UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K





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





For
the fiscal year ended December 31, 2009





[  ]
            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:  0-26003





ALASKA
PACIFIC BANCSHARES, INC.


(Exact
name of registrant as specified in its charter)






Alaska
            
            92-0167101(State or other
      jurisdiction of incorporation or organization)
            
            (I.R.S. Employer
      Identification No.)2094
      Jordan Avenue, Juneau, Alaska 99801

              (Address
      of principal executive offices) (Zip code)
              
              Registrant’s
      telephone number, including area code: (907)
  789-4844Securities
      registered pursuant to Section 12(b) of the Exchange
      Act:  NoneSecurities
      registered pursuant to Section 12(g) of the Exchange 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 15(d) of the Exchange


Act. Yes
[  ]  No [X]





Indicate
by check mark whether the registrant (1) 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 the 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 small 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
March 1, 2010, there were 655,415 issued and 654,486 outstanding shares of the
registrant’s Common Stock, which are traded on the over-the-counter market
through the OTC “Electronic Bulletin Board” under the symbol “AKPB.” Based on
the closing price of the Common Stock on June 30, 2009, the aggregate value of
the Common Stock outstanding held by nonaffiliates of the registrant
was  $2.1














million
(512,035 shares at $4.05 per share). For purposes of this calculation, shares of
common stock held by each executive officer and director have been
excluded.







DOCUMENTS
INCORPORATED BY REFERENCE





1.
            Portions
      of the Proxy Statement for the 2009 Annual Meeting of Stockholders are
      incorporated by reference in this Form 10-K in response to Part
      III.





-2 -


Forward-Looking
Statements





“Safe
Harbor” statement under the Private Securities Litigation Reform Act of 1995:
This Form 10-K contains certain "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements may be identified by the use of words such as “believe,” “expect,”
“anticipate,” “should,” “planned,” “estimated,” and “potential.” These
forward-looking statements relate to, among other things, expectations of the
business environment in which we operate, projections of future performance,
perceived opportunities in the market, potential future credit experience, and
statements regarding our strategies. These forward-looking statements are based
upon current management expectations and may, therefore, involve risks and
uncertainties. Our actual results, performance, or achievements may differ
materially from those suggested, expressed, or implied by forward-looking
statements as a result of a wide variety or range of factors including, but not
limited to: the credit risks of lending activities, including changes in the
level and trend of loan delinquencies and write-offs that may be impacted by
deterioration in the housing and commercial real estate markets and may lead to
increased losses and non-performing assets in our loan portfolio, result in our
allowance for loan losses not being adequate to cover actual losses, and require
us to materially increase our reserves; 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; deposit flows; fluctuations in the demand for loans, the number of
unsold homes and other properties and fluctuations in real estate values in our
market areas; adverse changes in the securities markets; results of examinations
of us and our bank subsidiary by the Office of Thrift Supervision and the
Federal Deposit Insurance Corporation, 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; the possibility that we will be unable to comply with the conditions
imposed upon us in the Memorandum of Understanding entered into with the Office
of Thrift Supervision, including but not limited to our ability to reduce our
non-performing assets, which could result in the imposition of additional
restrictions on our operations; 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 risk associated with the loans
on our balance sheet; staffing fluctuations in response to product demand or the
implementation of corporate strategies that affect our work force and potential
associated charges; computer systems on which we depend could fail or experience
a security breach, or the implementation of new technologies may not be
successful; 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; our ability to retain key members of
our senior management team; costs and effects of litigation, including
settlements and judgments; 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
changes in regulatory polices 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;
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 accounting issues and
details of the implementation of new accounting methods; the economic impact of
war or any terrorist activities; other economic, competitive, governmental,
regulatory, and technological factors affecting our operations; pricing,
products and services; time to lease excess space in Company-owned buildings;
future legislative changes in the United States Department of Treasury Troubled
Asset Relief Program Capital Purchase Program; and other risks detailed in our
reports filed with the Securities and Exchange Commission. Any of the
forward-looking statements that we make in this Form 10-K and in the other
public statements we make may turn out to be wrong because of the inaccurate
assumptions we might make, because of the factors illustrated above or because
of other factors that we cannot foresee.  Because of these and other
uncertainties, our actual future results may be materially different from those
expressed in any forward- looking statements made by or on our behalf.
Therefore, these factors should be considered in evaluating the forward-looking
statements, and undue reliance should not be placed on such statements. We
undertake no responsibility to update or revise any forward-looking
statements.





As used
throughout this report, the terms “we”, “our” or “us” refer to Alaska Pacific
Bancshares, Inc. and our consolidated subsidiary, Alaska Pacific
Bank.





-3 -


Available
Information





Alaska
Pacific Bancshares, Inc. posts 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 on its investor information page at
www.alaskapacificbank.com.  These reports are posted as soon as
reasonably practicable after they are electronically filed with the Securities
and Exchange Commission (“SEC”). All of Alaska Pacific Bancshares, Inc’s SEC
filings are also available free of charge at the SEC's website at www.sec.gov or
by calling the SEC at 1-800-SEC-0330.





PART
I





Item
1.  Business





General





Alaska
Pacific Bancshares, Inc. (“Company”), an Alaska corporation, was organized on
March 19, 1999 for the purpose of becoming the holding company for Alaska
Pacific Bank (“Alaska Pacific” or the “Bank”) upon the Bank’s conversion from a
federal mutual to a federal stock savings bank (“Conversion”). The Conversion
was completed on July 1, 1999. At December 31, 2009, the Company had total
assets of $178.3
million, total deposits of $148.2 million and stockholders’ equity of $18.7
million. The Company has not engaged in any significant activity other than
holding the stock of the Bank. Accordingly, the information set forth in this
report, including financial statements and related data, relates primarily to
the Bank.





Alaska
Pacific was founded as “Alaska Federal Savings and Loan Association of Juneau”
in 1935 and changed its name to “Alaska Federal Savings Bank” in October 1993.
In connection with the Conversion, Alaska Pacific changed its name from “Alaska
Federal Savings Bank” to its current title. The Bank, as a federally-chartered
savings institution, is regulated by the Office of Thrift Supervision (“OTS”),
its primary federal regulator, and the Federal Deposit Insurance Corporation
(“FDIC”), as its deposit insurer. The Bank’s deposits are insured up to
applicable limits by the Deposit Insurance Fund administered by the FDIC. The
Bank has been a member of the Federal Home Loan Bank (“FHLB”) System since
1937.





Alaska
Pacific operates as a community oriented financial institution and is devoted to
serving the needs of its customers. The Bank’s business consists primarily of
attracting retail deposits from the general public and using those funds to
originate one-to-four-family mortgage loans, commercial business loans, consumer
loans, construction loans and commercial real estate loans.





Participation
in the U.S. Treasury’s Capital Purchase Program





On February 9, 2009, we received $4.8
million from the U.S. Treasury Department as part of the Treasury’s Capital
Purchase Program. We issued $4.8 million in senior preferred stock, with a
related warrant to purchase up to $717,150 in common stock, to the U.S.
Treasury. The warrant provides the Treasury the option to purchase up to 175,772
shares of the Company’s common stock at a price of $4.08 per share at any time
during the next ten years. The preferred stock pays a 5% dividend for the first
five years, after which the rate will increase to 9% if the preferred shares are
not redeemed by the Company. The terms and conditions of the transaction and the
preferred stock conform to those provided by the U.S. Treasury. A summary of the
Capital Purchase Program can be found on the Treasury’s web site at www.ustreas.gov/initiatives/eesa.
The additional capital enhances our capacity to support the communities we serve
through expanded lending activities and economic development. This capital will
also add flexibility in considering strategic opportunities that may be
available to us as the financial services industry continues to
consolidate.





Memorandum
of Understanding





On January 7, 2009 the OTS finalized a
supervisory agreement (“MOU”) which was reviewed and approved by the Board of
Directors of the Bank on December 19, 2008. The Board of Directors and
management do not believe that the MOU will restrict the Bank’s business plans
and that there has already been substantial








-4-





progress
made in satisfying the requirements of the MOU. While management believes the
Bank is currently in compliance with the terms of the MOU, if the Bank fails to
comply with these terms, the OTS could take additional enforcement action
against the Bank, including the imposition of monetary penalties or the issuance
of a cease and desist order requiring further corrective action. For further
information regarding the terms of the MOU, see Item 1A, “Risk Factors -- Risks
Related to our Business -- We are subject to the restrictions and conditions of
a Memorandum of Understanding with, and other commitments we have made to, the
Office of Thrift Supervision. Failure to comply with the Memorandum of
Understanding could result in additional enforcement action against us,
including the imposition of monetary penalties.”





In
connection with the MOU, the Company’s Board of Directors has executed two
resolutions to assure the OTS that the Company is committed to supporting the
Bank should it be necessary, and that the Company would comply with the
restrictions in the Bank’s MOU.  See Item 1A, “Risk Factors -- Risks
Related to our Business -- We are subject to the restrictions and conditions of
a Memorandum of Understanding with, and other commitments we have made to, the
Office of Thrift Supervision. Failure to comply with the Memorandum of
Understanding could result in additional enforcement action against us,
including the imposition of monetary penalties.”





Market
Area





Alaska
Pacific’s primary markets are in the communities of Juneau, Ketchikan and Sitka,
but serve the entire region of southeast Alaska considered to span the 500 miles
from Yakutat in the north to Prince of Wales Island to the south. The region
encompasses approximately 35,000 square miles of land distributed amongst the
islands and coastline of the Alaska Panhandle. Southeast Alaska is home to
approximately 69,000 residents in 14 communities, a number that, with the
exception of Juneau, Ketchikan and Sitka, has shown slow but steady decline over
the past nine years. While the region shares similar economic characteristics,
there is some diversity and unique industries around the region.





Southeast
Alaska has historically been relatively immune from the direct impact of
economic problems in the “lower 48.” The region has demonstrated its stability
over time missing the “booms” and avoiding the “busts” without significant
swings. The region has remained relatively insulated from the deep recession
experienced by many other parts of the country but has been an impact on the
region. According to the State of Alaska Department of Labor, there were about
750 jobs lost in the region during 2009. The region has experienced a measurable
slow down in commercial and consumer loan activity. While there has been some
downward adjustment in residential real estate values, for the most part the
market has remained relatively stable. Most adjustments over the past two years
were directly related to small adjustments in each local market based on supply,
demand and interest rates.





While
avoiding most economic instability, the notable exception is tourism, with a
focus in the Southeast Alaska region on cruise ship visitors. Clearly the
patterns and expenditures on travel have been felt throughout the industry, and
the number of cruise ships and related visitors dedicated to the various
ports-of-call throughout the region are being monitored closely. Total ship
visitors to the region are expected to decline. It appears that businesses
engaged in this segment of the economy are making appropriate adjustments to
respond to anticipated declines; and in turn municipalities can anticipate lower
sales tax revenue. There are, however, two major projects in our region that we
currently anticipate will have a material positive impact on the region’s
employment. The Kensington Gold Mine in Juneau, and the Ketchikan Shipyard in
Ketchikan, will collectively create more than 400 new, high paying jobs in the
region, already giving rise to an assessment of available housing in both
communities.





Alaska
Pacific’s administrative headquarters and largest banking office, one full
service branch and the Bank’s mortgage operation, are located in Juneau which
has a population as of 2008 of 30,427. The population showed a 1% increase
between 2007 and 2008. Juneau is the capital of Alaska with its primary economic
resources being state and federal government, tourism, fish processing, fishing
and mining. Juneau’s historically active mining industry (primarily gold and
silver), which had seen decades of decline, has gained importance in the area’s
economy. According to the Alaska Department of Labor, the largest employers in
Juneau are the state, local and federal agencies, followed by Bartlett Regional
Hospital and the University of Alaska. In terms of










-5-





employment
and total payroll between private and government in 2008, the private sector
employed an annual average of 10,658 employees with annual wages of $373 million
while government employed an annual average of 7,324 with annual wages
of  $352 million. Unemployment in Juneau increased from 6.0% to 6.5%
from December 2008 to December 2009, reflecting an increasing trend seen
statewide. (Source: State of Alaska Department of Labor)





Two
full service offices of Alaska Pacific are located in Ketchikan (population
approximately 12,993 estimated as of July 2008 by the Alaska Department of
Labor). Ketchikan is an industrial center and a major port of entry in Southeast
Alaska with a diverse economy. A large fishing fleet, fish processing
facilities, timber and wood products manufacturing, and tourism are Ketchikan’s
main economic support. The largest employers in the Ketchikan Gateway Borough
include the city and state government, Ketchikan General Hospital, the Ketchikan
Gateway School District, the Ketchikan Pulp Mill and the federal
government.





One
full service office of Alaska Pacific is located in Sitka (population
approximately 8,615 estimated as of July 2008 by the Alaska Department of
Labor), located on the west coast of Baranof Island fronting the Pacific Ocean,
on Sitka Sound. The primary economic sources in Sitka are fishing, fish
processing, tourism, government, transportation, retail and health care
services. The largest employers in Sitka include the Southeast Alaska Regional
Health Corp., the Sitka Borough School District, city, state and federal
governments and the Sitka Community Hospital. Other Sitka employers include the
Alaska State Trooper Training Academy and numerous businesses involved in
commercial and sport fishing and tourism.








Lending
Activities





General. At December 31, 2009,
Alaska Pacific’s loan portfolio (excluding loans held for sale) amounted to
$158.1 million, or 89% of total assets at that date. Alaska Pacific
originates conventional mortgage loans, construction loans, commercial real
estate loans, land loans, consumer loans and commercial business loans. Over 75%
of Alaska Pacific’s loan portfolio is secured by real estate, either as primary
or secondary collateral, located in its primary market area.





Loan Portfolio Analysis. The
following table sets forth the composition of Alaska Pacific’s loan portfolio
(excluding loans held for sale) as of the dates indicated.






-6-






(dollars in thousands)
      December 31,
            
            2009
            
            
            2008Amount
            
            
            Percent
            
            
            Amount
            
            
            PercentReal
      estate:Permanent:One-to-four-family
            
            $
            33,787
            
            
            
            21.37
            %
            
            $
            38,875
            
            
            
            23.01
            %Multifamily
            
            
            1,736
            
            
            
            1.10
            
            
            
            2,575
            
            
            
            1.52Commercial
      nonresidential
            
            
            64,453
            
            
            
            40.77
            
            
            
            56,019
            
            
            
            33.15Total
      permanent
            
            
            99,976
            
            
            
            63.24
            
            
            
            97,469
            
            
            
            57.68Land
            
            
            9,697
            
            
            
            6.13
            
            
            
            13,360
            
            
            
            7.91Construction:One-to-four-family
            
            
            3,050
            
            
            
            1.93
            
            
            
            4,179
            
            
            
            2.47Commercial
      nonresidential
            
            
            2,637
            
            
            
            1.67
            
            
            
            5,064
            
            
            
            3.00Total
      construction
            
            
            5,687
            
            
            
            3.60
            
            
            
            9,243
            
            
            
            5.47Commercial
      business
            
            
            19,856
            
            
            
            12.56
            
            
            
            24,429
            
            
            
            14.46Consumer:Home
      equity
            
            
            16,522
            
            
            
            10.45
            
            
            
            18,661
            
            
            
            11.04Boat
            
            
            4,287
            
            
            
            2.71
            
            
            
            4,060
            
            
            
            2.40Automobile
            
            
            1,269
            
            
            
            0.80
            
            
            
            998
            
            
            
            0.59Other
            
            
            814
            
            
            
            0.51
            
            
            
            762
            
            
            
            0.45Total
      consumer
            
            
            22,892
            
            
            
            14.47
            
            
            
            24,481
            
            
            
            14.48Total
      loans
            
            
            158,108
            
            
            
            100.00
            %
            
            
            168,982
            
            
            
            100.00
            %Less:Allowance
      for loan losses
            
            
            1,786
            
            
            
            
            
            
            
            2,688Loans,
      net
            
            $
            156,322
            
            
            
            
            
            
            $
            166,294





One-to-four-family Real Estate
Lending. Historically, Alaska Pacific has concentrated its lending
activities on the origination of loans secured by first mortgages on existing
one-to-four-family residences located in its primary market area. At December
31, 2009, $33.8 million, or 21.4%, of Alaska Pacific’s
total loan portfolio consisted of these loans. Alaska Pacific originated $47.6
million and $38.2 million of one-to-four-family residential mortgage loans
during the years ended December 31, 2009 and 2008, respectively.





Generally,
Alaska Pacific’s fixed-rate one-to-four-family mortgage loans have maturities of
15 and 30 years and are fully amortizing with monthly payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
Generally, Alaska Pacific originates these loans under terms, conditions and
documentation which permits them to be sold to U.S. Government sponsored
agencies such as the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and
the Alaska Housing Finance Corporation (“AHFC”), a state agency that provides
affordable housing programs. Alaska Pacific’s fixed-rate loans customarily
include “due on sale” clauses, which gives the Bank the right to declare a loan
immediately due and payable in the event the borrower sells or otherwise
disposes of the real property subject to the mortgage and the loan is not
paid.





Alaska
Pacific offers adjustable rate mortgage loans at rates and terms competitive
with market conditions. At December 31, 2009, $3.5 million, or 10.7%, of Alaska
Pacific’s one-to-four-family residential loan portfolio consisted of adjustable
rate mortgage loans. Demand for conventional adjustable rate mortgage loans has
been very low in the Bank’s market area, but have increased with the advent of
“hybrid mortgages,” which are adjustable rate loans with the interest rate fixed
for an initial period of three to five years.





Alaska
Pacific originates one-to-four-family mortgage loans under Freddie Mac, the
Federal Housing Administration, the Veterans Administration, and AHFC programs.
Alaska Pacific generally sells these loans in the secondary market, with
servicing retained. This means that Alaska Pacific retains the right to collect
principal and interest payments on the loans and forward these payments to the
purchaser of the loan, maintain escrow accounts for payment of taxes and
insurance and perform other loan administration functions. See “-- Loan
Originations, Sales and Purchases.” Alaska Pacific also uses three larger
private mortgage investors as sources for funding mortgages through
correspondent lending programs.






-7-





Alaska
Pacific requires title insurance insuring the status of its lien on all loans
where real estate is the primary source of security. Alaska Pacific also
requires that fire and casualty insurance, and flood insurance where
appropriate, be maintained in an amount at least equal to the outstanding loan
balance.





One-to-four-family
residential mortgage loans may be made up to 80% of the appraised value of the
security property without private mortgage insurance. Pursuant to underwriting
guidelines adopted by the Board of Directors, Alaska Pacific can lend up to 97%
of the appraised value of the property securing a one-to-four-family residential
loan; however, Alaska Pacific generally obtains private mortgage insurance on
the portion of the principal amount that exceeds 80% of the appraised value of
the security property.





Alaska
Pacific also originates loans secured by non-owner occupied residential
properties that are sold to Freddie Mac.





Land Lending. Alaska Pacific
also originates loans secured by first mortgages on residential building lots on
which the borrower proposes to construct a primary residence. These loans
generally have terms of up to twelve years and can be either fixed-rate or
floating rate loans.  Alaska Pacific also originates commercial land
loans, which have floating rates that adjust annually. At December 31, 2009 and
2008, land loans amounted to $9.7 million and $13.4million,
respectively. The decrease in land loans was primarily attributable to the
charge off of $3.0 million of land loans during 2009.





Loans
secured by undeveloped land or improved lots involve greater risks than
one-to-four-family residential mortgage loans because these loans are more
difficult to evaluate. If the estimate of value proves to be inaccurate, in the
event of default and foreclosure, Alaska Pacific may be confronted with a
property value that is insufficient to assure full repayment of the
loan.





Construction Lending. At
December 31, 2009, construction loans amounted to $5.7 million, or 3.6% of total
loans, most of which were secured by properties located in Alaska Pacific’s
primary market area. This compares with $9.2 million, or 5.5% of the total
loan portfolio at December 31, 2008. The decrease is attributable to a decline
in demand for construction loans, both residential and commercial.





At
December 31, 2009, $5.7 million of our construction loan portfolio consisted of
loans requiring interest only payments of which $2.5 million or 44% of the total
construction loans were relying on the interest reserve to make this payment. 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.





Construction
loans are made for maximum terms of nine to 18 months. Construction loans are
made at fixed or adjustable rates with interest payable monthly. Alaska Pacific
originates construction loans to individuals who have a contract with a builder
for the construction of their residence. Alaska Pacific typically requires that
permanent financing with Alaska Pacific or some other lender be in place prior
to closing any construction loan to an individual. Alaska Pacific generally
underwrites these loans, which typically convert to a fully amortizing
adjustable- or fixed-rate loan at the end of the construction term, according to
the underwriting standards for a permanent loan.





Construction
loans to builders, or speculative loans, are typically made with a maximum
loan-to-value ratio of the lesser of 80% of the cost of construction or 75% of
the appraised value. Construction loans made to home builders are termed
“speculative” because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either Alaska Pacific or another lender for the
finished home. The home buyer may be identified either during or after the
construction period, with the risk that the builder will have to service the
debt on the speculative construction loan and finance real estate taxes and
other carrying costs of the completed home for a significant time after the
completion of construction until the home buyer is identified.





Prior
to making a commitment to fund a construction loan, Alaska Pacific requires an
appraisal of the property by an independent state-licensed and qualified
appraiser approved by the Board of Directors. Alaska







-8-





Pacific’s
staff also reviews and inspects projects prior to any disbursement of funds
during the term of the construction loan. The review consists of examining the
percentage of funds expended compared to the percentage of work completed and
examining interest reserves compared to work left to finish the
project.





Although
construction lending affords Alaska Pacific the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than one-to-four-family
mortgage lending, construction lending is generally considered to involve a
higher degree of risk than one-to-four-family mortgage lending. It is more
difficult to evaluate construction loans than permanent loans. At the time the
loan is made, the value of the collateral securing the loan must be estimated
based on the projected selling price at the time the residence is completed,
typically six to 12 months later, and on estimated building and other costs
(including interest costs). However, appraisers will use both market and income
valuation approaches in addition to cost to establish value. Changes in the
demand for new housing in the area and higher-than-anticipated building costs
may cause actual results to vary significantly from those estimated.
Accordingly, Alaska Pacific may be confronted, at the time the residence is
completed, with a loan balance exceeding the value of the collateral. Because
construction loans require active monitoring of the building process, including
cost comparisons and on-site inspections, these loans are more difficult and
costly to monitor. Increases in market rates of interest may have a more
pronounced effect on construction loans by rapidly increasing the
end-purchasers’ borrowing costs, thereby reducing the overall demand for new
housing. The fact that in-process homes are difficult to sell and typically must
be completed in order to be successfully sold also complicates the process of
working out problem construction loans. This may require Alaska Pacific to
advance additional funds and/or contract with another builder to complete the
residence. Furthermore, in the case of speculative construction loans, there is
the added risk associated with identifying an end-purchaser for the finished
home.





Alaska
Pacific has attempted to minimize the foregoing risks by, among other things,
limiting its construction lending, and especially speculative loans, to a small
number of well-known local builders. One-to-four-family construction loans
generally range in size from $100,000 to $600,000, while commercial
nonresidential and multifamily construction loans have generally ranged from
$500,000 to $2.5 million. At December 31, 2009, the largest construction
loan was approximately $1.9 million for a multi-use real estate project
located in Alaska, which was performing in accordance with its
terms.





Multifamily and Commercial Real
Estate Lending. The multifamily residential loan portfolio consists
primarily of loans secured by small apartment buildings and the commercial real
estate loan portfolio consists primarily of loans secured by retail, office,
warehouse, mini-storage facilities and other improved commercial properties.
These loans generally range in size from $100,000 to $2.5 million and at
December 31, 2009 the largest loan totaled $2.7 million and was performing in
accordance with its terms. At December 31, 2009, Alaska Pacific had
$1.7 million of multifamily residential and $64.5 million of commercial
real estate loans, or 1.1% and 40.8%, respectively, of the total loan portfolio
at this date. Multifamily and commercial real estate loans are generally
underwritten with loan-to-value ratios of up to 75% of the lesser of the
appraised value or the purchase price of the property. These loans generally are
made at interest rates based on the prime rate for 15 to 20 year terms, with
adjustment periods of one, three or five years and an adjustment rate equal to
the prime rate plus a negotiated margin of 1% to 3%. In addition, many of these
loans have interest rate floors ranging from 5.75% to 6.25%. Alaska Pacific is
increasingly using interest rate floors in the current low interest rate
environment to protect or enhance yield. While a majority of Alaska Pacific’s
multifamily and commercial real estate loans are secured by properties located
within Alaska Pacific’s primary market area, others are secured by properties
elsewhere in Alaska as well as Washington, Oregon, Utah, Colorado, California,
and Idaho.





Alaska
Pacific is also an approved lender under the AHFC Multifamily Participation
Program, which was introduced in 1998. The AHFC Multifamily Participation
Program provides for up to 80% of the loan amount, which allows Alaska Pacific
to pursue larger lending opportunities while mitigating its risk.





From
time to time, Alaska Pacific purchases participations in multifamily and
commercial real estate loans from other banks in Alaska and the Pacific
Northwest, generally ranging from $500,000 to $2.5 million. Such loans are
on similar terms and are subject to the same underwriting standards as loans
originated by Alaska Pacific. Alaska Pacific lending policy limits participation
loans by geographic region, loan type and lead lender
concentrations.  Additionally, the Board of Directors must approve all
participation loans. Alaska Pacific monitors








-9-





participation
loans by maintaining consistent communication with lead lenders, receipt of
status updates on each credit and by review of annual financial statements of
the borrowers.





Multifamily
residential and commercial real estate lending entails significant additional
risks as compared with single-family residential property lending. Multifamily
residential and commercial real estate loans typically involve large loan
balances to single borrowers or groups of related borrowers. The payment
experience on these loans typically is dependent on the successful operation of
the real estate project. Supply and demand conditions in the market for office,
retail and residential space can significantly affect these risks, and, as such,
may be subject to a greater extent to adverse conditions in the economy
generally. Alaska Pacific reviews all commercial real estate loans in excess of
$500,000 on an annual basis to ensure that the loan meets current underwriting
standards.





Future
growth of commercial real estate loans is restricted by regulation which
generally limits such loans, under Alaska Pacific’s federal thrift charter, to
400% of total capital for regulatory purposes, or approximately
$74.0 million at December 31, 2009.





Commercial Business Lending.
At December 31, 2009, commercial business loans amounted to $19.9 million,
or 12.6% of total loans. Future growth of commercial business loans is
restricted by regulation which generally limits such loans, under Alaska
Pacific’s federal thrift charter, to 20% of total assets, or approximately $36
million at December 31, 2009.





Alaska
Pacific originates commercial business loans to small sized businesses in its
primary market area. Commercial business loans are generally made to finance the
purchase of seasonal inventory needs, new or used equipment, and for short-term
working capital. Security for these loans generally includes equipment, boats,
accounts receivable and inventory, although commercial business loans are
sometimes granted on an unsecured basis. Commercial business loans are made for
terms of seven years or less, depending on the purpose of the loan and the
collateral, with operating lines of credit made for one year or less renewed
annually at an interest rate based on the prime rate, usually adding a margin of
between one half and three percentage points. Such loans generally are
originated in principal amounts between $100,000 and $1 million. At
December 31, 2009, the largest commercial business loan for $2.0 million was
secured by equipment and inventory and was performing in accordance with
terms.





Alaska
Pacific originates guaranteed loans through the Small Business Administration,
the U.S. Department of Agriculture and the Alaska Industrial Development and
Export Authority. Alaska Pacific has also worked with local municipal agencies,
such as the Juneau Economic Development Council and the cities of Sitka and
Ketchikan in exploring participation or guaranty programs in each of these
cities. Generally in these programs, Alaska Pacific receives guarantees of
between 75% and 90% of the loan amount. In addition, Alaska Pacific has retained
portions of commercial business loans originated through participation programs
with economic development agencies such as the Alaska Industrial Development and
Export Authority, often retaining portions of as little as 10%.





Alaska
Pacific also makes commercial business loans secured by commercial charter boats
and commercial fishing boats. These loans have 10 to 15 year terms with an
interest rate that adjusts based on the prime interest rate. In connection with
the loans on these boats, Alaska Pacific receives a ship’s preferred marine
mortgage to protect its interest in the collateral. Alaska Pacific has also
granted a flooring line to one boat dealer for the purchase of boats and other
related marine equipment.





Commercial
business lending generally involves greater risk than residential mortgage
lending and involves risks that are different from those associated with
residential, commercial and multifamily real estate lending. Real estate lending
is generally considered to be collateral based lending with loan amounts based
on predetermined loan-to-collateral values, and liquidation of the underlying
real estate collateral is viewed as the primary source of repayment in the event
of borrower default. Although commercial business loans often have equipment,
inventory, accounts receivable or other business assets as collateral, the
liquidation of collateral in the event of a borrower default is often not a
sufficient source of repayment because accounts receivable may be uncollectible
and inventories and equipment may be obsolete or of limited use, among other
conditions.








-10-





Accordingly,
the repayment of a commercial business loan depends primarily on the
creditworthiness of the borrower (and any guarantors), while liquidation of
collateral is a secondary and often insufficient source of
repayment.





Consumer Lending. At December
31, 2009, consumer loans totaled $22.9 million, or 14.5% of total
loans.  Consumer loans generally have shorter terms to maturity or
repricing and higher interest rates than long-term, fixed-rate mortgage loans.
In addition to home equity, boat loans and automobile loans, Alaska Pacific’s
consumer loans consist of loans secured by land, airplanes, deposit accounts,
and unsecured loans for personal or household purposes.





The
largest category of Alaska Pacific’s consumer loan portfolio is home equity
loans that are made on the security of residences. At December 31, 2009, home
equity loans totaled $16.5 million, or 10.5% of the total loan portfolio,
compared to $18.7 million, or 11.0% of the total loan portfolio at December 31,
2008. Home equity loans generally do not exceed 95% of the appraised value of
the residence or 100% of the tax assessment including the outstanding principal
of the first mortgage. Closed-end loans are generally fixed-rate and have terms
of up to 25 years requiring monthly payments of principal and interest. Home
equity lines of credit generally have adjustable interest rates. These rates are
graduated based on credit scores. Recently, with the slowdown in price
appreciation or actual declines in values, homeowner’s equity in some high loan
to value (LTV) home equity loans may have declined. However, Alaska has not
experienced the rapid declines in home prices experienced by many parts of the
country where home prices rose much faster.





At
December 31, 2009, consumer boat loans amounted to $4.3 million, or 2.7%, of the
total loan portfolio compared to $4.1 million, or 2.4% of the total loan
portfolio at December 31, 2008. Alaska Pacific offers boat loans with maturities
of between five and 20 years, which generally range in principal amounts from
$15,000 to $350,000 and are secured by new and used boats. Alaska Pacific makes
boat loans of less than $100,000 at fixed rates of interest and loans over
$100,000 are made at an interest rate that is adjustable based on the prime
lending rate. Alaska Pacific generally makes boat loans on new boats of up to
90% of the value and 85% on used boats, but in certain instances it will loan up
to 100% of the value depending on the borrower’s credit score.





At
December 31, 2009, automobile loans amounted to $1.3 million, or 0.8%, of the
total loan portfolio compared to $998,000, or 0.6% of the total loan portfolio
at December 31, 2008. Alaska Pacific offers automobile loans with maturities of
up to seven years with fixed rates of interest.





Other
consumer loans include loans collateralized by deposit accounts and other types
of collateral, and by unsecured loans to qualified individuals. These loans
amounted to $814,000, or 0.5%, of total loans at December 31, 2009, compared to
$762,000, or 0.5% of total loans at December 31, 2008.





Alaska
Pacific also requires title, fire and casualty insurance on secured consumer
loans. The only title exception is for home equity loans under $50,000 where a
property profile, obtained from a title company, indicates there are no liens or
encumbrances not previously disclosed.





Consumer
loans entail greater risk than do residential mortgage loans, particularly in
the case of consumer loans which are unsecured or secured by rapidly
depreciating assets such as automobiles or boats and particularly used
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 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 which can be recovered on these loans.
These loans may also give rise to claims and defenses by a consumer loan
borrower against an assignee of these loans such as Alaska Pacific, and a
borrower may be able to assert against this assignee claims and defenses that it
has against the seller of the underlying collateral.






-11-





Loan Maturity and Repricing.
The following table sets forth certain information at December 31, 2009
regarding the dollar amount of loans maturing in Alaska Pacific’s portfolio
based on their contractual terms to final maturity, but does not include
scheduled payments or potential prepayments. Demand loans, loans having no
stated schedule of repayments and no stated maturity, and overdrafts are
reported as due in one year or less. Loan balances are net of undisbursed loan
proceeds and unearned discounts, and do not include loans held for
sale.





