total stockholders’ equity	68,676			67,444
Total liabilities and stockholders’ equity	$	478,880		$	469,654

See accompanying notes to condensed consolidated financial statements (unaudited).

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ANCHOR BANCORP AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except share data) (Unaudited)	Three Months Ended September 30,
	Three Months Ended September 30,
	2018			2017
Interest income:
Loans receivable, including fees	$	5,528		$	5,133
Securities	173			34
Mortgage-backed securities	115			130
Total interest income	5,816			5,297
Interest expense:
Deposits	914			842
FHLB advances	179			109
Total interest expense	1,093			951
Net interest income before provision for loan losses	4,723			4,346
Provision for loan losses	50			75
Net interest income after provision for loan losses	4,673			4,271
Noninterest income:
Deposit service fees	261			313
Other deposit fees	194			199
Other loan fees	226			228
(Loss) gain on sale of loans	(2		)	110
Bank owned life insurance investment	129			129
Other income	341			193
Total noninterest income	1,149			1,172
Noninterest expense:
Compensation and benefits	1,962			2,084
General and administrative expenses	580			574
Merger expenses	266			34
Real estate impairment	50			—
Real estate owned holding costs, net	20			30
Federal Deposit Insurance Corporation ("FDIC") insurance premiums	47			36
Information technology	498			537
Occupancy and equipment	398			433
Deposit services	96			104
Marketing	59			91
Loss on sale of property, premises and equipment	—			5
Total noninterest expense	3,976			3,928
Income before provision for income taxes	1,846			1,515
Provision for income taxes	559			471
Net income	$	1,287		$	1,044
Basic earnings per share	$	0.52		$	0.43
Diluted earnings per share	$	0.52		$	0.43
Weighted average number of basic shares outstanding	2,484,011			2,421,049
Weighted average number of diluted shares outstanding	2,489,475			2,432,960

See accompanying notes to condensed consolidated financial statements (unaudited).

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ANCHOR BANCORP AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands) (Unaudited)	Three Months Ended September 30,
	Three Months Ended September 30,
	2018			2017
NET INCOME	$	1,287		$	1,044
OTHER COMPREHENSIVE (LOSS) INCOME, net of income tax
Unrealized holding (losses) gains on available-for-sale securities during the period, net of income tax (benefit) expense of $(28) and $19, respectively	(117		)	36
Other comprehensive (loss) income, net of income tax	(117		)	36
COMPREHENSIVE INCOME	$	1,170		$	1,080

See accompanying notes to condensed consolidated financial statements (unaudited).

Table of Contents



ANCHOR BANCORP AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands, except share data) (Unaudited)	Three Months Ended September 30,
	Three Months Ended September 30,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	1,287		$	1,044
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization	149			158
Net amortization of premiums on securities	52			70
Provision for loan losses	50			75
ESOP expense	49			43
Real estate owned impairment	50			—
Deferred federal income taxes	368			326
Stock compensation expense	13			47
Increase in cash surrender value of life insurance investment	(129		)	(129		)
Loss (gain) on sale of loans	2			(110		)
Originations of loans held for sale	(1,001		)	(1,994		)
Proceeds from sale of loans held for sale	98			3,655
Loss on sale of property, premises, and equipment	—			5
Change in operating assets and liabilities:
Accrued interest receivable	(1		)	(12		)
Prepaid expenses and other assets	283			257
Supplemental Executive Retirement Plan ("SERP")	8			8
Accounts payable and other liabilities	452			832
Net cash provided by operating activities	1,730			4,275
CASH FLOWS FROM INVESTING ACTIVITIES
Principal repayments on mortgage-backed available-for-sale securities	783			937
Principal repayments on mortgage-backed held-to-maturity securities	283			374
Loan originations, net of undisbursed loan proceeds and principal repayments	22,650			(7,179		)
Capital improvements on real estate owned	(2		)	—
Proceeds from sale of property, premises, and equipment, net	—			160
Redemption of FHLB stock	—			312
Net cash provided by (used in) investing activities	23,714			(5,396		)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits	6,636			3,189
Net change in advance payments by borrowers for taxes and insurance	898			708
Proceeds from FHLB advances	—			15,200
Repayment of FHLB advances	—			(23,000		)
Net share settlement of stock awards	—			(245		)
Net cash provided by (used in) financing activities	$	7,534		$	(4,148	)

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ANCHOR BANCORP AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Dollars in thousands, except share data) (Unaudited)	Three Months Ended September 30,
	Three Months Ended September 30,
	2018			2017
NET CHANGE IN CASH AND CASH EQUIVALENTS	$	32,978		$	(5,269	)
Beginning of period	17,568			14,194
End of period	$	50,546		$	8,925
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest	$	1,093		$	960
Income taxes	$	—		$	145
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES
Noncash investing activities:
Net loans transferred to real estate owned	$	53		$	1,791
Unrealized holding (loss) gain on available-for-sale securities, net of tax	$	(117	)	$	36

See accompanying notes to condensed consolidated financial statements (unaudited).

Table of Contents

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Nature of Business

Anchor Bancorp (the “Company”), a Washington corporation, was formed in connection with the conversion of Anchor Mutual Savings Bank (the “Bank”) from the mutual to the stock form of organization. On January 25, 2011, the Bank completed its conversion from mutual to stock form, changed its name to “Anchor Bank” and became the wholly-owned subsidiary of the Company.

