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First Financial Northwest, Inc. - Quarter Report: 2014 March (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended March 31, 2014
 
 
or
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
           For the transition period from ____________ to ____________
 
Commission File Number: 001-33652
 
 
FIRST FINANCIAL NORTHWEST, INC.
(Exact name of registrant as specified in its charter)
 
Washington
 
26-0610707
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
 
 
201 Wells Avenue South, Renton, Washington
 
98057
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant’s telephone number, including area code:
 
(425) 255-4400
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES    X   NO      

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

YES    X   NO      

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

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

YES       NO   X   

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: As of May 2, 2014, 16,552,079 shares of the issuer's common stock, $0.01 par value per share, were outstanding.



FIRST FINANCIAL NORTHWEST, INC.
FORM 10-Q
TABLE OF CONTENTS
                                                                    
 
 
Page
PART I - FINANCIAL INFORMATION
 
 
Item 1.
Financial Statements
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
Item 4.
Controls and Procedures
   PART II - OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
 
Item 1A.
Risk Factors
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Item 3.
Defaults upon Senior Securities
 
Item 4.
Mine Safety Disclosures
 
Item 5.
Other Information
 
Item 6.
Exhibits
SIGNATURES
 
 


2

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data)
(Unaudited)

Part I. Financial Information

Item 1. Financial Statements

 
 
 
 
 
March 31, 2014
 
December 31, 2013
Assets
 
 
 
 
 
Cash on hand and in banks
$
5,440

 
$
6,074

Interest-earning deposits
28,073

 
49,501

Investments available-for-sale, at fair value
139,868

 
144,364

Loans receivable, net of allowance of $12,093 and $12,994
671,848

 
663,153

Premises and equipment, net
17,139

 
17,291

Federal Home Loan Bank ("FHLB") stock, at cost
6,952

 
7,017

Accrued interest receivable
3,509

 
3,698

Deferred tax assets, net
13,124

 
14,835

Other real estate owned ("OREO")
11,609

 
11,465

Prepaid expenses and other assets
3,917

 
3,581

Total assets
$
901,479

 
$
920,979

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 
 
 
 
 
Interest-bearing deposits
$
578,237

 
$
601,446

Noninterest-bearing deposits
8,810

 
10,619

Advances from the FHLB
119,000

 
119,000

Advance payments from borrowers for taxes and insurance
3,722

 
1,846

Accrued interest payable
91

 
88

Other liabilities
3,791

 
3,625

Total liabilities
713,651

 
736,624

 
 

 
 
Commitments and contingencies


 


 
 

 
 
Stockholders' Equity
 

 
 
  Preferred stock, $0.01 par value; authorized 10,000,000 shares; no shares issued or
 
 
 
    or outstanding

 

  Common stock, $0.01 par value; authorized 90,000,000 shares; issued and outstanding
 
 
 
    16,454,139 shares at March 31, 2014 and 16,392,139 shares at December 31, 2013
165

 
164

   Additional paid-in capital
167,568

 
166,866

Retained earnings, substantially restricted
31,098

 
29,220

Accumulated other comprehensive loss, net of tax
(1,410
)
 
(2,020
)
Unearned Employee Stock Ownership Plan ("ESOP") shares
(9,593
)
 
(9,875
)
Total stockholders' equity
187,828

 
184,355

Total liabilities and stockholders' equity
$
901,479

 
$
920,979

See accompanying selected notes to consolidated financial statements.

3

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Income Statements
(Dollars in thousands, except share data)
(Unaudited)

 
Three Months Ended March 31,
 
2014
 
2013
Interest income
 
 
 
Loans, including fees
$
9,026

 
$
9,044

Investments available-for-sale
604

 
473

Interest-earning deposits
20

 
21

Dividends on FHLB stock
2

 

Total interest income
$
9,652

 
$
9,538

Interest expense
 

 
 

Deposits
1,347

 
1,893

FHLB advances
251

 
256

Total interest expense
$
1,598

 
$
2,149

Net interest income
8,054

 
7,389

Recapture of loan loss provision
(500
)
 

Net interest income after recapture for loan loss provision
$
8,554

 
$
7,389

Noninterest income
 

 
 

Other
68

 
104

Total noninterest income
$
68

 
$
104

Noninterest expense
 

 
 

Salaries and employee benefits
2,900

 
3,614

Occupancy and equipment
351

 
354

Professional fees
357

 
356

Data processing
173

 
162

Loss (gain) on sale of OREO property, net
71

 
(632
)
OREO market value adjustments
196

 
145

OREO-related expenses, net
61

 
334

Regulatory assessments
78

 
283

Insurance and bond premiums
88

 
114

Marketing
25

 
18

Prepayment penalty on FHLB advances

 
679

Other general and administrative
224

 
451

Total noninterest expense
$
4,524

 
$
5,878

Income before provision for federal income tax
4,098

 
1,615

            Federal income tax provision
1,453

 
59

Net income
$
2,645

 
$
1,556

 
 
 
 
Basic earnings per share
$
0.17

 
$
0.09

Diluted earnings per share
$
0.17

 
$
0.09


See accompanying selected notes to consolidated financial statements.






4

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)


 
Three Months Ended March 31,
 
2014
 
2013
Net income
$
2,645

 
$
1,556

 
 
 
 
Other comprehensive income, before tax:
 
 
 
   Unrealized holding gains (loss) on available-for-sale securities
939

 
(636
)
Other comprehensive income (loss), before tax
939

 
(636
)
   Income tax provision related to items of other comprehensive income
329

 

Other comprehensive income (loss), net of tax
$
610

 
$
(636
)
Total comprehensive income
$
3,255

 
$
920


See accompanying selected notes to consolidated financial statements.



5

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the Three Months Ended March 31, 2014
(Dollars in thousands, except share data)
(Unaudited)

 
Shares
 
Common 
Stock
 
Additional 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Income (Loss),  net of tax
 
Unearned
ESOP
Shares
 
Total
Stockholders' Equity
Balances at December 31, 2013
16,392,139

 
164

 
$
166,866

 
$
29,220

 
$
(2,020
)
 
$
(9,875
)
 
$
184,355

Other comprehensive income, net of tax

 

 

 
2,645

 
610

 

 
3,255

Cash dividend declared and paid ($0.05 per share)

 

 

 
(767
)
 

 

 
(767
)
Exercise of stock options
62,000

 
1

 
605

 

 

 

 
606

Compensation related to stock options and restricted stock awards

 

 
85

 

 

 

 
85

Allocation of 28,213 ESOP shares

 

 
12

 

 

 
282

 
294

Balances at March 31, 2014
16,454,139

 
165
 
$
167,568

 
$
31,098

 
$
(1,410
)
 
$
(9,593
)
 
$
187,828


See accompanying selected notes to consolidated financial statements.

6

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
2,645

 
$
1,556

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 
Recapture of loan loss provision
(500
)
 

OREO market value adjustments
196

 
145

Loss (gain) on sale of OREO property, net
71

 
(632
)
Depreciation of premises and equipment
191

 
207

Net amortization of premiums and discounts on investments
394

 
419

Deferred federal income taxes
1,382

 

ESOP expense
294

 
227

Compensation expense related to stock options and restricted stock awards
85

 
481

Changes in operating assets and liabilities:
 
 
 

Prepaid expenses and other assets
(336
)
 
24

Net increase in advance payments from borrowers for taxes and insurance
1,876

 
1,360

Accrued interest receivable
189

 
(39
)
Accrued interest payable
3

 
(162
)
Other liabilities
166

 
(356
)
Net cash provided by operating activities
$
6,656

 
$
3,230

 
 
 
 
Cash flows from investing activities:
 

 
 

Capitalized improvements in OREO

 
(33
)
Proceeds from sales of OREO properties
780

 
4,933

Principal repayments on investments
5,041

 
5,735

Purchases of investments

 
(8,974
)
Net increase in loans receivable
(9,386
)
 
(2,277
)
FHLB stock redemption
65

 
66

Net proceeds from sale or disposal of premises and equipment
11

 

Purchases of premises and equipment
(50
)
 
(1
)
Net cash used by investing activities
$
(3,539
)
 
$
(551
)
Cash flows from financing activities:
 

 
 

Net decrease in deposits
(25,018
)
 
(15,663
)
Advances from the FHLB

 
34,000

Repayments of advances from the FHLB

 
(83,066
)
Proceeds from exercise of stock options
606

 

Dividends paid
(767
)
 

Net cash used by financing activities
$
(25,179
)
 
$
(64,729
)
Net decrease in cash
(22,062
)
 
(62,050
)
Cash and cash equivalents:
 

 
 

Beginning of period
55,575

 
87,741

End of period
$
33,513

 
$
25,691

 
 
 
 

7

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

Continued
 
 
 
 
Three Months Ended March 31,
 
2014
 
2013
Supplemental disclosures of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

  Interest
$
1,595

 
$
2,311

  Federal income taxes
112

 

Noncash transactions:
 

 
 

Loans, net of deferred loan fees and allowance for loan and lease losses ("ALLL"),
 
 
 
     transferred to OREO
$
1,191

 
$
3,376

 Change in unrealized gain (loss) on investments available for sale
939

 
(636
)
   Investment transactions payable

 
6,324


See accompanying selected notes to consolidated financial statements.


8


FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 - Description of Business

First Financial Northwest, Inc. (“First Financial Northwest”), a Washington corporation, was formed on June 1, 2007 for the purpose of becoming the holding company for First Savings Bank Northwest (“First Savings Bank” or “the Bank”) in connection with the conversion from a mutual holding company structure to a stock holding company structure completed on October 9, 2007. First Financial Northwest's business activities generally are limited to passive investment activities and oversight of its investment in First Savings Bank. Accordingly, the information presented in the consolidated financial statements and related data, relates primarily to First Savings Bank. First Financial Northwest is a savings and loan holding company and is subject to regulation by the Board of Governors of the Federal Reserve Bank of San Francisco (“FRB”). First Savings Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State Department of Financial Institutions (“DFI”).

First Savings Bank is a community-based savings bank primarily serving King and, to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through one full-service banking office located in Renton, Washington. First Savings Bank's business consists of attracting deposits from the public and utilizing these deposits to originate one-to-four family residential, multifamily, commercial real estate, business, consumer loans and construction/land development. The Bank's current business strategy emphasizes one-to-four family residential, multifamily and commercial real estate lending.

As used throughout this report, the terms "we," "our," "us," or the "Company" refer to First Financial Northwest, Inc. and its consolidated subsidiary First Savings Bank Northwest, unless the context otherwise requires.

Note 2 - Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. These unaudited consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC. In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial statements in accordance with GAAP have been included. All significant intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. In preparing the unaudited consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the ALLL, the valuation of OREO and the underlying collateral of loans in the process of foreclosure, deferred tax assets and the fair value of financial instruments.

Certain amounts in the unaudited consolidated financial statements for prior periods have been reclassified to conform to the current unaudited financial statement presentation with no effect on income or stockholders' equity.

Note 3 - Recently Issued Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11, Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU No. 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. No new recurring disclosures are required. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2013 and are to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of ASU No. 2013-11 did not have a material impact on the Company's consolidated financial statements.

9

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



In January 2014, the FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. ASU 2014-01 permits an entity to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortized the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014 and should be applied prospectively. The Company is currently reviewing the requirements of ASU No. 2014-01, but does not expect the ASU to have a material impact on the Company's consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon foreclosure. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The ASU is effective for annual and interim reporting periods beginning on or after December 15, 2014 and can be applied with a modified retrospective transition method or prospectively. The Company is currently reviewing the requirements of ASU No. 2014-04, but does not expect the ASU to have a material impact on the Company's consolidated financial statements.