After
            After
            After
            
            
            
            After
      1 Year(in thousands)
              December
      31, 2009
            Within
              1
      Year
            1
      Year
              Through
              3
      Years
            3
      Years
              Through
              5
      Years
            5
      Years
              Through
              10
      Years
            Beyond
              10
      Years
            Total
            
            Fixed
              Rates
            Adjust-
              able
              RatesReal
      estate:Permanent:One-to-four-
              family
            $
      886
            $   751
            $452
            $
      5,855
            $25,843
            $33,787
            
            $29,840
            $  3,061Multifamily
            -
            -
            -
            693
            1043
            1,736
            
            693
            1,043Commercial
              nonresidential
            415
            3,154
            4,013
            5,911
            50,960
            64,453
            
            3,540
            60,498Land
            2,566
            4,133
            1,641
            607
            750
            9,697
            
            2,222
            4,909Construction:One-to-four-
              family
            2,654
            396
            -
            -
            -
            3,050
            
            -
            396Commercial
              nonresidential
            2,408
            229
            -
            -
            -
            2,637
            
            -
            229Commercial
              business
            4,362
            2,517
            2,009
            5,149
            5,819
            19,856
            
            1,688
            13,806Consumer:Home
      equity
            71
            270
            583
            3,631
            11,967
            16,522
            
            11,938
            4,513Boat
            1
            98
            199
            1,264
            2,725
            4,287
            
            3,761
            525Automobile
            19
            279
            484
            487
            -
            1,269
            
            1,250
            -Other
            73
            78
            112
            47
            504
            814
            
            448
            294Net
      Loans
            $13,455
            $11,905
            $9,493
            $23,644
            $99,611
            $158,108
            
            $55,379
            $89,274





Loan Solicitation and
Processing. Alaska Pacific obtains its loan applicants from walk-in
traffic, which is generated through media advertising and referrals from
existing customers, from on-line loan applications through its web site, and
through officer business development calls and activities. Local real estate
agents refer a portion of Alaska Pacific’s mortgage loan applicants, and dealers
refer some consumer loans, such as boat loans. Alaska Pacific requires title
insurance on all of its mortgage loans. All mortgage loans require fire and
extended coverage on appurtenant structures and flood insurance, if
applicable.





Loan
approval authority varies based on loan type. The Chief Executive Officer, the
Chief Credit Officer, and the Chief Lending Officer each has authority to
approve all residential mortgage loans up to and including $300,000 that are
originated for Alaska Pacific’s portfolio, and up to the agency limit if the
loan is to be sold in the secondary market; multifamily and commercial real
estate loans up to and including $300,000; commercial business loans up to and
including $300,000 ($100,000 if unsecured); and consumer loans up to and
including $300,000 ($100,000 if unsecured). Alaska Pacific’s Senior Loan
Committee, consisting of the Chief Executive Officer, Chief Credit Officer,
Chief Lending Officer and a senior lending officer, must approve loans in excess
of these amounts up to and including $750,000. The Directors’ Loan Committee
must approve all loans in excess of the Senior Loan Committee’s approval
authority up to 75% of Alaska Pacific’s legal lending limit. The Board of
Directors must approve all loans in excess of the Directors’ Loan Committee’s
approval authority.





Upon
receipt of a loan application from a prospective borrower, a credit report and
other data are obtained to verify specific information relating to the loan
applicant’s employment, income and credit standing. An independent appraiser
approved by Alaska Pacific and licensed or certified by the State of Alaska
undertakes an







-12-





appraisal
of any real estate offered as collateral. Alaska Pacific promptly notifies
applicants of the decision. Interest rates are subject to change if the approved
loan is not closed within the time of the commitment.





Alaska
Pacific has an automated underwriting system for consumer loans, enabling
expedited approval of consumer loans at any branch location. This system also
enables processing of online loan applications from customers. In addition,
Alaska Pacific has a system for online loan applications for mortgage
loans.




Pursuant
to OTS regulations, loans to one borrower cannot exceed 15% of Alaska Pacific’s
unimpaired capital and surplus. At December 31, 2009, the loans-to-one-borrower
limitation for Alaska Pacific was $2.9 million, and Alaska Pacific had no loans
in excess of this limitation except where guaranteed by a government agency or
approved prior to December 31, 2009, at a time when the Bank's legal lending
limit was higher.




Loan Originations,
Sales and Purchases.
Alaska Pacific’s lending activities include the origination of
one-to-four-family residential mortgage loans, construction and land loans,
loans to businesses, commercial real estate, multi-family and consumer
loans.





Alaska
Pacific generally sells loans without recourse and with servicing retained
except in its correspondent lending programs. Correspondent lending involves the
sale of one-to-four-family mortgages to private (non-government sponsored
enterprises or GSE) institutional investors, usually with servicing rights
released. By retaining the servicing, Alaska Pacific receives fees for
performing the traditional services of processing payments, accounting for loan
funds, and collecting and paying real estate taxes, hazard insurance and other
loan-related items, such as private mortgage insurance. At December 31, 2009,
Alaska Pacific’s servicing portfolio was $119.6 million. For the year ended
December 31, 2009, loan servicing fees totaled $295,000 before amortization
of servicing rights.





The
value of the loans that are serviced for others is significantly affected by
interest rates. In general, during periods of falling interest rates, mortgage
loans prepay at faster rates and the value of the mortgage servicing declines.
Conversely, during periods of rising interest rates, the value of the servicing
rights generally increases as a result of slower rates of prepayment. Alaska
Pacific may be required to recognize a decrease in value by taking a charge
against earnings, which would cause its profits to decrease.





In addition, Alaska Pacific retains certain amounts in escrow
for the benefit of investors. Alaska Pacific is able to invest these funds but
is not required to pay interest on them. At December 31, 2009, these escrow
balances totaled $751,000.







-13-





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





(in thousands)
      Year ended December 31,
            2009
            
            2008Loans
      originated:Real estate:Permanent:One-to-four-family
            $47,598
            
            $38,167Multifamily
            -
            
            880Commercial nonresidential
            10,551
            
            29,642Land
            874
            
            1,304Construction:One-to-four-family
            4,203
            
            1,598Multifamily
            1,505
            
            -Commercial nonresidential
            851
            
            1,490Commercial
      business
            11,439
            
            14,743Consumer:Home equity
            2,430
            
            4,187Boat
            1,238
            
            971Automobile
            719
            
            435Other
            2,697
            
            3,523Total loans originated
            84,105
            
            96,940Loans
      purchased
            647
            
            893Loans
      sold
            (39,309
            )
            (17,713
            )Foreclosed
      loans
            (3,508
            )
            (742
            )Principal
      repayments and other changes
            (55,340
            )
            (76,236
            )Net
      increase (decrease) in loans and loans held for sale
            $  (13,405
            )
            $  3,142





The
increase in loans sold relates to an increase in one-to-four-family loans sold
primarily to Freddie Mac without recourse.





A portion
of Alaska Pacific’s originations in 2009 and 2008 represent refinancing of loans
originally made by Alaska Pacific and other lenders.





Loan Commitments.
Occasionally, Alaska Pacific issues, without charge, commitments for fixed- and
adjustable-rate single-family residential mortgage loans conditioned upon the
occurrence of certain events. These commitments are made in writing on specified
terms and conditions and are honored for up to 60 days. Commercial commitments
issued by Alaska Pacific include commitments for fixed-term loans as well as
business lines of credit; letters of credit are not offered. At December 31,
2009, Alaska Pacific had $15.0 million of outstanding net loan commitments,
including unused portions on commercial business lines of credit and undisbursed
funds on construction loans. For additional information on loan commitments, see
Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of
this Form 10-K.





Loan Origination and Other
Fees. Alaska Pacific often receives loan origination fees and discount
“points.”  Loan fees and points are a percentage of the principal
amount of the loan that are charged to the borrower for funding the loan. The
amount of fees and points charged by Alaska Pacific varies, though the range
generally is between one half and two points. Accounting standards require fees
received (net of certain loan origination costs) for originating loans to be
deferred and amortized into interest income over the contractual life of the
loan. Net deferred fees associated with loans that are prepaid are recognized as
income at the time of prepayment. Alaska Pacific had $567,000 of net deferred
loan fees at December 31, 2009.





Nonperforming Assets and
Delinquencies. Alaska Pacific utilizes one loan collector that is a Bank
employee to monitor the loan portfolio and communicate with customers concerning
past due payments. The size of the portfolio and historically low delinquency
rates allow one individual to manage consumer, commercial and residential loans,
including those loans serviced for other investors. When a borrower fails to
make a required







-14-





payment,
Alaska Pacific institutes collection procedures. The process for monitoring
consumer, commercial and residential loans is the same for each type of loan
until foreclosure or repossession of the collateral. Depending on the value or
nature of the collateral, the loan servicing manager, senior lender or senior
management directs any further action in consultation with the Bank’s legal
counsel.





Customers
who miss a payment are mailed a computer-generated notice 15 days after the
payment due date. If the customer does not pay promptly, the collector
telephones the customer 20 days after the payment due date. After 30 days, the
collector sends a letter, which begins the demand process. Follow-up contacts
are made between the 30th and
60th day,
after which the collector sends a demand letter that specifies the action Alaska
Pacific will take and the deadline for resolving the delinquency. While most
delinquencies are cured promptly, the collector initiates foreclosure or
repossession, according to the terms of the security instrument and applicable
law, if the deadline in the 60-day letter is not met.





Residential
loans have a highly structured process for foreclosure. In addition to Alaska
Pacific’s residential loan portfolio, Alaska Pacific services real estate loans
for other investors who in turn have their own requirements that must be
followed. Alaska Pacific evaluates consumer and commercial business loans
individually depending on the nature and value of the collateral.





Alaska
Pacific places all loans that are past due 90 days or more on nonaccrual status
and all previously accrued interest income is reversed. Alaska Pacific charges
off consumer loans when it is determined they are no longer
collectible.





Alaska
Pacific’s Board of Directors is informed monthly as to the status of all
mortgage, commercial and consumer loans that are delinquent 30 days or more, the
status on all loans currently in foreclosure, and the status of all foreclosed
and repossessed property owned by Alaska Pacific.





The
following table sets forth information with respect to Alaska Pacific’s
nonperforming assets at the dates indicated. It is the policy of Alaska Pacific
to cease accruing interest on loans 90 days or more past due.





(dollars in thousands)
      December 31,
            2009
            
            2008Loans
      accounted for on a nonaccrual basis:Consumer
            $   78
            
            $   22Commercial
      business
            236
            
            410Real
      Estate
            2,541
            
            5,639Total
            2,855
            
            6,071Accruing
      loans which are contractually past due 90
              days or more
            -
            
            -Total
      of nonaccrual and 90 days past due loans
            2,855
            
            6,071Repossessed
      assets
            2,598
            
            408Total
      nonperforming assets
            $   5,453
            
            $   6,479Nonaccrual
      and 90 days or more past due loans as a
              percentage of loans
            1.81
            %
            3.59
            %Nonaccrual
      and 90 days or more past due loans as a
              percentage of total assets
            1.60
            %
            3.18
            %Nonperforming
      assets as a percentage of total assets
            3.06
            %
            3.39
            %





As of
December 31, 2009 and 2008, approximately $789,000 and $665,000, respectively,
of interest would have been recorded if these loans had been current according
to their original terms and had been outstanding throughout the
year.






-15-




Other Real Estate Owned and
Repossessed Assets. Alaska Pacific classifies real estate acquired as a
result of foreclosure and other repossessed collateral as repossessed assets
until sold. When Alaska Pacific acquires collateral, it is recorded at the lower
of its cost, which is the unpaid principal balance of the related loan plus
acquisition costs, or fair value. Subsequent to acquisition, the property is
carried at the lower of the acquisition amount or fair value. At December 31,
2009, Alaska Pacific held repossessed assets of $2.6 million, which consisted of
other real estate owned and repossessed consumer assets.





Asset Classification. The OTS
has adopted various regulations regarding problem assets of savings
institutions. The regulations require that each insured institution review and
classify its assets on a regular basis.  In addition, in connection
with examinations of insured institutions, OTS examiners have authority to
identify problem assets and, if appropriate, require them to be classified.
There are three classifications for problem assets:  substandard,
doubtful and loss. Substandard assets must have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Doubtful assets
have the weaknesses of substandard assets with the additional characteristic
that the weaknesses make collection or liquidation in full on the basis of
currently existing facts, conditions and values questionable, and there is a
high possibility of loss. An asset classified loss is considered uncollectible
and of such little value that continuance as an asset of the institution is not
warranted. The regulations have also created a special mention category,
described as assets which do not currently expose an insured institution to a
sufficient degree of risk to warrant classification but do possess credit
deficiencies or potential weaknesses deserving management’s close attention. If
an asset or portion thereof is classified loss, the loss amount is charged
off.





Alaska
Pacific monitors its asset quality through the use of an Asset Classification
Committee, which is comprised of senior lenders and executive officers. The
Committee meets monthly to review the loan portfolio, with specific attention
given to assets with an identified weakness, as well as reviewing the local,
state and national economic trends and the adequacy of the allowance for loan
losses.





At
December 31, 2009 and 2008, the aggregate amounts of Alaska Pacific’s
classified, special mention and repossessed assets (as determined by Alaska
Pacific), were as follows:





(in thousands) December
      31,
            2009
            2008Doubtful
            $450
            $1,055Substandard
      assets
            4,892
            6,936Special
      mention
            3,623
            1,865Other
      real estate owned and repossessed assets
            2,598
            408Total
      classified loans and repossessed assets
            $11,563
            $10,364





At
December 31, 2009 total classified loans totaled $5.3 million compared to
$8.0 million at December 31, 2008.





Impaired Loans.Loans with
balances totaling $5.3 million at December 31, 2009 and $10.7 million at
December 31, 2008 were considered to be impaired. The $5.4 million decrease
in impaired loans consisted of loans no longer classified as impaired or charged
off offset with additional loans. The total number of impaired loans was 15 and
23 as of December 31, 2009 and 2008, respectively. Total estimated impairments
of $514,000 and $875,000, respectively, were recognized on impaired loans in
evaluating the adequacy of the allowance for loan losses at December 31, 2009
and 2008.


-16 -





The following table reflects loan
balances considered to be impaired by asset type at December 31, 2009 and
2008.





(in thousands) December
      31,
            2009
            2008Residential
      real estate
            $
      541
            $      66Commercial
      real estate
            909
            2,612Land
            3,263
            5,898Construction
      - residential
            180
            180Construction
      - commercial
            209
            250Consumer
            212
            15Commercial
      business
            28
            1,664Total
      impaired loans
            $5,342
            $
      10,685





At December 31, 2009, 77% of classified
loans totaling $4.1 million included loans to three borrowers. Loans to one of
these borrowers were for a residential land development project affected by the
downturn in the housing market located outside of Alaska. Additional information
regarding these three borrowers, by market area as of December 31, 2009 is
provided in the following table:





December
      31,
              2009Loan
      Type
            Description
            Market
      Area
            (in
      thousands)Land
            Residential
      land development project
            Washington
            $1,321Land
            Commercial
      land
            Alaska
            1,942Commercial
      Real Estate
            Commercial
      real estate
            Alaska
            845Total
      –Impaired loans of three largest credit relationships
            
            $4,108





Potential Problem Loans.Potential problem loans are loans that do not yet meet the criteria for
placement on non-accrual status, but where known information about the possible
credit problems of the borrowers causes management to have serious concerns as
to the ability of the borrower to comply with present loan repayment terms, and
may result in the future inclusion of such loans in the non-accrual loan
category. At December 31, 2009, Alaska Pacific had $3.6 million of loans that
were identified as potential problems consisting primarily of permanent
commercial non-residential loans secured by real estate located outside of
Alaska.





Allowance for Loan Losses.Alaska Pacific maintains an allowance for loan losses sufficient to
absorb losses inherent in the loan portfolio. Alaska Pacific has established a
systematic methodology to ensure that the allowance is adequate. The Asset Classification Policy
requires an ongoing quarterly assessment of the probable estimated losses in the
portfolios. The Asset Classification Committee reviews the following
information:





·
            All loans classified during
      the previous analysis. Current information as to payment history or
      actions taken to correct the deficiency are reviewed, and if justified,
      the loan is no longer classified. If conditions have not improved, the
      loan classification is reviewed to ensure that the appropriate action is
      being taken to mitigate loss.





·
            Growth and composition of the
      portfolio. The Committee considers changes in composition of loan
      portfolio and the relative risk of these loan portfolios in assessing the
      adequacy of the allowance.





·
            Historical loan losses.
      The Committee reviews Alaska Pacific’s historical loan losses and
      historical industry losses in considering losses inherent in the loan
      portfolio.





·
            Past due loans. The
      Committee reviews loans that are past due 30 days or more, taking into
      consideration the borrower, nature of the collateral and its value, the
      circumstances that have caused the delinquency, and the likelihood of the
      borrower correcting the conditions that have resulted in
    the






-17-


delinquent
      status. The Committee may recommend more aggressive collection activity,
      inspection of the collateral, or no change in its
      classification.




·
            Reports from Alaska Pacific’s
      managers and analysis of potential problem loans. Lending managers
      may be aware of a borrower’s circumstances that have not yet resulted in
      any past due payments but has the potential for problems in the future.
      Each lending manager reviews their respective lending unit’s loans and
      identifies any that may have developing weaknesses. This “self
      identification” process is an important component of maintaining credit
      quality, as each lender is accountable for monitoring as well as
      originating loans.





·
            Current economic
      conditions. Alaska Pacific takes into consideration economic
      conditions in its market area, the state’s economy, and national economic
      factors that could influence the quality of the loan portfolio in general.
      The unique, isolated geography of Alaska Pacific’s market area of
      Southeast Alaska requires that each community’s economic activity be
      reviewed. The Bank also reviews out of market economic data associated
      with participation loans and their respective
  markets.





·
            Trends in Alaska Pacific’s
      delinquencies. Alaska Pacific’s market area has seasonal trends and
      as a result, the portfolio tends to have similar fluctuations. Prior
      period statistics are reviewed and evaluated to determine if the current
      conditions exceed expected trends.





Theamount that is to be
added to allowance for loan losses is based upon a variety of factors. An
important component is a loss percentage set for each major category of loan
that is based upon Alaska Pacific’s past loss experience. In certain instances,
Alaska Pacific’s own loss experience has been minimal, and the related loss
factor is modified based on consideration of published national loan loss data.
The loss percentages are also influenced by economic factors as well as
management experience.





Each
individual loan, previously classified by management or newly classified during
the quarterly review, is evaluated for loss potential, and any specific
estimates of impairment are added to the overall required reserve amount. As a
result of the size of the institution, the size of the portfolio, and the
relatively small number of classified loans, most members of the asset
classification committee are often directly familiar with the borrower, the
collateral or the circumstances giving rise to the concerns. For the remaining
portion of the portfolio, comprised of “pass” loans, the loss percentages
discussed above are applied to each loan category.





The
calculated amount is compared to the actual amount recorded in the allowance at
the end of each quarter and a determination is made as to whether the allowance
is adequate or needs to be increased. Management increases the amount of the
allowance for loan losses by charges to income and decreases it by loans charged
off (net of recoveries).





Alaska
Pacific’s loan categories that it considers in evaluating risk may be broadly
described as residential, commercial and consumer. The following comments
represent management’s view of the risks inherent in several component portfolio
categories.





·
            One-to-four-family Residential
      -Alaska Pacific’s market area is comprised primarily of a
      population with above-average incomes and market conditions that have,
      over the long term, supported a stable or increasing market value of real
      estate. Absent an overall economic downturn in the economy, experience in
      this portfolio indicates that losses are minimal provided the property is
      reasonably maintained, and marketing time to resell the property is
      relatively short.





·
            Multifamily Residential -There have been minimal losses taken in this segment of the
      portfolio, however, the rental market is very susceptible to the effects
      of an economic downturn. While Alaska Pacific monitors loan-to-value
      ratios, the conditions that would create a default and foreclosure would
      carry through to a new owner, which may require that Alaska Pacific
      discount the property or hold it until conditions
  improve.






-18-





·
            Commercial Real Estate -As with multifamily loans, the classification of commercial real
      estate loans closely corresponds to economic conditions which will limit
      the income potential and marketability of the property, resulting in
      higher risk than a loan secured by a single-family
    residence.





·
            Construction Loans
      (Residential and Commercial) -There are a variety of risks in
      construction lending, increased in Alaska by a short building season,
      difficult building sites and construction delays attributable to delivery
      of materials. While Alaska Pacific has established construction loan
      policies and underwriting guidelines designed to mitigate the risk, there
      is still a higher risk of loss with these
loans.





·
            Commercial Business Loans -These types of loans carry the highest degree of risk, relying on
      the ongoing success of the business to repay the loan. Collateral for
      commercial credits is often difficult to secure, and even more difficult
      to liquidate in the event of a
default.





·
            Consumer Loans -The
      consumer loan portfolio has a wide range of factors, determined primarily
      by the nature of the collateral and the credit history and capacity of the
      borrower. These loans tend to be smaller in principal amount and secured
      by second deeds of trust on homes, automobiles, and pleasure boats. Loans
      for automobiles and pleasure boats generally experience higher than
      average wear in the Alaskan environment and hold a higher degree of risk
      of loss in the event of
repossession.





The
allowance for loan losses represents management's best estimate of incurred
credit losses inherent in the Company's loan portfolio as of December 31, 2009.
Although management believes that it uses the best information available to make
these determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations.





While
Alaska Pacific believes it has established its existing allowance for loan
losses in accordance with generally accepted accounting principles, there can be
no assurance that regulators, in reviewing Alaska Pacific’s loan portfolio, will
not request Alaska Pacific to increase significantly its allowance for loan
losses. In addition, because future events affecting borrowers and collateral
cannot be predicted with certainty, there can be no assurance that the existing
allowance for loan losses will be adequate or that substantial increases will
not be necessary should the quality of any loans deteriorate as a result of the
factors discussed above. Any material increase in the allowance for loan losses
may adversely affect Alaska Pacific’s financial condition and results of
operations.  In addition, the determination of the amount of the
Company's 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.






-19-





The
following table sets forth an analysis of the changes in the allowance for loan
losses for the periods indicated.





(dollars in thousands)
      Year ended December 31,
            2009
            
            2008Allowance
      at beginning of period
            $2,688
            
            $1,783Provision
      for loan losses
            2,947
            
            5,034Charge-offs:Real
      estate
            (3,090
            )
            (2,853
            )Commercial
      business
            (760
            )
            (1,319
            )Consumer:Boat
            (25
            )
            -Other
            -
            
            (10
            )Total
      charge-offs
            (3,875
            )
            (4,182
            )Recoveries:Commercial
      business
            26
            
            49Consumer:Home
      Equity
            -
            
            2Automobile
            -
            
            2Total
      recoveries
            26
            
            53Net
      charge-offs
            (3,849
            )
            (4,129
            )Balance
      at end of period
            $1,786
            
            $2,688Allowance
      for loan losses as a percentage of loans
              outstanding at the end of the period
            1.13
            %
            1.59
            %Net
      charge-offs as a percentage of average loans
              outstanding during the period
            2.32
            %
            2.36
            %Allowance
      for loan losses as a percentage of
              nonperforming
      loans at end of period
            62.56
            %
            41.49
            %








-20 -





The
following table sets forth the breakdown of the allowance for loan losses by
loan category for the dates indicated.





December
      31,
            2009
            2008(dollars
      in thousands)
            Amount
            As
      a % of
              Outstanding
              Loans
      in
              Category
            %
      of Loans
              in
              Category
              to
      Total
              Loans
            Amount
            As
      a % of
              Outstanding
              Loans
      in
              Category
            %
      of
              Loans
      in
              Category
              to
      Total
              LoansReal
      estate:Permanent:One-to-four-family
            $  56
            0.16%
            21.40%
            $  23
            0.06%
            23.01%Multifamily
            13
            0.75
            1.10
            7
            0.27
            1.52Commercial
      non-residential
            444
            0.69
            40.78
            899
            1.60
            33.15Land
            56
            0.57
            6.14
            409
            3.06
            7.91Construction:One-to-four-family
            144
            4.66
            1.95
            5
            0.12
            2.47Multifamily
            -
            -
            -
            -
            -
            -Commercial
      nonresidential
            236
            8.82
            1.69
            256
            5.06
            3.00Commercial
            615
            3.09
            12.53
            1,049
            4.29
            14.46Consumer:Home
      equity
            114
            0.69
            10.40
            15
            0.08
            11.04Boat
            87
            2.03
            2.70
            23
            0.57
            2.40Automobile
            2
            0.16
            0.80
            1
            0.10
            0.59Other
            19
            2.34
            0.51
            1
            0.13
            0.45Total
      allowance for loan losses
            $1,786
            1.13%
            100.00%
            $2,688
            1.59%
            100.00%





Investment
Activities





Federal
law permits Alaska Pacific to invest in various types of liquid assets,
including U.S. Treasury obligations, securities of various federal agencies and
of state and municipal governments, deposits at the FHLB of Seattle,
certificates of deposit of federally insured institutions, certain bankers’
acceptances and federal funds. Subject to various restrictions, Alaska Pacific
may also invest a portion of its assets in commercial paper and corporate debt
securities. Alaska Pacific must also maintain an investment in FHLB stock as a
condition of membership in the FHLB of Seattle.





Investment
securities provide liquidity for funding loan originations and deposit
withdrawals and enable Alaska Pacific to improve the match between the
maturities and repricing of its interest-rate sensitive assets and liabilities.
See Item 7, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources and Regulation”
herein.





Alaska
Pacific’s Asset Liability Management Committee determines appropriate
investments in accordance with the Board of Directors’ approved investment
policies and procedures. Alaska Pacific’s policies generally limit investments
to U.S. Government and agency securities and mortgage-backed securities issued
and guaranteed by Freddie Mac, the Federal National Mortgage Association
(“Fannie Mae”) and the Government National Mortgage Association (“Ginnie Mae”).
Alaska Pacific’s policies provide that investment purchases be ratified at
monthly Board of Directors meetings. Certain considerations, which include the
interest rate, yield, settlement date and maturity of the investment, Alaska
Pacific’s liquidity position, and anticipated cash needs and sources (which in
turn include outstanding commitments, upcoming maturities, estimated deposits
and anticipated loan amortization and repayments) affect the making of
investments. The effect that the proposed investment would have on Alaska
Pacific’s credit and interest rate risk, and risk-based capital is also
considered. From time to time, investment levels may be increased or decreased
depending upon the yields on investment alternatives and upon management’s
judgment as to the attractiveness of the yields then available in relation to
other opportunities







-21-





and its
expectation of the level of yield that will be available in the future, as well
as management’s projections as to the short-term demand for funds to be used in
Alaska Pacific’s loan origination and other activities.





The
following table sets forth the composition of Alaska Pacific’s investment and
mortgage-backed securities portfolios at the dates indicated.





December
      31,
            2009
            
            2008(dollars
      in thousands)
            Fair
              Value
            Amortized
              Cost
            Percent
              of
              Portfolio
            
            Fair
              Value
            Amortized
              Cost
            Percent
              of
              PortfolioMortgage-backed
      securities:Fannie
      Mae
            $1,930
            $1,890
            74.5
            %
            $2,394
            $2,405
            74.4
            %Freddie
      Mac
            254
            263
            10.4
            %
            364
            376
            11.6Ginnie
      Mae
            330
            292
            11.5
            %
            387
            353
            11.0U.S.
      agencies and corporations:Small
      Business Administration
              pools
            92
            91
            3.6
            %
            98
            99
            3.0Total
      investment securities
              available for sale
            $2,606
            $2,536
            100.0
            %
            $3,243
            $3,233
            100.0
            %





While
management has no specific plans to sell any security, the entire portfolio has
been designated as “available-for-sale” at December 31, 2009 and 2008, to allow
flexibility in managing the portfolio.





At
December 31, 2009, the portfolio of U.S. Government and agency securities had an
aggregate estimated fair value of $92,000 and the portfolio of mortgage-backed
securities had an estimated fair value of $2.5 million.





At
December 31, 2009, mortgage-backed securities consisted of Freddie Mac, Fannie
Mae and Ginnie Mae issues with an amortized cost of $2.4 million. The
mortgage-backed securities portfolio had coupon rates ranging from 2.5% to 9.0%
and had a weighted average yield of 4.6% at December 31, 2009.





Mortgage-backed
securities, which also are known as mortgage participation certificates or
pass-through certificates, typically represent interests in pools of
single-family or multifamily mortgages in which payments of both principal and
interest on the securities are generally made monthly. The principal and
interest payments on these mortgages are passed from the mortgage originators,
through intermediaries, generally U.S. Government agencies and government
sponsored enterprises, that pool and resell the participation interests in the
form of securities, to investors such as Alaska Pacific. These U.S. Government
agencies and government-sponsored enterprises, which guarantee the payment of
principal and interest to investors, primarily include the Freddie Mac, Fannie
Mae and the Ginnie Mae. Mortgage-backed securities typically are issued with
stated principal amounts, and the securities are backed by pools of mortgages
that have loans with interest rates that fall within a specific range and have
varying maturities. Mortgage-backed securities generally yield less than the
loans that underlie these securities because of the cost of payment guarantees
and credit enhancements. In addition, mortgage-backed securities are usually
more liquid than individual mortgage loans and may be used to collateralize
certain liabilities and obligations of Alaska Pacific. These types of securities
also permit Alaska Pacific to optimize its regulatory capital because they have
low risk weighting.





The
actual maturity of a mortgage-backed security may be less than its stated
maturity due to prepayments of the underlying mortgages. Prepayments that are
faster than anticipated may shorten the life of the security and may result in a
loss of any premiums paid and thereby reduce the net yield on these securities.
Although prepayments of underlying mortgages depend on many factors, including
the type of mortgages, the coupon rate, the age of mortgages, the geographical
location of the underlying real estate collateralizing the mortgages and general
levels of market interest rates, the difference between the interest rates on
the underlying mortgages and the prevailing mortgage interest rates generally is
the most significant determinant of the rate of prepayments. During periods of
declining mortgage interest rates, if the coupon rate of the underlying
mortgages exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the







-22-





prepayment
of the underlying mortgages and the related security. Under these circumstances,
Alaska Pacific may be subject to reinvestment risk because, to the extent that
Alaska Pacific’s mortgage-backed securities amortize or prepay faster than
anticipated, Alaska Pacific may not be able to reinvest the proceeds of these
repayments and prepayments at a comparable rate.





The
table below sets forth certain information regarding the carrying value,
weighted average yields and maturities or periods to repricing of Alaska
Pacific’s investment and mortgage-backed securities at December 31,
2009.





(dollars in thousands)
      as of
              December
      31, 2009
            Amortized
              Cost
            Weighted
              Average
              Yield
            Weighted
              Average
              Maturity
      (Yrs)Mortgage
      Backed Securities
            $2,445
            4.56%
            8.32US
      Agency
            91
            3.98%
            9.42








Alaska
Pacific’s investment policy permits investment in “off balance sheet” derivative
instruments such as “forwards,” “futures,” “options” and “swaps” used as hedges;
however, Alaska Pacific has not utilized such instruments.





As a
member of the FHLB of Seattle, the Bank is required to own capital stock in the
FHLB of Seattle. The minimum amount of stock held is based on percentages
specified by the FHLB of Seattle outstanding advances.  The carrying
value of FHLB of Seattle stock totaled $1.8 million at December 31, 2009.
The redemption of any excess stock held by the Bank is at the discretion of the
FHLB of Seattle, and under present policies may take up to five years. The yield
on the FHLB of Seattle stock is normally paid through stock dividends that are
subject to the discretion of the board of directors of the FHLB of Seattle.
However, the FHLB of Seattle suspended the payment of dividends during the
fourth quarter of 2004 until the third quarter of 2006. The FHLB of Seattle
resumed the payment of dividends in the fourth quarter of 2006, with the
announcement of a $0.10 per share cash dividend. In 2007, the FHLB of Seattle
paid a cumulative $0.60 per share cash dividend with Alaska Pacific receiving
$12,000 in dividends.





In 2008,
the FHLB of Seattle paid a cumulative $0.95 per share in cash dividends. Based
on the FHLB of Seattle's third-quarter 2008 results, the FHB of Seattle
announced they would not pay a dividend for the third quarter. 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 its capital stock. The FHLB of Seattle is not
anticipated to resume dividend payments until their financial results improve.
The FHLB of Seattle has not indicated when dividend payments may
resume.





Alaska
Pacific had no securities (other than U.S. Government and agency securities and
mutual funds which invest exclusively in such securities), which had an
aggregate book value in excess of 10% of shareholders’ equity at December 31,
2009.





Deposit
Activities and Other Sources of Funds





General. Deposits and
loan repayments are the major sources of Alaska Pacific’s funds for lending and
other investment purposes.  Scheduled loan repayments are a relatively
stable source of funds, while general interest rates and money market conditions
significantly influence deposit inflows and outflows and loan prepayments.
Alaska Pacific may use borrowings on a short-term basis to compensate for
reductions in the availability of funds from other sources. Alaska Pacific may
also use borrowings on a longer-term basis for general business
purposes.