Anchor Bank is a community-based savings bank primarily serving Western Washington through its nine full-service bank offices within Grays Harbor, Thurston, Lewis, and Pierce counties, and one loan production office located in King County, Washington. Anchor Bank’s business consists of attracting deposits from the public and utilizing those deposits to originate loans.

Note 2 - Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. It is recommended that these unaudited interim consolidated financial statements be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 2018 (“2018 Form 10-K”). The results of operations for the three months ended September 30, 2018 are not necessarily indicative of results that may be expected for the entire fiscal year ending June 30, 2019. Certain prior year amounts have been reclassified to conform to current fiscal year presentation. The reclassifications had no impact on previously reported consolidated net income or equity. The Company has evaluated events and transactions subsequent to September 30, 2018 for potential recognition or disclosure.

Note 3 - Recently Issued Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842). The amendments in this ASU require lessees to recognize the following for all leases (with the exception of short-term) at the commencement date; a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. The amendments in this ASU leave lessor accounting largely unchanged, although certain targeted improvements were made to align lessor accounting with the lessee accounting model. This ASU simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842), Targeted Improvements. This ASU amended the new leases standard to give entities another option for transition and to provide lessors with a practical expedient. The transition option allows entities to not apply the new leases standard in the comparative periods they present in their financial statements in the year of adoption. The practical expedient provides lessors with an option to not separate non-lease components from the associated lease components when certain criteria are met and requires them to account for the combined component in accordance with the new revenue standard if the associated non-lease components are the predominant components. The amendments have the same effective date as ASU 2016-02. The effect of the adoption will depend on leases at time of adoption. Once adopted, we expect to report higher assets and liabilities as a result of including right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements, however, based on current leases the adoption of these ASUs is not expected to have a material impact on the Company's consolidated financial statements.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The standard will take effect for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Once adopted, we expect our allowance for loan losses to increase, however, until our evaluation is complete the magnitude of the increase will not be known.

In March 2017, the FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. The standard will take effect for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The adoption of ASU No. 2017-08 is not expected to have a material impact on the Company's consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income ("AOCI"). ASU 2018-02 eliminates the stranded tax effects within AOCI resulting from the application of current U.S. GAAP in response to the change in the U.S. corporate income tax rate from 35 percent to 21 percent as part of the Tax Cuts and Jobs Act of 2017 enacted in December 2017 (the "Tax Act"). Stranded tax effects unrelated to the Tax Act are released from AOCI using the security-by-security approach. The Company elected to early adopt ASU 2018-02 effective during the year ended June 30, 2018 and applied the provisions retrospectively within our Consolidated Balance Sheets and Consolidated Statements of Shareholders' Equity. This adoption resulted in a one-time reclassification of the effect of remeasuring deferred tax liabilities related to items, primarily unrealized gains and losses on investments, within AOCI to retained earnings resulting from the change in the U.S. corporate income tax rate. This reclassification resulted in a decrease to AOCI and an increase to retained earnings in the amount of $39,496 for the year ended June 30, 2018, with no net impact to total stockholders' equity.

In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740). This ASU was issued to provide guidance on the income tax accounting implications of the Tax Act and allows for entities to report provisional amounts for specific income tax effects of the Act for which the accounting under ASC Topic 740 was not yet complete but a reasonable estimate could be determined. A measurement period of one-year is allowed to complete the accounting effects under ASC Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Company adopted this ASU with the provisional adjustments as reported in the Consolidated Financial Statements in the Form 10-Q for the quarter ended December 31, 2017. As of September 30, 2018 the Company did not incur any adjustments to the provisional recognition.

In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This ASU amends the accounting for shared-based payments awards to nonemployees to align with the accounting for employee awards. Under the new guidance, the existing employee guidance will apply to nonemployee share-based transactions (as long as the transaction is not effectively a form of financing), with the exception of specific guidance related to the attribution of compensation cost. The cost of nonemployee awards will continue to be recorded as if the grantor had paid cash for the goods or services. In addition, the contractual term will be able to be used in lieu of an expected term in the option-pricing model for nonemployee awards. Amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The adoption of ASU No. 2018-07 is not expected to have a material impact on the Company's consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). This ASU modifies the disclosure requirements on fair value measurements. The following disclosure requirements were removed from FASB Accounting Standards Codification (“ASC”) Topic 820 - Fair Value Measurement: (1) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (2) the policy for timing of transfers between levels; and (3) the valuation processes for Level 3 fair value measurements. This ASU clarifies that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The ASU adds the following disclosure requirements for Level 3 measurements: (1) changes in unrealized gains and losses for the period included in other comprehensive income for the recurring Level 3 fair value measurements held at the end of the reporting period; and (2) the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. Amendments in this ASU are effective for

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for any removed or modified disclosures. The adoption of ASU 2018-13 is not expected to have a material impact on the Company's consolidated financial statements.