Note 4 - Investments

Investment securities available-for-sale are summarized as follows:
 
March 31, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value

(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
44,321

 
$
645

 
$
(337
)
 
$
44,629

   Freddie Mac
24,736

 
379

 
(234
)
 
24,881

   Ginnie Mae
32,517

 
95

 
(348
)
 
32,264

Municipal bonds
2,042

 
1

 
(110
)
 
1,933

U.S. Government agencies
22,562

 
101

 
(467
)
 
22,196

Corporate bonds
14,075

 
21

 
(131
)
 
13,965

Total
$
140,253

 
$
1,242

 
$
(1,627
)
 
$
139,868

 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
46,234

 
$
623

 
$
(625
)
 
$
46,232

   Freddie Mac
25,707

 
343

 
(194
)
 
25,856

   Ginnie Mae
34,403

 
63

 
(593
)
 
33,873

Municipal bonds
2,043

 
6

 
(199
)
 
1,850

U.S. Government agencies
23,222

 
123

 
(641
)
 
22,704

Corporate bonds
14,079

 
36

 
(266
)
 
13,849

Total
$
145,688

 
$
1,194

 
$
(2,518
)
 
$
144,364


10

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
The following table summarizes the aggregate fair value and gross unrealized loss by length of time those investments have been continuously in an unrealized loss position:
 
March 31, 2014
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
23,616

 
$
(320
)
 
$
3,137

 
$
(17
)
 
$
26,753

 
$
(337
)
   Freddie Mac
6,851

 
(215
)
 
2,287

 
(19
)
 
9,138

 
(234
)
   Ginnie Mae
7,093

 
(193
)
 
12,096

 
(155
)
 
19,189

 
(348
)
Municipal bonds
495

 
(5
)
 
1,295

 
(105
)
 
1,790

 
(110
)
U.S. Government agencies
3,557

 
(162
)
 
9,481

 
(305
)
 
13,038

 
(467
)
Corporate bonds
7,961

 
(97
)
 
2,466

 
(34
)
 
10,427

 
(131
)
Total
$
49,573

 
$
(992
)
 
$
30,762

 
$
(635
)
 
$
80,335

 
$
(1,627
)
 
December 31, 2013
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
27,429

 
$
(625
)
 
$

 
$

 
$
27,429

 
$
(625
)
   Freddie Mac
8,704

 
(155
)
 
2,483

 
(39
)
 
11,187

 
(194
)
   Ginnie Mae
16,617

 
(278
)
 
12,730

 
(315
)
 
29,347

 
(593
)
Municipal bonds

 

 
1,201

 
(199
)
 
1,201

 
(199
)
U.S. Government agencies
7,702

 
(596
)
 
4,955

 
(45
)
 
12,657

 
(641
)
Corporate bonds
8,796

 
(266
)
 

 

 
8,796

 
(266
)
Total
$
69,248

 
$
(1,920
)
 
$
21,369

 
$
(598
)
 
$
90,617

 
$
(2,518
)

At March 31, 2014, the Company had 18 securities with a gross unrealized loss of $635,000 with a fair value of $30.8 million that had an unrealized loss for greater than one year. At December 31, 2013, there were 11 securities with a gross unrealized loss of $598,000 and a fair value of $21.4 million that had an unrealized loss for greater than one year. Management reviewed the financial condition of the entities issuing these securities at March 31, 2014 and December 31, 2013, and determined that due to changes in interest rates an other-than-temporary impairment ("OTTI") was not warranted. The Company does not intend to sell the securities and will likely not be required to do so.

The amortized cost and estimated fair value of investments available-for-sale at March 31, 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed investments are shown separately.

11

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
March 31, 2014
 
Amortized Cost
 
Fair Value
 
(In thousands)
Due within one year
$
50

 
$
50

Due after one year through five years
14,832

 
14,750

Due after five years through ten years
16,609

 
16,381

Due after ten years
7,188

 
6,913

 
38,679

 
38,094

Mortgage-backed investments
101,574

 
101,774

Total
$
140,253

 
$
139,868


Under Washington state law, in order to participate in the public funds program the Company is required to pledge as collateral an amount equal to 100% of the public deposits held in the form of eligible securities. Investments with a market value of $20.5 million and $21.3 million were pledged as collateral for public deposits at March 31, 2014 and December 31, 2013, respectively, both of which exceeded the collateral requirements established by the Washington Public Deposit Protection Commission.

There were no sales of investment securities during the quarters ended March 31, 2014 and March 31, 2013.

Note 5 - Loans Receivable

Loans receivable are summarized as follows: 

12

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
March 31, 2014
 
December 31, 2013
 
(In thousands)
One-to-four family residential: (1)
 
 
 
   Permanent
$
279,244

 
$
280,674

 
279,244

 
280,674

Multifamily:
 
 
 

   Permanent
114,551

 
106,152

   Construction
7,445

 
12,360

 
121,996

 
118,512

Commercial real estate:
 
 
 

   Permanent
247,019

 
227,016

   Construction
6,100

 
19,905

   Land
1,607

 
1,831

 
254,726

 
248,752

Construction/land development: (2)
 
 
 

   One-to-four family residential
5,226

 
3,977

   Multifamily
15,718

 
12,491

   Commercial
4,656

 
6,726

   Land development
7,141

 
7,461

 
32,741

 
30,655

 
 
 
 
Business
614

 
1,142

Consumer
8,583

 
9,201

Total loans
697,904

 
688,936

 
 
 
 
Less:
 
 
 

   Loans in process ("LIP")
11,339

 
10,209

   Deferred loan fees, net
2,624

 
2,580

   ALLL
12,093

 
12,994

Loans receivable, net
$
671,848

 
$
663,153

___________
(1) 
Includes $120.1 million and $121.9 million of non-owner occupied loans at March 31, 2014 and December 31, 2013, respectively.
(2) 
Excludes construction loans that will convert to permanent loans. The Company considers these loans to be "rollovers" in that one loan is originated for both the construction loan and permanent financing. These loans are classified according to the underlying collateral. At March 31, 2014, the Company had $6.1 million, or 2.4% of the total commercial real estate portfolio and $7.4 million, or 6.1% of its total multifamily portfolio in these "rollover" type of loans. At December 31, 2013, the Company had $19.9 million, or 8.0% of the total commercial real estate portfolio and $12.4 million, or 10.4% of the total multifamily portfolio in these "rollover" type of loans. At March 31, 2014 and December 31, 2013, $1.6 million and $1.8 million, respectively, of commercial real estate loans were not included in the construction/land development category because the Company classifies raw land or buildable lots when it does not intend to finance the construction as commercial real estate land loans.

At March 31, 2014 and December 31, 2013 there were no loans classified as held for sale.


13

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following tables summarize changes in the ALLL and loan portfolio by loan type and impairment method: 
 
At or For the Three Months Ended March 31, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
5,141

 
$
1,377

 
$
5,881

 
$
399

 
$
14

 
$
182

 
$
12,994

   Charge-offs
(18
)
 

 
(311
)
 
(223
)
 

 
(1
)
 
(553
)
   Recoveries

 

 
151

 

 

 
1

 
152

   Provision (recapture)
(548
)
 
29

 
(185
)
 
212

 
(7
)
 
(1
)
 
(500
)
Ending balance
$
4,575

 
$
1,406

 
$
5,536

 
$
388

 
$
7

 
$
181

 
$
12,093

 
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
3,056

 
$
1,326

 
$
4,970

 
$
388

 
$
7

 
$
181

 
$
9,928

Specific reserve
$
1,519

 
$
80

 
$
566

 
$

 
$

 
$

 
$
2,165

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 

Total Loans
$
279,244

 
$
121,639

 
$
253,420

 
$
23,065

 
$
614

 
$
8,583

 
$
686,565

General reserve (2)
$
231,882

 
$
119,210

 
$
240,648

 
$
23,065

 
$
614

 
$
8,540

 
$
623,959

Specific reserve (3)
$
47,362

 
$
2,429

 
$
12,772

 
$

 
$

 
$
43

 
$
62,606

____________ 
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.
 
At or For the Three Months Ended March 31, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
5,562

 
$
1,139

 
$
5,207

 
$
437

 
$
30

 
$
167

 
$
12,542

   Charge-offs
(159
)
 
(346
)
 
(98
)
 

 

 
(16
)
 
(619
)
   Recoveries

 

 
1

 
70

 

 
8

 
79

   Provision (recapture)
41

 
405

 
(329
)
 
(121
)
 
2

 
2

 

Ending balance
$
5,444

 
$
1,198

 
$
4,781

 
$
386

 
$
32

 
$
161

 
$
12,002

 
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
4,105

 
$
1,198

 
$
4,440

 
$
386

 
$
32

 
$
161

 
$
10,322

Specific reserve
$
1,339

 
$

 
$
341

 
$

 
$

 
$

 
$
1,680

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 

Total Loans
$
300,892

 
$
108,820

 
$
226,567

 
$
13,984

 
$
3,104

 
$
10,132

 
$
663,499

General reserve (2)
$
242,642

 
$
104,963

 
$
209,433

 
$
9,237

 
$
3,104

 
$
9,400

 
$
578,779

Specific reserve (3)
$
58,250

 
$
3,857

 
$
17,134

 
$
4,747

 
$

 
$
732

 
$
84,720

_____________ 
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.

14

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Nonperforming loans, net of LIP, were $2.5 million and $4.0 million at March 31, 2014 and December 31, 2013, respectively. Foregone interest on nonperforming loans for the quarter ended March 31, 2014 was $44,000, compared to $290,000 for the same quarter in 2013.
 
There were no funds committed to be advanced in connection with impaired loans at either March 31, 2014 or December 31, 2013.

We continually monitor our loan portfolio for delinquent loans and changes in the financial condition of each borrower. When an issue is identified with one of our borrowers and it is determined that the loan needs to be classified as nonperforming and/or impaired, an evaluation of the collateral is performed prior to the end of the financial reporting period and, if necessary, an appraisal is ordered in accordance with our appraisal policy guidelines. Based on this evaluation, any additional provision for loan loss or charge-offs that may be needed is recorded prior to the end of the financial reporting period.

A loan is considered impaired when we have determined that we may be unable to collect payments of principal or interest when due under the terms of the original loan document. When identifying loans as impaired, management takes into consideration factors which include payment history and status, collateral value, financial condition of the borrower and the probability of collecting scheduled payments in the future. Minor payment delays and insignificant payment shortfalls typically do not result in a loan being classified as impaired. The significance of payment delays and shortfalls is considered by management on a case-by-case basis, after taking into consideration the circumstances surrounding the loan and the borrower, including payment history and the amounts of any payment shortfall, length and reason for delay and the likelihood of a return to stable performance. Impairment is measured on a loan-by-loan basis for all loans in the portfolio. We obtain annual updated appraisals for impaired collateral dependent loans that exceed $1.0 million and loans that have been transferred to OREO. In addition, we may order appraisals on collateral not included within these guidelines when there are extenuating circumstances where we are not otherwise able to determine the fair value of the property.