Deposit Accounts. Alaska
Pacific attracts deposits from within its primary market area through the
offering of a broad selection of deposits as set forth in the following table.
In determining the terms of its deposit accounts, Alaska Pacific considers
current market interest rates, profitability to Alaska Pacific, matching deposit







-23-





and loan
products and its customer preferences and concerns. Alaska Pacific’s deposit mix
and pricing is generally reviewed weekly. Deposits from municipalities and other
public entities were $4.8 million at December 31, 2009.





Alaska
Pacific had $1.7 million of brokered deposits at December 31, 2009 issued
through the Certificate of Deposit Account Registry Service (“CDARS”). CDARS
deposits range in maturities from one month to three years, and carry interest
rates that are generally higher than locally obtained time deposits. As a
result, Alaska Pacific utilizes these deposits as an alternative supplemental
funding source in addition to advances from the FHLB of Seattle.





In
the unlikely event Alaska Pacific is liquidated, depositors will be entitled to
full payment of their deposit accounts prior to any payment being made to the
Corporation, as the sole stockholder of the Bank. Substantially all of the
Bank’s depositors are residents of the State of Alaska.





The following table sets forth
information concerning Alaska Pacific’s time deposits and other interest-bearing
deposits at December 31, 2009.





Weighted
              Average
              Interest
              Rate
            Original
              Term
            Category
            Amount
              (in
      thou-
              sands)
            Minimum
              Balance
            Percentage
              of
      Total
              Deposits0.00%
            N/A
            Noninterest-bearing
            $27,416
            $   100
            18.50
            %0.11
            N/A
            Interest-bearing
      demand
            32,474
            100
            21.910.43
            N/A
            Money
      market deposit accounts
            28,982
            100
            19.550.15
            N/A
            Savings
      accounts
            19,170
            100
            12.93Certificates of Deposit0.24
            Seven
      days
            Fixed-rate
            302
            2,000
            0.200.20
            One
      month
            Fixed-rate
            11
            2,000
            0.010.40
            Two
      months
            Fixed-rate
            96
            2,000
            0.070.56
            Three
      months
            Fixed-rate
            2,254
            2,000
            1.520.82
            Six
      months
            Fixed-rate
            3,722
            2,000
            2.511.34
            Nine
      months
            Fixed-rate
            1,185
            2,000
            0.801.68
            One
      year
            Fixed-rate
            9,091
            2,000
            6.132.00
            15
      months
            Fixed-rate
            3,055
            2,000
            2.062.94
            18
      months
            Fixed-rate
            5,961
            2,000
            4.022.82
            Two
      years
            Fixed-rate
            2,355
            2,000
            1.593.02
            Three
      years
            Fixed-rate
            499
            2,000
            0.343.89
            Four
      years
            Fixed-rate
            240
            2,000
            0.163.95
            Five
      years
            Fixed-rate
            2,669
            2,000
            1.801.04
            Various
      specials
            Fixed-rate
            748
            5,000
            0.512.32
            Gold
      minor one
              year
            Fixed-rate
            1,958
            500
            1.328.00
            Deferred
      Comp
              one year
            Fixed-rate
            1,223
            2,000
            0.832.39
              1.00
            CDARS
      -
              various
              One
      year
            Fixed-rate
              Variable-rate
            1,705
              1,157
            2,000
              2,000
            1.15
              0.781.74
            2-1/2
      years
            Variable-rate
            1,944
            2,000
            1.310.74%
            
            TOTAL
            $148,217
            
            100.00
            %








-24-


The
following table sets forth the balances and changes in dollar amounts of
deposits in the various types of accounts offered by Alaska Pacific at the dates
indicated.





(dollars in thousands)December 31,
            2009
            
            
            
            2008Amount
            Percent of
              Total
            
            Increase
              (Decrease)
            
            Amount
            Percent of
              TotalNoninterest-bearing
      demand accounts
            $27,416
            18.50
            %
            $  1,709
            
            $  25,707
            15.85
            %Interest-bearing
      demand accounts
            32,474
            21.91
            
            1,432
            
            31,042
            19.14Money
      market deposit accounts
            28,982
            19.55
            
            (4,090
            )
            33,072
            20.39Savings
      accounts
            19,170
            12.93
            
            1,634
            
            17,536
            10.81Fixed-rate
      certificates which mature:Within
      1 year
            20,590
            13.90
            
            (22,237
            )
            42,827
            24.62After
      1 year, but within 2 years
            11,371
            7.67
            
            5,457
            
            5,914
            2.48After
      2 years, but within 5 years
            3,408
            2.30
            
            320
            
            3,088
            2.62Variable-rate
      certificates which
              mature:Within
      1 year
            2,862
            1.93
            
            1,060
            
            1,802
            1.34After
      1 year, but within 2 years
            -
            -
            
            (625
            )
            625
            0.55After
      2 years, but within 5 years
            1,944
            1.31
            
            1,382
            
            562
            0.33Total
            $148,217
            100.00
            %
            $(13,958
            )
            $162,175
            100.00
            %








Time
Deposits Maturities and Weighted Average Rates





The
following table sets forth the amount, maturities and weighted average rates of
time deposits at December 31, 2009.





(In thousands) Year
              ending
      December 31,
            
            Weighted
              Average
              Interest
      Rate2010
            $23,452
            1.82%2011
            11,371
            3.15%2012
            2,443
            2.50%2013
            240
            3.23%2014
      and thereafter
            2,669
            2.20%$40,175





Deposit
Activities and Other Sources of Funds





The
following table sets forth the deposit activities of Alaska Pacific for the
periods indicated.





(in thousands)
      Year ended December 31,
            2009
            
            2008Beginning
      balance
            $162,175
            
            $149,367Net
      deposits before interest credited
            (15,327
            )
            10,223Interest
      credited
            1,369
            
            2,585Net
      increase (decrease) in deposits
            (13,958
            )
            12,808Ending
      balance
            $148,217
            
            $162,175





Borrowings. Deposits and loan
repayments are the primary source of funds for Alaska Pacific’s lending and
investment activities. However, Alaska Pacific may rely upon advances from the
FHLB of Seattle to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Seattle







-25-





functions
as a central reserve bank providing credit for thrift institutions and many
other member financial institutions. The FHLB of Seattle requires Alaska
Pacific, as a member, to own capital stock in the FHLB of Seattle and authorizes
it to apply for advances on the security of this stock and certain of its
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 made pursuant to several different credit
programs. Each credit program has 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. At December 31, 2009, Alaska Pacific had a
borrowing capacity of approximately $44.8 million with the FHLB of Seattle, of
which $35.0 million was unused compared with $47.7 million and $20.4 million,
respectively, at December 31, 2008. At December 31, 2009, Alaska Pacific had
$9.8 million outstanding on the line of credit.




The
following table sets forth certain information regarding Alaska Pacific’s
advances from the FHLB of Seattle at the end of and during the periods
indicated:





(dollars in thousands)
      Year ended December 31,
            2009
            
            2008Advances:Maximum
      amount of borrowings outstanding
              during the year at any month end
            $23,624
            
            $23,681Average
      outstanding during the year
            12,156
            
            14,611Balance
      outstanding at end of year
            9,834
            
            10,320Approximate
      weighted average rate paid:Average
      during the year
            4.06
            %
            5.00
            %At
      end of year
            3.05
            
            5.63








REGULATION





General





The
Bank, as a federally-chartered savings institution, is subject to federal
regulation and oversight by the OTS extending to all aspects of its operations.
The Bank also is subject to regulation and examination by the FDIC, which
insures the deposits of The Bank to the maximum extent permitted by law, and
requirements established by the Federal Reserve Board. Federally chartered
savings institutions are required to file periodic reports with the OTS and are
subject to periodic examinations by the OTS and the FDIC. The investment and
lending authority of savings institutions are prescribed by federal laws and
regulations, and these institutions are prohibited from engaging in any
activities not permitted by the laws and regulations. This regulation and
supervision primarily is intended for the protection of depositors and not for
the purpose of protecting stockholders. Congress enacted the Emergency Economic
Stabilization Act of 2008 (“EESA”), which granted significant authority to the
U.S. Department of the Treasury (the “Treasury”) to invest in financial
institutions, guarantee debt, buy troubled assets and take other action designed
to stabilize financial markets.





The
OTS regularly examines the Bank and prepares reports for the consideration of
the Bank’s Board of Directors on any deficiencies that it may find in the Bank’s
operations. The FDIC also has the authority to examine the Bank in its roles as
the administrator of the Deposit Insurance Fund. The Bank’s relationship with
its depositors and borrowers also is regulated to a great extent by both federal
and state laws, especially in matters such as the ownership of savings accounts
and the form and content of the Bank’s mortgage requirements. Any change in
these regulations, whether by the FDIC, the OTS or Congress, could have a
material adverse impact on the Bank and its operations.


-26-


Regulation
and Supervision of Savings Institutions





Office of Thrift Supervision.
The OTS has extensive authority over the operations of savings institutions. As
part of this authority, the Bank is required to file periodic reports with the
OTS and is subject to periodic examinations by the OTS and the FDIC. All savings
institutions are subject to a semi-annual assessment, based upon the
institution’s total assets, to fund the operations of the OTS. The OTS also has
extensive enforcement authority over all savings institutions and their holding
companies, including the Bank and the Corporation. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease-and-desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the OTS. Except under certain circumstances, public
disclosure of final enforcement actions by the OTS is required.





In
addition, the investment, lending and branching authority of the Bank is
prescribed by federal laws and it is prohibited from engaging in any activities
not permitted by these laws. For example, no savings institution may invest in
non-investment grade corporate debt securities. In addition, the permissible
level of investment by federal institutions in loans secured by non-residential
real property may not exceed 400% of total capital, except with approval of the
OTS. Federal savings institutions are also generally authorized to branch
nationwide. The Bank is in compliance with the noted restrictions.





The Bank's
general permissible lending limit for loans-to-one-borrower is equal to the
greater of  $500,000 or 15% of unimpaired capital and surplus (except
for loans fully secured by certain readily marketable collateral, in which case
this limit is increased to 25% of unimpaired capital and surplus). At December
31, 2009, the Bank's lending limit under this restriction was $2.9 million and,
at that date, the Bank had no loans to one borrower exceeding this amount except
where guaranteed by a government agency or approved prior to December 31,
2009 at a time when the Bank's legal lending limit was higher.





The OTS, as
well as the other federal banking agencies, has adopted guidelines establishing
safety and soundness standards on such matters as loan underwriting and
documentation, asset quality, earnings standards, internal controls and audit
systems, interest rate risk exposure and compensation and other employee
benefits.  Any institution that fails to comply with these standards
must submit a compliance plan.





All
savings institutions are required to pay assessments to the OTS to fund the
agency’s operations. The general assessments, paid on a semi-annual basis, are
determined based on the institution’s total assets, including consolidated
subsidiaries. The Bank’s OTS assessment for the year ended December 31, 2009 was
$107,000.





FHLB System. The 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,
the Bank is required to purchase and maintain stock in the FHLB of Seattle. At
December 31, 2009, the Bank had $1.8 million in FHLB stock, which was in
compliance with this requirement. In past years, the Bank has received
substantial dividends on its FHLB stock until such dividends were suspended
during the fourth quarter of 2004 until the third quarter of 2006. The FHLB of
Seattle resumed the payment of dividends in the fourth quarter of 2006, with the
announcement of a $0.10 per share cash dividend. In 2007, the FHLB of Seattle
paid a cumulative $0.60 per share cash dividend with Alaska Pacific receiving
$12,000 in dividends.





In 2008, the
Federal Home Loan Bank of Seattle paid a cumulative $0.95 per share in cash
dividends and Alaska Pacific received $16,000 in dividends. Based on the FHLB of
Seattle's third-quarter 2008 results, the FHLB of Seattle announced they would
not pay a dividend for the third quarter. Subsequent to December 31,







-27-





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 its
capital stock. The FHLB of Seattle is not anticipated to resume dividend
payments until their financial results improve. The FHLB of Seattle has not
indicated when dividend payments may resume.





Under federal
law, the Federal Home Loan Banks are required to provide funds for the
resolution of troubled savings institutions and 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 the Bank’s FHLB stock may result in a corresponding
reduction in the Bank’s capital.





Federal Deposit
Insurance Corporation. The FDIC is an independent federal agency that
insures the deposits, up to applicable limits, of depository institutions. As
insurer of the Bank’s deposits, the FDIC has supervisory and enforcement
authority over Alaska Pacific.





The deposits
of the Bank are insured up to applicable limits by the Deposit Insurance Fund,
or DIF, which is administered by the FDIC. The FDIC insures deposits up to the
applicable limits and this insurance is backed by the full faith and credit of
the United States government. As insurer, the FDIC imposes deposit insurance
premiums and is authorized to conduct examinations of and to require reporting
by institutions insured by the FDIC. It also may prohibit any institution
insured by the FDIC from engaging in any activity determined by regulation or
order to pose a serious risk to the institution and the DIF. The FDIC also has
the authority to initiate enforcement actions 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.





The FDIC
assesses deposit insurance premiums on all FDIC-insured institutions quarterly
based on annualized rates for one of four risk categories. Each institution is
assigned to one of four risk categories based on its capital, supervisory
ratings and other factors. Well capitalized institutions that are financially
sound with only a few minor weaknesses are assigned to Risk Category I. Risk
Categories II, III and IV present progressively greater risks to the DIF. Under
the FDIC’s risk-based assessment rules, effective April 1, 2009, the initial
base assessment rates prior to adjustments range from 12 to 16 basis points for
Risk Category I, and are 22 basis points for Risk Category II, 32 basis points
for Risk Category III, and 45 basis points for Risk Category IV. Initial base
assessment rates are subject to adjustments based on an institution’s unsecured
debt, secured liabilities and brokered deposits, such that the total base
assessment rates after adjustments range from 7 to 24 basis points for Risk
Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points
for Risk Category III, and 40 to 77.5 basis points for Risk Category
IV.  Rates increase uniformly by three basis points effective January
1, 2011.





In addition
to the regular quarterly assessments, due to losses and projected losses
attributed to failed institutions, the FDIC imposed on every insured institution
a special assessment of five basis points on the amount of each depository
institution’s assets reduced by the amount of its Tier 1 capital (not to exceed
10 basis points of its assessment base for regularly quarterly premiums) as of
June 30, 2009, which was collected on September 30, 2009.




As a result
of a decline in the reserve ratio (the ratio of the DIF to estimated insured
deposits) and concerns about expected failure costs and available liquid assets
in the DIF, the FDIC adopted a rule requiring each insured institution to prepay
on December 30, 2009 the estimated amount of its quarterly assessments for the
fourth quarter of 2009 and all quarters through the end of 2012 (in addition to
the regular quarterly assessment for the third quarter which was due on December
30, 2009). The prepaid amount is recorded as an asset with a zero risk weight
and the institution will continue to record quarterly expenses for deposit
insurance. For purposes of calculating the prepaid amount, assessments were
measured at the institution’s assessment rate as of September 30, 2009, with a
uniform increase of 3 basis points effective January 1, 2011, and were based on
the institution’s assessment base for the third quarter of 2009, with growth
assumed quarterly at annual rate of 5%. If events cause actual assessments
during the prepayment period to vary from the prepaid amount, institutions will
pay excess assessments in cash or receive a rebate of prepaid amounts not
exhausted after collection of assessments due on June 30, 2013, as applicable.
Collection of the prepayment does not preclude the FDIC from changing assessment
rates or revising the risk-based assessment system in the future. The rule
includes a process for exemption from the







-28-





prepayment
for institutions whose safety and soundness would be affected adversely.Alaska Pacific prepaid
$1.3 million in FDIC assessments during the fourth quarter of 2009 and the
balance of the prepaid assessment was $1.2 million at December 31,
2009.





The FDIC
estimates that the reserve ratio (the ratio of the net worth of the DIF to
estimated insured deposits) will reach the designated reserve ratio of 1.15% by
2017 as required by statute.





Federally
insured institutions are required to pay a Financing Corporation assessment in
order to fund the interest on bonds issued to resolve thrift failures in the
1980s. For the quarterly period ended December 31, 2009, the Financing
Corporation assessment equaled 1.02 basis points for each $100 in domestic
deposits. These assessments, which may be revised based upon the level of DIF
deposits, will continue until the bonds mature in the years 2017 through 2019.
For 2009, Alaska Pacific incurred $16,000 in FICO assessments.





The FDIC may
terminate the deposit insurance of any insured depository institution 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 the
deposit insurance of Alaska Pacific.





Capital Requirements.
Federally insured savings institutions, such as Alaska Pacific Bank, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings institutions. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual institutions on a case-by-case
basis.





The
capital regulations require tangible capital of at least 1.5% of adjusted total
assets (as defined by regulation). Tangible capital generally includes common
stockholders’ equity and retained income, and certain noncumulative perpetual
preferred stock and related income. In addition, all intangible assets must be
deducted from tangible capital for calculating compliance with the requirement.
At December 31, 2009, the Bank had tangible capital of $17.2 million, or
9.70% of adjusted total assets, which is $14.6 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that
date.





The
capital standards also require core capital equal to at least 4% of adjusted
total assets unless an institution’s supervisory condition is such to allow it
to maintain a 3.0% ratio. Core capital generally consists of tangible capital
plus certain intangible assets, including a limited amount of purchased credit
card relationships. At December 31, 2009, the Bank had core capital equal to
$17.2 million, or 9.70% of adjusted total assets, which is $10.1 million
above the minimum requirement of 4% in effect on that date.





The
OTS also requires savings institutions to have core capital equal to 4% of
risk-weighted assets ("Tier 1 risk-based"). At December 31, 2009, the Bank had
Tier 1 risk-based capital of $18.5 million, or 12.84% of risk-weighted
assets, which is $7.0 million above the minimum on that date. The OTS
risk-based requirement requires savings institutions to have total capital of at
least 8% of risk-weighted assets. Total capital consists of core capital, as
defined above, and supplementary capital. Supplementary capital consists of
certain permanent and maturing capital instruments that do not qualify as core
capital and general valuation loan and lease loss allowances up to a maximum of
1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the
risk-based requirement only to the extent of core capital. The OTS is also
authorized to require a savings institution to maintain an additional amount of
total capital to account for concentration of credit risk and the risk of
non-traditional activities.






-29-





In
determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet items, are multiplied by a risk weight, ranging from 0% to
100%, based on the risk inherent in the type of asset. For example, the OTS has
assigned a risk weight of 50% for prudently underwritten permanent one- to- four
family first lien mortgage loans not more than 90 days delinquent and having a
loan-to-value ratio of not more than 80% at origination unless insured to such
ratio by an insurer approved by Fannie Mae or Freddie Mac.





On
December 31, 2009, the Bank had total risk-based capital of $18.5 million and
risk-weighted assets of $144.0 million, or total capital of 12.84% of
risk-weighted assets. This amount was $7.0 million above the 8% requirement in
effect on that date.




The Bank
currently is operating under the restrictions imposed by an MOU issued by the
OTS on January 7, 2009.  Among other restrictions, the MOU
requires the Bank to: (a) submit a business plan that sets forth a plan for
maintaining Tier 1 (Core) Leverage Ratio of 8% and a minimum Total Risk-Based
Capital Ratio of 12% and provides a detailed financial forecast including
capital ratios, earnings and liquidity and containing comprehensive business
line goals and objectives; and (b) remain in compliance with the minimum capital
ratios contained in the business plan. As of December 31, 2009, the Bank’s
Tier-1 (Core) Leverage Ratio was 9.70% (1.70% over the new required minimum) and
Risk-Based Capital Ratio was 12.84%, (0.84% over the new required minimum).
Management believes that the Bank is currently in compliance with the terms of
the MOU. For further information regarding the MOU, see Item 1A, “Risk Factors
-- Risks Related to our Business -- We are subject to the restrictions and
conditions of a Memorandum of Understanding with, and other commitments we have
made to, the Office of Thrift Supervision. Failure to comply with the Memorandum
of Understanding could result in additional enforcement action against us,
including the imposition of monetary penalties.”





The
OTS and the FDIC are authorized and, under certain circumstances, required to
take certain actions against savings institutions that fail to meet their
capital requirements. The OTS is generally required to take action to restrict
the activities of an “undercapitalized institution,” which is an institution
with less than either a 4.0% core capital ratio, a 4.0% Tier 1 risk-based
capital ratio, or an 8.0% risk-based capital ratio. Any such institution must
submit a capital restoration plan and until the plan is approved by the OTS, may
not increase its assets, acquire another institution, establish a branch or
engage in any new activities, and generally may not make capital distributions.
The OTS is authorized to impose the additional restrictions that are applicable
to significantly undercapitalized institutions. As a condition to the approval
of the capital restoration plan, any company controlling an undercapitalized
institution must agree that it will enter into a limited capital maintenance
guarantee with respect to the institution’s achievement of its capital
requirements.





Any
savings institution that fails to comply with its capital plan or has Tier 1
risk-based or core capital ratios of less than 3.0% or a risk-based capital
ratio of less than 6.0% and is considered “significantly undercapitalized” will
be made subject to one or more additional specified actions and operating
restrictions which may cover all aspects of its operations and may include a
forced merger or acquisition of the institution. An institution that becomes
“critically undercapitalized” because it has a tangible capital ratio of 2.0% or
less is subject to further mandatory restrictions on its activities in addition
to those applicable to significantly undercapitalized institutions. In addition,
the OTS must appoint a receiver, or conservator with the concurrence of the
FDIC, for a savings institution, with certain limited exceptions, within 90 days
after it becomes critically undercapitalized. Any undercapitalized institution
is also subject to the general enforcement authority of the OTS and the FDIC,
including the appointment of a conservator or a receiver.





The
OTS is also generally authorized to reclassify an institution into a lower
capital category and impose the restrictions applicable to such category if the
institution is engaged in unsafe or unsound practices or is in an unsafe or
unsound condition. The imposition by the OTS or the FDIC of any of these
measures on the Bank may have a substantial adverse effect on its operations and
profitability.





Emergency Economic
Stabilization Act of 2008.In October 2008, the
EESA was enacted. The EESA authorizes the U.S. Treasury Department to
purchase from financial institutions and their holding companies up to $700
billion in mortgage loans, mortgage-related securities and certain other
financial instruments, including debt and equity securities issued by financial
institutions and their holding companies in a troubled asset relief program
(“TARP”). The purpose of TARP is to restore confidence and stability to the U.S.
banking system and to







-30-





encourage
financial institutions to increase their lending to customers and to each other.
Under the TARP Capital Purchase Program (“CPP”), the Treasury may purchase debt
or equity securities from participating institutions. The TARP also allows
direct purchases or guarantees of troubled assets of financial institutions.
Participants in the CPP are subject to executive compensation limits and are
encouraged to expand their lending and mortgage loan modifications. The Company
completed its TARP CPP transaction in the first quarter of fiscal 2009,
receiving $4.8 million in funding on February 6, 2009. For additional
information regarding the TARP CPP transaction, see “Participation in the U.S.
Treasury Capital Purchase Program.”





EESA also
included additional provisions directed at bolstering the economy, which we were
able to participate in, such as the temporary increase in FDIC insurance
coverage of deposit accounts, which increased from $100,000 to $250,000 through
December 31, 2013.





Standards for Safety
and Soundness. The federal banking regulatory agencies have prescribed,
by regulation, standards for all insured depository institutions relating to:
(i) internal controls, information systems and internal audit systems;
(ii) loan documentation; (iii) credit underwriting; (iv) interest
rate risk exposure; (v) asset growth; (vi) asset quality; (vii) earnings;
and (viii) compensation, fees and benefits (“Guidelines”).  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. If the OTS determines that the Bank fails to
meet any standard prescribed by the Guidelines, the OTS may require the Bank to
submit an acceptable plan to achieve compliance with the standard. OTS
regulations establish deadlines for the submission and review of such safety and
soundness compliance plans. Management of the Bank is not aware of any
conditions relating to these safety and soundness standards which would require
submission of a plan of compliance.





Temporary Liquidity
Guaranty Program.Following a systemic risk determination, the FDIC
established as Temporary Liquidity Guarantee Program (“TLGP”) on October 14,
2008.  Under the interim rule for the TLGP, there are two parts to the
program: the Debt Guarantee Program (“DGP”) and the Transaction Account
Guarantee Program (“TAGP”).  Eligible entities generally are
participants unless they exercised opt out rights on or before December 5,
2008.





For the DGP,
eligible entities are generally US bank holding companies, savings and loan
holding companies, and FDIC-insured institutions. Under the DGP, the FDIC
guarantees new senior unsecured debt, and with special approval certain
convertible debt of an eligible entity issued not later than October 31, 2009.
The guarantee is effective through the earlier of the maturity date or June 30,
2012 (for debt issued before April 1, 2009) or December 31, 2012 (for debt
issued on or after April 1, 2009). The DGP coverage limit is generally 125% of
the eligible entity’s eligible debt outstanding on September 30, 2008 and
scheduled to mature on or before June 30, 2009, or for certain institutions, 2%
of liabilities as of September 30, 2008. The nonrefundable DGP fee ranges from
50 to 100 basis points (annualized), depending on maturity, for covered debt
outstanding during the period until the earlier of maturity or June 30, 2012,
with various surcharges of 10 to 50 basis points applicable to debt with a
maturity of one year or more issued on or after April 1, 2009. Generally,
eligible debt of a participating entity becomes covered when and as issued until
the coverage limit is reached, except that under some circumstances,
participating entities can issue nonguaranteed debt. Various features of the
program require applications and approvals.  The Bank and the Company
do not participate in the DGP.





For the TAGP,
eligible entities are FDIC-insured institutions. Under the TAGP, the FDIC
provides unlimited deposit insurance coverage for noninterest-bearing
transaction accounts (typically business checking accounts), NOW accounts
bearing interest at 0.5% or less, and certain funds swept into
noninterest-bearing savings accounts. Other NOW accounts and money market
deposit accounts are not covered. TAGP coverage lasts until December 31, 2009
and, unless the participant has opted out of the extension period, during the
extension period of January 1, 2010 through June 30, 2010. Participating
institutions pay fees of 10 basis points (annualized) on the balance of each
covered account in excess of $250,000 during the period through December 31,
2009. During the extension period, such fees are 15 basis points for
institutions in Risk Category I, 20 basis points for those in Risk Category II
and 25 basis points for those in Risk Categories III and IV (Risk Categories are
those assigned for deposit insurance purposes). The Bank participates in the
TAGP.






-31-





The American Recovery
and Reinvestment Act of 2009.On February 17, 2009,
President Obama signed The American Recovery and Reinvestment Act of 2009
(“ARRA”) into law. The ARRA is intended to revive the U.S. economy by creating
millions of new jobs and stemming home foreclosures. For financial institutions
that have received or will receive financial assistance under TARP or related
programs, the ARRA significantly rewrites the original executive compensation
and corporate governance provisions of Section 111 of the EESA.  Among
the most important changes instituted by the ARRA are new limits on the ability
of TARP recipients to pay incentive compensation to up to 20 of the next most
highly-compensated employees in addition to the “senior executive officers,” a
restriction on termination of employment payments to senior executive officers
and the five next most highly-compensated employees and a requirement that TARP
recipients implement “say on pay” shareholder votes. For additional information
regarding the effects of the ARRA on the Company’s senior executive officers as
a result of the Company’s participation in TARP, see “Risk Factors – Risks
Related to our Business—Risks specific to our participation in
TARP.”





Qualified Thrift
Lender Test. All savings institutions, including Alaska Pacific, are
required to meet a qualified thrift lender (“QTL”) test to avoid certain
restrictions on their operations. This test requires a savings institution to
have at least 65% of its portfolio assets, as defined by regulation, in
qualified thrift investments on a monthly average for nine out of every 12 month
period on a rolling basis.  As an alternative, the savings institution
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code (“Code”). Under either test, such assets primarily
consist of residential housing related loans and investments. At December 31,
2009, the Bank met the test, with a ratio of 71.82%.





Any savings
institution that fails to meet the QTL test must convert to a national bank
charter, unless it requalifies as a QTL within one year of failure and
thereafter remains a QTL. If such an association has not yet requalified or
converted to a national bank, its new investments and activities are limited to
those permissible for both a savings institution and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such an institution
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. If any association that fails the QTL test is
controlled by a holding company, then within one year after the failure, the
holding company must register as a bank holding company and become subject to
all restrictions on bank holding companies.  See “ - Savings and Loan
Holding Company Regulations.”





Limitations on
Capital Distributions. OTS regulations impose various restrictions on
savings institutions with respect to their ability to make distributions of
capital, which include dividends, stock redemptions or repurchases, cash-out
mergers and other transactions charged to the capital account.Generally,
savings institutions, such as Alaska Pacific, that before and after the proposed
distribution are well-capitalized, may make capital distributions during any
calendar year equal to up to 100% of net income for the year-to-date plus
retained net income for the two preceding years. However, an institution deemed
to be in need of more than normal supervision by the OTS may have its dividend
authority restricted by the OTS. The Bank may pay dividends to the Company in
accordance with this general authority; however, it must also comply with the
MOU and provide notice to, and obtain a non-objection from, the OTS prior to
declaring a dividend.





Savings
institutions proposing to make any capital distribution need not submit written
notice to the OTS prior to such distribution unless they are a subsidiary of a
holding company or would not remain well-capitalized following the distribution.
Savings institutions that do not, or would not meet their current minimum
capital requirements following a proposed capital distribution or propose to
exceed these net income limitations, must obtain OTS approval prior to making
such distribution. The OTS may object to the distribution during that 30-day
period based on safety and soundness concerns. See “- Capital
Requirements.”





Liquidity. All
savings institutions, including the Bank, are required to maintain sufficient
liquidity to ensure a safe and sound operation.





Activities of
Associations and Their Subsidiaries. When a savings institution
establishes or acquires a subsidiary or elects to conduct any new activity
through a subsidiary that the association controls, the savings institution must
notify the FDIC and the OTS 30 days in advance and provide the information each
agency may,








-32-





by
regulation, require. Savings institutions also must conduct the activities of
subsidiaries in accordance with existing regulations and orders.





The OTS may
determine that the continuation by a savings institution of its ownership
control of, or its relationship to, the subsidiary constitutes a serious risk to
the safety, soundness or stability of the association or is inconsistent with
sound banking practices or with the purposes of the FDIA. Based upon that
determination, the FDIC or the OTS has the authority to order the savings
institution to divest itself of control of the subsidiary. The FDIC also may
determine by regulation or order that any specific activity poses a serious
threat to the SAIF. If so, it may require that no SAIF member engage in that
activity directly.





Transactions with
Affiliates.The
Bank's authority to engage in transactions with "affiliates" is limited by OTS
regulations and by Sections 23A and 23B of the Federal Reserve Act as
implemented by the Federal Reserve Board's Regulation W. The term "affiliates"
for these purposes generally means any company that controls or is under common
control with an institution. The Corporation and its non-savings institution
subsidiaries are affiliates of the Bank. In general, transactions with
affiliates must be on terms that are as favorable to the institution as
comparable transactions with non-affiliates. In addition, certain types of
transactions are restricted to an aggregate percentage of the institution's
capital. Collateral in specified amounts must usually be provided by affiliates
in order to receive loans from an institution. In addition, savings institutions
are prohibited from lending to any affiliate that is engaged in activities that
are not permissible for bank holding companies and no savings institution may
purchase the securities of any affiliate other than a subsidiary.





The
Sarbanes-Oxley Act of 2002 generally prohibits a company from making loans to
its executive officers and directors. However, there is a specific exception for
loans by a depository institution to its executive officers and directors in
compliance with federal banking laws. Under such laws, the Bank's authority to
extend credit to executive officers, directors and 10% stockholders
("insiders"), as well as entities that such person’s control is limited. The law
restricts both the individual and aggregate amount of loans the Bank may make to
insiders based, in part, on the Bank's capital position and requires certain
Board approval procedures to be followed. Such loans must be made on terms
substantially the same as those offered to unaffiliated individuals and not
involve more than the normal risk of repayment. There is an exception for loans
made pursuant to a benefit or compensation program that is widely available to
all employees of the institution and does not give preference to insiders over
other employees. There are additional restrictions applicable to loans to
executive officers.





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 December 31, 2009, the Bank’s deposit with the Federal Reserve Bank
and vault cash exceeded its reserve requirements.





Community Reinvestment Act.
Under the Community Reinvestment Act, every FDIC-insured institution has a
continuing and affirmative obligation consistent with safe and sound banking
practices to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The Community Reinvestment Act does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution’s discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the Community Reinvestment Act. The Community Reinvestment Act
requires the OTS, in connection with the examination of the Bank, to assess the
institution’s record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications, such as a
merger or the establishment of a branch, by the Bank. An unsatisfactory rating
may be used as the basis for the denial of an application by the OTS. Due to the
heightened attention being given to the Community Reinvestment Act in the past
few years, the Bank may be required to devote additional funds for investment
and lending in its local community. The Bank was examined in 2004 for Community
Reinvestment Act compliance and received a rating of satisfactory in its latest
examination.