Application of New Accounting Guidance

On July 1, 2018, the Company adopted FASB issued ASU No. 2014‑09, Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively “ASC 606”), which created Topic 606 and supersedes Topic 605, Revenue Recognition. In August 2015, FASB issued ASU No. 2015‑14, Revenue from Contracts with Customers (Topic 606), which postponed the effective date of 2014‑09. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under past guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. For financial reporting purposes, the Company utilized the modified retrospective approach, meaning the ASU is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. As a bank holding company, key revenue sources, such as interest income on loans, investment securities and deposits, as well as other sources of income including loan fees, security sales, and derivatives have been identified as out of the scope of this new guidance. Management conducted an assessment of the revenue streams that were affected by the new guidance and identified those considered material and in scope to ensure compliance with the new guidance concluding those related to credit and debit card fees, and service charges and fees on deposit accounts. No additional changes to processes or procedures were identified for the recognition of revenues in scope. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements. The additional disclosures required by this ASU have been included in “Note 13 - Revenue from Contracts with Customers”.

On July 1, 2018, the Company adopted FASB issued ASU No. 2016‑01, Financial Instruments - Overall (Subtopic 825‑10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance improves the recognition and measurement of financial instruments. This ASU requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. Exit price is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This ASU also eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The adoption of ASU No. 2016-01 did not have a material impact on the Company’s consolidated financial statements. The disclosures to the Company’s consolidated financial statements have been updated appropriately using the exit price notion in “Note 9 - Fair Value of Financial Instruments”.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230), a consensus of the FASB’s Emerging Issues Task Force. The ASU is intended to reduce diversity in practice in how certain transactions are presented and classified in the statement of cash flows. Management adopted the new guidance on July 1, 2018. The adoption of ASU No. 2016-15 did not have a material impact on the Company's consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash. The ASU amends the required statement of cash flow disclosures to include the change in amounts generally described as restricted cash. Management adopted the new guidance on July 1, 2018. The adoption of ASU No. 2016-18 did not have a material impact on the Company’s consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU provides clarity on the guidance related to stock compensation when there has been changes to the terms or conditions of a share-based payment award to which an entity would be required to apply modification accounting under ASC 718. The ASU provides the three following criteria must be met in order to not account for the effect of the modification of terms or conditions: the fair value, the vesting conditions and the classification as an equity or liability instrument of the modified award is the same as the original award immediately before the original award is modified. Management adopted the new guidance on July 1, 2018. The adoption of ASU No. 2017-09 did not have a material impact on the Company's consolidated financial statements.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting recognition and presentation requirements in ASC 815 to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. The amendments in this ASU permit hedge accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. Management adopted the new guidance on July 1, 2018. The adoption of ASU No. 2017-12 did not have a material impact on the Company's consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal Use Software (Subtopic 350-40), Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU address how a customer should account for the costs of implementing a cloud computing service arrangement (also referred to as a “hosting arrangement”). Entities should account for costs associated with implementing a cloud computing arrangement that is considered a service contract in the same way as accounting for implementation costs incurred to develop or obtain software for internal use using the guidance in ASC 350-40. The amendments also addresses when costs should be capitalized rather than expensed, the term to use when amortizing capitalized costs, and how to evaluate the unamortized portion of these capitalized implementation costs for impairment and includes guidance on how to present implementation costs in the financial statements and creates additional disclosure requirements. Amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2020. The adoption of ASU No. 2018-15 is not expected to have a material impact on the Company's consolidated financial statements.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 4 - Earnings Per Share ("EPS")

Basic earnings per common share is the amount of earnings available to each share of common stock outstanding during the reporting period and is equal to net income divided by the weighted average number of shares outstanding during the period, without considering any dilutive items. Unvested share-based awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in ASC 260-10-45-60B. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the period adjusted to include the effect of potentially dilutive common shares that may be issued upon the vesting of restricted stock awards. Therefore, under the two-class method, the difference in EPS is not significant since the Company did not pay dividends. The following table details the calculation of basic and diluted earnings per share:



	For the Three Months Ended September 30,
	2018		2017
	(Dollars in thousands, except share data)
Net income	$	1,287	$	1,044
Earnings allocated to common shareholders	$	1,287	$	1,044

Basic weighted-average common shares outstanding	2,484,011		2,421,049
Potentially dilutive incremental shares	5,464		11,911
Diluted weighted-average common shares outstanding	2,489,475		2,432,960

Basic earnings per share	$	0.52	$	0.43
Diluted earnings per share	$	0.52	$	0.43

Shares owned by the Company's ESOP that have not been allocated are not considered to be outstanding for the purpose of computing basic and diluted EPS. As of September 30, 2018 and September 30, 2017 there were 46,766 and 53,649 shares, respectively, which had not been allocated under the Company's ESOP.

Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For both the three months ended September 30, 2018 and 2017, there were no anti-dilutive shares included in the computation of diluted earnings per share.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 5 - Investments

The amortized cost and estimated fair market values of investment securities as of September 30, 2018 and June 30, 2018, were as follows:



September 30, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
Securities available-for-sale
Municipal bonds	$	152	$	—	$	—		$	152
Mortgage-backed securities:
FHLMC ⁽¹⁾	10,037		10		(418		)	9,629
FNMA ⁽²⁾	7,011		—		(340		)	6,671
GNMA ⁽³⁾	386		—		(21		)	365
	$	17,586	$	10	$	(779	)	$	16,817
Securities held-to-maturity
Mortgage-backed securities:
FHLMC	$	1,684	$	28	$	(88	)	$	1,624
FNMA	943		35		(30		)	948
GNMA	660		—		(44		)	616
	$	3,287	$	63	$	(162	)	$	3,188

⁽¹⁾Federal Home Loan Mortgage Corporation ("Freddie Mac")