15

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following tables present a summary of loans individually evaluated for impairment by loan type:
 
March 31, 2014
 
Recorded Investment (1)
 
Unpaid Principal Balance (2)
 
Related Allowance
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
$
3,388

 
$
3,723

 
$

      Non-owner occupied
29,230

 
29,277

 

  Multifamily
228

 
263

 

   Commercial real estate
5,705

 
6,010

 

   Consumer
43

 
70

 

Total
38,594

 
39,343

 

 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
3,398

 
3,468

 
236

      Non-owner occupied
11,346

 
11,402

 
1,283

   Multifamily
2,201

 
2,201

 
80

   Commercial real estate
7,067

 
7,067

 
566

Total
24,012

 
24,138

 
2,165

 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
6,786

 
7,191

 
236

      Non-owner occupied
40,576

 
40,679

 
1,283

   Multifamily
2,429

 
2,464

 
80

   Commercial real estate
12,772

 
13,077

 
566

   Consumer
43

 
70

 

Total
$
62,606

 
$
63,481

 
$
2,165

_________________ 
(1) Represents the loan balance less charge-offs.
(2) Contractual loan principal balance.

16

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
December 31, 2013
 
Recorded Investment (1)
 
Unpaid Principal Balance (2)
 
Related Allowance
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
$
3,878

 
$
4,281

 
$

      Non-owner occupied
28,782

 
28,854

 

  Multifamily
233

 
264

 

   Commercial real estate
6,224

 
6,511

 

   Construction/land development
223

 
4,812

 

   Consumer
44

 
70

 

Total
39,384

 
44,792

 

 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
3,191

 
3,238

 
263

      Non-owner occupied
12,297

 
12,352

 
1,277

   Multifamily
2,208

 
2,208

 
85

   Commercial real estate
7,085

 
7,085

 
555

Total
24,781

 
24,883

 
2,180

 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
7,069

 
7,519

 
263

      Non-owner occupied
41,079

 
41,206

 
1,277

   Multifamily
2,441

 
2,472

 
85

   Commercial real estate
13,309

 
13,596

 
555

   Construction/land development
223

 
4,812

 

   Consumer
44

 
70

 

Total
$
64,165

 
$
69,675

 
$
2,180

_____________ 
(1) Represents the loan balance less charge-offs.
(2) Contractual loan principal balance.

 

17

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
Three Months Ended March 31,
 
2014
 
2013
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
$
3,633

 
$
38

 
$
5,070

 
$
30

      Non-owner occupied
29,006

 
432

 
31,951

 
430

Multifamily
231

 

 
4,904

 
20

Commercial real estate
5,964

 
82

 
9,587

 
66

Construction/land development
112

 

 
4,757

 

Consumer
43

 

 
745

 

Total
38,989

 
552

 
57,014

 
546

 
 
 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
3,295

 
39

 
5,557

 
58

      Non-owner occupied
11,822

 
157

 
15,993

 
226

   Multifamily
2,204

 
34

 

 

   Commercial real estate
7,076

 
87

 
8,100

 
117

Total
24,397

 
317

 
29,650

 
401

 
 
 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
6,928

 
77

 
10,627

 
88

      Non-owner occupied
40,828

 
589

 
47,944

 
656

Multifamily
2,435

 
34

 
4,904

 
20

Commercial real estate
13,040

 
169

 
17,687

 
183

Construction/land development
112

 

 
4,757

 

Consumer
43

 

 
745

 

Total
$
63,386

 
$
869

 
$
86,664

 
$
947



18

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Certain loan modifications or restructurings are accounted for as troubled debt restructured loans ("TDRs"). In general, the modification or restructuring of a debt is considered a TDR if, for economic or legal reasons related to the borrower's financial difficulties, a concession is granted to the borrower that the Company would not otherwise consider. Once the loan is restructured, a current, well-documented credit evaluation of the borrower's financial condition and prospects for repayment are performed to assess the likelihood that all principal and interest payments required under the terms of the modified agreement will be collected in full. A loan that is determined to be classified as a TDR is generally reported as a TDR until the loan is paid in full or otherwise settled, sold or charged-off. The following is a summary of information pertaining to nonperforming assets and TDRs:
 
March 31, 2014
 
December 31, 2013
 
(In thousands)
Nonperforming assets: (1)
 

 
 

   Nonaccrual loans
$
2,065

 
$
3,027

   Nonaccrual TDRs
469

 
968

Total nonperforming loans
2,534

 
3,995

   OREO
11,609

 
11,465

Total nonperforming assets
$
14,143

 
$
15,460

 
 
 
 
Performing TDRs
$
60,072

 
$
60,170

Nonaccrual TDRs
469

 
968

Total TDRs
$
60,541

 
$
61,138

_____________
(1) There were no loans 90 days or more past due and still accruing interest at March 31, 2014 and December 31, 2013. All loans are reported net of LIP.

The accrual status of a loan may change after it has been classified as a TDR. Management considers the following in determining the accrual status of restructured loans: (1) if the loan was on accrual status prior to the restructuring, the borrower has demonstrated performance under the previous terms, and a credit evaluation shows the borrower's capacity to continue to perform under the restructured terms (both principal and interest payments), the loan will remain on accrual at the time of the restructuring; (2) if the loan was on nonaccrual status before the restructuring, and the Company's credit evaluation shows the borrower's capacity to meet the restructured terms, the loan would remain as nonaccrual for a minimum of six months after restructuring until the borrower has demonstrated a reasonable period of sustained repayment performance (thereby providing reasonable assurance as to the ultimate collection of principal and interest in full under the modified terms).

Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual when they are 90 days delinquent or when, in management's opinion, the borrower is unable to meet scheduled payment obligations.

In order to return a nonaccrual loan to accrual status, each loan is evaluated on a case-by-case basis. The Company evaluates the borrower's financial condition to ensure that future loan payments are reasonably assured. The Company also takes into consideration the borrower's willingness and ability to make the loan payments and historical repayment performance. The Company requires the borrower to make loan payments consistently for a period of at least six months as agreed to under the terms of the loan agreement before the Company will consider reclassifying the loan to accrual status.
 

19

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following table is a summary of nonaccrual loans by loan type: 
 
March 31, 2014
 
December 31, 2013
 
(In thousands)
One-to-four family residential
$
1,600

 
$
2,297

Multifamily
228

 
233

Commercial real estate
706

 
1,198

Construction/land development

 
223

Consumer

 
44

Total nonaccrual loans
$
2,534

 
$
3,995


The following tables represent a summary of the aging of loans by type: 
 
Loans Past Due as of March 31, 2014
 
 
 
 
 
31-60 Days
 
61-90 Days
 
Over 90 Days
 
Total
 
Current
 
Total Loans (1) (2)
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
$
826

 
$

 
$
531

 
$
1,357

 
$
157,755

 
$
159,112

Non-owner occupied
167

 

 
477

 
644

 
119,488

 
120,132

Multifamily

 

 

 

 
121,639

 
121,639

Commercial real estate
329

 

 
601

 
930

 
252,490

 
253,420

Construction/land development

 

 

 

 
23,065

 
23,065

Total real estate
1,322

 

 
1,609

 
2,931

 
674,437

 
677,368

Business

 

 

 

 
614

 
614

Consumer

 
34

 

 
34

 
8,549

 
8,583

Total
$
1,322

 
$
34

 
$
1,609

 
$
2,965

 
$
683,600

 
$
686,565

 ________________ 
(1) There were no loans 90 days past due and still accruing interest at March 31, 2014.
(2) Net of LIP.

 
Loans Past Due as of December 31, 2013
 
 
 
 
 
31-60 Days
 
61-90 Days
 
Over 90 Days
 
Total
 
Current
 
Total Loans (1) (2)
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
$
923

 
$
337

 
$
575

 
$
1,835

 
$
156,962

 
$
158,797

Non-owner occupied

 

 
692

 
692

 
121,185

 
121,877

Multifamily

 

 

 

 
117,181

 
117,181

Commercial real estate
331

 

 
1,089

 
1,420

 
245,982

 
247,402

Construction/land development

 

 
223

 
223

 
22,904

 
23,127

Total real estate
1,254

 
337

 
2,579

 
4,170

 
664,214

 
668,384

Business

 

 

 

 
1,142

 
1,142

Consumer
103

 
34

 

 
137

 
9,064

 
9,201

Total
$
1,357

 
$
371

 
$
2,579

 
$
4,307

 
$
674,420

 
$
678,727

_________________ 
(1) There were no loans 90 days past due and still accruing interest at December 31, 2013.
(2) Net of LIP.

20

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
Credit Quality Indicators. The Company utilizes a nine-point risk rating system and assigns a risk rating for all credit exposures. The risk rating system is designed to define the basic characteristics and identify risk elements of each credit extension. Credits risk rated 1 through 5 are considered to be “pass” credits. Pass credits include assets, such as cash secured loans with funds on deposit with the Bank, where there is virtually no credit risk. Pass credits also include credits that are on the Company's watch list, where the borrower exhibits potential weaknesses, which may, if not checked or corrected, negatively affect the borrower’s financial capacity and threaten their ability to fulfill debt obligations in the future. Credits classified as special mention are risk rated 6 and possess weaknesses that deserve management’s close attention. Special mention assets do not expose the Company to sufficient risk to warrant adverse classification in the substandard, doubtful or loss categories. Substandard credits are risk rated 7. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful are risk rated 8 and have all the weaknesses inherent in those credits classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values. Assets classified as loss are risk rated 9 and are considered uncollectible and cannot be justified as a viable asset for the Company. There were no loans classified as doubtful or loss as of March 31, 2014 and December 31, 2013.

        The following tables represent a summary of loans by type and risk category:
 
March 31, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/ 
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
265,112

 
$
118,998

 
$
236,888

 
$
23,065

 
$
614

 
$
8,361

 
$
653,038

   Special mention
5,642

 
1,198

 
14,467

 

 

 

 
21,307

   Substandard
8,490

 
1,443

 
2,065

 

 

 
222

 
12,220

Total
$
279,244

 
$
121,639

 
$
253,420

 
$
23,065

 
$
614

 
$
8,583

 
$
686,565

 _____________ 
(1) Net of LIP.

 
December 31, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction /
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
265,511

 
$
114,525

 
$
229,149

 
$
22,904

 
$
1,142

 
$
8,934

 
$
642,165

   Special mention
5,825

 
1,203

 
15,134

 

 

 
1

 
22,163

   Substandard
9,338

 
1,453

 
3,119

 
223

 

 
266

 
14,399

Total
$
280,674

 
$
117,181

 
$
247,402

 
$
23,127

 
$
1,142

 
$
9,201

 
$
678,727

______________ 
(1) Net of LIP.
 

21

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The following tables summarize the loan portfolio by type and payment activity:
 
March 31, 2014
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction /
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Performing (2)
$
277,644

 
$
121,411

 
$
252,714

 
$
23,065

 
$
614

 
$
8,583

 
$
684,031

Nonperforming (3)
1,600

 
228

 
706

 

 

 

 
2,534

Total
$
279,244

 
$
121,639

 
$
253,420

 
$
23,065

 
$
614

 
$
8,583

 
$
686,565

____________ 
(1) 
Net of LIP.
(2) 
There were $158.1 million of owner-occupied one-to-four family residential loans and $119.5 million of non-owner occupied one-to-four family residential loans classified as performing.
(3) 
There were $1.0 million of owner-occupied one-to-four family residential loans and $600,000 of non-owner occupied one-to-four family residential loans classified as nonperforming.
 
December 31, 2013
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/
Land
Development
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Performing (2)
$
278,377

 
$
116,948

 
$
246,204

 
$
22,904

 
$
1,142

 
$
9,157

 
$
674,732

Nonperforming (3)
2,297

 
233

 
1,198

 
223

 

 
44

 
3,995

Total
$
280,674

 
$
117,181

 
$
247,402

 
$
23,127

 
$
1,142

 
$
9,201

 
$
678,727

_____________ 
(1) Net of LIP.    
(2) There were $157.3 million of owner-occupied one-to-four family residential loans and $121.1 million of non-owner occupied one-to-four family residential loans classified as performing.
(3) There were $1.5 million of owner-occupied one-to-four family residential loans and $817,000 of non-owner occupied one-to-four family residential loans classified as nonperforming.

The following table presents TDRs and their recorded investment prior to the modification and after the modification:
 
Three Months Ended March 31,
 
2014
 
2013
 
Number
of Loans
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
 
Number
of Loans
 
Pre-Modification Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
 
(Dollars in thousands)
 
 
 
 
 
 
TDRs that Occurred During the Period:
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family
residential:
 
 
 
 
 
 
 
 
 
 
 
      Principal and interest with
interest rate concession
1
 
221

 
221

 

 

 

   Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
      Principal and interest
reamortized with no interest
rate concession
 
$

 
$

 
1

 
335

 
334

Total
1
 
$
221

 
$
221

 
1

 
$
335

 
$
334


22

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)




At March 31, 2014 and 2013, the Company had no commitments to extend additional credit to borrowers whose loan terms have been modified in TDRs. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the ALLL.