-33-





Environmental Issues
Associated With Real Estate Lending.The Comprehensive Environmental
Response, Compensation and Liability Act (“CERCLA”), a federal statute,
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 the 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.





Privacy Standards.The Gramm-Leach-Bliley Financial Services Modernization Act of 1999
("GLBA"), which was enacted in 1999, modernized the financial services industry
by establishing a comprehensive framework to permit affiliations among
commercial banks, insurance companies, securities firms and other financial
service providers. The Bank is subject to OTS regulations implementing the
privacy protection provisions of the GLBA. These regulations require the Bank to
disclose its privacy policy, including identifying with whom it shares
"non-public personal information," to customers at the time of establishing the
customer relationship and annually thereafter.





Anti-Money Laundering
and Customer Identification.Congress enacted the Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on October 26, 2001 in
response to the terrorist events of September 11, 2001. The USA Patriot Act
gives the federal government new powers to address terrorist threats through
enhanced domestic security measures, expanded surveillance powers, increased
information sharing, and broadened anti-money laundering requirements. In 2006,
Congress re-enacted certain expiring provisions of the USA Patriot
Act.





Regulation
and Supervision of the Company





General. The
Company is a unitary savings and loan holding company subject to regulatory
oversight of the OTS. Accordingly, the Company is required to register and file
reports with the OTS and is subject to regulation and examination by the OTS. In
addition, the OTS has enforcement authority over the Company and its non-savings
institution subsidiaries which also permits the OTS to restrict or prohibit
activities that are determined to present a serious risk to the subsidiary
savings institution.





In connection
with the MOU, the Company’s Board of Directors executed two resolutions to
assure the OTS that the Company is committed to supporting the Bank should it be
necessary, and that the Company would comply with the restrictions in the Bank’s
MOU. See Item 1A, “Risk Factors -- Risks Related to our Business --We are
subject to the restrictions and conditions of a Memorandum of Understanding
with, and other commitments we have made to, the Office of Thrift Supervision.
Failure to comply with the Memorandum of Understanding could result in
additional enforcement action against us, including the imposition of monetary
penalties.”





Activities
Restrictions. The Company and its
non-savings institution subsidiaries are subject to statutory and regulatory
restrictions on their business activities specified by federal regulations,
which include performing services and holding properties used by a savings
institution subsidiary, activities authorized for savings and loan holding
companies as of March 5, 1987, and non-banking activities permissible for bank
holding companies pursuant to the Bank Holding Company Act of 1956 or authorized
for financial holding companies pursuant to the GLBA.





If the Bank
fails the qualified thrift lender test, the Company must, within one year of
that failure, register as, and will become subject to, the restrictions
applicable to bank holding companies. See "- Regulation and Supervision of
Savings Institutions - Qualified Thrift Lender Test."






-34-





Dividend Payments and
Common Stock Repurchases.As an Alaska corporation, the Company is
subject to restrictions on the payment of dividends under Alaska law. In
addition, as a savings and loan holding company, the Company’s ability to
declare and pay dividends is dependent on certain federal regulatory
considerations. The Company is an entity separate and distinct from its
principal subsidiary, Alaska Pacific Bank, and derives substantially all of its
revenue in the form of dividends from this subsidiary. Accordingly, the Company
is, and will be, dependent upon dividends from the Bank to pay the principal of
and interest on its indebtedness, to satisfy its other cash needs and to pay
dividends on its common stock. The Bank’s ability to pay dividends is subject to
their ability to earn net income and to meet certain regulatory requirements.
See “—Regulation and Supervision of Savings Institutions - Limitations on
Capital Distributions” and Item 1A, “Risk Factors - Risks Related to our
Business -- There are regulatory and contractual limitations that may limit or
prevent us from paying dividends on the common stock and we may limit or
eliminate our dividends to shareholders.”





As a result
of our participation in the TARP CPP, we are subject to certain limitations
regarding the payment of dividendson
and the repurchase of our common stock.Without the consent of
the U.S. Treasury, we may not increase the cash dividend on our common stock or,
pay any dividends on our common stock unless we are current in our dividend
payments to the U.S. Treasury on the Series A Preferred Stock. In addition and
subject to limited exceptions, with the consent of the U.S. Treasury, we also
may not redeem, repurchase or otherwise acquire shares of our common stock or
preferred stock other than the Series A Preferred Stock or trust preferred
securities. For additional information, see “Risk Factors - Risks Related to our
Business -- Risks specific to our participation in TARP -- The securities
purchase agreement between us and Treasury limits our ability to pay dividends
on and repurchase our common stock.”





Mergers and
Acquisitions.The Company must obtain approval from the OTS before
acquiring more than 5% of the voting stock of another savings institution or
savings and loan holding company or acquiring such an institution or holding
company by merger, consolidation or purchase of its assets. In evaluating an
application for the Company to acquire control of a savings institution, the OTS
would consider the financial and managerial resources and future prospects of
the Company and the target institution, the effect of the acquisition on the
risk to the insurance funds, the convenience and the needs of the community and
competitive factors.





Sarbanes-Oxley Act of
2002.The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) was signed
into law on July 30, 2002 in response to public concerns regarding corporate
accountability in connection with the recent 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 generally applies to all companies that file or are required
to file periodic reports with the Securities and Exchange Commission (“SEC”),
under the Securities Exchange Act of 1934 (“Exchange Act”), including the
Company.





The
Sarbanes-Oxley Act includes very specific additional disclosure requirements and
new corporate governance 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.








TAXATION





Federal
Taxation





General. The Company and the
Bank report their income on a fiscal year basis using the accrual method of
accounting and are subject to federal income taxation in the same manner as
other Companies with some exceptions, including particularly the Bank’s reserve
for bad debts discussed below. The following discussion of tax matters is
intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to the Bank or the Company.






-35-





Bad Debt Reserve.
Historically, savings institutions such as the Bank which met certain
definitional tests primarily related to their assets and the nature of their
business (“qualifying thrift”) were permitted to establish a reserve for bad
debts and to make annual additions thereto, which may have been deducted in
arriving at their taxable income. The Bank’s deductions with respect to
“qualifying real property loans,” which are generally loans secured by certain
interest in real property, were computed using an amount based on the Bank’s
actual loss experience, or a percentage equal to 8% of the Bank’s taxable
income, computed with certain modifications and reduced by the amount of any
permitted additions to the non-qualifying reserve. Due to the Bank’s loss
experience, the Bank generally recognized a bad debt deduction equal to 8% of
taxable income.





The
thrift bad debt rules were revised by Congress in 1996. The new rules eliminated
the 8% of taxable income method for deducting additions to the tax bad debt
reserves for all thrifts for tax years beginning after December 31, 1995. These
rules also required that all institutions recapture all or a portion of their
bad debt reserves added since the base year (last taxable year beginning before
January 1, 1988). The Bank has no post-1987 reserves subject to recapture. For
taxable years beginning after December 31, 1995, the Bank’s bad debt deduction
will be determined under the experience method using a formula based on actual
bad debt experience over a period of years. The unrecaptured base year reserves
will not be subject to recapture as long as the institution continues to carry
on the business of banking. In addition, the balance of the pre-1988 bad debt
reserves continue to be subject to provisions of present law referred to below
that require recapture in the case of certain excess distributions to
shareholders.





Distributions. To the extent
that the Bank makes “nondividend distributions” to the Company, such
distributions will be considered to result in distributions from the balance of
its bad debt reserve as of December 31, 1987 (or a lesser amount if the
Bank’s loan portfolio decreased since December 31, 1987) and then from the
supplemental reserve for losses on loans (“Excess Distributions”), and an amount
based on the Excess Distributions will be included in the Bank’s taxable income.
Nondividend distributions include distributions in excess of the Bank’s current
and accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. However, dividends paid out of
the Bank’s current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a distribution
from the Bank’s bad debt reserve. The amount of additional taxable income
created from an Excess Distribution is an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. Thus,
if, after the Conversion, the Bank makes a “nondividend distribution,” then
approximately one and one-half times the Excess Distribution would be includable
in gross income for federal income tax purposes, assuming a 34% corporate income
tax rate (exclusive of state and local taxes). See “Regulation” for limits on
the payment of dividends by the Bank. The Bank does not intend to pay dividends
that would result in a recapture of any portion of its tax bad debt
reserve.





Corporate Alternative Minimum
Tax. The Code imposes a tax on alternative minimum taxable income
(“AMTI”) at a rate of 20%. The excess of the tax bad debt reserve deduction
using the percentage of taxable income method over the deduction that would have
been allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. In addition, only 90% of AMTI can be offset by
net operating loss carryovers. AMTI is increased by an amount equal to 75% of
the amount by which the Bank’s adjusted current earnings exceeds its AMTI
(determined without regard to this preference and prior to reduction for net
operating losses). For taxable years beginning after December 31, 1986, and
before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI
(with certain modification) over $2.0 million is imposed on Companies, including
the Bank, whether or not an Alternative Minimum Tax is paid.





Dividends-Received Deduction.
The Company may exclude from its income 100% of dividends received from the Bank
as a member of the same affiliated group of Companies. The corporate
dividends-received deduction is generally 70% in the case of dividends received
from unaffiliated Companies with which the Company and the Bank will not file a
consolidated tax return, except that if the Company or the Bank owns more than
20% of the stock of a Company distributing a dividend, then 80% of any dividends
received may be deducted.


-36-





State
Taxation





The
Alaska state income tax rate applicable to the Bank is based on a graduated tax
rate schedule, with a maximum rate of 9.4% on income over $90,000. There have
not been any audits of the Bank’s state tax returns during the past five
years.





Audits





The
Company’s income tax returns have not been audited by federal or state
authorities within the last five years. For additional information regarding
income taxes, see Note 13 of the Notes to Consolidated Financial Statements
contained in Item 8 of this Form 10-K.





Subsidiary
Activities





As
of December 31, 2009, Alaska Pacific did not own any active
subsidiaries.





Executive
Officers





The
following table sets forth certain information with respect to the executive
officers of the Company and the Bank are as follows:





Age
      at
              December 31,
            PositionName
            2009
            Company
            BankCraig
      E. Dahl
            60
            Director,
      President
            Director,
      Presidentand
      Chief Executive Officer
            and
      Chief Executive OfficerJulie
      M. Pierce
            38
            Senior
      Vice President, Chief
            Senior
      Vice President andFinancial
      Officer and Secretary
            Chief
      Financial OfficerJohn
      E. Robertson
            62
            --
            Senior
      Vice President andChief
      Credit OfficerChristopher
      P. Bourque
            58
            --
            Senior
      Vice President andChief
      Operating OfficerLeslie
      Dahl
            50
            --
            Senior
      Vice President andChief
      Lending Officer





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:





Craig E. Dahl joined the Bank
in 1992 and has served as President and Chief Executive Officer of the Bank
since 1996 and as President and Chief Executive Officer of the Company since its
formation in 1999.  Prior to joining the Bank, he was President of the
B.M. Behrends Bank in Juneau, Alaska. Mr. Dahl and Leslie Dahl, the Bank’s
Senior Vice President and Chief Lending Officer, are married to each
other.





Julie M. Pierce joined the
Bank in September 2007. Ms. Pierce previously held the positions of Assistant
State and State Comptroller for the State of Alaska from 2005 until 2007,
Director of Finance for Sealaska Heritage Institute from 2004 until 2005, and
Chief Financial Officer for True North Federal Credit Union from 1999 until
2004.





John E. Robertson joined the
Bank in December 2002. Mr. Robertson previously held the position of Group Vice
President/Senior Relationship Banker at ABN Amro Bank from 1995 until
2002.






-37-





Christopher P. Bourque joined
the Bank in June 2003 and has served as Senior Vice President and Chief
Operating Officer since April 2006. Mr. Bourque previously held the position of
Senior Vice President of Operations at  Mount McKinley Bank in
Fairbanks, Alaska from 1992 until 2000.





Leslie Dahl joined the Bank
in February 2000 and has served as Senior Vice President and Chief Lending
Officer since April 2006. Ms. Dahl has 30 years of commercial lending
experience. Ms. Dahl and Craig E. Dahl, the Company’s and the Bank’s President
and Chief Executive Officer, are married to each other.





Personnel





As
of December 31, 2009, the Bank had 62 full-time and four part-time employees,
none of whom are represented by a collective bargaining unit. The Bank believes
its relationship with its employees is good.





Competition





Alaska
Pacific faces strong competition in its primary market area for the attraction
of deposits (its primary source of lendable funds) and in the origination of
loans. Its most direct competition for deposits has historically come from
commercial banks and credit unions operating in its primary market area. The
Bank competes with four commercial banks (including one Southeast Alaska based
community bank, two giant super-regional banks and one statewide regional bank)
and six credit unions in its primary market area. Particularly in times of high
interest rates, Alaska Pacific has faced additional significant competition for
investors’ funds from short-term money market securities, other corporate and
government securities and credit unions. The Bank’s competition for loans also
comes from mortgage bankers and Internet-based marketers. This competition for
deposits and the origination of loans may limit Alaska Pacific’s future
growth.





Alaska
Pacific’s market share is approximately 12.0% of deposits in Southeast Alaska,
however, this calculation does not include deposits held by credit unions. If
state-wide credit unions were included in this calculation as well as “non-bank”
competitors such as brokerage firms and money market mutual funds, Alaska
Pacific’s share would be somewhat less. Alaska Pacific’s largest competitor is
Wells Fargo, with a market share of approximately 49.8%. Wells Fargo acquired
the former National Bank of Alaska in 2000, and Alaska Pacific has achieved some
success in drawing customers away from Wells Fargo, especially small businesses,
through a targeted calling effort and a marketing emphasis on the advantages of
banking locally.








Item
1A – Risk Factors





An investment in our common stock is
subject to risks inherent in our business. 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. The risks discussed below also include forward-looking statements,
and our actual results may differ substantially from those discussed in these
forward-looking statements. This report is qualified in its entirety by these
risk factors.








Risks
Related to our Business





Our
business is subject to general economic risks that could adversely impact our
results of operations and financial condition.





We
are subject to the restrictions and conditions of a Memorandum of Understanding
with, and other commitments we have made to, the Office of Thrift Supervision.
Failure to comply with the








-38-




Memorandum
of Understanding could result in additional enforcement action against us,
including the imposition of monetary penalties.





On January 7, 2009 the Office of Thrift
Supervision finalized a supervisory agreement (a memorandum of understanding or
“MOU”) which was reviewed and approved by the Board of Directors of Alaska
Pacific Bank on December 19, 2008.  The MOU  specifically
requires the Bank to: (a) submit a business plan that sets forth a plan for
maintaining Tier 1 (Core) Leverage Ratio of 8% and a minimum Total Risk-Based
Capital Ratio of 12% and provides a detailed financial forecast
including  capital ratios, earnings and liquidity and containing
comprehensive business line goals and objectives; (b) remain in compliance with
the minimum capital ratios contained in the business plan; (b) provide notice to
and obtain a non-objection from the  OTS  prior to the Bank
declaring a dividend; (c) maintain an adequate Allowance for Loan and Lease
Losses (ALLL); (d) engage an independent consultant to conduct a loan review of
the Bank’s purchased loan participations  current nonperforming loans
and any new loans that are  in excess of $500,000 and that were
originated since the last review; and (e)  develop a written
comprehensive plan, that is acceptable to the OTS, to reduce classified
assets.





The Board
of Directors and management of the Bank do not believe that the MOU will
constrain the Bank’s   business plans and that there has already
been substantial progress made in satisfying the requirements of the MOU.
Management believes that the primary reason that the OTS requested the Bank
enter into an MOU with the OTS was specific participation loans that give rise
to the high level of classified assets.  An independent loan review
was conducted in March 2009. As of December 31, 2009, the Bank’s Tier-1 (Core)
Leverage Ratio was 9.70% (1.70% over the new required minimum) and Risk-Based
Capital Ratio was 12.84%, (0.84% more than the new required minimum). While we
believe we are currently in compliance with the terms of the MOU, if we fail to
comply with these terms, the Office of Thrift Supervision could take additional
enforcement action against us, including the imposition of monetary penalties or
the issuance of a cease and desist order requiring further corrective
action.





In March
2009, subsequent to the MOU, the Company’s Board of Directors executed two
resolutions to assure the Office of Thrift Supervision that the Company was
committed to supporting the Bank should it be necessary, and that the Company
would comply with the restrictions in the Bank’s MOU. The first resolution was
required by the OTS of all OTS regulated holding companies. The resolution,
referred to as a “Source of Strength” resolution, ensures that the Company is
prepared to contribute additional capital to the Bank should it become
necessary.  The second resolution states that the Company would issue
dividends only upon the “nonobjection” of the OTS, would maintain sufficient
cash and cash flow so that Company’s activities would not be paid for by the
Bank, and that the Company would not issue debt without the nonobjection of the
OTS.





Our
business may continue to be adversely affected by downturns in the national
economy and the states where our out of market area loans are
located.





Since the
latter half of 2007, depressed economic conditions have prevailed in portions of
the United States outside of our primary area of Southeast Alaska, including
areas where the Bank has participation loans, specifically in the States of
Washington, Oregon, Idaho, California and Colorado. We provide banking and
financial services to customers located in our primary market of Southeast
Alaska, which up to this point in time and based upon its geographic location
and diverse resource-based economy has not experienced the serious problems as
those of markets in the lower-48 states. If there were to be a further decline
of the economic conditions in our primary market, this could have an adverse
effect on our business, financial condition, results of operations and
prospects.





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:





·
            an
      increase in loan delinquencies problem assets and
      foreclosures;




·
            the
      slowing of sales of foreclosed
assets;






-39-




·
            a
      decline in demand for our products and
services;




·
            a
      continuing decline in the value of collateral for loans may in turn reduce
      customers’ borrowing power, and the value of assets and collateral
      associated with existing loans;
and






·
            a
      decrease in the amount of our low cost or non-interest bearing
      deposits.







We
may be required to make further increases in our provisions for loan losses and
to charge off additional loans in the future, which could adversely affect our
results of operations.





Although our provision for loan losses
decreased during the year ended December 31, 2009, we may be required to make
further increases as a result of any further decline in the economy. The
decrease in the provision for loan losses reflected the decrease in our non
performing loans and assets during 2009. In comparison, during the year ended
December 31, 2008, we experienced increasing loan delinquencies and credit
losses and we substantially increased our provision for loan losses, which
adversely affected our results of operations. With the exception of residential
construction and land development loans, non performing loans and assets
generally reflect unique operating difficulties for individual borrowers rather
than a weakness in the overall economy of our primary market area. In addition,
our portfolio is concentrated in construction and land loans and commercial and
multifamily loans, all of which have a higher risk of loss than residential
mortgage loans. As a result, 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.





Our
emphasis on commercial real estate lending may expose us to increased lending
risks.




Our
current business strategy is focused on the expansion of commercial real estate
lending. This type of lending activity, while potentially more profitable than
single-family residential lending, is generally more sensitive to regional and
local economic conditions, making loss levels more difficult to predict.
Collateral evaluation and financial statement analysis in these types of loans
requires a more detailed analysis at the time of loan underwriting and on an
ongoing basis. A downturn in housing, or the real estate market, could increase
loan delinquencies, defaults and foreclosures, and significantly impair the
value of our collateral and our ability to sell the collateral upon
foreclosure.




At
December 31, 2009, we had $1.7 million of multifamily residential and $64.5
million of commercial real estate loans, representing 1.1% and 40.8%,
respectively, of our total loan portfolio. These loans typically involve higher
principal amounts than other types of loans, and repayment is dependent upon
income generated, or expected to be generated, by 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. For
example, if the cash flow from the borrower’s project is reduced as a result of
leases not being obtained or renewed, the borrower’s ability to repay the loan
may be impaired. 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 typically cannot be sold as easily as
residential real estate.




A
secondary market for most types of commercial real estate loans is not readily
liquid, so we have less opportunity to mitigate credit risk by selling part or
all of our interest in these loans. As a result of these characteristics, if we
foreclose on a commercial or multi-family real estate loan, our holding period
for the collateral typically is longer than for one-to-four family residential
mortgage loans because there are fewer potential purchasers of the collateral.
Accordingly, charge-offs on commercial and multi-family real estate loans may be
larger on a per loan basis than those incurred with our residential or consumer
loan portfolios.




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 Thrift Supervision have promulgated joint
guidance on sound risk management practices for financial institutions with
concentrations in commercial real estate lending. Under this guidance, a
financial institution that, like us, is actively involved in commercial real
estate lending







-40-





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 development, and other
land represent 100% or more of total capital, or (ii) total reported loans
secured by multifamily and non-farm residential properties, loans for
construction, land 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. We have concluded that we have a concentration in commercial real
estate lending under the foregoing standards because our $64.5 million balance
in commercial real estate loans at December 31, 2009 represents 300% or more of
total capital. 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.




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.




At
December 31, 2009, we had $19.9 million or 12.6% of total loans in commercial
business loans. Commercial 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 loans are primarily
made based on the cash flow of the borrower and secondarily on the underlying
collateral provided by the borrower. The borrowers' cash flow may be
unpredictable, and collateral securing these loans may fluctuate in value.
Although commercial 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 credit worthiness of the
borrower and secondarily on the underlying collateral provided by the
borrower.




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




At
December 31, 2009, $33.8 million, or 21.4% of our total loan portfolio, was
secured by one-to-four single-family mortgage loans and home equity lines of
credit.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 housing markets 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. Continued declines in the housing market and the economy and the
associated increases in unemployment may result in higher than expected loan
delinquencies or problem assets, a decline in demand for our products and
services, or lack of growth or a decrease in deposits. These potential negative
events may cause us to incur losses, adversely affect our capital and liquidity,
and damage our financial condition and business operations.





High
loan-to-value ratios on a portion of our residential mortgage loan portfolio
exposes us to greater risk of loss.





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 upon
purchase a first mortgage with an 80% loan-to-value ratio, have originated a
home equity loan with a combined loan-to-value ratio of up to 90% or because of
the decline in home values in our market areas. Residential loans with high
loan-to-value ratios will be more







-41-





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. As a result, these loans may
experience higher rates of delinquencies, defaults and losses.




We
may have continuing losses and continuing variation in our quarterly
results.





We had
net losses of $2.2 million for the year ended December 31, 2009 and $2.3 million
for the year ended December 31, 2008. These losses primarily resulted from our
high level of non-performing assets and the resultant increased provision for
loan losses. We may continue to experience further losses as a result of these
factors.  In addition, several factors affecting our business can
cause significant variations in our quarterly results of operations. In
particular, variations in the volume of our loan originations and sales, the
differences between our costs of funds and the average interest rates of
originated or purchased loans, changes in our provision for loan losses and
non-performing assets can result in significant increases or decreases in our
revenues from quarter to quarter.





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:








•
            the
      cash flow of the borrower and/or the project being
    financed;•
            changes
      and uncertainties as to the future value of the collateral, in the case of
      a collateralized loan;•
            the
      duration of the loan;•
            the
      credit history of a particular borrower; and•
            changes
      in economic and industry
conditions.




We
maintain an allowance for loan losses, which is a reserve established through a
provision for loan losses charged to expense, which we believe is appropriate to
provide for probable losses in our loan portfolio. 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 and certain macroeconomic
      factors based on management’s expectations of future events;
      and•
            our
      specific reserve, based on our evaluation of nonperforming loans and their
      underlying collateral.




The
determination of the appropriate level of the allowance for loan losses
inherently involves a high degree of subjectivity and requires us to make
various assumptions and judgments about the collectability of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans. In determining the amount of the allowance for loan losses, we review
our loans and the loss and delinquency experience, and evaluate economic
conditions and make significant estimates of current credit risks and future
trends, all of which may undergo material changes. If our estimates are
incorrect, the allowance for loan losses may not be sufficient to cover losses
inherent in our loan portfolio, resulting in the need for additions to our
allowance through an increase in the provision for loan losses. 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. Our allowance for loan losses was 1.13% of total
loans held for investment and 62.6% of nonperforming loans at December 31, 2009.
In addition, bank regulatory agencies periodically review our allowance for loan
losses and may require an increase in the provision for possible loan







-42-





losses or
the recognition of further loan charge-offs, based on judgments different than
those of management. If charge-offs in future periods exceed the allowance for
loan losses, we will need additional provisions to increase the allowance for
loan losses. 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.





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 and the property taken in as other real estate owned
(“OREO”), and at certain other times during the assets holding period. Our net
book value 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 net book
value over its fair value. If our valuation process is incorrect, the fair value
of our investments in real estate may not be sufficient to recover our net book
value  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 REO and may require us to recognize further charge-offs.
Any increase in our charge-offs, as required by such regulators, may have a
material adverse effect on our financial condition and results of
operations.





We
may suffer losses in our loan portfolio despite our underwriting
practices.





We seek to mitigate the risks inherent
in our loan portfolio by adhering to specific underwriting practices. Although
we believe that our underwriting criteria are appropriate for the various kinds
of loans we make, we may incur losses on loans that meet our underwriting
criteria, and these losses may exceed the amounts set aside as reserves in our
allowance for loan losses.





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 FHLB of Seattle (“FHLB”), the Federal Reserve Bank of San Francisco ("FRB")
and other borrowings to fund our operations. 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 FRB, 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 - such as a disruption in the financial markets or negative views and
expectations about the prospects for the financial services industry in light of
the recent turmoil faced by banking organizations and the continued
deterioration in credit markets. 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 our primary market area of Southeast
Alaska where our loans are concentrated or adverse regulatory action against
us.




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. In addition,
the Bank may not incur additional debt without the prior written non-objective
of the OTS. 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.






-43-





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 regulatory
authorities to maintain adequate levels of capital to support our operations. We
anticipate that our capital resources will satisfy our capital requirements for
the foreseeable future. Nonetheless, we may at some point 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 andperformance.
Accordingly, we cannot make assurances that we will 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, it may have a material adverse effect on
our financial condition and liquidity, results of operations and
prospects.





There
are regulatory and contractual limitations that may limit or prevent us from
paying dividends on the common stock and we may limit or eliminate our dividends
to shareholders.





As an Alaska corporation, under Alaska
law we are subject to restrictions on the payment of dividends. In addition, as
a savings and loan holding company, Alaska Pacific’s ability to declare and pay
dividends is dependent on certain federal regulatory considerations. Alaska
Pacific is an entity separate and distinct from its principal subsidiary, Alaska
Pacific Bank, and derives substantially all of its revenue in the form of
dividends from this subsidiary. Accordingly, Alaska Pacific is and will be
dependent upon dividends from Alaska Pacific Bank to pay the principal of and
interest on its indebtedness, to satisfy its other cash needs and to pay
dividends on its common stock. Alaska Pacific Bank’s ability to pay dividends is
subject to their ability to earn net income and to meet certain regulatory
requirements. In the event the Bank is unable to pay dividends to Alaska
Pacific, it may not be able to pay its obligations or pay dividends on Alaska
Pacific’s common stock. See “Regulation - Regulation and Supervision of Savings
Institutions - Limitations on Capital Distributions” and Note 3 of the Notes to
Consolidated Financial Statements. Also, Alaska Pacific’s right to participate
in a distribution of assets upon a subsidiary’s liquidation or reorganization is
subject to the prior claims of the subsidiary’s creditors.





Alaska Pacific is also subject to
certain regulatory restrictions that could prohibit it from declaring or paying
dividends or making liquidation payments on its common stock. See “Regulation -
Regulation and Supervision of the Company - Dividend Payments and Common Stock
Repurchases” above. In addition, the securities purchase agreement between us
and Treasury limits our ability to pay dividends on and repurchase our common
stock.The
securities purchase agreement between us and Treasury provides that prior to the
earlier of (i) November 21, 2011 and (ii) the date on which all of the shares of
the Series A Preferred Stock have been redeemed by us or transferred by Treasury
to third parties, we may not, without the consent of Treasury, (a) increase the
cash dividend on our common stock or (b) subject to limited exceptions, redeem,
repurchase or otherwise acquire shares of our common stock or preferred stock
other than the Series A Preferred Stock or trust preferred securities. In
addition, we are unable to pay any dividends on our common stock unless we are
current in our dividend payments on the Series A Preferred Stock.





Our board of directors regularly
reviews our dividend policy in light of current economic conditions for
financial institutions as well as our capital needs and any applicable
contractual restrictions. On a quarterly basis, the board of directors
determines whether a dividend will be paid and in what amount, if
any.





We
operate in a highly regulated environment and may be adversely affected by
changes in federal and state laws and regulations, including changes that may
restrict our ability to foreclose on single-family home loans and offer
overdraft protection.





We are subject to extensive
examination, supervision and comprehensive regulation by the OTS and the FDIC.
Banking regulations are primarily intended to protect depositors' funds, federal
deposit insurance funds, and the banking system as a whole, and not holders of
our common stock. These regulations affect our lending practices, capital
structure, investment practices, dividend policy, and growth, among other
things. Congress and federal regulatory agencies continually review banking
laws, regulations, and policies for possible changes.







-44-





Changes
to statutes, regulations, or regulatory policies, including changes in
interpretation or implementation of statutes, regulations, or policies, could
affect us in substantial and unpredictable ways. Such changes could subject us
to additional costs, limit the types of financial services and products we may
offer, restrict mergers and acquisitions, investments, access to capital, the
location of banking offices, and/or increase the ability of non-banks to offer
competing financial services and products, among other things. Failure to comply
with laws, regulations or policies could result in sanctions by regulatory
agencies, civil money penalties and/or reputational damage, which could have a
material adverse effect on our business, financial condition and results of
operations. While we have policies and procedures designed to prevent any such
violations, there can be no assurance that such violations will not
occur.





New
legislation proposed by Congress may give bankruptcy courts the power to reduce
the increasing number of home foreclosures by giving bankruptcy judges the
authority to restructure mortgages and reduce a borrower’s payments. Property
owners would be allowed to keep their property while working out their debts.
Other similar bills placing additional temporary moratoriums on foreclosure
sales or otherwise modifying foreclosure procedures to the benefit of borrowers
and the detriment of lenders may be enacted by either Congress or the States of
Alaska, Washington, Oregon, Idaho, Utah and Colorado in the future. These laws
may further restrict our collection efforts on one-to-four single-family loans.
Additional legislation proposed or under consideration in Congress would give
current debit and credit card holders the chance to opt out of an overdraft
protection program and limit overdraft fees which could result in additional
operational costs and a reduction in our non-interest income.




Our
investment in Federal Home Loan Bank stock may be impaired.





At
December 31, 2009, we owned $1.8 million of stock of the Federal Home Loan Bank
of Seattle, or FHLB.  As a condition of membership at the FHLB, we are
required to purchase and hold a certain amount of 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 Capital Plan of
the FHLB. Our FHLB stock has a par value of $100, is carried at cost, and it is
subject to recoverability testing per SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. The FHLB recently announced that it had a
risk-based capital deficiency under the regulations of the Federal Housing
Finance Agency (the "FHFA"), 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. The FHLB has communicated that it believes the
calculation of risk-based capital under the current rules of the FHFA
significantly overstates the market risk of the FHLB's private-label
mortgage-backed securities in the current market environment and that it has
enough capital to cover the risks reflected in its balance sheet. As a result,
we have not recorded an other-than-temporary impairment on our investment in
FHLB stock. However, continued deterioration in the FHLB's financial position
may result in impairment in the value of those securities. We will continue to
monitor the financial condition of the FHLB as it relates to, among other
things, the recoverability of our investment.





Continued
weak or worsening credit availability could limit our ability to replace
deposits and fund loan demand, which could adversely affect our earnings and
capital levels.





Continued weak or worsening credit
availability and the inability to obtain adequate funding to replace deposits
and fund continued loan growth may negatively affect asset growth and,
consequently, our earnings capability and capital levels. In addition to any
deposit growth, maturity of investment securities and loan payments, we rely
from time to time on advances from the FHLB to fund loans and replace deposits.
If the economy does not improve or continues to deteriorate, this additional
funding source could be negatively affected, which could limit the funds
available to us. Our liquidity position could be significantly constrained if we
are unable to access funds from the FHLB.





The
maturity and repricing characteristics of our assets and liabilities are
mismatched and subject us to interest rate risk which could adversely affect our
net earnings and economic value.


-45-





Our financial condition and operations
are influenced significantly by general economic conditions, including the
absolute level of interest rates as well as changes in interest rates and the
slope of the yield curve. Our profitability is dependent to a large extent on
our net interest income, which is the difference between the interest received
from our interest-earning assets and the interest expense incurred on our
interest-bearing liabilities. Significant changes in market interest rates or
errors or misjudgments in our interest rate risk management procedures could
have a material adverse effect on our net earnings and economic value. We
currently believe that declining interest rates will adversely affect our
near-term net earnings.