⁽²⁾Federal National Mortgage Association ("Fannie Mae")

⁽³⁾Government National Mortgage Association ("Ginnie Mae")



June 30, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
Securities available-for-sale
Municipal bonds	$	155	$	—	$	—		$	155
Mortgage-backed securities:
FHLMC	10,337		11		(350		)	9,998
FNMA	7,494		—		(323		)	7,171
GNMA	421		—		(20		)	401
	$	18,407	$	11	$	(693	)	$	17,725
Securities held-to-maturity
Mortgage-backed securities:
FHLMC	$	1,805	30		(84		)	$	1,751
FNMA	982		40		(26		)	996
GNMA	797		—		(44		)	753
	$	3,584	$	70	$	(154	)	$	3,500

There were 56 and 55 securities in an unrealized loss position at September 30, 2018 and June 30, 2018, respectively. The unrealized losses on investments in mortgage-backed securities relate principally to the general change in interest rates and illiquidity, and not credit quality, that has occurred since the securities' purchase dates, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future. We do not intend to sell the temporarily impaired securities and it is not likely that we will be required to sell the securities prior to their maturity. We do expect to recover the entire amortized cost basis of the securities. The fair value of temporarily impaired securities, the amount of unrealized losses, and the length of time these unrealized losses existed as of the dates indicated, were as follows:

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
September 30, 2018	(In thousands)
Securities available-for-sale
Mortgage-backed securities:
FHLMC	$	5,071	$	(154	)	$	4,320	$	(265	)	$	9,391	$	(419	)
FNMA	—		—			6,671		(340		)	6,671		(340		)
GNMA	—		—			365		(20		)	365		(20		)
	$	5,071	$	(154	)	$	11,356	$	(625	)	$	16,427	$	(779	)



	Less Than 12 Months				12 Months or Longer					Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
September 30, 2018	(In thousands)
Securities held-to-maturity
Mortgage-backed securities:
FHLMC	$	—	$	—	$	1,141	$	(88	)	$	1,141	$	(88	)
FNMA	—		—		410		(30		)	410		(30		)
GNMA	—		—		616		(44		)	616		(44		)
	$	—	$	—	$	2,167	$	(162	)	$	2,167	$	(162	)



	Less Than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2018	(In thousands)
Securities available-for-sale
Mortgage-backed securities:
FHLMC	$	5,696	$	(143	)	$	3,650	$	(207	)	$	9,346	$	(350	)
FNMA	781		(27		)	6,389		(296		)	7,170		(323		)
GNMA	—		—			402		(20		)	402		(20		)
	$	6,477	$	(170	)	$	10,441	$	(523	)	$	16,918	$	(693	)



	Less Than 12 Months				12 Months or Longer					Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2018	(In thousands)
Securities held-to-maturity
Mortgage-backed securities:
FHLMC	$	—	$	—	$	1,206	$	(84	)	$	1,206	$	(84	)
FNMA	—		—		434		(26		)	434		(26		)
GNMA	—		—		753		(44		)	753		(44		)
	$	—	$	—	$	2,393	$	(154	)	$	2,393	$	(154	)

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Contractual maturities of securities at September 30, 2018 are listed below. Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay the obligations; therefore, these securities are classified separately with no specific maturity date.



September 30, 2018	Amortized Cost		Fair Value
	(In thousands)
Securities available-for-sale
Municipal bonds:
Due after five to ten years	$	152	$	152
Mortgage-backed securities:
FHLMC	10,037		9,629
FNMA	7,011		6,671
GNMA	386		365
	$	17,586	$	16,817



Securities held-to-maturity
Mortgage-backed securities:
FHLMC	$	1,684	$	1,624
FNMA	943		948
GNMA	660		616
	$	3,287	$	3,188

There were no sales of securities available-for-sale for the three months ended September 30, 2018 and 2017.

Pledged securities at the dates indicated are summarized as follows:



	September 30, 2018				June 30, 2018
Pledged to secure:	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In thousands)
Public deposits	$	3,825	$	3,671	$	4,035	$	3,903
FHLB borrowings	727		730		766		770
Federal Reserve borrowing line	1,145		1,070		1,323		1,249

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 6 - Loans Receivable, net

Loans receivable consisted of the following at the dates indicated:



	September 30, 2018		June 30, 2018
	(In thousands)
Real estate:
One-to-four family	$	63,387	$	62,110
Multi-family	56,292		57,639
Commercial	156,452		150,050
Construction	64,106		85,866
Land	5,133		5,515
Total real estate	345,370		361,180
Consumer:
Home equity	12,522		12,291
Credit cards	2,198		2,284
Automobile	299		372
Other consumer	1,139		960
Total consumer	16,158		15,907

Business:
Commercial business	13,098		20,329
Total loans	374,626		397,416
Less:
Deferred loan fees and loan premiums, net	915		1,002
Allowance for loan losses	4,420		4,370
Loans receivable, net	$	369,291	$	392,044

Allowance for Loan Losses. 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. 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.