The TDR that occurred during the quarter ended March 31, 2014 was primarily a result of granting the borrower an interest rate concession for a period of 3.25 years. The impaired portion of the loan with an interest rate concession for a specific period of time is calculated based on the present value of expected future cash flows discounted at the loan’s effective interest rate. The effective interest rate is the rate of return implicit on the original loan. This impaired amount increases the ALLL as a valuation allowance is established. As loan payments are received in future periods, the ALLL entry is reversed and the valuation allowance is reduced utilizing the level yield method over the modification period. TDRs resulted in no charge-offs to the ALLL for the three months ended March 31, 2014. TDRs resulted in charge-offs to the ALLL of $4,000 for the three months ended March 31, 2013.

The following is a summary of loans that were modified as TDRs within the previous 12 months and for which there was a payment default during the three months ended March 31, 2014 and 2013: 
 
Three Months Ended March 31,
 
2014
 
2013
 
Types of Modifications
 
Types of Modifications
 
Number of
Loans
 
No Interest Rate Concession with Modified Principal and Interest Payment
 
Advancement of Maturity Date
 
Number of
Loans
 
Interest Only Payments
 
Interest Rate Concession
 
(Dollars in thousands)
TDRs that Subsequently Defaulted:
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family residential
 
$

 
$

 
1

 
$

 
$
71

   Commercial real estate
1
 

 
430

 
2

 
2,324

 

Total
1
 
$

 
$
430

 
3

 
$
2,324

 
$
71


TDRs that default after they have been modified are typically evaluated individually on a collateral basis. Any additional impairment further reduces the ALLL.

Note 6 - Other Real Estate Owned

The following table is a summary of OREO: 
 
Three Months Ended March 31,
 
2014
 
2013
 
(In thousands)
Balance at beginning of period
$
11,465

 
$
17,347

   Loans transferred to OREO
1,191

 
3,376

   Capitalized improvements

 
33

   Dispositions of OREO
(851
)
 
(4,301
)
   Market value adjustments
(196
)
 
(145
)
Balance at end of period
$
11,609

 
$
16,310

 

23

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


OREO includes properties acquired by the Company through foreclosure and deed in lieu of foreclosure. OREO at March 31, 2014 consisted of $1.2 million in one-to-four family residential homes, $9.8 million in commercial real estate properties and $556,000 in construction/land development projects.

Note 7 - Fair Value

Fair value is defined 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.

The Company determines the fair values of its financial instruments based on the fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair values. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect its estimate for market assumptions.

Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions that market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from an independent source. Unobservable inputs are assumptions based on the Company's own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date.

All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy:

Level 1 - 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.
Level 3 - Instruments whose significant value drivers are unobservable.

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis (there were no transfers between Level 1, Level 2 and Level 3 recurring measurements):
 
Fair Value Measurements at March 31, 2014
 
Fair Value Measurements
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
(In thousands)
Available-for-sale investments:
 
 
 
 
 
 
 
Mortgage-backed investments:
 
 
 
 
 
 
 
Fannie Mae
$
44,629

 
$

 
$
44,629

 
$

Freddie Mac
24,881

 

 
24,881

 

Ginnie Mae
32,264

 

 
32,264

 

Municipal bonds
1,933

 

 
1,933

 

U.S. Government agencies
22,196

 

 
22,196

 

Corporate bonds
13,965

 

 
13,965

 

 
$
139,868

 
$

 
$
139,868

 
$



24

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
Fair Value Measurements at December 31, 2013
 
Fair Value Measurements
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs (Level 3)
 
(In thousands)
Available-for-sale investments:
 
 
 
 
 
 
 
Mortgage-backed investments:
 
 
 
 
 
 
 
Fannie Mae
$
46,232

 
$

 
$
46,232

 
$

Freddie Mac
25,856

 

 
25,856

 

Ginnie Mae
33,873

 

 
33,873

 

Municipal bonds
1,850

 

 
1,850

 

U.S. Government agencies
22,704

 

 
22,704

 

Corporate bonds
13,849

 

 
13,849

 

 
$
144,364

 
$

 
$
144,364

 
$


The estimated fair value of Level 2 investments is based on quoted prices for similar investments in active markets, identical or similar investments in markets that are not active and model-derived valuations whose inputs are observable.    

    

25

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The tables below present the balances of assets and liabilities measured at fair value on a nonrecurring basis. 
 
Fair Value Measurements at March 31, 2014
 
Fair Value
Measurements
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Losses
 
(In thousands)
Impaired loans (included in loans
 
 
 
 
 
 
 
 
 
   receivable, net) (1)
$
60,441

 
$

 
$

 
$
60,441

 
$
2,165

OREO (2)
11,609

 

 

 
11,609

 
196

Total
$
72,050

 
$

 
$

 
$
72,050

 
$
2,361

_______________ 
(1) The loss represents the specific reserve against loans that were considered impaired at March 31, 2014
(2) The loss represents OREO market value adjustments for the quarter ended March 31, 2014.

 
Fair Value Measurements at December 31, 2013
 
Fair Value
Measurements
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Losses
 
(In thousands)
Impaired loans (included in loans
 
 
 
 
 
 
 
 
 
   receivable, net) (1)
$
61,985

 
$

 
$

 
$
61,985

 
$
2,180

OREO (2)
11,465

 

 

 
11,465

 
403

Total
$
73,450

 
$

 
$

 
$
73,450

 
$
2,583

________________ 
(1) The loss represents the specific reserve against loans that were considered impaired at December 31, 2013.
(2) The loss represents OREO market value adjustments for the year ended December 31, 2013.
 
The fair value of impaired loans is calculated using the collateral value method or on a discounted cash flow basis. Inputs used in the collateral value method include appraised values, estimates of certain completion costs and closing and selling costs. Some of these inputs may not be observable in the marketplace. Appraised values may be discounted based on management's historical knowledge, changes in market conditions from the time of valuation and/or management's expertise and knowledge of the borrower.

OREO properties are measured at the lower of their carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis.
 
March 31, 2014
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input(s)
 
Range (Weighted Average)
 
(Dollars in thousands)
Impaired Loans
$
60,441

 
Market approach
 
Adjusted for differences between comparable sales
 
0% - 9%
(0.44%)
 
 
 
 
 
 
 
 
OREO
$
11,609

 
Market approach
 
Adjusted for differences between comparable sales
 
(16%) - 9.72% (1.85%)

26

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The carrying amounts and estimated fair values of financial instruments were as follows:
 
March 31, 2014
 
 
 
Estimated
 
Fair Value Measurements Using:
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
Financial Assets:
 
 
 
 
 
 
 
 
 
   Cash on hand and in banks
$
5,440

 
$
5,440

 
$
5,440

 
$

 
$

   Interest-earning deposits
28,073

 
28,073

 
28,073

 

 

   Investments available-for-sale
139,868

 
139,868

 

 
139,868

 

   Loans receivable, net
671,848

 
690,026

 

 

 
690,026

   FHLB stock
6,952

 
6,952

 

 
6,952

 

   Accrued interest receivable
3,509

 
3,509

 

 
3,509

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 

 
 

 
 

 
 

 
 
   Deposits
189,083

 
189,083

 
189,083

 

 

   Certificates of deposit
397,964

 
400,301

 

 
400,301

 

   Advances from the FHLB
119,000

 
118,653

 

 
118,653

 

   Accrued interest payable
91

 
91

 

 
91

 


 
December 31, 2013
 
 
 
Estimated
 
Fair Value Measurements Using:
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
Financial Assets:
 
 
 
 
 
 
 
 
 
   Cash on hand and in banks
$
6,074

 
$
6,074

 
$
6,074

 
$

 
$

   Interest-earning deposits
49,501

 
49,501

 
49,501

 

 

   Investments available-for-sale
144,364

 
144,364

 

 
144,364

 

   Loans receivable, net
663,153

 
680,622

 

 

 
680,622

   FHLB stock
7,017

 
7,017

 

 
7,017

 

   Accrued interest receivable
3,698

 
3,698

 

 
3,698

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 

 
 

 
 

 
 

 
 
   Deposits
201,658

 
201,658

 
201,658

 

 

   Certificates of deposit
410,407

 
413,417

 

 
413,417

 

   Advances from the FHLB
119,000

 
118,610

 

 
118,610

 

   Accrued interest payable
88

 
88

 

 
88

 


Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments:

Financial instruments with book value equal to fair value: The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value equal to book value. These instruments include cash on hand and in banks, interest-bearing deposits, FHLB stock, accrued interest receivable, accrued interest payable and investment transactions payable. FHLB stock is not publicly-traded, however it may be redeemed on a dollar-for-dollar basis, for any amount the Bank is not required to hold, subject to the FHLB’s discretion. The fair value is therefore equal to the book value.


27

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Investments available-for-sale: The fair value of all investments excluding FHLB stock was based upon quoted market prices for similar investments in active markets, identical or similar investments in markets that are not active and model-derived valuations whose inputs are observable.

Loans receivable: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value of fixed-rate loans is estimated using discounted cash flow analysis, utilizing interest rates that would be offered for loans with similar terms to borrowers of similar credit quality. As a result of current market conditions, cash flow estimates have been further discounted to include a credit factor. The fair value of nonperforming loans is estimated using the fair value of the underlying collateral.

Liabilities: The fair value of deposits with no stated maturity, such as statement savings, NOW and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using current interest rates for certificates of deposit with similar remaining maturities. The fair value of FHLB advances is estimated based on discounting the future cash flows using current interest rates for debt with similar remaining maturities.

Off balance sheet commitments: No fair value adjustment is necessary for commitments made to extend credit, which represents commitments for loan originations or for outstanding commitments to purchase loans. These commitments are at variable rates, are for loans with terms of less than one year and have interest rates which approximate prevailing market rates, or are set at the time of loan closing.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments.

Note 8 - Federal Home Loan Bank Stock

At March 31, 2014, the Bank held $7.0 million of FHLB stock. FHLB stock is carried at par value ($100 per share) and does not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions and can only be purchased and redeemed at par.

Management evaluates FHLB stock for impairment. The determination of whether this investment is impaired is based on the Bank's 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.

Prior to 2014, the FHLB announced that the Federal Housing Finance Agency had granted them the authority to repurchase up to $25 million in excess capital stock per quarter and pay quarterly dividends, provided that their financial condition - measured primarily by the ratio of market value of equity-to-par value of capital stock - does not deteriorate. As a result, the FHLB repurchased shares on a pro-rata basis from its shareholders, including 656 shares from the Bank, at par value during the first quarter of 2014. Also, the Bank received $1,767 in dividends from the FHLB in the quarter ended March 31, 2014. During the first quarter of 2013, the Bank received no dividends on FHLB stock and 659 shares of FHLB stock were repurchased. The Bank has determined there was no OTTI on the FHLB stock investment as of March 31, 2014.    

Note 9 - Stock-Based Compensation

In June 2008, First Financial Northwest's shareholders approved the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“Plan”). The Plan provides for the grant of stock options, restricted stock and stock appreciation rights.

Total compensation expense for the Plan was $84,800 and $481,000 for the three months ended March 31, 2014 and 2013, respectively, and the related income tax benefit was $29,700 and $168,000 for the three months ended March 31, 2014 and 2013.

Stock Options

28

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



The Plan authorizes the grant of stock options totaling 2,285,280 shares to Company directors, advisory directors, officers and employees. Option awards are granted with an exercise price equal to the market price of First Financial Northwest's common stock at the grant date. These option awards have a vesting period of five years, with 20% vesting on the anniversary date of each grant date, and a contractual life of 10 years. Any unexercised stock options will expire ten years after the grant date or sooner in the event of the award recipient’s death, disability or termination of service with the Company or the Bank. First Financial Northwest has a policy of issuing new shares from authorized but unissued common stock upon the exercise of stock options. At March 31, 2014, remaining options for 766,756 shares of common stock were available for grant under the Plan.