Our activities, like all financial
institutions, inherently involve the assumption of interest rate risk. Interest
rate risk is the risk that changes in market interest rates will have an adverse
impact on our earnings and underlying economic value. Interest rate risk is
determined by the maturity and repricing characteristics of our assets,
liabilities and off-balance-sheet contracts. Interest rate risk is measured by
the variability of financial performance and economic value resulting from
changes in interest rates. Interest rate risk is the primary market risk
affecting our financial performance.





We believe that the greatest source of
interest rate risk to us results from the mismatch of maturities or repricing
intervals for our rate sensitive assets, liabilities and off-balance-sheet
contracts. This mismatch or gap is generally characterized by a substantially
shorter maturity structure for interest-bearing liabilities than
interest-earning assets. Additional interest rate risk results from mismatched
repricing indices and formulae (basis risk and yield curve risk), and product
caps and floors and early repayment or withdrawal provisions (option risk),
which may be contractual or market driven, that are generally more favorable to
customers than to us.





Our primary monitoring tool for
assessing interest rate risk is asset/liability simulation modeling, which is
designed to capture the dynamics of balance sheet, interest rate and spread
movements and to quantify variations in net interest income and net market value
of equity resulting from those movements under different rate environments. We
update and prepare our simulation modeling at least quarterly for review by
senior management and our directors. We believe the data and assumptions are
realistic representations of our portfolio and possible outcomes under the
various interest rate scenarios. Nonetheless, the interest rate sensitivity of
our net interest income and net market value of our equity could vary
substantially if different assumptions were used or if actual experience differs
from the assumptions used and, as a result, our interest rate risk management
strategies may prove to be inadequate.





See Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” and “Market Risk
and Asset/Liability Management” for additional information concerning interest
rate risk.





If
external funds were not available, this could adversely impact our growth and
prospects.





We rely on deposits and advances from
the FHLB of Seattle and other borrowings to fund our operations. Although we
have historically been able to replace maturing deposits and advances if
desired, we might not be able to replace such funds in the future if our
financial condition or the financial condition of the FHLB of Seattle or market
conditions were to change. While we consider such sources of funds adequate for
our liquidity needs, we may be compelled or elect to seek additional sources of
financing in the future. Likewise, we may seek additional debt in the future to
achieve our long-term business objectives, in connection with future
acquisitions or for other reasons. Additional borrowings, if sought, may not be
available to us or, if available, may not be on reasonable terms. If additional
financing sources are unavailable or not available on reasonable terms, our
financial condition, results of operations and future prospects could be
materially adversely affected.





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




Beginning
in late 2008, the economic environment caused higher levels of bank failures,
which dramatically increased FDIC resolution costs and led to a significant
reduction in the Deposit Insurance Fund. As a result, the FDIC has significantly
increased the initial base assessment rates paid by financial institutions for
deposit insurance. The base assessment rate was increased by seven basis points
(seven cents for every $100 of deposits) for the first quarter of 2009.
Effective April 1, 2009, initial base assessment rates were changed to
range







-46-





from 12
basis points to 45 basis points across all risk categories with possible
adjustments to these rates based on certain debt-related components. These
increases in the base assessment rate have increased our deposit insurance costs
and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed
a special assessment on all insured institutions due to recent bank and savings
association failures. The emergency assessment amounts to five basis points on
each institution’s assets minus Tier 1 capital as of June 30, 2009, subject
to a maximum equal to 10 basis points times the institution’s assessment base.
Our FDIC deposit insurance expense for fiscal the year ended December 31, 2009
was $387,000, including the special assessment of $84,000 paid at the end of
September 2009. Any additional emergency special assessment imposed by the FDIC
will negatively impact our earnings.




The
loss of key members of our senior management team could adversely affect our
business.





We believe that our success depends
largely on the efforts and abilities of our senior management. Their experience
and industry contacts significantly benefit us. The competition for qualified
personnel in the financial services industry is intense, and the loss of any of
our key personnel or an inability to continue to attract, retain and motivate
key personnel could adversely affect our business. In addition, the American
Recovery and Reinvestment Act has imposed significant limitations on executive
compensation for recipients, such as us, of funds under the TARP Capital
Purchase Program, which may make it more difficult for us to retain and recruit
key personnel.





Our
real estate lending also exposes us to the risk of environmental
liabilities.




In the
course of our business, we may foreclose and take title to real estate, and we
could be subject to environmental liabilities with respect to these properties.
We may be held liable to a governmental entity or to third persons for property
damage, personal injury, investigation, and clean-up costs incurred by these
parties in connection with environmental contamination, or may be required to
investigate or clean up hazardous or toxic substances, or chemical releases at a
property. The costs associated with investigation or remediation activities
could be substantial. In addition, as the owner or former owner of a
contaminated site, we may be subject to common law claims by third parties based
on damages and costs resulting from environmental contamination emanating from
the property. If we ever become subject to significant environmental
liabilities, our business, financial condition and results of operations could
be materially and adversely affected.




Our
information systems may experience an interruption or breach in
security.





We rely heavily on communications and
information systems to conduct our business. Any failure, interruption or breach
in security of these systems could result in failures or disruptions in our
customer relationship management, general ledger, deposit, loan and other
systems. While we have policies and procedures designed to prevent or limit the
effect of the failure, interruption or security breach of our information
systems, there can be no assurance that any such failures, interruptions or
security breaches will not occur or, if they do occur, that they will be
adequately addressed. The occurrence of any failures, interruptions or security
breaches of our information systems could damage our reputation, result in a
loss of customer business, subject us to additional regulatory scrutiny, or
expose us to civil litigation and possible financial liability, any of which
could have a material adverse effect on our financial condition and results of
operations.





We
rely on dividends from Alaska Pacific Bank for most of our revenue.





Alaska Pacific is a separate and
distinct legal entity from Alaska Pacific Bank. We receive substantially all of
our revenue from dividends from Alaska Pacific Bank. These dividends are the
principal source of funds to pay dividends on our common stock. Various federal
laws and regulations limit the amount of dividends that Alaska Pacific Bank may
pay to Alaska Pacific. Also, our right to participate in a distribution of
assets upon a subsidiary’s liquidation or reorganization is subject to the prior
claims of the subsidiary’s creditors. In the event the Bank is unable to pay
dividends to Alaska Pacific, we may not be able to pay obligations or pay
dividends on Alaska Pacific’s common stock. The inability to receive dividends
from the Bank could have a material adverse effect on our business, financial
condition and results of operations. See Item 1,
“Business-Regulation.”






-47-





If
we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results or
prevent fraud, and, as a result, investors and depositors could lose confidence
in our financial reporting, which could adversely affect our business, the
trading price of our stock and our ability to attract additional
deposits.





In connection with the enactment of the
Sarbanes-Oxley Act of 2002 (“Act”) and the implementation of the rules and
regulations promulgated by the SEC, we document and evaluate our internal
control over financial reporting in order to satisfy the requirements of Section
404 of the Act. This requires us to prepare an annual management report on our
internal control over financial reporting, including among other matters,
management’s assessment of the effectiveness of internal control over financial
reporting and an attestation report by our independent auditors addressing these
assessments. If we fail to identify and correct any significant deficiencies in
the design or operating effectiveness of our internal control over financial
reporting or fail to prevent fraud, current and potential shareholders and
depositors could lose confidence in our internal controls and financial
reporting, which could adversely affect our business, financial condition and
results of operations, the trading price of our stock and our ability to attract
and retain deposits.





Item 1B. Unresolved Staff
Comments.





Not
applicable.


-48-





Item
2.  Properties





The
      following table sets forth certain information regarding Alaska Pacific’s
      offices at December 31, 2009.





Location
            Year
              Opened
            Square
              Footage
            Deposits
              (in
      thousands)Main
      Office:Nugget
      Mall Office (1)
            1984
            16,000
            $72,5382094
      Jordan AvenueJuneau,
      Alaska 99801Branch
      Offices:301
      N. Franklin Street
            1960
            6,268
            30,683Juneau,
      Alaska  99801410
      Mission Street (2)
            1974
            2,300
            14,665Ketchikan,
      Alaska  999012442
      Tongass Avenue (3)
            1997
            1,550
            7,001Ketchikan,
      Alaska 99901315
      Lincoln Street (4)
            1978
            2,032
            23,330Sitka,
      Alaska  99835Alaska
      Pacific Mortgage (5)2092
      Jordan Avenue, Suite 595
            2003
            2,500
            Non-depositoryJuneau,
      Alaska 99801


_____________


(1)
            Lease
      expires in January 2019, with one 10-year option to
  renew.


(2)
            Lease
      expires in February 2013, with option to renew for five-year
      term.


(3)
            Lease expires in
      November 2010, with two 6-month options to
  renew.


(4)
            Lease
      expires in December 2013, with option to renew for five-year
      term.


(5)
            Lease
      expires in October 2013





Alaska
Pacific maintains 11 automated teller machines including six in the Juneau area,
two in the Sitka area, two in the Ketchikan area, and one in Hoonah. At December
31, 2009, the net book value of Alaska Pacific’s properties and its fixtures,
furniture and equipment was $2.8 million.





Item 3.  Legal
Proceedings





Periodically,
there have been various claims and lawsuits involving the Bank, mainly as a
defendant, such as claims to enforce liens, condemnation proceedings on
properties in which the Bank holds security interests, claims involving the
making and servicing of real property loans and other issues incident to the
Bank’s business. The Bank is not a party to any pending legal proceedings that
it believes would have a material adverse effect on the financial condition or
operations of the Bank.





Item
4.  [Reserved]







-49-





PART
II





Item 5.Market for
Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases
of Equity Securities





The
Company’s common stock is traded on the over-the-counter market through the OTC
“Electronic Bulletin Board” under the symbol “AKPB.”  As of December
31, 2009, there were approximately 367 stockholders of record and 654,486 shares
outstanding. Generally, if the Bank satisfies its regulatory capital
requirements, it may make dividend payments up to the limits prescribed in the
OTS regulations. However, an institution that has converted to the stock form of
ownership may not declare or pay a dividend on, or repurchase any of, its common
stock if the effect thereof would cause the regulatory capital of the
institution to be reduced below the amount required for the liquidation account
which was established in connection with the institution’s mutual-to-stock
conversion.




The Bank
is restricted by the amount of dividends it may pay to the Company. It is
generally limited to the net income of the current fiscal year and that of the
two previous fiscal years, less dividends already paid during those periods.
Based on this calculation, at December 31, 2009, none of the Bank’s retained
earnings were available for dividends to the Company. However, payment of
dividends may be further restricted by the OTS if such payment would reduce the
Bank’s capital ratios below required minimums or would otherwise be considered
to adversely affect the safety and soundness of the institution.




The Bank
currently is operating under the restrictions imposed by an MOU issued by the
OTS on January 7, 2009.  Among other restrictions, the MOU
requires the Bank to: (a) submit a business plan that sets forth a plan for
maintaining Tier 1 (Core) Leverage Ratio of 8% and a minimum Total Risk-Based
Capital Ratio of 12% and provides a detailed financial forecast including
capital ratios, earnings and liquidity and containing comprehensive business
line goals and objectives; and (b) remain in compliance with the minimum capital
ratios contained in the business plan. As of December 31, 2009, the Bank’s
Tier-1 (Core) Leverage Ratio was 9.70% (1.70% over the new required minimum) and
Risk-Based Capital Ratio was 12.84%, (0.84% more than the new required minimum).
Management believes that the Bank is currently in compliance with the terms of
the MOU. For further information regarding the MOU, see Item 1A, “Risk Factors
-- Risks Related to our Business -- We are subject to the restrictions and
conditions of a Memorandum of Understanding with, and other commitments we have
made to, the Office of Thrift Supervision. Failure to comply with the Memorandum
of Understanding could result in additional enforcement action against us,
including the imposition of monetary penalties.”




The Company received $4.8 million from
the U.S. Treasury Department on February 9, 2009 as part of the Treasury’s
Capital Purchase program. The securities purchase agreement between us and
Treasury limits our ability to pay dividends on and repurchase our common stock.
The securities purchase agreement between us and Treasury provides that prior to
the earlier of (i) November 21, 2011 and (ii) the date on which all of the
shares of the Series A Preferred Stock have been redeemed by us or transferred
by Treasury to third parties, we may not, without the consent of Treasury, (a)
increase the cash dividend on our common stock or (b) subject to limited
exceptions, redeem, repurchase or otherwise acquire shares of our common stock
or preferred stock other than the Series A Preferred Stock or trust preferred
securities. In addition, we are unable to pay any dividends on our common stock
unless we are current in our dividend payments on the Series A Preferred Stock.
These restrictions, together with the potentially dilutive impact of the warrant
described in the next risk factor, could have a negative effect on the value of
our common stock. Moreover, holders of our common stock are entitled to receive
dividends only when, as and if declared by our Board of Directors. Although we
have historically paid cash dividends on our common stock, we are not required
to do so and our Board of Directors could reduce or eliminate our common stock
dividend in the future.










-50-









The
following table sets forth market price information of the Company’s stock for
2009 and 2008.




Market
      PriceYears
      Ended December 31,
            High
            Low
            Dividends2009:First
      Quarter
            $5.00
            $3.60
            $0.00Second
      Quarter
            4.50
            3.55
            0.00Third
      Quarter
            5.90
            4.01
            0.00Fourth
      Quarter
            5.80
            4.25
            0.002008:First
      Quarter
            $23.00
            $19.40
            $0.10Second
      Quarter
            22.50
            18.25
            0.10Third
      Quarter
            20.10
            13.00
            0.00Fourth
      Quarter
            15.00
            2.75
            0.00








Equity
Compensation Plan Information





The equity compensation plan
information presented under subparagraph (d) in Part III, Item 11 of this Form
10-K is incorporated herein by reference.





Issuer
Purchases of Equity Securities





During
the fourth quarter of the year ended December 31, 2009, the Company had no
purchases of its Common Stock.





Item 6.Selected
Financial Data





Not
Applicable





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




General




The
following discussion is intended to assist in understanding the consolidated
financial condition and results of operations of the Company. The Company is not
engaged in any significant business activity other than holding the stock of the
Bank. Accordingly, the information in this discussion applies primarily to the
Bank. The information contained in this section should be read in conjunction
with the consolidated financial statements and the accompanying notes included
in Item 8 of this annual report. In the following discussion, except as
otherwise noted, references to “2009” or “2008” indicate the year ended December
31, 2009 or 2008, respectively.




The
Bank’s results of operations depend primarily on its net interest income, which
is the difference between the income earned on its interest-earning assets,
consisting of loans and investments, and the cost of its interest-bearing
liabilities, consisting of deposits and FHLB borrowings. Among other things, fee
income, provisions for loan losses, operating expenses and income tax provisions
also affect the Bank’s net income. General economic and competitive conditions,
particularly changes in market interest rates, government legislation and
policies concerning monetary and fiscal affairs, housing and financial
institutions and the attendant actions of the regulatory authorities also
significantly affect the Bank’s results of operations.






-51-




Operating
Strategy




The Company’s strategy is to operate a
community-oriented financial institution devoted to serving the needs of its
customers.The Company’s business consists primarily of attracting retail
deposits from the general public and using those funds to originate residential
real estate loans, land, construction, commercial real estate loans, commercial
business loans, and a variety of consumer loans.




Financial
Condition




Total
assets were $178.3 million at December 31, 2009, compared with
$190.9 million at December 31, 2008. The $12.5 million decrease was
primarily the result of a decline in loans.




Loans
decreased $10.9 million, or 6.5%, to $158.1 million at December 31, 2009
from $169.0 million at December 31, 2008. The decrease is largely
attributable to a decrease in one-to-four family mortgage loans and commercial
business loans offset with an increase in commercial real estate
loans.





Total
commercial real estate loans increased 15.2% to $64.5 million, or 40.8% of the
portfolio at December 31, 2009, from $56.0 million, or 33.2% of the
portfolio at December 31, 2008. Land loans decreased 27.6% to $9.7 million, or
6.1% of the portfolio at December 31, 2009, from $13.4 million, or 7.9% of
the portfolio at December 31, 2008. Total commercial business loans decreased
18.4% to $19.9 million, or 12.6% of the portfolio at December 31, 2009, from
$24.4 million, or 14.5% of the portfolio at December 31, 2008.




Production
of one-to-four-family mortgage loans continued to grow in 2009. Originations
totaled $47.6 million in 2009, a 24.6% increase over the $38.2 million
originated in 2008. Most of these loans were sold in the secondary market and,
as a result, total one-to-four-family mortgages declined to 21.4% of the loan
portfolio at December 31, 2009, compared with 23.0% of the loan portfolio at
December 31, 2008.




Cash and
cash equivalents decreased $2.5 million to $6.9 million at December 31, 2009,
compared to $9.4 million at December 31, 2008.




Available-for-sale
securities decreased $600,000 to $2.6 million at December 31, 2009, compared to
$3.2 million at December 31, 2008. The decrease was the result of normal
principal reductions on mortgage-backed securities.




Premises
and equipment was $2.8 million at December 31, 2009, a
$300,000 decrease from $3.1 million at the end of 2008.




Total
deposits decreased 8.6% to $148.2 million at December 31, 2009 from $162.2
million at December 31, 2008. Money market accounts decreased a total of $4.1
million to $29.0 million at December 31, 2009 compared to $33.1 million a year
ago. During the same period, however, regular savings increased $1.6 million and
non-interest bearing demand increased $1.7 million. Certificates of deposit
decreased $14.6 million to $40.2 million at December 31, 2009.




At
December 31, 2009 and 2008, $1.7 million and $2.1 million, respectively, of the
certificates of deposit were brokered CDs obtained through the Certificate of
Deposit Account Registry Service (“CDARS”). These deposits carry interest rates
that are generally higher than locally obtained CDs, but which are generally
lower than FHLB advances. Total CDs made by a public entity under a CD program
for qualified Alaskan financial institutions amounted to $15 million at December
31, 2008. We had no CDs under this program at December 31, 2009.





FHLB
advances decreased $500,000 to $9.8 million at December 31, 2009 from $10.3
million at December 31, 2008.






-52-




Results
of Operations




Net Loss.For the year ended
December 31, 2009, the Company reported a net loss of $2.2 million, or $(3.76)
per diluted share, after recording a $2.9 million provision for loan losses and
$905,000 provision for deferred income tax benefit. This compares to a net loss
of $2.3 million, or $(3.54) per diluted share, after recording a $5.0 million
provision for loan losses, for 2008. The loss in 2009 is primarily attributable
to an increase in provision for loan loss and a decrease in net interest income.
For purposes of comparison, pre-tax income may be separated into major
components as follows:




Income
              Increase(in thousands)Year
      ended December 31,
            2009
            
            2008
            
            (Decrease)Net
      interest income
            $8,322
            
            $8,760
            
            $(438
            )Gain
      on sale of loans
            712
            
            251
            
            461Other
      noninterest income
            1,172
            
            1,091
            
            81Net
      revenues
            10,206
            
            10,102
            
            104Noninterest
      expense
            (9,432
            )
            (8,791
            )
            (641
            )Subtotal
            774
            
            1,311
            
            (537
            )Provision
      for loan losses
            (2,947
            )
            (5,034
            )
            2,087Income
      (loss) before income tax
            $(2,173
            )
            $(3,723
            )
            $1,550







Net Interest Income.Net
interest income decreased $500,000, or 5.7%, to $8.3 million in 2009 from
$8.8 million in 2008. The decrease is due to a combination of factors,
including nonaccrual loans and decline in averages balances. See the tables in
“Average Balances, Interest and Average Yields/Cost” and in “Rate/Volume
Analysis” elsewhere in this discussion. The net interest margin on average
earning assets was 4.86% for 2009 compared with 4.76% in 2008 reflecting the
decrease in interest earning assets offset with a more rapid decline in cost of
funds than yield on earning assets as a result of the rapid drop in interest
rates. Nonaccrual loans were $2.9 million and $6.1 million at December 31, 2009
and 2008, respectively. As of December 31, 2009 and 2008, $789,000 and $665,000,
respectively, of interest would have been recorded if these loans had been
current according to their original terms and had been outstanding throughout
the year.




Average
loans (including held for sale) decreased $8.9 million, or 5.1%, to
$165.8 million in 2009 from $174.7 million in 2008. The net interest margin
on average interest-earning assets increased 100 basis points to 4.86% in 2009
from 4.76% in 2008.




Noninterest Income.The gain
on sale of loans increased $461,000 to $712,000 in 2009 from $251,000 in 2008 as
a result of a decline in brokered loan income and gain on sale of loans
origination fees/costs.




Excluding
mortgage banking income, noninterest income increased $81,000, or 7.4%, to $1.2
million in 2009 compared with $1.1 million in 2008. The increase is primarily in
document preparation fee income. Additionally, non-recurring income of $56,000
was recognized in 2008 from the cash proceeds received on shares redeemed
associated with the Company’s ownership in VISA and VISA’s initial public
offering and business combination.







Noninterest Expense.Noninterest expense increased $641,000, or 7.3%, to $9.4 million in 2009
from $8.8 million in 2008. The net increase in expense is attributable to higher
repossessed asset expense and an increase in FDIC assessments.






Income Tax. During the fourth quarter of 2009,
the Company recorded a valuation allowance of $905,000 against its net deferred
tax asset of $1.3 million due to uncertainty about the Company’s ability to
generate sufficient taxable income in the near term; the valuation allowance of
$905,000 had the effect of increasing the provision for income taxes in
2009.  There was no prior valuation allowance recorded.  The
Company will not be able to recognize the tax benefits on future losses until it
can show that it is more likely than not that it will generate enough taxable
income in future periods to realize the benefits of its deferred tax asset and
loss carryforwards.  Management believes it is more likely than not
that these tax benefits will be realized which would result in a reversal of the
deferred tax valuation allowance.






-53-


Provision
and Allowance for Loan Losses
  Provisions
for loan losses are charges to earnings to bring the total allowance for loan
losses to a level considered by management to be adequate to provide for known
and inherent risks in the loan portfolio, including management's continuing
analysis of factors underlying the quality of the loan portfolio.


The
provision for loan losses decreased $2.1 million to $2.9 million for 2009 from
$5.0 million for  2008. The provision for both years was considered
appropriate in order for the allowance for loan losses to reflect management's
best estimate of losses inherent in the loan portfolio. The allowance for loan
losses decreased $900,000, or 33.3%, to $1.8 million at December 31, 2009 from
$2.7 million at December 31, 2008. The provision and the resulting allowance are
reflective of numerous factors, including the following:




·
            Loan losses.
      Net loan charge offs were $3.8 million (2.4% of total loans) in 2009
      compared with $4.1 million (2.4% of total loans) in
  2008.




·
            Growth and composition
      of the portfolio. Total loans decreased $10.9 million to
      $158.1 million at December 31, 2009 compared with
      $169.0 million at December 31, 2008. The decline reflects
      gradual changes in the loan portfolio composition away from single-family
      mortgages, moving to a greater proportion of commercial real estate.
      Management considered the higher relative risk of these loans in assessing
      the adequacy of the allowance.




·
            Management analysis of
      loans. As part of an assessment of the adequacy of the allowance,
      management performed a detailed review of individual loans for which full
      collectibility may not be assured. Loans judged to be impaired amounted to
      $5.3 million (3.4% of total loans) at December 31, 2009, compared
      with $10.7 million (6.3% of total loans) at December 31, 2008. A
      specific allowance for estimated impairments of $514,000 and $875,000,
      respectively, was established for these
loans.




·
            Past-due Loans.
      At December 31, 2009, 2.2% of all loan balances were past due 30 days or
      more, compared with 6.1% at December 31,
2008.




·
            Nonperforming and
      classified loans. Nonaccrual loans were $2.9 million (1.8% of total
      loans) at December 31, 2009, compared with $6.1 million (3.6% of
      total loans) at December 31, 2008. Loans classified as “substandard” or
      “doubtful” were $5.3 million (3.4% of total loans) at
      December 31, 2009 compared with $8.0 million (4.7% of total
      loans) at December 31, 2008.




·
            Economic
      conditions. Management considered known economic conditions in each
      of the geographic areas in which the Bank makes loans. For the last
      several years, Southeast Alaska’s economy has been relatively “flat” but
      stable, and management knows of no current economic conditions that
      warrant expectations of significant decline in the Bank’s markets.
      However, uncertainties in both the national and local economies have been
      considered in assessing the
allowance.




The
Company’s accounting for the allowance for loan losses is its most critical
accounting process and is also the most subjective. While management believes
that it uses the best information available to determine the allowance for loan
losses, unforeseen market conditions and other events might result in adjustment
to the allowance if circumstances differ substantially from the assumptions used
in making the final determination. One or more of these events could have a
significant effect on net income, and the effect could be both material and
adverse.




For
further information on the Bank’s accounting for the allowance for loan losses
as well as how loan impairment is determined, see Note 1 of the Notes to
Consolidated Financial Statements included in Item 8 of this Form
10-K.









-54-


Average
Balances, Interest and Average Yields/Cost




The
earnings of the Company depend largely on the spread between the yield on
interest-earning assets, which consist primarily of loans and investments, and
the cost of interest-bearing liabilities, which consist primarily of deposit
accounts and borrowings, as well as the relative size of the Company’s
interest-earning assets and interest-bearing liabilities.




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 ratio of average interest-earning assets to average
interest-bearing liabilities. Average balances are generally daily averages for
the period.




(dollars
      in thousands)
              Year
      ended December 31,
            
            
            2009
            
            
            
            
            2008Average
              Balance
            
            Interest
            Average
      Yield/ Cost
            
            Average
              Balance
            
            Interest
            Average
      Yield/ CostInterest-earning
      assets:Loans
      (1)
            $165,807
            
            $10,053
            6.06
            %
            $174,655
            
            $11,838
            6.78
            %Investment
      securities (1)
            4,721
            
            126
            2.67
            
            5,336
            
            195
            3.65Interest-earning
      deposits in banks
            818
            
            5
            0.61
            
            3,984
            
            42
            1.05Total
      interest-earning assets
            171,346
            
            10,184
            5.94
            
            183,975
            
            12,075
            6.56Allowance
      for loan losses
            (2,349
            )
            
            
            
            (3,077
            )Cash
      and due from banks
            6,924
            
            
            
            
            6,940Other
      assets
            8,709
            
            
            
            
            6,942Total
      assets
            $184,630
            
            
            
            
            $194,780Interest-bearing
      liabilities:Deposits:Interest-bearing
      demand
            $  31,161
            
            $   54
            0.17
            %
            $  29,192
            
            $   93
            0.32
            %Money
      market
            30,295
            
            218
            0.72
            
            29,687
            
            545
            1.84Savings
            18,243
            
            47
            0.26
            
            16,682
            
            64
            0.38Certificates
      of deposit
            40,933
            
            1,050
            2.57
            
            53,721
            
            1,883
            3.51Total
      interest-bearing deposits
            120,632
            
            1,369
            1.13
            
            129,282
            
            2,585
            2.00Borrowings
            12,156
            
            493
            4.06
            
            14,611
            
            730
            5.00Total
      interest-bearing liabilities
            132,788
            
            1,862
            1.40
            
            143,893
            
            3,315
            2.30Noninterest-bearing
      demand deposits
            27,720
            
            
            
            
            27,447Mortgage
      escrows
            1,227
            
            
            
            
            1,261Other
      liabilities
            3,430
            
            
            
            
            4,393Shareholders’
      equity
            19,465
            
            
            
            
            17,786Total
      liabilities and shareholders’ equity
            $184,630
            
            
            
            
            $194,780Net
      interest income
            
            
            $8,322
            
            
            
            
            $8,760Interest
      rate spread
            
            
            
            4.54
            %
            
            
            
            4.26
            %Net
      interest margin:On
      average interest-earning assets
            
            
            
            4.86
            %
            
            
            
            4.76
            %On
      average total assets
            
            
            
            4.51
            
            
            
            
            4.50Ratio
      of average interest-earning assets to average interest-bearing
      liabilities
            129.04
            %
            
            
            
            127.86
            %





(1) 
      Average loans include nonperforming loans and loans held for sale.
      Interest income does not include interest on nonaccrual loans. Average
      investment
              securities includes FHLB stock.









-55-




Rate/Volume
Analysis




The
following table sets forth the effects of changing rates and volumes on net
interest income of the Company. Information is provided with respect to effects
on interest income attributable to changes in volume, which are changes in
volume multiplied by prior rate; effects on interest income attributable to
changes in rate, which are changes in rate multiplied by prior volume; and
changes in rate/volume, which is a change in rate multiplied by change in
volume.







(in
      thousands)
              Year
      ended December 31, 2009 compared with year ended 2008
            
            Rate
            
            
            Volume
            
            
            Rate/
              Volume
            
            
            TotalInterest-earning
      assets:Loans
            
            $
            (1,249
            )
            
            $
            (600
            )
            
            $
            64
            
            
            $
            (1,785
            )Investment
      securities
            
            
            (53
            )
            
            
            (22
            )
            
            
            6
            
            
            
            (69
            )Interest-earning
      deposits in banks
            
            
            (18
            )
            
            
            (33
            )
            
            
            14
            
            
            
            (37
            )Total
      net change in interest income
            
            
            (1,320
            )
            
            
            (655
            )
            
            
            84
            
            
            
            (1,891
            )Interest-bearing
      liabilities:Interest-bearing
      demand accounts
            
            
            (42
            )
            
            
            6
            
            
            
            (3
            )
            
            
            (39
            )Money
      market accounts
            
            
            (331
            )
            
            
            11
            
            
            
            (7
            )
            
            
            (327
            )Savings
      accounts
            
            
            (21
            )
            
            
            6
            
            
            
            (2
            )
            
            
            (17
            )Certificates
      of deposit
            
            
            (505
            )
            
            
            (448
            )
            
            
            120
            
            
            
            (833
            )Borrowings
            
            
            (137
            )
            
            
            (123
            )
            
            
            23
            
            
            
            (237
            )Total
      net change in interest expense
            
            
            (1,036
            )
            
            
            (548
            )
            
            
            131
            
            
            
            (1,453
            )Net
      change in net interest income
            
            $
            (284
            )
            
            $
            (107
            )
            
            $
            (47
            )
            
            $
            (438
            )















-
56 -






Yields
Earned and Rates Paid




The
following table sets forth, at the date and for the periods indicated, the
weighted average yields earned on the Company’s assets and the weighted average
interest rates paid on the Company’s liabilities, together with the net yield on
interest-earning assets.




At
              December
      31,
            
            For
      the Year Ended December 31,2009
            
            2009
            2008Weighted
      average yield on:Loans
            6.08%
            
            6.06%
            6.78%Investment
      securities
            2.12
            
            2.67
            3.65Interest-earning
      deposits in banks
            -
            
            0.61
            1.05Total
      interest-earning assets
            5.95
            
            5.94
            6.56Weighted
      average rate paid on:Interest-bearing
      demand accounts
            0.11
            
            0.17
            0.32Money
      market accounts
            0.42
            
            0.72
            1.84Savings
      accounts
            0.18
            
            0.26
            0.38Certificates
      of deposit
            2.06
            
            2.57
            3.51Total
      interest-bearing deposits
            11.24
            
            1.13
            2.00Borrowings
            3.05
            
            4.06
            5.00Total
      interest-bearing liabilities
            1.06
            
            1.40
            2.30Interest
      rate spread
            4.89
            
            4.54
            4.26Net
      interest margin on:Average
      interest-earning assets
            --
            
            4.86
            4.76Average
      total assets
            --
            
            4.51
            4.50







Liquidity
and Capital Resources




The
Bank’s primary sources of funds are deposits, proceeds from principal and
interest payments on loans and mortgage-backed securities, and FHLB advances.
While maturities and scheduled amortization of loans and mortgage-backed
securities are a predictable source of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and competition.




The
primary investing activity of the Bank has been the origination of loans,
including one- to four-family mortgages, commercial real estate loans,
commercial business loans, and consumer loans,  Deposits, FHLB
borrowings, and principal repayments on loans and mortgage-backed securities
were the primary means for funding these activities.




The Bank
must maintain an adequate level of liquidity to ensure the availability of
sufficient funds to support loan growth and deposit withdrawals, to satisfy
financial commitments and to take advantage of investment opportunities. The
Bank’s sources of funds include deposits, principal and interest payments from
loans and investments, and FHLB advances. During 2009 and 2008, the Bank used
its sources of funds primarily to fund new loans and to pay maturing
certificates and other deposit withdrawals. At December 31, 2009, the Bank had
loan commitments including unused portions of lines of credit and undisbursed
construction loans, of $15.0 million.