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2018:



	One-to- four family		Multi- family		Commercial real estate		Construction			Land			Consumer (1)			Commercial business		Unallocated		Three months ended 9/30/18
	(In thousands)
Allowance for loan losses:
Beginning balance	$	339	$	585	$	1,478	$	1,280		$	83		$	353		$	252	$	—	$	4,370
Provision (benefit) for loan losses	41		73		239		(355		)	(21		)	40			33		—		50
Charge-offs	—		—		—		—			—			(20		)	—		—		(20		)
Recoveries	14		—		—		1			—			5			—		—		20
Ending balance	$	394	$	658	$	1,717	$	926		$	62		$	378		$	285	$	—	$	4,420


⁽¹⁾	Consumer loans include home equity, credit cards, automobile, and other consumer loans. The only consumer loans with impairment are home equity loans.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2017:



	One-to- four family			Multi- family		Commercial real estate			Construction		Land			Consumer (1)			Commercial business			Unallocated		Three months ended 9/30/17
	(In thousands)
Allowance for loan losses:
Beginning balance	$	495		$	580	$	1,566		$	651	$	120		$	378		$	316		$	—	$	4,106
Provision (benefit) for loan losses	(207		)	10		168			169		(1		)	(40		)	(24		)	—		75
Charge-offs	—			—		(200		)	—		—			(1		)	—			—		(201		)
Recoveries	14			—		—			1		—			17			5			—		37
Ending balance	$	302		$	590	$	1,534		$	821	$	119		$	354		$	297		$	—	$	4,017


⁽¹⁾	Consumer loans include home equity, credit cards, automobile, and other consumer loans. The only consumer loans with impairment are home equity loans.

A loan is considered impaired when the Company has determined that it may be unable to collect payments of principal 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.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2018:



	Recorded Investments		Unpaid Principal Balance		Related Allowance
	(In thousands)
With no allowance recorded
One-to-four family	$	703	$	896	$	—
Home equity	316		330		—
Commercial business	63		125		—
With an allowance recorded
One-to-four family	$	2,295	$	2,305	$	95
Land	246		246		6
Home equity	252		252		65
Other consumer	12		12		12
Commercial business	141		162		17
Total
One-to-four family	$	2,998	$	3,201	$	95
Land	246		246		6
Home equity	568		582		65
Other consumer	12		12		12
Commercial business	204		287		17
Total	$	4,028	$	4,328	$	195

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2018:



	Recorded Investments		Unpaid Principal Balance		Related Allowance
	(In thousands)
With no allowance recorded
One-to-four family	$	608	$	794	$	—
Home equity	330		345		—
Commercial business	285		366		—
With an allowance recorded
One-to-four family	$	2,341	$	2,351	$	85
Land	300		300		13
Home equity	150		150		80
Other consumer	14		14		13
Total
One-to-four family	$	2,949	$	3,145	$	85
Land	300		300		13
Home equity	480		495		80
Other consumer	14		14		13
Commercial business	285		366		—
Total	$	4,028	$	4,320	$	191

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the average recorded investment in loans individually evaluated for impairment and the interest income recognized for the three months ended September 30, 2018 and 2017:



	Three Months Ended September 30, 2018				Three Months Ended September 30, 2017
	Three Months Ended September 30, 2018				Three Months Ended September 30, 2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In thousands)
With no allowance recorded
One-to-four family	$	656	$	1	$	1,716	$	3
Commercial real estate	—		—		996		—
Home equity	323		1		281		1
Commercial business	174		1		480		1
With an allowance recorded
One-to-four family	$	2,318	$	9	$	3,084	$	11
Land	273		7		310		7
Home equity	201		1		261		1
Other consumer	13		—		—		—
Commercial business	71		—		12		—
Total
One-to-four family	$	2,974	$	10	$	4,800	$	14
Commercial real estate	—		—		996		—
Land	273		7		310		7
Home equity	524		2		542		2
Other consumer	13		—		—		—
Commercial business	245		1		492		—
Total	$	4,029	$	20	$	7,140	$	23

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2018:



	One-to-four family		Multi- family		Commercial real estate		Construction		Land		Consumer(1)		Commercial business		Unallocated		Total
	(In thousands)
Allowance for loan losses:
Ending balance	$	394	$	658	$	1,717	$	926	$	62	$	378	$	285	$	—	$	4,420
Ending balance: individually evaluated for impairment	95		—		—		—		6		77		17		—		195
Ending balance: collectively evaluated for impairment	$	299	$	658	$	1,717	$	926	$	56	$	301	$	268	$	—	$	4,225

Loans receivable:
Ending balance	$	63,387	$	56,292	$	156,452	$	64,106	$	5,133	$	16,158	$	13,098	$	—	$	374,626
Ending balance: individually evaluated for impairment	2,998		—		—		—		246		580		204		—		4,028
Ending balance: collectively evaluated for impairment	$	60,389	$	56,292	$	156,452	$	64,106	$	4,887	$	15,578	$	12,894	$	—	$	370,598


⁽¹⁾	Consumer loans include home equity, credit cards, auto and other consumer loans.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2018:



	One-to-four family		Multi- family		Commercial real estate		Construction		Land		Consumer(1)		Commercial business		Unallocated		Total
	(In thousands)
Allowance for loan losses:
Ending balance	$	339	$	585	$	1,478	$	1,280	$	83	$	353	$	252	$	—	$	4,370
Ending balance: individually evaluated for impairment	85		—		—		—		13		93		—		—		191
Ending balance: collectively evaluated for impairment	$	254	$	585	$	1,478	$	1,280	$	70	$	260	$	252	$	—	$	4,179

Loans receivable:
Ending balance	$	62,110	$	57,639	$	150,050	$	85,866	$	5,515	$	15,907	$	20,329	$	—	$	397,416
Ending balance: individually evaluated for impairment	2,949		—		—		—		300		494		285		—		4,028
Ending balance: collectively evaluated for impairment	$	59,161	$	57,639	$	150,050	$	85,866	$	5,215	$	15,413	$	20,044	$	—	$	393,388


⁽¹⁾	Consumer loans include home equity, credit cards, auto, and other consumer loans.

Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual when, in management's opinion, the borrower may be unable to meet payment of obligations as they become due, as well as when required by regulatory provisions.

The following table presents the recorded investment in nonaccrual loans by type of loans as of the dates indicated:



	September 30, 2018		June 30, 2018
	(In thousands)
One-to-four family	$	450	$	507
Home equity	297		207
Commercial business	141		222
Total	$	888	$	936

There were no loans past due 90 days or more and still accruing interest at September 30, 2018 and June 30, 2018.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents past due loans, net of partial loan charge-offs, by class of loan, as of September 30, 2018:



	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due ⁽¹⁾		Total Past Due		Current		Total Loans
	(In thousands)
One-to-four family	$	330	$	179	$	450	$	959	$	62,428	$	63,387
Multi-family	—		—		—		—		56,292		56,292
Commercial real estate	—		—		—		—		156,452		156,452
Construction	—		—		—		—		64,106		64,106
Land	—		—		—		—		5,133		5,133
Home equity	57		—		297		354		12,168		12,522
Credit cards	6		4		—		10		2,188		2,198
Automobile	—		—		—		—		299		299
Other consumer	3		3		—		6		1,133		1,139
Commercial business	—		—		141		141		12,957		13,098
Total	$	396	$	186	$	888	$	1,470	$	373,156	$	374,626


	⁽¹⁾ Includes loans on nonaccrual status.

The following table presents past due loans, net of partial loan charge-offs, by class of loan as of June 30, 2018:



	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due ⁽¹⁾		Total Past Due		Current		Total Loans
	(In thousands)
One-to-four family	$	683	$	122	$	507	$	1,312	$	60,798	$	62,110
Multi-family	—		—		—		—		57,639		57,639
Commercial real estate	—		—		—		—		150,050		150,050
Construction	—		—		—		—		85,866		85,866
Land	—		—		—		—		5,515		5,515
Home equity	220		—		207		427		11,864		12,291
Credit cards	6		8		—		14		2,270		2,284
Automobile	—		—		—		—		372		372
Other consumer	4		—		—		4		956		960
Commercial business	9		—		222		231		20,098		20,329
Total	$	922	$	130	$	936	$	1,988	$	395,428	$	397,416

⁽¹⁾ Includes loans on nonaccrual status.

Credit Quality Indicators. We utilize a ten-point risk rating system and assign a risk rating for all credit exposures. The risk rating system is designed to define the basic characteristics and identify risk elements of each credit extension.

Credits risk rated 1 through 7 are considered to be “pass” credits. Pass credits can be assets where there is virtually no credit risk, such as cash secured loans with funds on deposit with the Bank. Pass credits also include credits that are on our watch and special mention lists, where the borrower exhibits potential weaknesses, which may, if not checked or corrected, negatively affect the borrower's financial capacity and threaten their ability to fulfill debt obligations in the future. A seasoned loan with a Debt Service Coverage Ratio ("DSCR") of greater than 1.00 is the minimum acceptable level for a "Pass Credit". Particular attention is paid to the coverage trend analysis as any loan with a declining DSCR trend may warrant a higher risk grade even if the current coverage is at or above the 1.00 threshold.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Credits classified as Watch are risk rated 6 and possess weaknesses that deserve management's close attention. These assets do not expose the Bank to sufficient risk to warrant adverse classification in the substandard, doubtful or loss categories. We use this rating when a material documentation deficiency exists but correction is anticipated within an acceptable time frame.

A loan classified as Watch may have the following characteristics:


•	Acceptable asset quality, but requiring increased monitoring. Strained liquidity and less than anticipated performance. The loan may be fully leveraged.


•	Apparent management weakness, perhaps demonstrated by an irregular flow of adequate and/or timely performance information required to support the credit.


•	The borrower has a plausible plan to correct problem(s) in the near future that is devoid of material uncertainties.


•	Lacks reserve capacity, so the risk rating will improve or decline in relatively short time (results of corrective actions should be apparent within six months or less).

Credits classified as Special Mention are risk rated 7. These credits have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset. Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.

A loan classified as Special Mention may have the following characteristics:


•	Performance is poor or significantly less than expected. A debt service deficiency either exists or cannot be ruled out.

•

Generally an undesirable business credit. Assets in this category are protected, but are potentially weak. These assets constitute an undue and unwarranted credit risk, but not to the point of justifying a classification of Substandard. Special Mention assets have potential weaknesses which may, if not checked or corrected, weaken the asset or inadequately protect the Bank's credit position at some future date.


•	Assets which might be detailed in this category include credits that the lending officer may be unable to supervise properly because of lack of expertise, an inadequate loan agreement, the condition of and control over collateral, failure to obtain proper documentation, or any other deviations from prudent lending practices.


•	An adverse trend in the borrower's operations or an imbalanced position in the balance sheet which does not jeopardize liquidation may best be handled by this classification.