The fair value of each option award is estimated on the grant date using a Black-Scholes model that uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. The historical volatility of the Company's stock price over a specified period of time is used for the expected volatility assumption. First Financial Northwest bases the risk-free interest rate on the U.S. Treasury Constant Maturity Indices in effect on the date of the grant. First Financial Northwest elected to use the “Share-Based Payments” method permitted by the Securities and Exchange Commission to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at the midpoint.
    
A summary of the Company’s stock option plan awards for the three months ended March 31, 2014, follows: 
 
 
Shares
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term in Years
 
Aggregate Intrinsic Value
 
Weighted-Average Grant Date Fair Value
Outstanding at January 1, 2014
 
1,203,535

 
$
9.49

 

 
$
1,103,186

 
$
2.11

Granted
 

 

 

 

 

Exercised
 
(62,000
)
 
9.78

 

 

 

Forfeited or expired
 

 

 

 

 

Outstanding at March 31, 2014
 
1,141,535

 
9.48

 
5.21

 
839,668

 
2.13

Expected to vest assuming a 3% forfeiture rate
 
 
 
 
 
 
 
 
 
 
    over the vesting term
 
1,135,235

 
9.48

 
5.19

 
831,016

 
 
 
 
 
 
 
 
 
 
 
 
 
Exercisable at March 31, 2014
 
931,535

 
9.56

 
4.41

 
551,268

 
 

As of March 31, 2014, there was $545,935 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over the remaining weighted-average vesting period of 4.0 years.

Restricted Stock Awards

The Plan authorizes the grant of restricted stock awards amounting to 914,112 shares to directors, advisory directors, officers and employees. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the grant date. The restricted stock awards’ fair value is equal to the value on the grant date. Shares awarded as restricted stock vest ratably over a five-year period beginning at the grant date with 20% vesting on the anniversary date of each grant date. At March 31, 2014, remaining restricted stock awards for 74,478 shares were available to be awarded and are held in trust until they are issued in connection with the agreement. There are 103,400 shares of restricted stock awards previously granted that have not vested as of March 31, 2014.


29

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


A summary of changes in nonvested restricted stock awards for the three months ended March 31, 2014, follows: 
Nonvested Shares
 
Shares
 
Weighted-Average Grant Date  Fair Value
Nonvested at January 1, 2014
 
103,400

 
$
8.24

Granted
 

 

Vested
 

 

Forfeited
 

 

Nonvested at March 31, 2014
 
103,400

 
8.24

 
 
 
 
 
Expected to vest assuming a 3% forfeiture rate over the vesting term
 
100,298

 
 


As of March 31, 2014, there was $705,890 of total unrecognized compensation costs related to nonvested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of 3.7 years. There were no shares of restricted stock vested during the quarter ended March 31, 2014 compared to 6,400 shares of restricted stock vested with a fair value of $53,000 during the quarter ended March 31, 2013.

Note 10 - Federal Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.

Our primary deferred tax assets relate to our net operating loss carryforward, our ALLL and our employee benefit plans.

Under GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that a portion of the deferred tax asset will not be realized. Our policy is to evaluate our deferred tax assets on a quarterly basis and record a valuation allowance for our deferred tax asset if we do not have sufficient positive evidence indicating that it is more likely than not that some or all of the deferred tax asset will be realized. Each quarter, we considered positive and negative evidence, which includes cumulative losses in the most recent three year period and uncertainty regarding short-term future earnings. We further considered that GAAP places heavy emphasis on prior earnings in determining the realizable deferred tax asset. After reviewing and weighing these various factors, in 2010 we recorded a valuation allowance for the balance of the deferred tax asset in excess of the tax carryback refund potential. During 2013, management determined that a full valuation allowance was no longer appropriate and reversed all but $431,000 of the deferred tax asset valuation allowance as of December 31, 2013. In reaching this determination, management considered the scheduled reversal of deferred tax assets and liabilities, taxes paid in carryback years, available tax planning strategies and projected taxable income.

As of March 31, 2014, the consolidated balance sheet includes gross deferred tax assets of $16.0 million and a deferred tax asset valuation allowance of $431,000 due to a prior period capital loss on investment. Deferred tax liabilities totaled $2.4 million, resulting in a net deferred tax asset of $13.1 million at March 31, 2014.

The Company's federal net operating loss carryforward was $17.7 million at March 31, 2014 and will begin to expire in 2030. The Company had an alternative minimum tax credit carryforward totaling $1.8 million, with no expiration date.

Note 11 - Earnings Per Share

Per the provisions of FASB ASC 260, Earnings Per Share, nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of EPS pursuant to the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for

30

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. ESOP shares are considered outstanding for basic and diluted earnings per share when the shares are committed to be released. Certain of the Company's nonvested restricted stock awards qualify as participating securities.

Net income is allocated between the common stock and participating securities pursuant to the two-class method, based on their rights to receive dividends, participate in earnings or absorb losses. Basic earnings per common shares is computed by dividing net earnings allocated to common shareholders by the weighted average number of common shares outstanding during the period, excluding participating nonvested restricted shares.

The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the periods indicated. 
 
 
Three Months Ended March 31,
 
 
2014
 
2013
 
 
(Dollars in thousands, except share data)
Net income
 
$
2,645

 
$
1,556

Earnings allocated to participating securities
 
(16
)
 
(18
)
Earnings allocated to common shareholders
 
2,629

 
1,538

 
 
 
 
 
Basic weighted-average common shares outstanding
 
15,252,445

 
17,380,640

Dilutive stock options
 
81,331

 
21,210

Dilutive restricted stock grants
 
23,344

 

Diluted weighted-average common shares outstanding
 
15,357,120

 
17,401,850

 
 
 
 
 
Basic earnings per share
 
$
0.17

 
$
0.09

Diluted earnings per share
 
$
0.17

 
$
0.09


Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. Options to purchase an additional 210,000 and 1,382,524 shares of common stock at March 31, 2014 and 2013, respectively, were not included in the computation of diluted earnings per share because their exercise price resulted in them being antidilutive.

Note 12 - Segment Information

The Company's activities are considered to be a single industry segment for financial reporting purposes. The Company is engaged in the business of attracting deposits from the general public and originating loans for our portfolio in our primary market area. Substantially all income is derived from a diverse base of commercial and residential real estate loans, consumer lending activities and investments.

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
Certain matters discussed in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. 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

31


and trend of loan delinquencies and write-offs, that may be affected by deterioration in the housing and commercial real estate markets, and may lead to increased losses and nonperforming assets in our loan portfolio, and may 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; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Federal Reserve Bank of San Francisco and our bank subsidiary by the Federal Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institutions, Division of Banks (“DFI”) or other regulatory authorities, including the possibility that any such regulatory authority may initiate an enforcement action against the Company or the Bank which could require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings; our ability to pay dividends on our common stock; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining the 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; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; 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 policies and principles, including the interpretation of regulatory capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd Frank Act") and the implementing regulations; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on 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; and other risks detailed in our filings with the U.S. Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2013 ("2013 Form 10-K"). Any of the forward-looking statements that we make in this Form 10-Q and in the other public reports and 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.

Overview

First Savings Bank is a wholly-owned subsidiary of First Financial Northwest and, as such, comprises substantially all of the activity for First Financial Northwest. First Savings Bank is a community-based savings bank primarily serving King and to a lesser extent, Pierce, Snohomish and Kitsap counties, Washington through our full-service banking office located in Renton, Washington. First Savings Bank’s business consists of attracting deposits from the public and utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land development, business and consumer loans. Our current business strategy emphasizes one-to-four family residential, multifamily and commercial real estate lending.

Our primary source of revenue is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income.

An offset to net interest income is the provision for loan losses, which represents the periodic charge to operations which is required to adequately provide for probable losses inherent in our loan portfolio.

Our noninterest expenses consist primarily of salaries and employee benefits, occupancy and equipment, data processing, OREO-related expenses, professional fees, regulatory assessments and other general and administrative expenses. Salaries and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes and expenses for retirement

32


and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of real estate taxes, depreciation expenses, maintenance and costs of utilities. OREO-related expenses consist primarily of maintenance and costs of utilities for the OREO inventory, market valuation adjustments, build-out expenses, gains and losses from OREO sales, legal fees, real estate taxes and insurance related to the properties included in the OREO inventory.

Net income for the three months ended March 31, 2014 was $2.6 million, or $0.17 per diluted share, as compared to net income of $1.6 million, or $0.09 per diluted share for the three months ended March 31, 2013. The change in operating results in the first quarter of 2014, as compared to the first quarter of 2013, was primarily the result of a $1.4 million decrease in noninterest expense, a $665,000 increase in net interest income, a $500,000 recapture of loan loss provision partially offset by a $1.4 million increase in the federal income tax provision.

During the three months ended March 31, 2014, our total loan portfolio increased $8.7 million, or 1.3% from December 31, 2013, due primarily to a $6.0 million, or 2.4% increase in commercial real estate loans, a $3.5 million, or 2.9% increase in multifamily loans and a $2.1 million, or 6.8% increase in construction/land development loans partially offset by a $1.4 million, or 0.5% decrease in one-to-four family residential loans.

The following table details our five largest lending relationships at March 31, 2014:
Borrower (1)
 
Number of Loans
 
One-to-Four Family Residential (Rental Properties)
 
Multifamily
 
Commercial Real Estate (Rental Properties)
 
Construction/Land Development
 
Aggregate Balance of Loans (2)
 
 
 
 
(In thousands)
Real estate investor
 
3

 
$

 
$

 
$
18,321

 
$

 
$
18,321

Real estate builder
 
63

 
15,200

 

 

 
2,756

 
17,956

Real estate builder (3)
 
91

 
14,161

 

 
212

 

 
14,373

Real estate investor
 
34

 
8,464

 
3,951

 
1,689

 

 
14,104

Real estate investor
 
2

 

 

 
13,636

 

 
13,636

Total
 
193

 
$
37,825

 
$
3,951

 
$
33,858

 
$
2,756

 
$
78,390

________
(1)
The composition of borrowers represented in the table may change between periods.
(2) 
Net of LIP.
(3)  
Of this amount, $13.2 million were considered impaired loans; and all of these loans were performing and consisted of one-to-four family residential loans.

These relationships, which represent 11.4% of our loans, net of undisbursed funds, decreased $1.2 million from December 31, 2013. All five borrowers were current on their loan payments at March 31, 2014. We monitor the performance of these borrowing relationships very closely due to the concentration risk they possess in relation to the entire loan portfolio.

Critical Accounting Policies

Our significant accounting policies are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and our financial results. These policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern the allowance for loan and lease losses ("ALLL"), the valuation of OREO and foreclosed assets, and the calculation of deferred taxes, fair values and other-than-temporary impairments on the market value of investments. These policies and estimates are described in further detail in Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1, Summary of Significant Accounting Policies with the 2013 Form 10-K. There have not been any material changes in the Company's critical accounting policies and estimates as compared to the disclosure contained in the Company's 2013 Form 10-K
 
Comparison of Financial Condition at March 31, 2014 and December 31, 2013


33


Assets. Total assets were $901.5 million at March 31, 2014, a decrease of $19.5 million, or 2.1% from $921.0 million at December 31, 2013. The following table details the changes in the composition of our assets at March 31, 2014 from December 31, 2013.
 