At
December 31, 2009, the Bank had $5,000 of net unrealized gains on investment
securities classified as available for sale, which represented 0.2% of the
amortized cost ($2.5 million) of the securities. This represented a
decrease of $5,000 compared with $10,000 of net unrealized gains at
December 31, 2008, primarily as a result of











-
57 -
 
 
 
 
 changes
in market demand. Movements in market interest rates will continue to affect the
unrealized gains and losses in these securities. However, assuming that the
securities are held to their individual dates of maturity, even in periods of
increasing market interest rates, as the securities approach their dates of
maturity, any unrealized gains or losses will begin to decrease and will
eventually be eliminated.




At December 31, 2009, certificates of
deposit amounted to $40.2 million, or 27.1% of the Bank’s total deposits,
including $23.5 million scheduled to mature by December 31, 2010. Historically,
the Bank has been able to retain a significant amount of its deposits as they
mature. Management believes it has adequate resources to fund all loan
commitments with deposits and, as needed, FHLB advances and sale of mortgage
loans, and that it can adjust the offering rates of certificates of deposits to
retain deposits in changing interest rate environments. In addition, the Bank
has available a line of credit with the FHLB generally equal to 25% of the
Bank’s total assets, or approximately $44.6 million at December 31, 2009, of
which $34.8 million was unused. At December 31, 2009, there was $9.8
million outstanding on the line of credit.




Given
these sources of liquidity and our expectations for cash needs, we believe our
sources of liquidity to be sufficient in the foreseeable future. However,
continued deterioration in the FHLB of Seattle’s financial position may result
in impairment in the value of our FHLB stock, the requirement that the Company
contribute additional funds to recapitalize the FHLB of Seattle, or a reduction
in the Company’s ability to borrow funds from the FHLB of Seattle, impairing the
Company’s ability to meet liquidity demands.





The Bank
is required to maintain specific amounts of capital pursuant to OTS
requirements. As of December 31, 2009, the Bank was in compliance with all
regulatory capital requirements that were effective as of this date with
tangible, core, and risk-based capital ratios of 9.70%, 9.70% and 12.84%,
respectively. For further information, see Note 3 of the Notes to Consolidated
Financial Statements included in Item 8 of this Form 10-K.






Recent
Accounting Pronouncements




On April
1, 2009, the FASB issued FSP FAS 141(R)-1 (codified in ASC 805), Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies. FSP FAS 141(R)-1 addresses concerns about the application
of Statement 141(R), Business
Combinations, to assets and liabilities arising from contingencies in a
business combination. Under the FSP, an acquirer is required to recognize at
fair value an asset acquired or a liability assumed in a business combination
that arises from a contingency if the acquisition-date fair value of that asset
or liability can be determined during the measurement period. If the
acquisition-date fair value cannot be determined, then the acquirer follows the
recognition criteria in Statement 54and Interpretation 145to determine whether the
contingency should be recognized as of the acquisition date or after it. Like
Statement 141(R), the FSP is effective for business combinations whose
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. FSP FAS 141(R)-1 did not have a
material impact on the Company’s financial condition or results of
operations.





On April
9, 2009, the FASB issued FSP FAS 157-4 (codified in ASC 820-10), Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.The FSP
provides additional guidance for estimating fair value of an asset or liability
in accordance with FASB Statement No. 157, Fair Value Measurements, when
the volume and level of activity for the asset or liability have significantly
decreased. FSP 157-4 also includes guidance on identifying circumstances that
indicate a transaction is not orderly. The FSP is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. The Company did not early adopt FSP 157-4 for the interim
period ended March 31, 2009. The FSP did not have a material impact on the
Company’s financial condition or results of operations.





On April
9, 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”)
28-1 (codified in ASC 825-10-50), Interim Disclosures About Fair Value
of Financial Instruments.The FSP requires disclosure about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. The FSP also amends APB Opinion No.
28, Interim Financial
Reporting, to require those disclosures in summarized financial
information at interim reporting periods. The FSP is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after










-
58 -
 
 
 
 
 March 15,
2009. The Company did not early adopt FSP 107-1 and APB 28-1 for
the interim period ended March 31, 2009.The FSP did not have a
material impact on the Company’s financial condition or results of
operations.





On April
9, 2009, the FASB issued FSP FAS 115-2 and FAS 124-2 (codified in ASC
320-10-35), Recognition and
Presentation of Other-Than-Temporary Impairments. The FSP amends the
other-than-temporary impairment guidance for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements. FSP 115-2 and 124-2 is effective for interim and annual periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. The Company did not early adopt FSP 115-2 and 124-2 for
the interim period ended March 31, 2009.The FSP did not have a
material impact on the Company’s financial condition or results of
operations.





On May
28, 2009, the FASB issued Statement No. 165, Subsequent Events (codified in ASC
855-10). ASC 855-10 is intended to establish general standards of
accounting for, and disclosure of, events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
Entities are required to disclose the date through which subsequent events were
evaluated as well as the rationale for why that date was selected. ASC 855-10 is
effective for interim and annual periods ending after June 15, 2009. The
Statementdid not
have a material impact on the Company’s financial condition or results of
operations.





On June
12, 2009, the FASB issued Statement No. 166 (codified in Accounting Standards
Update (“ASU”) 2009-16), Accounting for Transfers of
Financial Assets – an amendment of FASB Statement No. 140(“SFAS 166”).
SFAS 166 amends the derecognition guidance in Statement No. 140 and eliminates
the exemption from consolidation for qualifying special-purpose entities
(“QSPEs”). As a result, a transferor will need to evaluate all existing QSPEs to
determine whether they must now be consolidated in accordance with Statement No.
167. SFAS 166 is effective for financial asset transfers occurring after the
beginning of an entity’s first fiscal year that begins after November 15, 2009.
The Statementis not
expected to have a material impact on the Company’s financial condition or
results of operations.





On June
12, 2009, the FASB issued Statement No. 167 (codified in ASU 2009-17), Amendments to FASB Interpretation
No. 46(R)(“SFAS 167”). SFAS 167 amends the consolidation guidance
applicable to variable interest entities. The amendments will significantly
affect the overall consolidation analysis under Interpretation 46(R). SFAS 167
is effective as of the beginning of the first fiscal year that begins after
November 15, 2009. The Statementis not expected to have a
material impact on the Company’s financial condition or results of
operations.





On June
30, 2009, the FASB issued Statement No. 168 (codified in ASC 105), The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of FASB Statement No. 162. Statement No. 162 identified the
sources of accounting principles and the framework for selecting the principles
used in preparing the financial statements of nongovernmental entities that are
presented in conformity with U.S. generally accepted accounting principles
(“GAAP”). ASC 105 divides nongovernmental U.S. GAAP into the authoritative
Codification and guidance that is nonauthoritative, doing away with the previous
four-level hierarchy.  ASC 105 is effective for financial statements
issued for interim and annual periods ending after September 15, 2009. The
Statementdid not
have a material impact on the Company’s financial condition or results of
operations.





On August
28, 2009, the FASB issued ASU 2009-05, Measuring Liabilities at Fair
Value. The Update provides amendments to Subtopic 820-10, Fair Value Measurements and
Disclosures-Overall, for the fair value measurement of liabilities. ASU
2009-05 reaffirms that fair value measurement of a liability assumes a liability
is transferred to a market participant as of the measurement date. The guidance
in ASU 2009-05 is effective for the first reporting period beginning after
issuance. For the Company, ASU 2009-05 was effective on October 1, 2009. ASU 2009-05 did not have a
material impact on the Company’s financial condition or results of
operations.





On
September 30, 2009, the FASB issued ASU 2009-12, Investments in Certain Entities That
Calculate Net Asset Value per Share (or its Equivalent).The Update
provides guidance on measuring the fair value of certain alternative investments
in entities that calculate net asset value per share. The guidance applies to










-
59 -
 
 
 
 
 investments
in which (1) the fair value of the investment is not readily determinable and
(2) the investment is in an entity that has all of the attributes of an
investment company that are specified in ASC 946-10-15-2 or is in an entity that
lacks one or more of the attributes specified in ASC 946-10-15-2. The guidance
in ASU 2009-12 is effective for the first reporting period ending after December
15, 2009. For the Company, ASU 2009-12 was effective on October 1, 2009. ASU 2009-12 did not have a
material impact on the Company’s financial condition or results of
operations.





On
January 21, 2010, the FASB issued ASU 2010-06, Improving Disclosures About Fair
Value Measurements. The Update amends ASC 820, Fair Value Measurements and
Disclosures, to add new requirements for disclosures about transfers into
and out of Levels 1 and 2 and separate disclosures about purchases, sales,
issuances, and settlements relating to Level 3 measurements. It also clarifies
existing fair value disclosures about the level of disaggregation and about
inputs and valuation techniques used to measure fair values. The guidance in ASU
2010-06 is effective for the first reporting period beginning after December 15,
2009. ASU 2009-05 is
not expected to not have a material impact on the Company’s financial condition
or results of operations.






Item
7A. Quantitative and Qualitative Disclosures about Market Risk




Qualitative Analysis - Risks When
Interest Rates Change.The Bank’s profitability depends primarily on its
net interest income, which is the difference between the income it receives on
its loan and investment portfolios and its cost of funds, which consists of
interest paid on deposits and borrowings. The relative amounts of
interest-earning assets and interest-bearing liabilities also affect net
interest income. When interest-earning assets equal or exceed interest-bearing
liabilities, any positive interest rate spread will generate net interest
income. The Bank’s profitability is also affected by the level of noninterest
income and expenses. Noninterest income includes service charges and fees and
gain on sale of loans and investments. Noninterest expenses primarily include
compensation and benefits, occupancy and equipment expenses, deposit insurance
premiums and data processing expenses. General economic and competitive
conditions, particularly changes in market interest rates, government
legislation and regulation, and monetary and fiscal policies also significantly
affect the Bank’s results of operations.




Quantitative Analysis - How the Bank
Measures Its Risk of Interest Rate Changes.The Bank does not maintain a
trading account for any class of financial instrument nor does it engage in
hedging activities or purchase high-risk derivative instruments. Furthermore,
the Bank has no significant foreign currency exchange rate risk or commodity
price risk.




The Bank
has sought to reduce the exposure of its earnings to changes in market interest
rates by attempting to manage the mismatch between asset and liability
maturities and interest rates. Principal elements in achieving this objective
include increasing the interest-rate sensitivity of the Bank’s interest-earning
assets by originating for its portfolio loans with interest rates that
periodically adjust to market conditions, as well as continuing decisions to
sell fixed-rate mortgage production versus keeping them in the portfolio. The
Bank relies on retail deposits as its primary source of funds. Historically,
retail deposits, compared to brokered deposits and borrowed funds, tend to
reduce the effects of interest rate fluctuations because they generally
represent a more stable source of funds.




In order
to encourage institutions to reduce interest rate risk, the OTS adopted a rule
incorporating an interest rate risk component into its risk-based capital rules.
Using data compiled by the OTS, the Bank receives a report that measures
interest rate risk by modeling the change in net portfolio value over a variety
of interest rate scenarios. Net portfolio value is the present value of expected
cash flows from assets, liabilities and off-balance-sheet contracts. The
calculation is intended to illustrate the change in net portfolio value that
will occur upon an immediate change in interest rates of at least 200 basis
points with no effect given to any steps that management might take to counter
the effect of that interest rate movement. Under OTS regulations, an institution
with a greater than “normal” level of interest rate risk takes a deduction from
total capital for purposes of calculating its risk-based capital. The OTS,
however, has delayed the implementation of this regulation. An institution with
a











-
60 -
 
 
 
 
 
 “normal”
level of interest rate risk is defined as one whose “measured interest rate
risk” is less than 2.0%. Institutions with assets of less than $300 million
and a risk-based capital ratio of more than 12.0% are exempt. The Bank is exempt
because of its asset size and risk-based capital ratio. Based on the Bank’s
regulatory capital levels at December 31, 2009, the Bank believes that, if the
proposed regulation had been implemented at that date, the Bank’s level of
interest rate risk would not have caused it to be treated as an institution with
greater than “normal” interest rate risk.




The
following table illustrates the change in net portfolio value at December 31,
2009, based on OTS assumptions that would occur in the event of an immediate
change in interest rates, with no effect given to any steps which management
might take to counter the effect of that interest rate movement.




(dollars
      in thousands)
            
            Net
      Portfolio Value
            
            Net
      Portfolio as % of
              Portfolio
      Value of AssetsBasis
      Point (“bp”)
              Change
      in Rates
            
            Dollar
              Amount
            Dollar
              Change
      (1)
            Percent
              Change
            
            Net
      Portfolio
              Value
      Ratio (2)
            Change
      (3)300 bp
            
            $24,744
            $(2,706)
            (10)%
            
            13.36%
            (118) bp200
            
            25,820
            (1,630)
            (6)
            
            13.84
            (70)100
            
            26,737
            (713)
            (3)
            
            14.24
            (30)0
            
            27,450
            -
            -
            
            14.54
            -(50)
            
            27,787
            337
            1
            
            14.68
            14(100)
            
            26,366
            (1,084)
            (4)
            
            14.02
            (51)





(1)
            Represents
      the increase (decrease) of the estimated net portfolio value at the
      indicated change in interest rates compared to the net portfolio value
      assuming no change in interest
rates.


(2)
            Calculated
      as the estimated net portfolio value divided by the portfolio value of
      total assets.


(3)
            Calculated
      as the increase (decrease) of the net portfolio value ratio assuming the
      indicated change in interest rates over the estimated net portfolio value
      ratio assuming no change in interest
rates.





The above
table illustrates, for example, that at December 31, 2009 an instantaneous 200
basis point increase in market interest rates would reduce the Bank’s net
portfolio value by $1.6 million, or 6%, and an instantaneous 100 basis
point decrease in market interest rates would decrease the Bank’s net portfolio
value by $1.1 million.




The
following table summarizes key exposure measures for the dates indicated. They
measure the change in net portfolio value ratio for an adverse change in
interest rates of 200 basis points (“bp”) upward.




December
      31,
              2009
            September
      30,
              2009
            December
      31,
              2008Pre-shock
      net portfolio
              value ratio
            14.54%
            14.08%
            12.32%Post-shock
      net portfolio
              value ratio
            13.84%
            13.55%
            11.81%Decline
      in net portfolio
              value ratio
            70
      bp
            53
      bp
            51
      bp





These
measures indicate a relatively low level of interest-rate risk at the present
time. Among other factors, this is attributable to management’s decisions in
recent years to affect a relative decrease in fixed-rate mortgages and a gradual
shift to earning assets that tend to reprice with greater
frequency.




The OTS
uses certain assumptions in assessing the interest rate risk of thrift
institutions. These assumptions relate to interest rates, loan prepayment rates,
deposit decay rates, and the market values of certain assets under differing
interest rate scenarios, among others. As with any method of measuring interest
rate risk, certain shortcomings are inherent in the method of analysis presented
in the foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in













-
61 -
 
 
 
 
 
 different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate mortgage
loans, have features that restrict changes in interest rates on a short-term
basis and over the life of the asset. Further, in the event of a change in
interest rates, expected rates of prepayments on loans and early withdrawals
from certificates of deposit could deviate significantly from those assumed in
calculating the table.














- 62 -





Item 8. Financial Statements
and Supplementary Data








Index
to Consolidated Financial Statements





Page
    No.Report of
      Independent Registered Public Accounting Firm
              
              64Consolidated
      Balance Sheets as of December 31, 2009 and 2008
              
              65Consolidated
      Statements of Operations For the Years EndedDecember
      31, 2009 and 2008
              
              66Consolidated
      Statements of Changes in Shareholders’ Equity and Comprehensive Income
      (Loss) For theYears Ended December 31, 2009 and 2008
              
              67Consolidated
      Statements of Cash Flows For the Years EndedDecember 31, 2009 and 2008
              
              68Notes to
      Consolidated Financial Statements
              
              70














- 63 -





REPORT
OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM








To the
Board of Directors and Shareholders


Alaska
Pacific Bancshares, Inc.


Juneau,
Alaska





We have
audited the accompanying consolidated balance sheets of Alaska Pacific
Bancshares, Inc. and Subsidiary (the “Company”) as of December 31, 2008 and
2007, and the related consolidated statements of operations, changes in
shareholder’s equity, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Alaska Pacific
Bancshares, Inc. and subsidiary as of December 31, 2008 and 2007, and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.








/s/Moss
Adams LLP





Spokane,
Washington


March 30, 2009









- 64 -


Alaska Pacific Bancshares,
Inc. and Subsidiary


Consolidated
Balance Sheets




(dollars in thousands)
      December 31,
            2009
            
            2008AssetsCash
      and due from banks
            $   6,273
            
            $   6,344Interest-earning
      deposits in banks
            669
            
            3,058Total
      cash and cash equivalents
            6,942
            
            9,402Investment
      securities available for sale, at fair value (amortized cost:
              2009 - $2,536; 2008 - $3,233)
            2,606
            
            3,243Federal
      Home Loan Bank stock, at cost
            1,784
            
            1,784Loans
      held for sale
            55
            
            2,586Loans
            158,108
            
            168,982Less
      allowance for loan losses
            (1,786
            )
            (2,688
            )Loans,
      net
            156,322
            
            166,294Accrued
      interest receivable
            698
            
            822Premises
      and equipment, net
            2,816
            
            3,122Repossessed
      assets
            2,598
            
            408Other
      assets
            4,487
            
            3,190Total
      Assets
            $178,308
            
            $190,851





Liabilities
      and Shareholders’ EquityDeposits:Noninterest-bearing
      demand
            $  27,416
            
            $  25,707Interest-bearing
      demand
            32,474
            
            31,042Money
      market
            28,982
            
            33,072Savings
            19,170
            
            17,536Certificates
      of deposit
            40,175
            
            54,818Total
      deposits
            148,217
            
            162,175Federal
      Home Loan Bank advances
            9,834
            
            10,320Advance
      payments by borrowers for taxes and insurance
            751
            
            733Accounts
      payable and accrued expenses
            379
            
            480Accrued
      interest payable
            307
            
            449Other
      liabilities
            140
            
            411Total
      liabilities
            159,628
            
            174,568Commitments
      and contingencies (Note 14)Shareholders’
      Equity:Preferred
      stock ($0.01 par value; 1,000,000 shares authorized; Series A –
              Liquidation
      preference$1,000
      per share, 4,781 and –0- shares issued and
              outstanding
      at December 31, 2009 andDecember
      31, 2008, respectively)
            4,497
            
            -Common
      stock ($0.01 par value; 20,000,000 shares authorized; 655,415
              shares
      issued;654,486
      shares outstanding at December 31, 2009 and at
              December 31,
      2008)
            7
            
            7Additional
      paid-in capital
            6,446
            
            6,121Treasury
      stock
            (11
            )
            (11
            )Retained
      earnings
            7,699
            
            10,161Accumulated
      other comprehensive income
            42
            
            5Total
      shareholders’ equity
            18,680
            
            16,283Total
      Liabilities and Shareholders’ Equity
            $178,308
            
            $190,851See
      notes to consolidated financial statements.







- 65 -


Alaska
Pacific Bancshares, Inc. and Subsidiary


Consolidated
Statements of Operations








(in thousands, except per
      share) Year ended December 31,
            2009
            
            2008Interest
      IncomeLoans,
      including fees
            $10,053
            
            $11,838Investment
      securities
            126
            
            195Interest-earning
      deposits in banks
            5
            
            42Total
      interest income
            10,184
            
            12,075Interest
      ExpenseDeposits
            1,369
            
            2,585Federal
      Home Loan Bank advances
            493
            
            730Total
      interest expense
            1,862
            
            3,315Net
      Interest Income
            8,322
            
            8,760Provision
      for loan losses
            2,947
            
            5,034Net
      interest income after provision for loan losses
            5,375
            
            3,726Noninterest
      IncomeMortgage
      servicing income
            186
            
            161Service
      charges on deposit accounts
            729
            
            709Other
      service charges and fees
            257
            
            165Gain
      on sale of loans
            712
            
            251Other
      noninterest income
            -
            
            56Total
      noninterest income
            1,884
            
            1,342Noninterest
      ExpenseCompensation
      and benefits
            4,696
            
            4,871Occupancy
      and equipment
            1,393
            
            1,537Data
      processing
            258
            
            255Professional
      and consulting fees
            541
            
            487Marketing
      and public relations
            268
            
            317Repossessed
      property, net
            235
            
            116Loss
      on sale or impairment of repossessed assets
            503
            
            -Other
            1,538
            
            1,208Total
      noninterest expense
            9,432
            
            8,791Loss
      before income tax
            (2,173
            )
            (3,723
            )Expense
      (Benefit) for income tax
            18
            
            (1,405
            )Net
      Loss
            $
      (2,191
            )
            $
      (2,318
            )Preferred
      stock dividend and discount accretionPreferred
      stock dividend
            $     216
            
            $          -Preferred
      stock discount accretion
            55
            
            -Net
      loss available to common shareholders
            $
      (2,462
            )
            $
      (2,318
            )Net
      loss per share:Basic
            $(3.76
            )
            $(3.54
            )Diluted
            (3.76
            )
            (3.54
            )See
      notes to consolidated financial statements.







- 66 -


Alaska
Pacific Bancshares, Inc. and Subsidiary


Consolidated
Statements of Changes in Shareholders’ Equity and Comprehensive Loss





(in
      thousands)
              Preferred
      Stock
              Common
                Stock
              Additional
                Paid-In
                Capital
              
              Treasury
                Stock
              
              Unearned
                ESOP
                Shares
              Retained
                Earnings
              
              Accumulated
      Other Comprehensive Income (Loss)
              TotalShare-holders’
      EquityBalance,
      January 1, 2008
              $-
              $7
              $6,067
              
              $(30
              )
              $(41)
              $12,675
              
              $(9)
              $18,669Net loss
              
              
              
              
              
              
              
              (2,318
              )
              
              (2,318
              )Other comprehensive income:Change
      in net unrealized losses on
                securities available for sale, net of
                related
      income tax effect
              
              
              
              
              
              
              
              
              
              14
              14Comprehensive
    loss
              
              
              
              
              
              
              
              
              
              
              (2,304
              )Exercise of stock options
              
              
              (4
              )
              19
              
              
              
              
              
              15Excess tax benefits from share-based payment arrangements
              
              
              7
              
              
              
              
              
              
              
              7ESOP shares earned
              
              
              25
              
              
              
              41
              
              
              
              66Stock compensation expense
              
              
              26
              
              
              
              
              
              
              
              26Cash dividends on common stock ($0.30 per share)
              
              
              
              
              
              
              
              (196
              )
              
              (196
              )Balance, December 31, 2008
              -
              7
              6,121
              
              (11
              )
              -
              10,161
              
              5
              16,283Net loss
              
              
              
              
              
              
              
              (2,191
              )
              
              (2,191
              )Other comprehensive income:Change in net unrealized gains on
                securities
      available for sale, net of
                related income tax effect
              
              
              
              
              
              
              
              
              
              37
              37Comprehensive
      loss
              
              
              
              
              
              
              
              
              
              
              (2,154
              )Stock compensation expense
              
              
              27
              
              
              
              
              
              
              
              27Issuance of preferred stock to U.S. Treasury
              4,442
              
              
              
              
              
              
              
              
              
              4,442Issuance of common stock warrants to U.S.
                Treasury
              
              
              339
              
              
              
              
              
              
              
              339Accretion of preferred stock discount
              55
              
              
              
              
              
              
              (55
              )Preferred stock issuance costs
              
              
              (41
              )
              
              
              
              
              
              
              (41
              )Cash dividends on preferred stock
              
              
              
              
              
              
              
              (216
              )
              
              (216
              )Balance,
      December 31, 2009
              $4,497
              $7
              $6,446
              
              $(11
              )
              $-
              $7,699
              
              $42
              $18,680
   See
      notes to consolidated financial statements.








-
67 -






Alaska
Pacific Bancshares, Inc. and Subsidiary


Consolidated
Statements of Cash Flows





(in thousands) Year
      ended December 31,
            2009
            
            2008Operating
      ActivitiesNet
      loss
            $(2,191
            )
            $(2,318
            )Adjustments
      to reconcile net loss to net cash provided by
              operating activities:Provision
      for loan losses
            2,947
            
            5,034Provision
      for income tax benefit
            905
            
            -Gain
      on sale of loans
            (712
            )
            (251
            )Depreciation
      and amortization
            335
            
            462Deferred
      income tax benefit
            (421
            )
            (513
            )Amortization
      of fees, discounts, and premiums, net
            (201
            )
            (326
            )ESOP
      expense
            -
            
            66Stock
      compensation expense
            27
            
            26Loans
      originated for sale
            (43,260
            )
            (16,816
            )Proceeds
      from sale of loans originated for sale
            46,503
            
            17,401Excess
      tax benefits from share-based payments arrangements
            -
            
            (7
            )Loss
      on sale or impairment of repossessed assets
            503
            
            -Cash
      provided by (used in) changes in operating assets and
      liabilities:Accrued
      interest receivable
            124
            
            156Other
      assets
            (1,804
            )
            (1,060
            )Advance
      payments by borrowers for taxes and insurance
            18
            
            2Accrued
      interest payable
            (142
            )
            (219
            )Accounts
      payable and accrued expenses
            (101
            )
            (54
            )Other
      liabilities
            (302
            )
            (19
            )Net
      cash provided by operating activities
            2,228
            
            1,564Investing
      ActivitiesMaturities
      and principal repayments of investment securities
              available for sale
            687
            
            681Loan
      originations, net of principal repayments
            3,728
            
            (8,007
            )Purchase
      of premises and equipment
            (29
            )
            (148
            )Proceeds
      from sale of repossessed assets
            815
            
            334Net
      cash used in investing activities
            (5,201
            )
            (7,140
            )Financing
      ActivitiesCash
      dividends paid on preferred stock
            (185
            )
            -Cash
      dividends paid on common stock
            -
            
            (196
            )Proceeds
      from issuance of preferred stock and common stock warrants
            4,781
            
            -Stock
      issuance costs paid
            (41
            )
            -     -
68 -
    Net
      decrease in Federal Home Loan Bank advances
            (486
            )
            (6,756
            )Net
      increase in demand and savings deposits
            685
            
            5,714Net
      increase (decrease) in certificates of deposit
            (14,643
            )
            7,094Excess
      tax benefits from share-based payments arrangements
            -
            
            7Proceeds
      from exercise of stock options
            -
            
            15Net
      cash provided by (used in) financing activities
            (9,889
            )
            5,878Increase
      (decrease) in cash and cash equivalents
            (2,460
            )
            302Cash
      and cash equivalents at beginning of year
            9,402
            
            9,100Cash
      and cash equivalents at end of year
            $6,942
            
            $9,402Supplemental
      information:Cash
      paid for interest
            $
      2,004
            
            $
      3,534Cash
      paid for (received from) income taxes
            (9
            )
            344Loans
      repossessed and transferred to repossessed assets
            3,508
            
            742Net
      change in unrealized gains and losses on securities available for sale,
      net of tax
            37
            
            14See
      notes to consolidated financial statements.







- 69 -







Alaska Pacific Bancshares, Inc. and
Subsidiary


Notes to
Consolidated Financial Statements


December
31, 2009 and 2008





Note
1 – Summary of Significant Accounting Policies




General:  The
accompanying consolidated financial statements include the accounts of Alaska
Pacific Bancshares, Inc. (the “Company”) and its wholly owned subsidiary, Alaska
Pacific Bank (the “Bank”). The Company and the Bank are collectively referred to
as the “Company.” All significant intercompany transactions have been eliminated
in consolidation.




The
Company was formed in 1999 when the Bank converted from a federally chartered
mutual savings bank to a federally chartered stock savings bank, issuing 655,415
shares in a subscription and community offering.  Concurrent with the
conversion, the Bank changed its name from Alaska Federal Savings Bank to Alaska
Pacific Bank.




The Bank
provides a range of financial services to individuals and small businesses in
Southeast Alaska. The Bank’s financial services include accepting deposits from
the general public and making residential and commercial real estate loans,
consumer loans, and commercial loans. The Bank also originates, sells, and
services residential mortgage loans under several federal and state
mortgage-lending programs.




Subsequent
Events:  The Company has evaluated subsequent events andthere were no additional
events requiring disclosure.





Cash and Cash
Equivalents:  Cash equivalents are any highly liquid investment
with a remaining maturity of three months or less at the date of
purchase. The Company has cash and cash equivalents on deposit with other
banks and financial institutions in amounts that periodically exceed the federal
insurance limit. The Company evaluates the credit quality of these banks
and financial institutions to mitigate its credit risk.




Investment
Securities:  Securities available for sale, including
mortgage-backed and related securities, are carried at fair value with
unrealized gains and losses excluded from earnings and reported in a separate
component of equity. Any security that management determines may not be held to
maturity is classified as available for sale at the time the security is
acquired. Any gains and losses realized on the sale of these securities are
based on the specific identification method and included in
earnings.




Purchase
discounts and premiums on investment securities are amortized using the level
yield method.




Prior to
the adoption of the recent accounting guidance on April 1, 2009, management
considered in determining whether other-than-temporary impairment exits, (1) the
length of time and the extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and (3) the
intent and ability of the Corporation to retain its investment in the issuer for
a period of time sufficient to allow for any anticipated recovery in fair
value.




For
equity securities, when the Company has decided to sell an impaired
available-for-sale security and the entity does not expect the fair value of the
security to fully recover before the expected time of sale, the security is
deemed other-than-temporarily impaired in the period of which the decision to
sell is made. The Company recognizes an impairment loss when the impairment is
deemed other than temporary even if a decision to sell has not been
made.




Loans:  Loans
are reported at the principal amount outstanding, adjusted for net deferred loan
fees and costs and other unamortized premiums or discounts.




Interest
is accrued as earned unless management doubts the collectability of the loan or
the unpaid interest. Interest accrual is generally discontinued and loans are
transferred to nonaccrual status when they become 90 days past due or earlier if
the loan is impaired and collection is considered doubtful. All previously
accrued but uncollected interest is











-
70 -








deducted
from interest income upon transfer to nonaccrual status. Income from nonaccrual
loans is recorded only when interest payments are received.




Loans or
portions of loans are charged off against the allowance for loan losses when
considered uncollectible. Prior to charging a loan off, a loss allowance may be
recognized on impaired loans for an estimated probable loss.




Loan
origination fees and direct loan origination costs are deferred and recognized
as an adjustment to interest income over the contractual life of the loan using
the level yield method. When loans are sold, the related net unamortized loan
fees and costs are included in the determination of the gain on sale of
loans.




Loans Held for
Sale:  Loans held for sale consist primarily of residential
mortgage loans and are individually valued at the lower of cost or market. Loans
are recorded as sold when the loan documents are sent to the investor. Net
unrealized losses, if any, are recognized through a valuation allowance by
charges to income.




Allowance for Loan
Losses:  The allowance for loan losses is maintained at a level
believed to be sufficient to absorb losses probable and inherent in the loan
portfolio. Management’s determination of the adequacy of the allowance is based
on a number of factors, including the level of nonperforming loans, loan loss
experience, collateral values, a review of the credit quality of the loan
portfolio, and current economic conditions. Loans are categorized as either
pass-graded or problem-graded based on periodic reviews of the loan portfolio.
The allowance is evaluated quarterly based on an estimated range of probable
loss comprised of two elements:




General
component:  The general allowance component is calculated by
loan category as a range of estimated loss by applying various loss factors to
pass-graded outstanding loans. The loss factors are based primarily on industry
loss statistics, adjusted for the Bank’s historical loss experience and other
significant factors that, in management’s judgment, affect the collectability of
the portfolio as of the evaluation date.




Specific
component:The specific allowance component is established in
cases where management has identified conditions or circumstances related to a
problem-graded loan that management believes indicate a probable
loss.  A range of estimated loss is established for each such
loan.




Loans are
deemed to be impaired when management determines that it is probable that all
amounts due under the contractual terms of the loan agreements will not be
collectible in accordance with the original loan agreement. All problem-graded
loans are evaluated for impairment. Impairment is measured by comparing the fair
value of the collateral or present value of future cash flows to the recorded
investment in the loan. Impaired loans include loans modified in troubled debt
restructurings where concessions have been granted to borrowers experiencing
financial difficulties. These concessions could include a reduction in the
interest rate on the loan, payment extensions, forgiveness of principal,
forbearance or other actions intended to maximize collection.




Mortgage Servicing
Rights:  Mortgage servicing rights are stated at amortized
cost. Cost is amortized in proportion to, and over the period of, future
expected net servicing income. Mortgage servicing rights are assessed for
impairment based on the fair value of those rights and any impairment is
recognized through a valuation allowance. In assessing impairment, the mortgage
servicing rights are stratified based on the nature and risk characteristics,
including coupon rates, of the underlying loans which, at December 31, 2009 and
2008, consisted primarily of one- to four-family residential mortgage
loans.




Premises and
Equipment:  Bank premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the
assets:  20 to 50 years for buildings, five to 10 years for leasehold
improvements depending on lease term, and three to 10 years for furniture and
equipment. Expenditures for improvements and major renewals are capitalized and
ordinary maintenance and repairs are charged to operations as
incurred.