•	A Special Mention classification should not be used as a compromise between a pass and substandard rating. Assets in which actual, not potential, weaknesses are evident and significant, and should be considered for more serious criticism.

A loan classified as Substandard is risk rated 8. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. An asset is considered Substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.

A loan classified as Substandard may have the following characteristics:


•	Unacceptable business credit. The asset is inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well defined weakness or weaknesses that jeopardize the liquidation of the debt.


•	Though no loss is envisioned, the outlook is sufficiently uncertain to preclude ruling out the possibility. Some liquidation of assets will likely be necessary as a corrective measure.


•	Assets in this category may demonstrate performance problems such as debt servicing deficiencies with no immediate relief, including having a DSCR of less than 1.00. Borrowers have an inability to adjust to prolonged and unfavorable industry or economic trends. Management's character and/or effectiveness have become suspect.

A loan classified as Doubtful is risk rated 9 and has all the inherent weaknesses as those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable is improbable.

A loan classified as Doubtful is risk rated 9 and has the following characteristics:


•	The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


•	Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.

A loan risk rated 10 is a loan for which a total loss is expected.

A loan classified as a Loss has the following characteristics:


•	An uncollectible asset or one of such little value that it does not warrant classification as an active, earning asset. Such an asset may, however, have recovery or salvageable value, but not to the point of deferring full write off, even though some recovery may occur in the future.


•	The Bank will charge off such assets as a loss during the accounting period in which they were identified.


•	Loan to be eliminated from the active loan reporting system via charge off.

The following table presents the internally assigned grade as of September 30, 2018, by class of loans:



	One-to- four family		Multi- family		Commercial real estate		Construction		Land		Home equity		Credit cards		Automobile		Other consumer		Commercial business		Total
	(In thousands)
Grade:
Pass	$	62,334	$	55,047	$	155,652	$	62,486	$	5,133	$	11,838	$	2,188	$	299	$	1,126	$	12,898	$	369,001
Watch	155		1,245		800		1,620		—		198		10		—		3		59		4,090
Special Mention	448		—		—		—		—		189		—		—		10		—		647
Substandard	450		—		—		—		—		297		—		—		—		141		888
Doubtful	—		—		—		—		—		—		—		—		—		—		—
Total	$	63,387	$	56,292	$	156,452	$	64,106	$	5,133	$	12,522	$	2,198	$	299	$	1,139	$	13,098	$	374,626

The following table presents the internally assigned grade as of June 30, 2018, by class of loans:



	One-to- four family		Multi-family		Commercial real estate		Construction		Land		Home equity		Credit cards		Automobile		Other consumer		Commercial business		Total
	(In thousands)
Grade:
Pass	$	60,525	$	57,315	$	148,584	$	85,866	$	5,515	$	11,637	$	2,270	$	360	$	951	$	19,829	$	392,852
Watch	689		324		1,466		—		—		297		14		12		5		278		3,085
Special Mention	389		—		—		—		—		150		—		—		4		—		543
Substandard	507		—		—		—		—		207		—		—		—		222		936
Doubtful	—		—		—		—		—		—		—		—		—		—		—
Total	$	62,110	$	57,639	$	150,050	$	85,866	$	5,515	$	12,291	$	2,284	$	372	$	960	$	20,329	$	397,416

Troubled Debt Restructures. A troubled debt restructure ("TDR") is a loan where the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider so that the borrower can continue to make payments while minimizing the Company's potential loss. The modifications have included items such as lowering the interest rate on the loan for a period of time and extending the maturity date of the loan. These modifications are made only when there is a reasonable and attainable workout plan that has been agreed to by the borrower and is in the Bank's best interest. At September 30, 2018, there were no commitments to lend additional funds to borrowers whose loans have been modified in a TDR.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents TDRs by accrual versus nonaccrual status and by loan class as of September 30, 2018:



	September 30, 2018
	Accrual Status		Nonaccrual Status		Total Modifications
	(In thousands)
One-to-four family	$	2,431	$	103	$	2,534
Land	246		—		246
Home equity	121		—		121
Other consumer	12		—		12
Commercial business	63		—		63
Total	$	2,873	$	103	$	2,976

The following table presents TDRs by accrual versus nonaccrual status and by loan class as of June 30, 2018:



	June 30, 2018
	Accrual Status		Nonaccrual Status		Total Modifications
	(In thousands)
One-to-four family	$	2,443	$	108	$	2,551
Land	299		—		299
Home equity	124		—		124
Other consumer	14		—		14
Commercial business	63		—		63
Total	$	2,943	$	108	$	3,051

There were no new TDR loans, or renewals or modifications of existing TDR loans during the three months ended September 30, 2018 and 2017.

For the three months ended September 30, 2018 and 2017, there were no TDRs for which there was a payment default within 12 months of their restructure.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 7 - Real Estate Owned, net

The following table is a summary of REO activity for the three months ended September 30, 2018 and 2017:



	Three Months Ended September 30,
	Three Months Ended September 30,
	2018			2017
	(In thousands)
Balance at the beginning of the period	$	737		$	867
Net loans transferred to real estate owned	53			1,791
Capitalized improvements	2			—
Impairments	(50		)	—
Balance at the end of the period	$	742		$	2,658

At September 30, 2018, there were two loans secured by residential real estate properties for which formal foreclosure proceedings were in process.