Balance at
March 31, 2014
 
Increase/(Decrease) from December 31, 2013
 
Percent Increase/(Decrease)
 
(Dollars in thousands)
Cash on hand and in banks                                           
$
5,440

 
$
(634
)
 
(10.4
)%
Interest-earning deposits                                           
28,073

 
(21,428
)
 
(43.3
)
Investments available-for-sale, at fair value
139,868

 
(4,496
)
 
(3.1
)
Loans receivable, net                                           
671,848

 
8,695

 
1.3

Premises and equipment, net
17,139

 
(152
)
 
(0.9
)
FHLB stock, at cost                                
6,952

 
(65
)
 
(0.9
)
Accrued interest receivable
3,509

 
(189
)
 
(5.1
)
Deferred tax assets, net
13,124

 
(1,711
)
 
(11.5
)
OREO
11,609

 
144

 
1.3

Prepaid expenses and other assets
3,917

 
336

 
9.4

Total assets                                
$
901,479

 
$
(19,500
)
 
(2.1
)%

Interest-earning deposits decreased $21.4 million to $28.1 million at March 31, 2014, from $49.5 million at December 31, 2013 to fund the decline in customer deposits. Investments available-for-sale decreased $4.5 million, or 3.1% to $139.9 million at March 31, 2014, from $144.4 million at December 31, 2013, primarily due to the principal repayment of $5.0 million of mortgage-backed securities. Net loans receivable increased $8.7 million to $671.8 million at March 31, 2014 from December 31, 2013. Loan originations for the quarter were $38.9 million, of which $10.3 million and $13.2 million were in one-to-four family residential and commercial real estate loans, respectively. Principal repayments for the loan portfolio during the quarter were $30.5 million and loans transferred to OREO were $1.2 million. OREO increased $144,000 or 1.3% to $11.6 million at March 31, 2014, from $11.5 million at December 31, 2013 as more loans became OREO than OREO properties that were sold.

Deposits. During the first three months of 2014, deposits decreased $25.0 million to $587.0 million at March 31, 2014, compared to $612.1 million at December 31, 2013. Deposit accounts consisted of the following:
 
Balance at March 31, 2014
 
Increase/ (Decrease) from December 31, 2013
 
Percent Increase/(Decrease)
 
(Dollars in thousands)
Noninterest-bearing
$
8,810

 
$
(1,809
)
 
(17.0
)%
NOW
21,238

 
(4,233
)
 
(16.6
)
Statement savings
22,178

 
1,782

 
8.7

Money market
136,857

 
(8,315
)
 
(5.7
)
Certificates of deposit
397,964

 
(12,443
)
 
(3.0
)
 
$
587,047

 
$
(25,018
)
 
(4.1
)%
 
Statement savings increased by $1.8 million during the first quarter of 2014 offset by decreases of $1.8 million, $4.2 million, $8.3 million and $12.4 million in noninterest-bearing, NOW, money market accounts and certificates of deposit, respectively. The decrease in certificates of deposit and money market accounts was primarily the result of our strategy to utilize our excess liquidity, mainly cash, to reduce higher-cost deposits by competing less aggressively on deposit interest rates. We believe customers who were more interest rate sensitive elected to withdraw their funds to invest in higher yielding investment products, which contributed to the decline in our deposit balances. Included in the certificates of deposit balance at March 31, 2014 was $10.8 million in public funds. We did not have any brokered deposits at March 31, 2014 or December 31, 2013.

Advances. We use advances from the FHLB as an alternative funding source to manage funding costs, reduce interest rate risk and to leverage our balance sheet. Total FHLB advances at March 31, 2014 were $119.0 million, unchanged from December 31, 2013.


34


Stockholders’ Equity. Total stockholders’ equity increased $3.5 million, or 1.9% to $187.8 million at March 31, 2014 from $184.4 million at December 31, 2013. The increase was primarily the result of net income of $2.6 million generated during the first quarter ended March 31, 2014 and an improvement of $1.2 million in other comprehensive income from unrealized holding gains on available-for-sale securities.

Comparison of Operating Results for the Three Months Ended March 31, 2014 and 2013

Net Interest Income. Net interest income for the quarter ended March 31, 2014 increased $665,000 before provision to $8.1 million, as compared to $7.4 million for the same quarter in 2013. The increase was attributable to an increase of $114,000 in interest income and a decrease of $551,000 in interest expense. Average interest-earning assets increased $9.7 million to $852.8 million for the three months ended March 31, 2014, from the same quarter in 2013 primarily due to an increase in our net loans receivable. Average interest-bearing liabilities increased $16.6 million to $705.2 million for the first quarter of 2014 compared to the first quarter of 2013, primarily due to an increase in our FHLB borrowings. During the same period, our yield on interest-earning assets did not change while our cost of funds decreased 34 basis points. Our interest rate spread for the quarter ended March 31, 2014 increased 34 basis points to 3.62% compared to 3.28% for the first quarter of 2013. Our net interest margin for the first quarter of 2014 increased 27 basis points to 3.78% from 3.51% for the same quarter last year.

The following table sets forth the effects of changes in rates and volumes on our net interest income:
 
Three Months Ended March 31, 2014 Compared to March 31, 2013 Increase/(Decrease) Due to
 
Rate
 
Volume
 
Total
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
   Loan receivable, net
$
(324
)
 
$
306

 
$
(18
)
   Investments available-for-sale
157

 
(26
)
 
131

   Interest-earning deposits
(1
)
 

 
(1
)
   FHLB stock
2

 

 
2

Total net change in income on interest-earning assets
(166
)
 
280

 
114

 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
   NOW
(1
)
 
3

 
2

   Statement savings
(2
)
 
1

 
(1
)
   Money market
(14
)
 
(11
)
 
(25
)
   Certificates of deposit
(306
)
 
(216
)
 
(522
)
   Advances from the FHLB
(450
)
 
445

 
(5
)
Total net change in expense on interest-bearing liabilities
(773
)
 
222

 
(551
)
Net change in net interest income
$
607

 
$
58

 
$
665


Interest Income. Total interest income for the first quarter of 2014 increased $114,000, or 1.2% to $9.7 million from $9.5 million, as compared to the first quarter of 2013.

The following table compares detailed average interest-earning asset balances, associated yields and resulting changes in interest and dividend income for the three months ended March 31, 2014 and 2013:

35


 
Three Months Ended March 31,
 
2014
 
2013
 
Increase/(Decrease) in Interest and Dividend Income
 
Average
Balance
 
Yield
 
Average
Balance
 
Yield
 
 
(Dollars in thousands)
Loans receivable, net                                           
$
670,311

 
5.39
%
 
$
650,955

 
5.56
%
 
$
(18
)
Investments available-for-sale
142,473

 
1.70

 
151,013

 
1.25

 
131

Interest-bearing deposits                                           
33,063

 
0.24

 
33,880

 
0.25

 
(1
)
FHLB stock                      
7,001

 
0.10

 
7,271

 

 
2

Total interest-earning assets                                                      
$
852,848

 
4.53
%
 
$
843,119

 
4.53
%
 
$
114


Interest income from net loans receivable declined $18,000 and remained at $9.0 million during the first three months of 2014, as compared to the same period in 2013. The slight decline was due to a 17 basis point decrease in the average loan yield from the comparable quarter in 2013 offsetting a $19.4 million increase in the average loan balance to $670.3 million at March 31, 2014.

Interest income from investments available-for-sale increased $131,000 to $604,000 for the three months ended March 31, 2014, as compared to $473,000 for the comparable period in 2013. The primary reason for this increase was a 45 basis points increase in the average investment yield, resulting in a $157,000 increase in interest income, reflecting adjustable rate mortgage backed securities trending upwards over the last year. This change was partially offset by a $26,000 decrease in interest income due to a $8.5 million decrease in the average balance of investments.

Interest Expense. Total interest expense for the three months ended March 31, 2014 was $1.6 million, a decrease of $551,000 compared to $2.1 million for the first quarter of 2013.

The following table details average balances, cost of funds and the resulting decrease in interest expense for the three months ended March 31, 2014 and 2013:
 
Three Months Ended March 31,
 
2014
 
2013
 
Increase/
(Decrease) in
Interest
Expense
 
Average
Balance
 
Cost
 
Average
Balance
 
Cost
 
 
(Dollars in thousands)
NOW                                
$
22,009

 
0.14
%
 
$
16,455

 
0.15
%
 
$
2

Statement savings                                                      
22,349

 
0.13

 
18,304

 
0.20

 
(1
)
Money market
138,161

 
0.18

 
158,468

 
0.22

 
(25
)
Certificates of deposit                                           
403,652

 
1.26

 
458,348

 
1.56

 
(522
)
Advances from the FHLB                                           
119,000

 
0.84

 
37,007

 
2.77

 
(5
)
Total interest-bearing liabilities                                                      
$
705,171

 
0.91
%
 
$
688,582

 
1.25
%
 
$
(551
)

Interest expense on our certificates of deposit accounts decreased $522,000, due to the $54.7 million decline in the average balance of certificates of deposit and a 30 basis point reduction in our cost of certificates for the first quarter of 2014, as compared to the first quarter of 2013. Interest expense on our money market accounts decreased $25,000, primarily as a result of a decrease in the average cost of these funds of four basis points, or $14,000 to 0.18% from 0.22%. Interest expense related to our FHLB advances decreased $5,000, primarily as a result of the 193 basis points decrease in our average cost of funds for FHLB advances to 0.84% at March 31, 2014 from 2.77% at March 31, 2013 being mostly offset by an increase of $82.0 million in the average balance of our advances to $119.0 million for the first quarter of 2014, as compared to $37.0 million during the quarter ended March 31, 2013.

Provision for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general allowance

36


is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, the prevailing economy, borrower’s ability to repay, the regulatory environment, competition, geographic and loan type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, managements’ experience level, our loan review and grading systems, the value of underlying collateral and the level of problem loans in assessing the ALLL. The specific allowance component is created when management believes that the collectability of a specific loan, has been impaired and a loss is probable. The specific reserves are computed using current appraisals, listed sales prices and other available information less costs to complete, if any, and costs to sell the property. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events differ from predictions.

During the quarter ended March 31, 2014, management evaluated the adequacy of the ALLL and concluded that a recapture of prior period provisions for loan loss in the amount of $500,000 was appropriate for the quarter, compared to no provision during the quarter ended March 31, 2013:

after careful review and ongoing monitoring, loans with principal balances totaling $12.3 million were upgraded during the quarter as a result of an improvement in their respective risk profiles, reducing the amounts allocated for future loan losses relating to these loans;

delinquent loans, loans over 30 days past due, decreased to $3.0 million at March 31, 2014, from $4.3 million at December 31, 2013 and $16.7 million at March 31, 2013;

nonperforming loans decreased to $2.5 million at March 31, 2014, from $4.0 million at December 31, 2013, and $19.0 million at March 31, 2013, reflecting continuing improvement in the quality of our loan portfolio;

nonperforming loans as a percentage of total loans improved to 0.37% at March 31, 2014, compared to 0.59% at December 31, 2013, and 2.86% at March 31, 2013; and

nonperforming assets decreased to $14.1 million at March 31, 2014, compared to $15.5 million at December 31, 2013, and $35.3 million at March 31, 2013.

The ALLL at March 31, 2014, was $12.1 million compared to $13.0 million at December 31, 2013. The ALLL represented 477.23% of nonperforming loans and 1.76% of total loans, net of LIP, at March 31, 2014 compared to 325.26% and 1.91%, respectively, at December 31, 2013.

We believe that the ALLL as of March 31, 2014 was adequate to absorb the probable and inherent risks of loss in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will be proven correct in the future, that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. Future additions to the allowance may become necessary based upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan balances, or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of our ALLL is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available to them at the time of their examination.