Long-lived
assets are assessed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In
performing the review for recoverability, estimated future cash flows











-
71 -








expected
to result from the use of the asset and its eventual disposition are compared
with the carrying value, and a direct writedown is recorded for the amount of
impairment, if any.




Repossessed
Assets:  Real estate or other collateral acquired in
satisfaction of a loan is initially recorded in repossessed assets at the lower
of cost or estimated fair value less estimated selling costs, with any
difference from the loan balance charged to the allowance for loan losses.
Subsequent changes in estimated fair value result in writing down the
properties, directly or through valuation accounts. Such writedowns and gains
and losses on disposal, as well as operating income and costs incurred during
the period of ownership, are recognized currently in noninterest
expense.




Federal Home Loan Bank
Stock:  The Bank’s investment in Federal Home Loan Bank of
Seattle (“FHLB”) stock is carried at cost because there is no active market for
the stock. As a member of the FHLB system, the Bank is required to maintain a
minimum level of investment in FHLB stock based on specified percentages of its
outstanding mortgages, total assets or FHLB advances. The Bank’s minimum
investment requirement was approximately $491,200 and $361,200 at December 31,
2009 and 2008, respectively. The Bank may request redemption at par value on any
stock in excess of the amount the Bank is required to hold. Stock redemptions
are granted at the discretion of the FHLB. This security is reported at par
value, which represents the Company’s cost. Management reviews for impairment
based on the ultimate recoverability of the cost basis in the FHLB
stock.





Management
periodically evaluates FHLB stock for other-than-temporary or permanent
impairment. Management’s determination of whether these investments are
impaired is based on its assessment of the ultimate recoverability of cost
rather than by recognizing temporary declines in value. The determination
of whether a decline affects the ultimate recoverability of cost is influenced
by criteria such as (1) the significance of any decline in net assets of the
FHLB as compared to the capital stock amount for the FHLB and the length of time
this situation has persisted, (2) commitments by the FHLB to make payments
required by law or regulation and the level of such payments in relation to the
operating performance of the FHLB, (3) the impact of legislative and regulatory
changes on institutions and, accordingly, the customer base of the FHLB, and (4)
the liquidity position of the FHLB. As of December 31, 2009, management has
concluded that our investment in FHLB stock is not impaired.





Advertising
Expense:  Advertising costs are expensed as incurred.
Advertising expense was $185,000 and $200,000 for the years ended December 31,
2009 and 2008, respectively.




Income
Tax:  The Company accounts for income tax using the asset and
liability method. The asset and liability method recognizes the amount of tax
payable at the date of the financial statements as a result of all events that
have been recognized in the financial statements, as measured by the provisions
of current enacted tax laws and rates. Net deferred tax assets are evaluated and
reduced through a valuation allowance to the extent that it is more likely than
not, those assets will not be fully recovered in the future.




Treasury
Stock:  Treasury stock is accounted for on the basis of average
cost, or $12.375 per share at December 31, 2009 and 2008.




Employee Stock Ownership
Plan:  Compensation expense under the Company’s Employee Stock
Ownership Plan (“ESOP”) is based upon the number of shares allocated to
employees each year multiplied by the average share price for the year. Expense
is reduced by the amount of dividends paid on unallocated shares.  In
computing earnings per share, shares outstanding are reduced by shares held by
the ESOP that have not yet been allocated to employees.




Stock Option
Plan:  The Company accounts for its stock option plans in
accordance with the provisions of FASB Accounting Standards Codification 718,
Stock Compensation which establishes accounting and disclosure requirements
using a fair-value-based method of accounting for stock-based employee
compensation plans and requires that the compensation cost relating to
share-based payment transactions such as stock options be recognized in the
Company’s financial statements over the period the options are earned by
employees. The adoption of this standard using the modified prospective method,
resulted in $27,000 and $26,000 of compensation expense for the years ended
December 31, 2009 and 2008, respectively.




- 72 -





Fair Value
Measurements:  FASB Accounting Standards Codification 820, Fair
Value Measurements and Disclosures, defines fair value as 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 standard
establishes a consistent framework for measuring fair value and disclosure
requirements about fair value measurements. The standards require the Company to
maximize the use of observable inputs and minimize the use of unobservable
inputs when measuring fair value. Observable inputs reflect market data
obtained from independent sources, while unobservable inputs reflect the
Company’s market assumptions. These two types of inputs create the
following fair value hierarchy:





Level 1 -
Unadjusted quoted prices for identical instruments in active
markets;





Level 2 -
Quoted prices for similar instruments in active markets; quoted prices for
identical or similar instruments in markets that are not active; and
model-derived valuations whose inputs are observable or whose significant value
drivers are observable; and





Level 3 -
Instruments whose significant value drivers are unobservable.





A
financial instrument’s level within the fair value hierarchy is based on the
lowest level of input that is significant to the fair value
measurement.





Use of
Estimates:  The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Material estimates that
are particularly susceptible to change in the near term relate to the
determination of the allowance for loan losses, fair value of assets carried at
fair value, deferred income taxes, and useful lives for depreciation of premises
and equipment. Actual results could differ from these estimates.




Statement of Cash
Flows:  The statement of cash flows has been prepared using the
“indirect” method for presenting cash flows from operating activities. For
purposes of this statement, cash and cash equivalents include cash and due from
banks and interest-bearing deposits with banks.




Segment
Reporting:  The Company has identified a single segment at the
entity-wide level used by senior management to make operating
decisions.




Recent Accounting
Pronouncements:Significant recent accounting pronouncements
are described below.




On April
1, 2009, the FASB issued FSP FAS 141(R)-1 (codified in ASC 805), Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies. FSP FAS 141(R)-1 addresses concerns about the application
of Statement 141(R), Business
Combinations, to assets and liabilities arising from contingencies in a
business combination. Under the FSP, an acquirer is required to recognize at
fair value an asset acquired or a liability assumed in a business combination
that arises from a contingency if the acquisition-date fair value of that asset
or liability can be determined during the measurement period. If the
acquisition-date fair value cannot be determined, then the acquirer follows the
recognition criteria in Statement 54and Interpretation 145to determine whether the
contingency should be recognized as of the acquisition date or after it. Like
Statement 141(R), the FSP is effective for business combinations whose
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. FSP FAS 141(R)-1 did not have a
material impact on the Company’s financial condition or results of
operations.





On April
9, 2009, the FASB issued FSP FAS 157-4 (codified in ASC 820-10), Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.The FSP
provides additional guidance for estimating fair value of an asset or liability
in accordance with FASB Statement No. 157, Fair Value Measurements, when
the volume and level of activity for the asset or liability have significantly
decreased. FSP 157-4 also includes guidance on identifying circumstances that
indicate a











-
73 -
 
 
 
 
 
 transaction
is not orderly. The FSP is effective for interim and annual periods ending after
June 15, 2009, with early adoption permitted for periods ending after March 15,
2009.  The Company did not early adopt FSP 157-4 for the interim
period ended March 31, 2009. The FSP did not have a material impact on the
Company’s financial condition or results of
operations.





On April
9, 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”)
28-1 (codified in ASC 825-10-50), Interim Disclosures About Fair Value
of Financial Instruments.The FSP requires disclosure about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. The FSP also amends APB Opinion No.
28, Interim Financial
Reporting, to require those disclosures in summarized financial
information at interim reporting periods. The FSP is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. The Company did not early adopt FSP 107-1 and APB 28-1 for
the interim period ended March 31, 2009.The FSP did not have a
material impact on the Company’s financial condition or results of
operations.





On April
9, 2009, the FASB issued FSP FAS 115-2 and FAS 124-2 (codified in ASC
320-10-35), Recognition and
Presentation of Other-Than-Temporary Impairments. The FSP amends the
other-than-temporary impairment guidance for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements. FSP 115-2 and 124-2 is effective for interim and annual periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. The Company did not early adopt FSP 115-2 and 124-2 for
the interim period ended March 31, 2009.The FSP did not have a
material impact on the Company’s financial condition or results of
operations.





On May
28, 2009, the FASB issued Statement No. 165, Subsequent Events(codified
in ASC 855-10).  ASC 855-10 is intended to establish general standards
of accounting for, and disclosure of, events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
Entities are required to disclose the date through which subsequent events were
evaluated as well as the rationale for why that date was selected. ASC 855-10 is
effective for interim and annual periods ending after June 15, 2009. The
Statementdid not
have a material impact on the Company’s financial condition or results of
operations.





On June
12, 2009, the FASB issued Statement No. 166 (codified in Accounting Standards
Update (“ASU”) 2009-16), Accounting for Transfers of
Financial Assets – an amendment of FASB Statement No. 140(“SFAS
166”).  SFAS 166 amends the derecognition guidance in Statement No.
140 and eliminates the exemption from consolidation for qualifying
special-purpose entities (“QSPEs”). As a result, a transferor will need to
evaluate all existing QSPEs to determine whether they must now be consolidated
in accordance with Statement No. 167. SFAS 166 is effective for financial asset
transfers occurring after the beginning of an entity’s first fiscal year that
begins after November 15, 2009.  The Statementis not expected to have a
material impact on the Company’s financial condition or results of
operations.





On June
12, 2009, the FASB issued Statement No. 167 (codified in ASU 2009-17), Amendments to FASB Interpretation
No. 46(R)(“SFAS 167”). SFAS 167 amends the consolidation guidance
applicable to variable interest entities. The amendments will significantly
affect the overall consolidation analysis under Interpretation
46(R).  SFAS 167 is effective as of the beginning of the first fiscal
year that begins after November 15, 2009. The Statementis not expected to have a
material impact on the Company’s financial condition or results of
operations.





On June
30, 2009, the FASB issued Statement No. 168 (codified in ASC 105), The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of FASB Statement No. 162. Statement No. 162 identified the
sources of accounting principles and the framework for selecting the principles
used in preparing the financial statements of nongovernmental entities that are
presented in conformity with U.S. generally accepted accounting principles
(“GAAP”). ASC 105 divides nongovernmental U.S. GAAP into the authoritative
Codification and guidance that is nonauthoritative, doing away with the previous
four-level hierarchy.  ASC 105 is effective for financial statements
issued for interim and annual periods ending after September 15, 2009. The
Statementdid not
have a material impact on the Company’s financial condition or results of
operations.





On August
28, 2009, the FASB issued ASU 2009-05, Measuring Liabilities at Fair
Value.The
Update provides amendments to Subtopic 820-10, Fair Value Measurements and
Disclosures-Overall, for the fair value










-
74 -
 
 
 
 
 measurement
of liabilities. ASU 2009-05 reaffirms that fair value measurement of a liability
assumes a liability is transferred to a market participant as of the measurement
date. The guidance in ASU 2009-05 is effective for the first reporting period
beginning after issuance. For the Company, ASU 2009-05 was effective on October
1, 2009. ASU 2009-05
did not have a material impact on the Company’s financial condition or results
of operations.





On
September 30, 2009, the FASB issued ASU 2009-12, Investments in Certain Entities That
Calculate Net Asset Value per Share (or its Equivalent).The Update
provides guidance on measuring the fair value of certain alternative investments
in entities that calculate net asset value per share. The guidance applies to
investments in which (1) the fair value of the investment is not readily
determinable and (2) the investment is in an entity that has all of the
attributes of an investment company that are specified in ASC 946-10-15-2 or is
in an entity that lacks one or more of the attributes specified in ASC
946-10-15-2. The guidance in ASU 2009-12 is effective for the first reporting
period ending after December 15, 2009.  For the Company, ASU 2009-12
was effective on October 1, 2009. ASU 2009-12 did not have a
material impact on the Company’s financial condition or results of
operations.





On
January 21, 2010, the FASB issued ASU 2010-06, Improving Disclosures About Fair
Value Measurements.The Update amends ASC
820, Fair Value Measurements
and Disclosures, to add new requirements for disclosures about transfers
into and out of Levels 1 and 2 and separate disclosures about purchases, sales,
issuances, and settlements relating to Level 3 measurements. It also clarifies
existing fair value disclosures about the level of disaggregation and about
inputs and valuation techniques used to measure fair values. The guidance in ASU
2010-06 is effective for the first reporting period beginning after December 15,
2009. ASU 2009-05 is
not expected to not have a material impact on the Company’s financial condition
or results of operations.







Note
2 – Cash and Cash Equivalents




The
Company is required to maintain prescribed reserves with the Federal Reserve
Bank in the form of cash.  Cash reserve requirements are computed by
applying prescribed percentages to various types of deposits. The Company is
required to maintain a $25,000 minimum average daily balance with the Federal
Reserve Bank for purposes of settling financial transactions and charges for
Federal Reserve Bank services. The Company is also required to maintain cash
balances or deposits with the Federal Reserve Bank sufficient to meet its
statutory reserve requirements. The average reserve requirement for the
maintenance period, which included December 31, 2009 and 2008 was $1.3 million
and $1.2 million, respectively.






Note
3 – Regulatory Capital Requirements and Restrictions




The Bank
is restricted on the amount of dividends it may pay to the
Company.  It is generally limited to the net income of the current
fiscal year and that of the two previous fiscal years, less dividends already
paid during those periods. Based on this calculation, at December 31, 2009, none
of the Bank’s retained earnings were available for dividends to the Company.
However, payment of dividends may be further restricted by the Bank’s regulatory
agency if such payment would reduce the Bank’s capital ratios below required
minimums or would otherwise be considered to adversely affect the safety and
soundness of the institution.




The Bank
is subject to various regulatory capital requirements administered by federal
banking agencies.  Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the
Company’s financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action (“PCA”), the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank’s
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank’s capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors.




Quantitative
measures have been established by regulation to ensure capital adequacy and
require the Bank to maintain minimum capital amounts and ratios (set forth in
the following table). The Bank’s primary regulatory agency, the Office of Thrift
Supervision (“OTS”), requires that the Bank maintain minimum amounts and ratios
(as defined in the











-
75 -








regulations)
of tangible capital of 1.5%, core capital of 4%, and total risk-based capital of
8%. The Bank is also subject to PCA capital requirement regulations set forth by
the Federal Deposit Insurance Corporation (“FDIC”). The FDIC requires the Bank
to maintain minimum amounts and ratios (as defined in the regulations) of total
and Tier I capital to risk-weighted assets.










- 76 -


Following
is a summary of the Bank’s capital ratios:




Minimum
      Capital Required(dollars
      in thousands)
            Actual
            For
      Capital Adequacy
              Purposes
            To
      Be Categorized as
              “Well
      Capitalized”
              Under
      PCA ProvisionsAmount
            Ratio
            Amount
            Ratio
            Amount
            RatioDecember
      31, 2009:Tangible
      capital (to total assets)
            $17,237
            9.70%
            $  2,666
            1.50%
            N/A
            N/ACore
      capital (to total assets)
            17,237
            9.70
            7,110
            4.00
            $  8,887
            5.00%Total
      risk-based capital (to risk weighted assets)
            18,508
            12.84
            11,531
            8.00
            14,413
            10.00Tier I
      risk-based capital (to risk weighted assets)
            17,237
            11.96
            N/A
            N/A
            8,648
            6.00December
      31, 2008:Tangible
      capital (to total assets)
            $16,053
            8.43%
            $  2,857
            1.50%
            N/A
            N/ACore
      capital (to total assets)
            16,053
            8.43
            7,618
            4.00
            $  9,522
            5.00%Total
      risk-based capital (to risk weighted assets)
            17,724
            11.58
            12,241
            8.00
            15,302
            10.00Tier I
      risk-based capital (to risk weighted assets)
            16,053
            10.49
            N/A
            N/A
            9,181
            6.00





On
January 7, 2009 the Office of Thrift Supervision (“OTS”) finalized a supervisory
agreement (a memorandum of understanding or “MOU”) which was reviewed and
approved by the Board of Directors of Alaska Pacific Bank on December 19,
2008.  The MOU specifically requires the Bank to submit a business
plan that sets forth a plan for maintaining Tier 1 (Core) Leverage Ratio of 8%
and a minimum Total Risk-Based Capital Ratio of 12%. As of December 31, 2009,
the Bank’s Tier-1 (Core) Leverage Ratio was 9.70% (1.70% over the minimum
required under the MOU) and its Risk-Based Capital Ratio was 12.84%, (0.84% over
the minimum required under the MOU).







Note
4 – Investment Securities Available for Sale




Amortized
cost and fair values of investment securities available for sale, including
mortgage-backed securities, are summarized as follows:




(in
      thousands)
            Amortized
              Cost
            Gross
              Unrealized
              Gains
            Gross
              Unrealized
              Losses
            
            Fair
              ValueDecember
      31, 2009:Mortgage-backed
      securities:
            $2,445
            $81
            $(12
            )
            $2,514U.S.
      government agencies
            91
            1
            -
            
            92Total
            $2,536
            $82
            $(12
            )
            $2,606December
      31, 2008:Mortgage-backed
      securities:
            $3,134
            $49
            $(38
            )
            $3,145U.S.
      government agencies
            99
            -
            (1
            )
            98Total
            $3,233
            $49
            $(39
            )
            $3,243














-
77 -





Impaired
securities (those with unrealized losses) at December 31, 2009 are summarized as
follows:




Impaired
      less than
              12
      months
            Impaired
      12 months
              or
      more
            Total(in
      thousands)
            Fair Value
            Unrealized
              Losses
            Fair Value
            Unrealized
              Losses
            Fair Value
            Unrealized
              LossesMortgage-backed
              securities
            $12
            $(1)
            $571
            $(11)
            $583
            $(12)U.S.
      government
              agencies
            -
            -
            -
            -
            -
            -Total
            $12
            $(1)
            $571
            $(11)
            $583
            $(12)







Impaired
securities (those with unrealized losses) at December 31, 2008 are summarized as
follows:




Impaired
      less than
              12
      months
            Impaired
      12 months
              or
      more
            Total(in
      thousands)
            Fair Value
            Unrealized
              Losses
            Fair Value
            Unrealized
              Losses
            Fair Value
            Unrealized
              LossesMortgage-backed
              securities
            $-
            $-
            $1,180
            $(38)
            $1,180
            $(38)U.S.
      agencies and
              corporations
            -
            -
            98
            (1)
            98
            (1)Total
            $-
            $-
            $1,278
            $(39)
            $1,278
            $(39)





Eight and
thirteen securities with unrealized losses at December 31, 2009 and 2008,
respectively, were mortgage-backed or other securities issued by the U.S.
government and agencies; collectability of principal and interest is considered
to be reasonably assured. The fair values of individual securities fluctuate
significantly with interest rates and with market demand for securities with
specific structures and characteristics. Management does not consider these
unrealized losses to be other than temporary.




No
securities were designated as held to maturity at December 31, 2009 or
2008.




All
investment securities at December 31, 2009 have final contractual maturities of
more than five years. Actual maturities may vary due to prepayment of the
underlying loans.




At
December 31, 2009 and 2008, investment securities with amortized cost of $2.5
million market value of $2.6 million and $3.2 million market value of $3.2
million, respectively, were pledged to secure public funds deposited with the
Bank.




There
were no sales of securities during 2009 or 2008. The Bank does not have a
securities trading portfolio or securities held to maturity.









-
78 -




Note
5 – Loans




Loans are
summarized as follows:




(in thousands) December
      31,
              2009
              2008Real
      estate:Permanent:One-
      to four-family
              $  33,787
              $  38,875Multifamily
              1,736
              2,575Commercial
      nonresidential
              64,453
              56,019Land
              9,697
              13,360Construction:One-
      to four-family
              3,050
              4,179Commercial
      nonresidential
              2,637
              5,064Commercial
      business
              19,856
              24,429Consumer:Home
      equity
              16,522
              18,661Boat
              4,287
              4,060Automobile
              1,269
              998Other
              814
              762Loans
              $158,108
              $168,982
   Loans
      held for sale
              $55
              $2,586





Loans are
net of deferred loan fees and other discounts amounting to $567,000 and $701,000
at December 31, 2009 and 2008, respectively.




Loans
include overdrawn balances of deposit accounts of $35,000 and $36,000 at
December 31, 2009 and 2008, respectively.




Interest
income from tax-exempt loans was $35,000 and $36,000 in 2009 and 2008,
respectively.




Real
estate loans are secured primarily by properties located in Southeast Alaska.
Commercial real estate loans are generally secured by warehouse, retail, and
other improved commercial properties. Commercial business loans are generally
secured by equipment, inventory, accounts receivable, or other business
assets.




Impaired
loans are summarized as follows:




(in thousands) Year
      ended December 31,
            2009
            2008Impaired
      loans at end of year
            $5,342
            $10,685Impaired
      loans at end of year for which specific valuation allowances have been
      provided
            1,922
            10,685Amount
      of allowances at end of year
            514
            875







(in thousands) Year
      ended December 31,
            2009
            2008Average
      investment in impaired loans
            $11,503
            $8,892Interest
      income recognized on impaired loans
            151
            313Interest
      income recognized on a cash basis on impaired loans
            151
            313











-
79 -




Included
in impaired loans were certain loans that are troubled debt restructurings and
classified as impaired. At December 31, 2009, the Company had $845,000 of loans
that were modified in troubled debt restructurings and impaired. In addition to
these amounts, the Company had troubled debt restructurings of $538,000 that
were performing in accordance with their modified loan terms and were not
classified as impaired.




Nonaccrual
loans were $2.9 million and $6.1 million at December 31, 2009 and 2008,
respectively. As of December 31, 2009 and 2008, approximately $789,000 and
$665,000, respectively, of interest would have been recorded if these loans had
been current according to their original terms and had been outstanding
throughout the year. There were no loans greater than 90 days past due that were
accruing interest at December 31, 2009 and 2008, respectively.




Mortgage Loan
Servicing:  The Bank services residential and other real estate
loans for the Alaska Housing Finance Corporation (“AHFC”), U.S. Government
agencies, and institutional and private investors totaling $119.6 million and
$101.3 million, as of December 31, 2009 and 2008, respectively. These loans
are the assets of the investors and, accordingly, are not included in the
accompanying balance sheets. Related servicing income, net of amortization of
mortgage servicing rights, amounted to $186,000 and $161,000 for 2009 and 2008,
respectively.




The
amortized cost of mortgage servicing rights was $813,000 and $646,000 at
December 31, 2009 and 2008, respectively. The amount of servicing assets
recognized during 2009 was $276,000 and amortization was $109,000 for the year.
The amount of servicing assets recognized during 2008 was $72,000 and
amortization was $101,000 for the year. Management has determined that a
valuation allowance for impairment was not required at December 31, 2009 or
2008.




Related Party
Loans:  In the ordinary course of business, the Bank makes
loans to executive officers and directors of the Bank and to their affiliates.
These loans are made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions. The
aggregate dollar amount of these loans was $3.2 million at December 31, 2009.
During the years ended December 31, 2009 and 2008, new loans of this
type were $388,000 and $196,000, respectively, and repayments were $359,000 and
$162,000, respectively.




Repossessed
Assets:  The Company held repossessed assets of $2.6 million
and $408,000 at December 31, 2009 and 2008, respectively. During 2009, the
Company received $815,000 in proceeds from the sale of repossessed assets and
recognized $503,000 net loss on sales. During 2008, the Company received
$334,000 in proceeds from the sale of repossessed assets and did not recognize
any net gain on sales. The Company also incurred $235,000 and $116,000 in
operating expenses related to repossessed assets in 2009 and 2008,
respectively.







Note
6 – Allowance for Loan Losses




Following
is an analysis of the changes in the allowance for loan losses:




(in thousands) Year
      ended December 31,
            2009
            
            2008Balance
      at beginning of year
            $2,688
            
            $1,783Provision
      for loan losses
            2,947
            
            5,034Loans
      charged off
            (3,875
            )
            (4,182
            )Recoveries
            26
            
            53Balance
      at end of year
            $1,786
            
            $2,688











-
80 -




Note
7 – Premises and Equipment




Following
is a summary of premises and equipment:




(in thousands) December
      31,
            2009
            2008Land
            $   424
            $   424Buildings
            2,254
            2,254Leasehold
      improvements
            3,670
            3,667Furniture,
      fixtures and equipment
            3,021
            2,9989,369
            9,343Less
      accumulated depreciation and amortization
            (6,553)
            (6,221)$2,816
            $3,122





Depreciation
and amortization expense for the years ended December 31, 2009 and 2008 amounted
to $335,000 and $462,000, respectively.






Note
8 – Deposits




Certificates
of deposit of $100,000 and more at December 31, 2009 and 2008 were $12.9
million and $23.7 million, respectively.




The
scheduled maturities of certificates of deposit as of December 31, 2009, are as
follows:




(in thousands) Year
      ending December 31,2010
            $23,4522011
            11,3712012
            2,4432013
            2402014
      and thereafter
            2,669$40,175





Interest
expense on deposits consists of the following:




(in thousands)Year
      ended December 31,
            2009
            2008Interest-bearing
      demand
            $
        54
            $
        93Money
      market
            218
            545Savings
            47
            64Certificates
      of deposit
            1,050
            1,883$1,369
            $2,585





The
weighted averages interest rates paid on deposits are as follows:




Year
      ended December 31,
            2009
            2008Interest-bearing
      demand
            0.17%
            0.32%Money
      market
            0.50
            1.84Savings
            0.23
            0.38Certificates
      of deposit
            2.36
            3.51





Deposits
from the Company’s executive officers, directors, and their related companies
were $2.9 million and $2.2 at December 31, 2009 and 2008,
respectively.








-
81 -




Note
9 – Federal Home Loan Bank Advances




FHLB
advances consist of the following:




(dollars in thousands)
      December 31,
            2009
            2008Overnight
      advances, 0.64%
            $4,800
            $  -Putable
      advance, maturing in 2009, putable earlier
              at discretion of FHLB, 6.13%
            -
            5,000Seven-year
      amortizing advance, final maturity in
              2010, 3.62%
            34
            320Four-year
      advance, maturing in 2010, 5.24%
            1,500
            1,500Five-year
      advance, maturing in 2011, 5.26%
            2,000
            2,000Seven-year
      advance, maturing in 2013, 5.30%
            1,500
            1,500$9,834
            $10,320





FHLB
advances at December 31, 2009 with final maturities of more than one year have
scheduled maturities as follows:





(in
      thousands)
              Year
      ending December 31,2010
            $1,5342011
            2,0002012
            -2013
            1,500Total
            $5,034





The
average balance of FHLB advances outstanding during 2009 and 2008 was $12.2
million and $14.6 million, respectively.  The maximum amount of
advances outstanding at any month end during 2009 and 2008 was $13.4 million and
$23.7 million, respectively.  Under a blanket pledge agreement, all
funds on deposit at the FHLB, as well as all unencumbered qualifying loans and
investment securities, are available to collateralize FHLB
advances.




The Bank
has available a line of credit with the FHLB generally equal to 25% of the
Bank’s total assets, or approximately $44.6 million at December 31, 2009.
The line is secured by a blanket pledge of the Company’s assets. At December 31,
2009, there was $9.8 million outstanding on the line of credit.






Note
10 – Stock-Based Compensation




Stock Option
Plan:In previous years, the Board of Directors, upon
stockholder approval, approved two stock option plans (the “Plans”); one for key
employees and one for directors of the Company.  The Incentive and
Director Stock Option Plan permits the grant of stock options to authorized key
employees for up to 65,574 shares of common stock plus (i) the number of shares
repurchased by the Company in the open market or otherwise with an aggregate
price no greater than the cash proceeds received by the Company from the
exercise of options granted under the Plan; plus (ii) any shares surrendered to
the Company in payment of the exercise price of options granted under the Plan.
The Committee of the Plans shall determine the time or times at which an option
may be exercised. Previous option awards generally vest based on five years of
continuous service.  The term of each option award shall be no greater
than 10 years in the case of an Incentive Stock Option or 15 years in the case
of a Non-Qualified Stock Option. Option awards under the Plans shall not be less
than 100% of the Market Value (as defined in the Plans) of a share on the date
of grant of such option. Stock options granted are eligible for adjustment in
the event that the outstanding common stock of the Company changes as a result
of a stock dividend, stock split, or other changes to existing stock. The 2000
Stock Option Plan and the 2003 Stock Option Plan will terminate on July 2, 2010
and May 22, 2013, respectively.




In 2000,
the Company’s shareholders approved the 2000 Stock Option Plan, providing for
the granting of options for up to 65,542 shares. Options for 65,542 shares were
granted in 2000, with an exercise price equal to the market price of the











-
82 -








stock at
the date of grant, or $9.75. Options on 3,400 shares were granted in 2003,
replacing forfeitures, with an exercise price of $17.50.




In 2003,
the Company’s shareholders approved the 2003 Stock Option Plan, providing for
the granting of options for up to 32,000 shares. Options for 22,600 shares were
granted in 2007, with an exercise price equal to the market price of the stock
at the date of grant, or $25.50. Options become exercisable in five equal annual
installments commencing one year after the date of grant, and unexercised
options expire ten years after the date of grant.




The
expected volatility is based on historical volatility. The risk-free interest
rates for periods within the contractual life of the awards are based on the
U.S. Treasury yield curve in effect at the time of the grant. The expected life
is based on historical exercise experience. The dividend yield assumption is
based on the Company’s history and expectation of dividend payouts.





Following
is a summary of the changes in stock options:




(in
      thousands)
              Year
      ended December 31,
            2009
            2008Number
      of
              Options
            Weighted
              Average
              Exercise
      Price
            Number
      of
              Options
            Weighted
              Average
              Exercise
      PriceStock
      options outstanding at
              beginning of year
            54,188
            $16.08
            57,665
            $16.25Granted
            -
            -
            -
            -Exercised
            -
            -
            (1,477)
            $9.75Forfeited
            -
            -
            (2,000)
            $25.50Stock
      options outstanding at
              end of year
            54,188
            $16.08
            54,188
            $16.08Options
      exercisable at end of
              year
            45,288
            $14.23
            41,268
            $13.13








There
were no options exercised during the year ended December 31, 2009. Options
exercised during the year ended December 31, 2008 had an aggregate intrinsic
value of $17,000. Stock options outstanding at December 31, 2009 are summarized
as follows:





Weighted-
              Average
              Exercise
              Price
            Number
              Outstanding
      at
              End
      of Year
            Weighted-Average
              Remaining
              Contractual
      Term
              (Years)
            Aggregate
              Intrinsic
              Value
            ExercisableNumber
      of
              Shares
            Aggregate
              Intrinsic
              Value$  9.75
            31,188
            0.6
            $
      -
            31,188
            $
      -17.50
              25.50
            2,400
              20,600
            3.1
              7.7
            -
              -
            2,400
              11,700
            -
              -$16.08
            54,188
            3.4
            $
      -
            45,288
            $
      -





ASC 718
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the consolidated income statement based on
their fair values. Compensation cost is recorded as if each vesting portion of
the award is a separate award. The adoption of this standard, as of January 1,
2006, using the modified prospective method, resulted in $27,000 and $26,000 of
compensation expense for the years ended December 31, 2009 and 2008, related to
the unvested portion of options granted in prior years. Net of taxes for the
years ended December 31, 2009 and 2008, respectively, this reduced net income by
$11,000 and $10,000, respectively. The basic and diluted earnings per











-
83 -








share
basis effect in December 31, 2009 and 2008, was zero. There was $51,000 in
unamortized stock-based compensation expense at December 31, 2009 with a
weighted average expense period of 2.3 years.




ASC 718
requires the recognition of stock-based compensation for the number of awards
that are expected to vest. Recognized stock compensation expense was not reduced
by estimated forfeitures because management believes the future effect to be
minimal. Estimated forfeitures will be continually evaluated in subsequent
periods and may change based on new facts and circumstances.






Note
11 – Retirement Plans




The Bank
has a salary deferral 401(k) plan. Employees who are at least 18 years of age
and have completed three months of service are eligible to participate in the
plan. Employees may contribute on a pretax basis a portion of their annual
salary up to a maximum limit under the law. Beginning in 2006, the Bank matches
100% of employee contributions of up to 4% of compensation. For the years ended
December 31, 2009 and 2008, the Bank contributed $111,000 and $109,000,
respectively, to the plan, including administrative expenses.




The
Company has an Employee Stock Ownership Plan (“ESOP”) that was established in
connection with the mutual to stock conversion. Eight percent of the shares
issued in the conversion, or 52,433 shares, were purchased by the ESOP in
exchange for a note payable to the Company. The shares are allocated to
employees over a ten-year period in proportion to the principal and interest
paid on the note at the end of each year. All employees who have completed one
year’s service automatically participate in the plan, and each year’s allocation
is distributed in proportion to total compensation of employees. Employees are
vested in the plan over a seven-year period. Dividends paid on allocated shares
are credited to employee’s accounts, but dividends on unallocated shares are
used to reduce the expense of the plan. At December 31, 2009 and 2008, 52,433
shares were allocated to employees. The Company’s expense for the plan,
including administrative expenses, amounted to $13,000 and $81,000 for the years
ended December 31, 2009 and 2008, respectively.