Note 8 - Employee Benefit Plans

On January 25, 2011, the Company established an ESOP for the benefit of substantially all employees. The ESOP borrowed $1.0 million from the Company and used those funds to acquire 102,000 shares of the Company's common stock at the time of the initial public offering at a price of $10.00 per share.

Shares purchased by the ESOP with the loan proceeds are held in a suspense account and allocated to ESOP participants on a pro rata basis as principal and interest payments are made by the ESOP to the Company. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Company's discretionary contributions to the ESOP and earnings on the ESOP assets. Payments of principal and interest are due annually on June 30th, the Company's fiscal year end.

As shares are committed to be released from collateral, the Company reports compensation expense equal to the daily average market prices of the shares and the shares become outstanding for EPS computations. The compensation expense is accrued throughout the year.

Compensation expense related to the ESOP for the three months ended September 30, 2018 and 2017 was $49,000 and $43,000, respectively.

Shares held by the ESOP as of the dates indicated are as follows:



	September 30, 2018		June 30, 2018
	(Dollars in thousands)
Allocated shares	55,234		53,514
Unallocated shares	46,766		48,486
Total ESOP shares	102,000		102,000
Fair value of unallocated shares	$	1,323	$	1,268

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 9 - Fair Value Measurements

On July 1, 2018, the Company adopted ASU 2016-01, Financial Instruments - Overall (Subtopic 825‑10), Recognition and Measurement of Financial Assets and Financial Liabilities, which requires us to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes rather than the previous method of entry price notion. Under the entry price notion, the fair value estimate of loans receivable was based on discounted cash flow. At September 30, 2018, the exit price notion used to estimate the fair value of loans receivable was based on similar techniques, with the addition of current origination spreads, liquidity premiums, or credit adjustments. The fair value of nonperforming loans is based on the underlying value of the collateral for periods prior to and after adoption of ASU 2016-01.

Assets and liabilities measured at fair value on a recurring basis - Assets and liabilities are considered to be fair valued on a recurring basis if fair value is measured regularly. The following definitions describe the levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2: Significant observable inputs other than quoted prices included within Level 1, such as quoted prices in markets that are not active, and inputs other than quoted prices that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company's own assumptions about the assumptions market participants would use in pricing an asset or liability based on the best information available in the circumstances.

There were no transfers between Level 1, Level 2, or Level 3 during the three months ended September 30, 2018. The following tables show the Company's assets and liabilities at the dates indicated measured at fair value on a recurring basis:



	September 30, 2018
	Level 1		Level 2		Level 3		Total
	(In thousands)
Municipal bonds	$	—	$	152	$	—	$	152
Mortgage-backed securities:
FHLMC	—		9,629		—		9,629
FNMA	—		6,671		—		6,671
GNMA	—		365		—		365



	June 30, 2018
	Level 1		Level 2		Level 3		Total
	(In thousands)
Municipal bonds	$	—	$	155	$	—	$	155
Mortgage-backed securities:
FHLMC	—		9,998		—		9,998
FNMA	—		7,171		—		7,171
GNMA	—		401		—		401

Assets and liabilities measured at fair value on a nonrecurring basis - Assets and liabilities are considered to be reflected at fair value on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, a nonrecurring valuation is the result of the application of other accounting pronouncements that require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value.

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the balances of assets measured at fair value on a nonrecurring basis at September 30, 2018:



	September 30, 2018
	Level 1		Level 2		Level 3		Total
	(In thousands)
Impaired loans:
Mortgage loans
One-to-four family	$	—	$	—	$	2,331	$	2,331
Land	—		—		246		246
Home equity	—		—		252		252
Other consumer	—		—		12		12
Commercial business	—		—		141		141
Total impaired loans	—		—		2,982		2,982

Real estate owned:
One-to-four family	$	—	$	—	$	599	$	599
Total real estate owned	—		—		599		599

Total	$	—	$	—	$	3,581	$	3,581

The following table presents the balances of assets measured at fair value on a nonrecurring basis at June 30, 2018:



	June 30, 2018
	Level 1		Level 2		Level 3		Total
	(In thousands)
Impaired loans:
Mortgage loans
One-to-four family	$	—	$	—	$	2,443	$	2,443
Land	—		—		300		300
Home equity	—		—		221		221
Other consumer	—		—		14		14
Total impaired loans	—		—		2,978		2,978

Total	$	—	$	—	$	2,978	$	2,978

ANCHOR BANCORP AND SUBSIDIARY

SELECTED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The fair values of impaired loans and real estate owned properties are generally based on third party appraisal of the properties, resulting in Level 3 classification.

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at September 30, 2018 and June 30, 2018:



	September 30, 2018
	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Average Discount)
	(Dollars in thousands)
Impaired loans	$	2,982	Fair value of underlying collateral	Discount applied to the obtained appraisal	0% - 10% (6%)
Real estate owned	$	599	Fair value of underlying collateral	Discount applied to the obtained appraisal	0% - 100% (8%)



	June 30, 2018
	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Average Discount)
	(Dollars in thousands)
Impaired loans	$	2,978	Fair value of underlying collateral	Discount applied to the obtained appraisal	0% - 10% (7%)

The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of the Company's financial instruments as of September 30, 2018 and June 30, 2018:

September 30, 2018

Carrying Amount

Fair Value

Quoted Prices in Active Markets for Identical Assets or Liabilities

Anchor Bancorp 10-Q