The following table presents a breakdown of our nonperforming assets and as a percent of total assets at the dates indicated:

37


 
March 31, 2014
 
December 31, 2013
 
March 31, 2013
 
Three Month Increase/(Decrease)
 
One Year Increase/ (Decrease)
 
(Dollars in thousands)
Nonperforming loans:
 
 
 
 
 
 
 
 
 
   One-to-four family residential
$
1,600

 
$
2,297

 
$
5,980

 
$
(697
)
 
$
(4,380
)
   Multifamily
228

 
233

 
2,623

 
(5
)
 
(2,395
)
   Commercial real estate
706

 
1,198

 
4,883

 
(492
)
 
(4,177
)
   Construction/land development

 
223

 
4,747

 
(223
)
 
(4,747
)
   Consumer

 
44

 
732

 
(44
)
 
(732
)
Total nonperforming loans
2,534

 
3,995

 
18,965

 
(1,461
)
 
(16,431
)
 
 
 
 
 
 
 
 
 
 
OREO
11,609

 
11,465

 
16,310

 
144

 
(4,701
)
Total nonperforming assets
$
14,143

 
$
15,460

 
$
35,275

 
$
(1,317
)
 
$
(21,132
)
 
 
 
 
 
 
 
 
 
 
Nonperforming assets as a percent of total assets
1.57
%
 
1.68
%
 
3.98
%
 
 
 
 

Nonperforming loans include loans to borrowers who are experiencing deteriorating financial conditions and there is doubt as to the ultimate recoverability of the full principal and interest due the Bank in accordance with the terms of the loan agreement. Nonperforming loans decreased $1.5 million to $2.5 million at March 31, 2014, from $4.0 million at December 31, 2013. This decrease was the result of $1.2 million of loans transferred to OREO, $553,000 in charge-offs, $215,000 in short sales and $60,000 in principal reductions offset by a net increase of $558,000 of loans classified as nonperforming during the three months ended March 31, 2014.

The three largest nonperforming loans in the loan portfolio at March 31, 2014 consisted of a $601,000 commercial loan, secured by a two-story office building in King County; a $326,000 one-to-four family loan secured by a two-story single family residence in Pierce County; and a $300,000 one-to-four family loan, secured by a two-story single family residence in Pierce County.

Nonperforming assets continued to decrease during the quarter. At their peak, nonperforming assets reached $166.4 million at March 31, 2010, decreasing to $14.1 million at March 31, 2014, representing a $152.3 million, or 91.5% decrease.

The following table presents a breakdown of our TDRs:
 
March 31, 2014
 
December 31, 2013
 
March 31, 2013
 
Three Month Increase/ (Decrease)
 
One Year Increase/ (Decrease)
 
(In thousands)
Nonperforming TDRs:
 
 
 
 
 
 
 
 
 
   One-to-four family residential
$
469

 
$
924

 
$
2,679

 
$
(455
)
 
$
(2,210
)
   Consumer

 
44

 
47

 
(44
)
 
(47
)
Total nonperforming TDRs
469

 
968

 
2,726

 
(499
)
 
(2,257
)
 
 
 
 
 
 
 
 
 
 
Performing TDRs:
 
 
 
 
 
 
 
 
 
   One-to-four family residential
45,762

 
45,851

 
52,270

 
(89
)
 
(6,508
)
   Multifamily
2,201

 
2,208

 
1,234

 
(7
)
 
967

   Commercial real estate
12,066

 
12,111

 
12,251

 
(45
)
 
(185
)
   Consumer
43

 

 

 
43

 
43

Total performing TDRs
60,072

 
60,170

 
65,755

 
(98
)
 
(5,683
)
 
 
 
 
 
 
 
 
 
 
Total TDRs
$
60,541

 
$
61,138

 
$
68,481

 
$
(597
)
 
$
(7,940
)


38


Our TDRs decreased $597,000, or 1.0% to $60.5 million at March 31, 2014, compared to $61.1 million at December 31, 2013 and decreased $7.9 million, or 11.6% as compared to $68.5 million at March 31, 2013. During the first three months of 2014, we did not transfer any nonperforming TDRs to OREO, while $345,000 of TDRs were paid off and $252,000 in principal payments were received.

As we work with our borrowers to help them through this difficult economic cycle, we explore all options available to minimize our risk of loss. At times, the best option for our customers and the Bank is to modify the loan for a period of time, usually one year or less. These modifications have included lowering the interest rate on the loan for a period of time and/or extending the maturity date of the loan or allowing interest only payments for a specific time frame. These modifications are granted only when there is a reasonable and attainable restructured loan plan that has been agreed to by the borrower and is in the Bank's best interest. Of the $60.5 million in TDRs at March 31, 2014, $60.1 million were performing and $469,000 were not performing according to their restructured payment terms.

The largest TDR relationship at March 31, 2014 totaled $13.2 million and was comprised of one-to-four family residential rental properties located in King, Kitsap, Pierce and Thurston counties. At March 31, 2014, there were no LIP in connection with these restructured and impaired loans.

OREO includes properties acquired by the Bank through foreclosure or deed in lieu of foreclosure. The following table presents a breakdown of our OREO by county and number of properties at March 31, 2014.
 
County
 
Total
 
Number of Properties
 
Percent of Total OREO
 
King
 
Pierce
 
Kitsap
 
All Other
 
 
 
 
(Dollars in thousands)
OREO:
 
 
 
 
 
 
 
 
 
 
 
 
 
   One-to-four family residential
$
711

 
$
505

 
$

 
$

 
$
1,216

 
7
 
10.5
%
   Commercial real estate (1)

 
8,152

 
773

 
912

 
9,837

 
13
 
84.7
%
   Construction/land development

 
223

 

 
333

 
556

 
2
 
4.8
%
Total OREO
$
711

 
$
8,880

 
$
773

 
$
1,245

 
$
11,609

 
22

 
100.0
%
_________
(1) Of the 13 properties classified as commercial real estate, there are nine office/retail buildings, one mixed-use buildings
and three are undeveloped lots.

The following table presents a breakdown of our OREO activity:
 
Three Months Ended March 31,
 
2014
 
2013
 
(In thousands)
Balance at beginning of period
$
11,465

 
$
17,347

   Loans transferred to OREO
1,191

 
3,376

   Capitalized improvements

 
33

   Dispositions of OREO
(851
)
 
(4,301
)
   Market value adjustments
(196
)
 
(145
)
Balance at end of period
$
11,609

 
$
16,310


OREO increased $144,000 during the first quarter of 2014, or 1.3% to $11.6 million at March 31, 2014 from December 31, 2013. We sold $851,000 of OREO during the first quarter of 2014, which was comprised of two properties and generated a net loss on sale of $71,000. OREO at March 31, 2014 consisted of $9.8 million in commercial real estate properties, $1.2 million in one-to-four family residential homes and $556,000 in construction/land development projects.

The three largest OREO properties at March 31, 2013 were an office/retail building valued at $3.4 million, an office/retail building valued at $1.1 million and an office/retail building valued at $837,000, all located in Pierce County.

We continue to focus our efforts on converting nonperforming loans to OREO through foreclosure or deeds in lieu of foreclosure and selling the properties. By taking ownership of these properties, we can convert nonearning assets into earning

39


assets on a more timely basis. Our success in this area is reflected by the improved ratio of our average interest-earning assets to average interest-bearing liabilities of 120.9% at March 31, 2014 compared to 122.4% at March 31, 2013.

The following table summarizes selected financial data related to our ALLL and loan portfolio. All loan balances and ratios are calculated using loan balances that are net of LIP.
 
At or For the Three Months Ended March 31,
 
2014
 
2013
 
(Dollars in thousands)
Recapture of loan loss provision
$
500

 
$

Charge-offs
553

 
619

Recoveries
152

 
79

ALLL
12,093

 
12,002

ALLL as a percent of total loans, net of LIP
1.76
%
 
1.81
%
ALLL as a percent of nonperforming loans, net of LIP
477.23

 
63.28

Total nonperforming loans, net of LIP
$
2,534

 
$
18,965

Nonperforming loans as a percent of total loans, net of LIP
0.37
%
 
2.86
%
Total loans receivable, net of LIP
$
686,565

 
$
663,499

Total loans originated
38,884

 
28,552


Noninterest Income. Noninterest income decreased $36,000 to $68,000 for the first quarter of 2014 from $104,000 for the same quarter in 2013. The following table provides a detailed analysis of the changes in the components of noninterest income:
 
Three Months Ended March 31, 2014
 
Increase/(Decrease) from March 31, 2013
 
Percent
Increase/(Decrease)
 
(Dollars in thousands)
Service fees on deposit accounts
$
15

 
$
(2
)
 
(11.5
)%
Loan service fees                                
21

 
(14
)
 
(41.0
)
Servicing rights, net                                
2

 
5

 
(158.8
)
Other           
30

 
(25
)
 
(44.7
)
Total noninterest income                                           
$
68

 
$
(36
)
 
(34.7
)%

The decrease in noninterest income for three months ended March 31, 2014 compared to the same period in 2013 was largely due to a $23,000 decrease in rental income from OREO properties.

Noninterest Expense. Noninterest expense decreased $1.4 million to $4.5 million for the first quarter of 2014 from $5.9 million for the comparable quarter in 2013. The following table provides a detailed analysis of the changes in the components of noninterest expense:

40


 
Three Months Ended March 31, 2014
 
Increase/(Decrease) from March 31, 2013
 
Percent
Increase/(Decrease)
 
(Dollars in thousands)
Salaries and employee benefits
$
2,900

 
$
(714
)
 
(19.7
)%
Occupancy and equipment                                           
351

 
(3
)
 
(0.9
)
Professional fees                                
357

 
(88
)
 
(19.7
)
Data processing                                
173

 
11

 
6.7

Loss on sales of OREO property, net                                
71

 
703

 
(111.2
)
OREO market value adjustments
196

 
51

 
35.1

OREO-related expenses, net
61

 
(273
)
 
(81.7
)
Regulatory assessments
78

 
(205
)
 
(72.4
)
Insurance and bond premiums                                           
88

 
(26
)
 
(22.7
)
Marketing
25

 
7

 
39.6

Prepayment penalty on FHLB advances

 
(679
)
 
(100.0
)
Other general and administrative
224

 
(138
)
 
(38.1
)
Total noninterest expense                                           
$
4,524

 
$
(1,354
)
 
(23.0
)%

The decrease in noninterest expense for the three months ended March 31, 2014 compared to the same period in 2013 was in part due to the FHLB prepayment penalty of $679,000 incurred during the quarter ended March 31, 2013 on the refinance of a $33.0 million advance with no comparable transaction during the quarter ending March 31, 2013. In addition, salaries and employee benefits decreased $714,000, as compared to the first quarter of last year due to 15.2% reduction in full-time equivalent employees to 95 from 112 employees. Also contributing to the change was a decline in stock based compensation, which was $85,000 during the quarter ended March 31, 2014 compared to $481,000 in the comparable quarter a year ago. The Bank also had decreases of $273,000 in OREO-related expenses and a $205,000 decrease in our regulatory assessments reflecting our improved financial condition. In addition, we had a net loss on sales of OREO property of $71,000 in the first quarter of 2014 compared to a net gain of $632,000 during the first quarter of 2013 .

Federal Income Tax Expense. We recorded a $1.5 million federal income tax provision for the quarter ended March 31, 2014, as a result of our increase in net income. This compared to $59,000 federal income tax provision for the three months ended March 31, 2013. The federal income tax provision for the three months ended March 31, 2013 was the result of the alternative minimum tax. For the three months ended March 31, 2014, the effective tax rate was 35.46%

Liquidity

We are required to have enough cash flow in order to maintain sufficient liquidity to ensure a safe and sound operation. We maintain cash flows above the minimum level believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. On a daily basis, we review and update cash flow projections to ensure that adequate liquidity is maintained.