Note
12 – Operating Leases




The Bank
leases certain of its premises and equipment under noncancelable operating
leases with terms in excess of one year. Future minimum lease payments under
these leases at December 31, 2009, are summarized as follows:




(in thousands) Year
      ending December 31,2010
            $   4792011
            4492012
            4492013
            3772014
            2712015
      and  thereafter
            1,107$3,132





Rent
expense was $498,000 and $501,000 for the years ended December 31, 2009 and
2008, respectively. Rental income on owned premises amounted to $19,000 and
$21,000 for the years ended December 31, 2009 and 2008,
respectively.








- 84
-




Note
13 – Income Tax




The
expense (benefit) for income tax consisted of the following:




(in thousands) Year
      ended December 31,
            2009
            2008Current
      tax expense (benefit):Federal
            $(397)
            $(758)State
            (70)
            (134)Total
      current
            (467)
            (892)Deferred
      tax expense (benefit):Federal
            (357)
            (436)State
            (63)
            (77)Total
      deferred
            (420)
            (513)Increase
      in deferred tax valuation allowance
            905Expense
      (Benefit) for income tax
            $18
            $(1,405)





A
reconciliation of taxes computed at federal statutory corporate tax rates (34%
in 2009 and 2008) to tax expense, as shown in the accompanying statements of
operations and changes in shareholders’ equity and comprehensive income (loss),
is as follows:




(in thousands) Year
      ended December 31,
            2009
            2008Income
      tax expense (benefit) at statutory rate
            $(739)
            $(1,266)Income
      tax effect of:State
      income tax
            (134)
            (223)Tax-exempt
      interest
            (12)
            (14)Increase
      in deferred tax valuation allowance
            905
            -Other
            (2)
            98Expense
      (Benefit) for income tax
            $18
            $(1,405)Effective
      tax rate
            (1%)
            38%














-
85 -





Deferred
federal income tax is provided for the temporary differences between the tax
basis and financial statement carrying amounts of assets and liabilities.
Components of the Company’s net deferred tax assets consisted of the
following:




(in thousands) December
      31,
            2009
            
            2008Deferred
      tax assets:Bad
      debt reserves
            $929
            
            $1,227Nonaccrual
      loan interest
            308
            
            252Premises
      and equipment
            128
            
            -Accrued
      vacation
            68
            
            68Nondeductible
      REO write-down
            21
            
            -Net
      operating loss carry-forward
            524Other
            29
            
            28Gross deferred tax
      assets
            2,007
            
            1,575Deferred
      tax liabilities:Deferred
      loan fees, net
            (48
            )
            (42
            )FHLB
      stock dividends
            (610
            )
            (610
            )Prepaids
            (94
            )
            -Premises
      and equipment
            -
            
            (38
            )Other
            -
            
            (50
            )Gross deferred tax
      liabilities
            (752
            )
            (740
            )Net
      deferred tax assets
            1,255
            
            835Valuation
      allowance for deferred tax asset
            (905
            )
            -Net
      deferred tax assets after valuation allowance
            $350
            
            $835





In August
1996, the Small Business Job Protection Act of 1996 (“the Act”) was signed into
law. Under the Act, the percentage of taxable income method of accounting for
tax basis bad debts is no longer available effective for the years ending after
December 31, 1995. As a result, the Bank is required to use the experience
method of accounting for tax basis bad debts for 1998 and later years. In
addition, the Act requires the recapture of post-1987 (the base year) additions
to the tax bad debt reserves made pursuant to the percentage of taxable income
method. The Bank is not subject to this recapture in 2009 or 2008, as its tax
bad debt reserves do not exceed its base year reserve. As a result of the bad
debt deductions, shareholders’ equity as of December 31, 2009, includes
accumulated earnings of approximately $1.8 million for which federal income tax
has not been provided. If, in the future, this portion of retained earnings is
used for any purpose other than to absorb losses on loans or on property
acquired through foreclosure, federal income tax may be imposed at
then-applicable rates.




On
January 1, 2007, the Bank adopted FASB ASC 740, Income Taxes. ASC 740
provides guidance on derecognition, classification, interest and penalties, and
accounting in interim periods; and requires expanded disclosure with respect to
the Company’s methodology for estimating and reporting uncertain tax
positions.





Currently,
the Company is subject to U.S. federal income tax and income tax in the
state of Alaska. The federal and state


income
taxes paid for the calendar years ending December 31, 2009, 2008, 2007, and 2006
may remain subject to examination by the applicable authorities.
The Company recognizes interest and penalties related to unrecognized
tax


benefits
as income tax expense in the Statements of operations. During the years ended
December 31, 2009 and 2008, the


Company
recognized no interest and penalties.





The Company
believes that it has appropriate support for the income tax positions taken and
to be taken on its tax returns and that its accruals for tax liabilities are
adequate for the open years based on an assessment of many factors, including
past experience and interpretations of tax law. The Company had no
unrecognized tax benefits which would require an adjustment to the January 1,
2009, beginning balance of retained earnings. The Company had no
unrecognized tax benefits at December 31, 2009 or 2008.









-
86 -




Note
14 – Commitments and Contingencies




Commitments:Commitments
to extend credit, including lines of credit, totaled $11.4 million and $10.5
million at December 31, 2009 and 2008, respectively. Commitments to extend
credit, generally at a variable interest rate, are arrangements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee by the customer. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The
Bank evaluates creditworthiness for commitments on an individual customer
basis.




There are
no commitments to lend additional funds to debtors loans whose terms have been
modified in troubled debt restructurings.




Undisbursed
loan proceeds, primarily for real estate construction loans, totaled $3.6
million and $1.8 million at December 31, 2009 and 2008, respectively. These
amounts are excluded from the balance of loans at year end.




Concentrations:More
than 75% of all loans in the Bank’s portfolio are secured by real estate located
in communities of Southeast Alaska.




Note
15 – Preferred Stock





On
February 6, 2009, as part of the Troubled Asset Relief Program (“TARP”) Capital
Purchase Program, the Company entered into a Letter Agreement and Securities
Purchase Agreement (collectively, the “Purchase Agreement”) with the United
States Department of the Treasury (“Treasury”), pursuant to which the Company
sold (i) 4,781 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred
Stock, Series A (the “Series A Preferred Stock”) and (ii) a warrant (the
“Warrant”) to purchase 175,772 shares of the Company’s common stock, par value
$0.01 per share (the “Common Stock”), for an aggregate issuance price of $4.8
million in cash.




The
Series A Preferred Stock qualifies as Tier 1 capital and is entitled to
cumulative dividends at a rate of 5% per annum for the first five years, and 9%
per annum thereafter. The Series A Preferred Stock may be redeemed by the
Company after three years. Prior to the end of three years, the Series A
Preferred Stock may be redeemed by the Company only with proceeds from the sale
of qualifying equity securities of the Company (a “Qualified Equity Offering”).
The restrictions on redemption are set forth in the Certificate of Designation
attached to the Statement of Establishment and Designation of Series of
Preferred Stock, which amends the Company’s Articles of Incorporation (the
“Certificate of Designation”).




The
Warrant has a 10-year term and is immediately exercisable upon its issuance,
with an exercise price, subject to anti-dilution adjustments, equal to $4.08 per
share of the Common Stock. Treasury has agreed not to exercise voting power with
respect to any shares of Common Stock issued upon exercise of the Warrant that
it holds.




Pursuant
to the terms of the Purchase Agreement, the ability of the Company to declare or
pay dividends or distributions on, or purchase, redeem or otherwise acquire for
consideration, shares of its Junior Stock (as defined below) and Parity Stock
(as defined below) is be subject to restrictions, including a restriction
against increasing dividends from the last quarterly cash dividend per share
($0.10) declared on the Common Stock prior to February 6, 2009. The redemption,
purchase or other acquisition of trust preferred securities of the Company or
its affiliates also is restricted. These restrictions will terminate on the
earlier of (a) the third anniversary of the date of issuance of the Series A
Preferred Stock, (b) the date on which the Series A Preferred Stock has been
redeemed in whole, and (c) the date Treasury has transferred all of the Series A
Preferred Stock to third parties.





In
addition, pursuant to the Certificate of Designation, the ability of the Company
to declare or pay dividends or distributions on, or repurchase, redeem or
otherwise acquire for consideration, shares of its Junior Stock and Parity Stock
will be subject to restrictions in the event that the Company fails to declare
and pay full dividends (or declare and set aside a sum sufficient for payment
thereof) on its Series A Preferred Stock.








-
87 -





“Junior
Stock” means the Common Stock and any other class or series of stock of the
Company the terms of which expressly provide that it ranks junior to the Series
A Preferred Stock as to dividend rights and/or rights on liquidation,
dissolution or winding up of the Company. “Parity Stock” means any class or
series of stock of the Company the terms of which do not expressly provide that
such class or series will rank senior or junior to the Series A Preferred Stock
as to dividend rights and/or rights on liquidation, dissolution or winding up of
the Company (in each case without regard to whether dividends accrue
cumulatively or non-cumulatively).





In
accordance with the relevant accounting pronouncements, the Company recorded the
Series A Preferred Stock and Warrants within Stockholders’ Equity on the
Consolidated Balance Sheets. The Series A Preferred Stock and Warrants were
initially recognized based on their relative fair values at the date of
issuance. As a result, the Series A Preferred Stock’s carrying value is at a
discount to the liquidation value or stated value. In accordance with the SEC’s
Staff Accounting Bulletin No. 68, Increasing Rate Preferred Stock, the discount
is considered an unstated dividend cost that is amortized over the period
preceding commencement of the perpetual dividend using the effective interest
method, by charging the imputed dividend cost against retained earnings and
increasing the carrying amount of the Series A Preferred Stock by a
corresponding amount. The discount is therefore being amortized over five years
using a 6.71% effective interest rate. The total stated dividends (whether or
not declared) and unstated dividend cost combined represents a period’s total
preferred stock dividend, which is deducted from net income (loss) to arrive at
net income (loss) available to common shareholders on the Consolidated
Statements of Operations.





The
Series A Preferred Stock and Warrants were initially recognized based on their
relative fair values at the date of issuance in accordance with Accounting
Principles Board (“APB”) Opinion No. 14, Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants. As a result, the value allocated to
the Warrant is different than the estimated fair value of the Warrant as of the
grant date. The following assumptions were used to determine the fair value of
the Warrant as of the grant date:





Dividend
yield 1.50%


Expected
life (years) 10.0


Expected
volatility 37%


Risk-free
rate 3.05%


Fair
value per warrant at grant date $ 4.15










Note
16 – Earnings (Loss) per Share




Basic
earnings (loss) per share (“EPS”) is computed by dividing net income (loss) by
the weighted-average number of common shares outstanding during the period less
treasury stock, unvested stock awards under the Management Recognition Plan
(“unvested stock awards”), and unallocated and not yet committed to be released
Employee Stock Ownership Plan shares (“unearned ESOP shares”). Diluted EPS is
calculated by dividing net income (loss) by the weighted-average number of
common shares used to compute basic EPS plus the incremental amount of potential
common stock from unvested stock awards and stock options, determined by the
treasury stock method. The following table shows the calculation of basic and
diluted EPS.




- 88 -





(in thousands)
      December 31,
            2009
            
            2008Net
      loss
            $     (2,191)
            
            $      (2,318)Preferred
      stock dividend accrual
            (216)
            
            -Preferred
      stock discount accretion
            (55)
            
            -Net
      loss available to common shareholders
            $     (2,462)
            
            $      (2,318)Average
      shares issued
            655,415
            
            655,415Less
      treasury stock
            (929)
            
            (1,114)Less
      unallocated ESOP shares
            -
            
            -Basic
      weighted average shares outstanding
            654,486
            
            654,301Net
      incremental shares
            -
            
            -Weighted
      incremental shares
            654,486
            
            654,301Loss
      per common shareBasic
            $             (3.76)
            
            $               (3.54)Diluted
            $             (3.76)
            
            $               (3.54)





Because
the Company recorded a net loss for the year ended December 31, 2009 and 2008,
all potentially dilutive shares were anti-dilutive and basic and diluted loss
per share were the same.







Note
17 – Fair Value of Financial Instruments




The
following table sets forth the estimated fair values of the Company’s financial
instruments as of December 31, 2009 and 2008, whether or not recognized or
recorded at fair value in the Consolidated Balance Sheet.




(in thousands) December
      31,
            2009
            2008Carrying
              Amount
            Estimated
              Fair
              Value
            Carrying
              Amount
            Estimated
              Fair
              ValueFinancial
      AssetsCash
      and cash equivalents
            $   6,942
            $   6,942
            $   9,402
            $   9,402Investment
      securities available for sale
            2,606
            2,606
            3,243
            3,243FHLB
      stock
            1,784
            1,784
            1,784
            1,784Loans,
      including held for sale
            158,163
            166,184
            171,568
            179,691Accrued
      interest receivable
            698
            698
            822
            822Mortgage
      servicing rights
            813
            1,234
            646
            804Financial
      LiabilitiesDemand
      and savings deposits
            108,042
            108,042
            107,357
            107,357Certificates
      of deposit
            40,175
            40,230
            55,814
            48,166FHLB
      Advances
            9,834
            10,082
            10,320
            10,915Accrued
      interest payable
            307
            307
            449
            449











-
89 -




The
following table presents information about the Company’s assets and liabilities
measured at fair value on a recurring basis at December 31, 2009.




Fair
      Value Measurements UsingFair
              Value
            
            
            Quoted
              Prices
      in
              Active
      Markets
              for
              Identical
      Assets
              (Level
      1)
            
            
            Significant
              Other
              Observable
              Inputs
              (Level
      2)
            
            
            Significant
      Unobservable
              Inputs
              (Level
      3)(in
      thousands)December
      31, 2009:Recurring:Available
      for sale securities:Mortgage
      backed securities
            
            $
            2,514
            
            
            $
            –
            
            
            $
            2,514
            
            
            $
            –U.S.
      government agencies
            
            
            92
            
            
            
            
            
            
            
            92Mortgage
      servicing rights
            
            
            1,234
            
            
            
            –
            
            
            
            1,234
            
            
            
            –Non-recurring:Impaired
      loans
            
            
            1,408
            
            
            
            –
            
            
            
            –
            
            
            
            1,408Repossessed
      assets
            
            
            2,598
            
            
            
            –
            
            
            
            2,598
            
            
            
            –December
      31, 2008:Recurring:Available
      for sale securities:Mortgage
      backed securities
            
            $
            3,145
            
            
            $
            –
            
            
            $
            3,145
            
            
            $
            –U.S.
      government agencies
            
            
            98
            
            
            
            
            
            
            
            98Mortgage
      servicing rights
            
            
            804
            
            
            
            –
            
            
            
            804
            
            
            
            –Non-recurring:Impaired
      loans
            
            
            3,033
            
            
            
            –
            
            
            
            –
            
            
            
            3,033Repossessed
      assets
            
            
            408
            
            
            
            
            
            
            
            408





The
following methods and assumptions were used to estimate the fair value of each
class of financial instrument:





Cash and cash
equivalents:  The fair value of cash and cash equivalents and
accrued interest receivable is estimated to be equal to the carrying value, due
to their short-term nature.




Securities:The
fair value of investment securities is based upon estimated market prices
obtained from independent safekeeping agents. Securities available-for-sale are
recorded at fair value on a recurring basis. Fair values are based on quoted
market prices, where available. If quoted market prices are not available, fair
values are estimated based on quoted market prices of comparable instruments
with similar characteristics or discounted cash flows. Changes in fair market
value are recorded in other comprehensive income, as the securities are
available for sale.





FHLB stock:  The
fair value of FHLB stock is considered to be equal to its carrying value, since
it may be redeemed at that value.




Loans:  The fair
value of loans is estimated using present value methods which discount the
estimated cash flows, including prepayments as well as contractual principal and
interest, using current interest rates appropriate for the type and maturity of
the loans.








-
90 -




Deposits:  For
demand and savings deposits and accrued interest payable, fair value is
considered to be carrying value. The fair values of fixed-rate certificates of
deposit and FHLB advances are estimated using present value methods and current
offering rates for such deposits and advances.





Mortgage servicing
rights:  Mortgage servicing rights (“MSR”) are measured at fair
value on a recurring basis. These assets are classified as Level 2 as
quoted prices are not available and the Company uses a model derived valuation
methodology to estimate the fair value of MSR obtained from an independent
broker on an annual basis.  The model pools loans into buckets of
homogeneous characteristics and performs a present value analysis of the future
cash flows. The buckets are created by individual loan characteristics such as
note rate, product type, and the remittance schedule. Current market rates are
utilized for discounting the future cash flows. Significant assumptions used in
the valuation of MSR include discount rates, projected prepayment speeds, escrow
calculations, ancillary income, delinquencies and option adjusted spreads. These
assets are recorded at amortized cost.





Impaired
loans:  Impaired loans are measured at fair value on a
non-recurring basis. These assets are classified as Level 3 where significant
value drivers are unobservable. The fair value of impaired loans are determined
using the fair value of each loan’s collateral for collateral-dependent loans as
determined, when possible, by an appraisal of the property, less estimated costs
related to liquidation of the collateral. The appraisal amount may also be
adjusted for current market conditions. Impaired loans were $5.3 million and
$10.7 million at December 31, 2009 and 2008, respectively, with estimated
reserves for impairment of $514,000 and $875,000, respectively.







Note
18 – Parent Company Financial Information




Summarized
financial information for Alaska Pacific Bancshares, Inc. (parent company only)
is presented below:




Parent
Company Condensed Balance Sheet




(in thousands) December
      31,
            2009
            2008AssetsCash
            $  1,431
            $     224Investment
      in subsidiary
            17,280
            16,059Total
      Assets
            $18,711
            $16,283Liabilities
      and Shareholders’ EquityOther
      liabilities
            $       31
            $         -Shareholders’
      equity
            18,680
            16,283Total
      Liabilities and Shareholders’ Equity
            $18,711
            $16,283








Parent
Company Condensed Income Statement




(in thousands) Year
      ended December 31,
            2009
            2008Deficit
      in earnings of subsidiary
            $(2,043)
            $(2,174)Total
      loss
            (2,043)
            (2,174)Operating
      expenses, net
            148
            144Net
      loss
            $(2,191)
            $(2,318)












-
91 -








Parent
Company Condensed Statement of Cash Flows




(in thousands) Year
      ended December 31,
            2009
            
            2008Cash
      flows from operating activities:Net
      loss
            $(2,191
            )
            $(2,318
            )Adjustments
      to reconcile net loss to net cash used in
              operating activities:Deficit
      in earnings of subsidiary
            2,043
            
            2,174Net
      cash used in operating activities
            (148
            )
            (144
            )Cash
      flows from investing activities:Distributions
      received from subsidiary
            -
            
            252Investment
      in subsidiary
            (3,200
            )
            -Net
      cash provided by (used in) investing activities
            (3,200
            )
            252Cash
      flows from financing activities:Proceeds
      from issuance of preferred stock and common
              stock warrants
            4,781
            
            -Stock
      issuance costs paid
            (41
            )
            -Issuance
      of common stock
            -
            
            15Cash
      dividends paid on preferred stock
            (185
            )
            -Cash
      dividends paid on common stock
            -
            
            (196
            )Net
      cash provided by (used in) financing activities
            4,555
            
            (181
            )Net
      increase (decrease) in cash
            1,207
            
            (73
            )Cash
      at beginning of year
            224
            
            297Cash
      at end of year
            $1,431
            
            $224











Item 9. Changes In and
Disagreements With Accountants on Accounting and Financial
Disclosure





No
disagreement with the Company’s independent
accountants on accounting and financial disclosure has occurred during the two
most recent fiscal years.





Item 9A. Controls and
Procedures





(a)      Evaluation of Disclosure
Controls and Procedures:   An evaluation of the Company’s
disclosure controls and procedures (as defined in Section 13(a)-15(e) of the
Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the
supervision and with the participation of the Company’s Chief Executive Officer,
Chief Financial Officer and several other members of the Company’s senior
management within the 90-day period preceding the filing date of this annual
report. The Company’s Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures as currently in
effect are effective in ensuring that the information required to be disclosed
by the Company in the reports it files or submits under the Exchange Act is (i)
accumulated and communicated to the Company’s management (including the Chief
Executive Officer and Chief Financial Officer) in a timely manner, and (ii)
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms.





(b)  Report of Management on
Internal Control over Financial Reporting:   Management of
the Company is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Securities Exchange Act of 1934). The Company's internal control over financial
reporting is a process designed under the supervision of the Company's
management, including its Chief Executive Officer and its Chief Financial
Officer, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of











-
92 -
 
 
 
 
 
 the
Company's financial statements for external reporting purposes in accordance
with generally accepted accounting principles in the United States of
America.





The
Company's internal control over financial reporting includes policies and
procedures that:  pertain to the maintenance of records which, in
reasonable detail, accurately and fairly reflect transactions and dispositions
of assets; provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles in the United States of America, and
that receipts and expenditures are being made only in accordance with
authorizations of management and the directors of the Company; and provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the Company's assets that could have a
material effect on the Company's financial statements.





Management
recognizes that there are inherent limitations in the effectiveness of any
system of internal control and, accordingly, even effective internal control can
provide only reasonable assurance with respect to financial statement
preparation and fair presentation. Further, because of changes in conditions,
the effectiveness of internal control may vary over time.





Under the
supervision and with the participation of the Company's management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
conducted an assessment of the effectiveness of the Company's internal control
over financial reporting based on the framework established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Based on this assessment, management has determined
that the Company's internal control over financial reporting as of December 31,
2009 is effective.








/s/
      Craig E. Dahl
            
            /s/
      Julie M. PierceCraig
      E. Dahl
            
            Julie
      M. PiercePresident
      and Chief Executive Officer
              (Principal
      Executive Officer)
            
            Senior
      Vice President, Chief Financial Officer
              (Principal
      Financial and Accounting Officer)





(c)           Changes in Internal
Controls:   For the year ended December 31, 2009, the
Company did not make any significant changes in, nor take any corrective actions
regarding, its internal controls or other factors that could significantly
affect these controls.





(d)           Attestation
report:   This annual report does not include an
attestation report of the Company’s registered public accounting firm regarding
internal control over financial reporting. Management’s report was not subject
to attestation by the Company’s registered public accounting firm pursuant to
temporary rules of the Securities and Exchange Commission that permit the
company to provide only management’s report in this annual report.








Item 9B. Other
Information





There was no information to be
disclosed by the Company in a report on Form 8-K during the fourth quarter of
fiscal 2009 that was not so disclosed.








PART
III





Item
10.  Directors, Executive
Officers, and Corporate Governance





The
information contained under the section captioned “Proposal I -- Election of
Directors” in the Company’s Definitive Proxy Statement for the 2009 Annual
Meeting of Stockholders (“Proxy Statement”) is incorporated herein by reference.
For information regarding the executive officers of the Company, see “Item 1.
Business - Executive Officers.”














-
93 -





Audit
Committee Financial Expert





The Audit Committee consisting of
Directors Milner (Chairman), Grummett and Rule is responsible for reviewing the
internal auditors’ report and results of their examination prior to review by
and with the entire Board of Directors and retains and establishes the scope of
the engagement of the Company’s independent auditors. The Board of Directors has
designated  Director Milner as the Audit Committee financial expert,
as defined in the SEC’s Regulation S-B, by the Bank’s Board of Directors.
Although the Company’s common stock is not listed on NASDAQ, its Board of
Directors has chosen to apply the definition of "independent" under the NASDAQ
rules. Using this definition, the Board has determined that Director Milner is
independent.





Compliance
with Section 16(a)





Section
16(a) of the Exchange Act requires Company directors and executive officers, and
persons who own more than 10% of a registered class of its equity securities, to
file with the SEC initial reports of ownership and reports of changes in
ownership of common stock and other equity securities of the Company. Officers,
directors and greater than 10% stockholders are required by SEC regulation to
furnish the Company with copies of all Section 16(a) forms they
file.





Reference
is made to the cover page of this Annual Report on Form 10-K, and the
information under the section captioned “Compliance with Section 16(a) of the
Exchange Act” in the Proxy Statement is incorporated herein by reference, with
regard to compliance with Section 16(a) of the Exchange Act.





Code
of Ethics





The
Board of Directors adopted a Code of Ethics for the Company’s officers
(including its senior financial officers), directors, and employees, which is
included as Exhibit 14 hereto. The Code of Ethics requires the Company’s
officers, directors, and employees to maintain the highest standards of
professional conduct. The Company has elected to provide a copy of its Code of
Ethics without charge to anyone who requests it.







Shareholder Recommendations for Board
Nominations






No
material changes have been made to the procedures by which security holders may
recommend nominees to the Company’s Board of Directors. See the sections
captioned "Meetings and Committees of the Board of Directors and Corporate
Governance Matters -- Committees and Committee Charters" and "Stockholder
Proposals" in the Proxy Statement, which are incorporated herein by
reference.







Item 11. Executive
Compensation





The
information contained under the sections captioned “Executive Compensation” in
the Proxy Statement is incorporated herein by reference.





Item 12. Security Ownership
of Certain Beneficial Owners and Management and Related Stockholder
Matters





(a)  Security Ownership of Certain
Beneficial Owners


Information
required by this item is incorporated herein by reference to the section
captioned “Security Ownership of Certain Beneficial Owners and Management” in
the Proxy Statement.





(b)  Security Ownership of
Management


Information
required by this item is incorporated herein by reference to the sections
captioned and “Security Ownership of Certain Beneficial Owners and Management”
and “Proposal I - Election of Directors” in the Proxy Statement.





(c)  Changes in
Control


The
Company is not aware of any arrangements, including any pledge by any person of
securities of the Company, the operation of which may at a subsequent date
result in a change in control of the Company.










-
94 -





(d)Equity Compensation Plan
Information.The following table summarizes share and exercise price
information about the Company’s equity compensation plans as of December 31,
2009.





Plan
      category
            (a)
              Number
      of securities to be
              issued
      upon exercise of
              outstanding
      options,
              warrants
      and rights
            (b)
              Weighted-average
      exercise
              price
      of outstanding
              options,
      warrants, and
              rights
            (c)
              Number
      of securities
              remaining
      available for
              future
      issuance under
              equity
      compensation plans
              (excluding
      securities
              reflectedin
      column (a))Equity
      compensation plans
              approved by security
              holdersOption
      plan
            45,288
            $16.08
            12,000Equity
      compensation plans
              not approved by security
              holders
            -
            
            -Total
            45,288
            $16.08
            12,000








Item 13. Certain
Relationships and Related Transactions, and Director
Independence





The
information required by this item is incorporated herein by reference to the
section captioned “Meetings and Committees of the Board of Directors and
Corporate Governance Matters – Corporate Governance – Related Party
Transactions" and “Meetings and Committees of the Board of Directors and
Corporate Governance Matters – Corporate Governance –Director Independence" in
the Proxy Statement.





Item 14. Principal
Accounting Fees and Services





The
information set forth under the section captioned “Proposal II – Ratification of
Appointment of Independent Auditors” in the Proxy Statement is incorporated
herein by reference.








-
95 -








Item 15. Exhibits, Financial
Statement Schedules





(a)
            Exhibits




3.1
            Articles
      of Incorporation of Alaska Pacific Bancshares, Inc.
  (1)


3.2
            Statement
      of Establishment and Designations of Series of Preferred Stock for the
      Series A Preferred Stock (2)


3.3
            Bylaws
      of Alaska Pacific Bancshares, Inc.
(3)


4.1
              Warrant
      For Purchase of shares of Common Stock
(2)
 4.2
                Letter
      Agreement dated February 6, 2009 between Alaska Pacific Bancshares, Inc.
      and United States Department of the Treasury, will respect to the issuance
      and sale of the Series A Preferred Stock and the
      Warrant(2)


10.1
            Employment
      Agreement with Craig E. Dahl (4)


10.2
            Severance
      Agreement with Julie M. Pierce (9)


10.3
            Severance
      Agreement with Thomas C. Sullivan
(4)


10.4
            Severance
      Agreement with Tammi L. Knight (4)


10.5
            Severance
      Agreement with John E. Robertson
(6)


10.6
            Severance
      Agreement with Leslie D. Dahl (9)


10.7
            Severance
      Agreement with Christopher P. Bourque
(98)


10.8
            Alaska
      Federal Savings Bank 401(k) Plan
(1)


10.9
            Alaska
      Pacific Bancshares, Inc. Employee Stock Ownership Plan
  (4)


10.10
            Alaska
      Pacific Bancshares, Inc. Employee Severance Compensation Plan
      (4)


10.11
            Alaska
      Pacific Bancshares, Inc. 2000 Stock Option Plan
  (5)


10.12
            Alaska
      Pacific Bancshares, Inc. 2003 Stock Option Plan
  (7)


10.13
            Form
      of Compensation Modification Agreement
(2)


14
            Code
      of Ethics (8)


21
            Subsidiaries
      of the Registrant


23
              Consent
      of Independent Registered Public Accounting
  Firm


31.1
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002


31.2
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002


32.1
            Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002


32.2
            Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002






99.1
            Certificationof
      Principal Executive Officer of Alaska Pacific Bancshares, Inc. to Chief
              Compliance Officer of the Troubled Asset Relief ProgramPursuant
      to 31 CFR § 30.1599.2
            Certification
      of Principal Financial Officer of Alaska Pacific Bancshares, Inc. to ChiefCompliance
              Officer of the Troubled Asset Relief ProgramPursuant
      to 31 CFR § 30.15




________________





(1)
            Incorporated
      by reference to the registrant’s Registration Statement on Form SB-2
      (333-74827).


(2)
            Incorporated
      by reference to the registrant’s current report on Form 8-K filed on
      February 6, 2009.


(3)
            Incorporated
      by reference to the registrant’s Registration Statement on Form SB-2
      (333-74827), except for amended Article III, Section 2, which was
      incorporated by reference to the registrant’s quarterly report on Form
      10-QSB for the quarterly period ended March 31,
  2004.


(4)
            Incorporated
      by reference to the registrant’s Annual Report on Form 10-KSB for the year
      ended December 31, 1999.


(5)
            Incorporated
      by reference to the registrant’s annual meeting proxy statement dated May
      5, 2000.


(6)
            Incorporated
      by reference to the registrant’s quarterly report on Form 10-QSB for the
      quarterly period ended March 31,
2004.


(7)
            Incorporated
      by reference to the registrant’s annual meeting proxy statement dated
      April 10, 2004.










-
96 -








(8)
            Incorporated
      by reference to the registrant’s Annual Report on Form 10-KSB for the year
      ended December 31, 2005.


(9)
            Incorporated
      by reference to the registrant’s quarterly report on Form 10-QSB for the
      quarterly period ended September 30,
2007.
















- 97 -


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





ALASKA
      PACIFIC BANCSHARES, INC.Date:
      March 30, 2010
            /s/
      Craig E. DahlCraig
      E. DahlPresident
      and Chief Executive Officer(Duly
      Authorized Representative)








Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.





/s/
      Craig E. Dahl
              
              March
      30, 2010Craig
      E. Dahl
              
              DatePresident
      and Chief Executive Officer
                (Principal
      Executive Officer)/s/
      Julie M. Pierce
              
              March
      30, 2010Julie
      M. Pierce
              
              DateSenior
      Vice President, Chief Financial Officer
                (Principal
      Financial and Accounting Officer)/s/
      Roger Grummett
              
              March
      30, 2010Roger
      Grummett
              
              DateChairman
      of the Board and Director/s/
      BethAnn Chapman
              
              March
      30, 2010BethAnn
      Chapman
              
              DateDirector/s/
      Scott C. Milner
              
              March
      30, 2010Scott
      C. Milner
              
              DateDirector/s/
      William J. Schmitz
              
              March
      30, 2010William
      J. Schmitz
              
              DateDirector/s/
      Hugh N. Grant
              
              March
      30, 2010Hugh
      N. Grant
              
              DateDirector
     -
98 -
   /s/
      William A. Corbus
              
              March
      30, 2010William
      A. Corbus
              
              DateDirector/s/
      Maxwell S. Rule
              
              March
      30, 2010Maxwell
      S. Rule
              
              DateDirector








-
99 -


Exhibit
Index





Exhibit
No.                      Description





21
            Subsidiaries
      of the Registrant


23
            Consent
      of Independent Registered Public Accounting
Firm


31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002


31.2
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002


32.1
            Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002


32.2
            Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002


99.1
            Certificationof
      Principal Executive Officer of Alaska Pacific Bancshares, Inc. to Chief
              Compliance
      Officer of the Troubled Asset Relief Program Pursuantto
      31 CFR § 30.15


99.2
            Certification
      of Principal Financial Officer of Alaska Pacific Bancshares, Inc. to Chief
      Compliance
              Officer
      of the Troubled Asset Relief Program Pursuantto
      31 CFR § 30.15