Our primary sources of funds are customer deposits, loan and investment repayments, maturing investment securities and advances from the FHLB. These funds, together with equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. At March 31, 2014, certificates of deposit scheduled to mature in one year or less totaled $244.3 million. Management's policy is to maintain deposit rates at levels that are competitive with other local financial institutions, although recently we have been less aggressive in competing for certificates of deposit and public funds in order to reduce our cost of funds. Historically, we have been able to retain a significant amount of the deposits as they mature. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the level of interest rates, economic conditions and competition. We measure our liquidity based on our ability to fund our assets and to meet liability obligations when they come due. Liquidity (and funding) risk occurs when funds cannot be raised at reasonable prices or in a reasonable time frame to meet our normal or unanticipated obligations. We regularly monitor the mix between our assets and our liabilities to manage effectively our liquidity and funding requirements.

When deposits are not readily available and/or cost effective to provide the funds for our assets, we use alternative funding sources. These sources include, but are not limited to: advances from the FHLB, wholesale funding, brokered deposits, federal funds purchased and dealer repurchase agreements, as well as other short-term alternatives. These funding sources are generally collateral dependent. We may also liquidate assets to meet our funding needs. At March 31, 2014, the Bank maintained credit

41


facilities with the FHLB totaling $228.6 million with an outstanding balance of $119.0 million. At March 31, 2014, we also had available a total of $50.0 million credit facilities with other financial institutions, with no balance outstanding. For additional information, see the Consolidated Statements of Cash Flow in Item 1 of this Form 10-Q.

On a monthly basis, we estimate our liquidity sources and needs for the next six months. Also, we determine funding concentrations and our need for sources of funds other than deposits. This information is used by our Asset/Liability Management Committee in forecasting funding needs and investing opportunities. We believe that our current liquidity position and our expected operating results are sufficient to fund all of our existing commitments

Commitments and Off-Balance Sheet Arrangements

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and the unused portions of lines of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Commitments to extend credit and lines of credit are not recorded as an asset or liability by us until the instrument is exercised. At March 31, 2014 and December 31, 2013, we had no commitments to originate loans for sale.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the customer. The amount and type of collateral required varies, but may include real estate and income-producing commercial properties.

The following table summarizes our outstanding commitments to originate loans, to advance additional amounts pursuant to outstanding lines of credit and to disburse funds related to our construction loans at March 31, 2014.
 
 
 
Amount of Commitment Expiration - Per Period
 
Total Amounts Committed
 
Through One Year
 
After One Through Three Years
 
After Three Through Five Years
 
After Five Years
 
(In thousands)
Commitments to originate loans                                                      
$
8,158

 
$
8,158

 
$

 
$

 
$

Unused portion of lines of credit                                                      
11,232

 
1,992

 
298

 
6,889

 
2,053

Undisbursed portion of construction loans
11,339

 
7,303

 
4,036

 

 

Total commitments
$
30,729

 
$
17,453

 
$
4,334

 
$
6,889

 
$
2,053


First Financial Northwest and its subsidiaries from time to time are involved in various claims and legal actions arising in the ordinary course of business. There are currently no matters that in the opinion of management, would have a material adverse effect on First Financial Northwest’s consolidated financial position, results of operation or liquidity.

Among our contingent liabilities are exposures to limited recourse arrangements with respect to sales of whole loans and participation interests.

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

Capital

At March 31, 2014, stockholders' equity totaled $187.8 million, or 20.8% of total assets. Our book value per share of common stock was $11.42 at March 31, 2014 compared to $11.25 at December 31, 2013. Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a “well-capitalized” institution in accordance with regulatory standards. As of March 31, 2014, the Bank exceeded all regulatory capital requirements. Regulatory capital ratios for the Bank only were as follows at March 31, 2014: Tier 1 leverage capital 18.61%; Tier 1 risk-based capital 26.98%; and Total risk-based capital 28.24%. The regulatory capital requirements to be considered well capitalized are 5%, 6% and 10%, respectively.

42


The Bank met the financial ratios for “well-capitalized” status at March 31, 2014. In addition, at March 31, 2014, First Financial Northwest, the parent company of the Bank, had $10.4 million of available cash to potentially increase its investment in the Bank.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

General. Our Board of Directors has approved an asset/liability management policy to guide management in maximizing net interest income by managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate sensitivity, credit risk and profitability. The policy established an Asset/Liability Management Committee ("ALCO") comprised of certain members of senior management and the Board of Directors. The Committee's purpose is to communicate, coordinate and manage our asset/liability position consistent with our business plan and Board-approved policies. The ALCO meets quarterly to review various areas including:
economic conditions;
interest rate outlook;
asset/liability mix;
interest rate risk sensitivity;
current market opportunities to promote specific products;
historical financial results;
projected financial results; and
capital position.

The Committee also reviews current and projected liquidity needs. As part of its procedures, the ALCO regularly reviews interest rate risk by forecasting the impact that changes in interest rates may have on net interest income and the market value of portfolio equity, which is defined as the net present value of an institution's existing assets, liabilities and off-balance sheet instruments and evaluating such impacts against the maximum potential change in the market value of portfolio equity that is authorized by the Board of Directors.

Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Our loans generally have longer maturities than our deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

We have utilized the following strategies in our efforts to manage interest rate risk:
we have attempted, where possible, to extend the maturities of our deposits which typically fund our long-term assets;
we have invested in securities with relatively short average lives, generally less than eight years; and
we have added adjustable-rate securities to our investment portfolio.

How We Measure the Risk of Interest Rate Changes. We monitor our interest rate sensitivity on a quarterly basis to measure the change in net interest income as a percentage of net income in varying rate environments. Management uses various assumptions to evaluate the sensitivity of our operations to changes in interest rates. Although management believes these assumptions are reasonable, the interest rate sensitivity of our assets and liabilities on net interest income and the market value of portfolio equity could vary substantially if different assumptions were used or actual experience differs from these assumptions. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react differently to changes in market interest rates. 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 of assets and liabilities lag behind changes in market interest rates. Non-uniform changes and fluctuations in market interest rates across various maturities will also affect the results presented. In addition, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, a portion of our adjustable-rate loans have interest rate floors below which the loan's contractual interest rate may not adjust. Approximately 25.4% of our total loans were comprised of adjustable-rate loans at March 31, 2014. At that date, $77.7 million, or 43.8% of these loans with a weighted-average interest rate of 4.4% were at their floor interest rate. The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates. Also, when loans are at their floors, there is a further risk that our interest income may not increase as rapidly as our cost of funds during periods of increasing interest rates. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all these factors in monitoring our interest rate exposure.

43



The assumptions we use are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, loan prepayments, deposit decay rates and the market value of certain assets under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans, investments and borrowings and use our own assumptions on deposit decay rates except for time deposits. Time deposits are modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposits can be maintained with rate adjustments not directly proportionate to the change in market interest rates, based upon our historical deposit decay rates which are substantially lower than market decay rates. We have demonstrated in the past that the tiering structure of our deposit accounts during changing rate environments results in relatively lower volatility and less than market rate changes in our interest expense for deposits. We tier our deposit accounts by balance and rate, whereby higher balances within an account earn higher rates of interest. Therefore, deposits that are not very rate sensitive (generally, lower balance tiers) are separated from deposits that are rate sensitive (generally, higher balance tiers). When interest rates rise, we do not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our analysis of our customer base, competitive factors and historical experience.

Our income simulation model examines changes in net interest income in which interest rates were assumed to remain at their base level, instantaneously increase by 100, 200 and 300 basis points or decline immediately by 100 basis points. Reductions of rates by 200 and 300 basis points were not reported due to the very low rate environment. The current federal funds rate is 0.25% making a 200 and 300 basis point decrease impossible.

The following table illustrates the change in our net interest income at March 31, 2014 that would occur in the event of a gradual change in interest rates equally across all maturities, with no effect given to any steps that we might take to counter the effect of that interest rate movement.
Net Interest Income Change at March 31, 2014
Basis Point Change in Rates
 
Net Interest Income
% Change
(Dollars in thousands)
+300
 
$
30,761

(3.09)%
+200
 
31,216

(1.66)
+100
 
31,610

(0.42)
 Base
 
31,742

(100)
 
30,641

(3.47)


44


The following table illustrates the change in our net portfolio value (“NPV”) at March 31, 2014 that would occur in the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that we might take to counter the effect of that interest rate movement.
Basis Point
 
 
 
 
 
 
 
Net Portfolio as % of
 
Market
Change in
 
Net Portfolio Value (2)
 
Portfolio Value of Assets
 
Value of
Rates (1)
 
Amount
 
$ Change (3)
 
% Change
 
NPV Ratio (4)
 
% Change (5)
 
Assets (6)
 
 
(Dollars in thousands)
+300

 
$
148,357

 
$
(45,942
)
 
(23.60
)%
 
17.74
%
 
(5.03
)%
 
$
836,279

+200

 
163,507

 
(30,792
)
 
(15.80
)
 
18.98

 
(3.37
)
 
861,330

+100

 
179,834

 
(14,465
)
 
(7.40
)
 
20.25

 
(1.58
)
 
887,977

 Base

 
194,299

 

 

 
21.28

 

 
913,218

(100
)
 
202,751

 
8,452

 
4.40

 
21.73

 
0.93

 
933,003

_____________ 
(1) The current federal funds rate is 0.25%, making a 200 and 300 basis point drop impossible.
(2) The net portfolio value is the difference between the present value of the discounted cash flows of assets and liabilities and represents the market value of the Company's equity for any given interest rate scenario. Net portfolio value is useful for determining, on a market value basis, how equity changes in response to various interest rate scenarios. Large changes in net portfolio value reflect increased interest rate sensitivity and generally more volatile earnings streams.
(3) The increase or decrease in the estimated net portfolio value at the indicated interest rates compared to the net portfolio value assuming no change in interest rates.
(4) Net portfolio value divided by the market value of assets.
(5) The increase or decrease in the net portfolio value divided by the market value of assets.
(6) The market value of assets represents the value of assets under the various interest rate scenarios and reflects the sensitivity of those assets to interest rate changes.

The net interest income and net portfolio value tables presented above are predicated upon a stable balance sheet with no growth or change in asset or liability mix. In addition, the net portfolio value is based upon the present value of discounted cash flows using our estimates of current replacement rates to discount the cash flows. The effects of changes in interest rates in the net interest income table are based upon a cash flow simulation of our existing assets and liabilities and assuming that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. Delinquency rates may change when interest rates change as a result of changes in the loan portfolio mix, underwriting conditions, loan terms or changes in economic conditions that have a delayed effect on the portfolio. Even if interest rates change in the designated amounts, there can be no assurance that our assets and liabilities would perform as set forth above. Also, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause changes to the net portfolio value and net interest income other than those indicated above.

At March 31, 2014, we did not have any derivative financial instruments or trading accounts for any class of financial instruments, nor have we engaged in hedging activities or purchased off-balance sheet derivative instruments. Interest rate risk continues to be one of our primary risks as other types of risks, such as foreign currency exchange risk and commodity pricing risk do not arise in the normal course of our business activities and operations.

Item 4. Controls and Procedures

The management of First Financial Northwest, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (“Exchange Act”). A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Additionally, in designing disclosure controls and procedures, our management was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. As a result of these inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, projections of any evaluation of effectiveness to future periods

45


are subject to risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

(a)
Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer (Principal Financial Officer) and several other members of our senior management as of the end of the period covered by this report. Our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2014, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is (i) accumulated and communicated to our 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)
Changes in Internal Controls: In the quarter ended March 31, 2014, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II
Item 1. Legal Proceedings

From time to time, we are engaged in various legal proceedings in the ordinary course of business, none of which are currently considered to have a material impact on our financial position or results of operations.

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in Part I, Item 1A of 2013 Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the first quarter of 2014, we did not sell any securities that were not registered under the Securities Act of 1933. There were no repurchases of equity securities in the first quarter of 2014.

On April 24, 2014, the Company announced that its Board of Directors has authorized the repurchase of up to 1,645,414 shares of the Company's common stock, or 10% of the Company's outstanding shares. The shares may be purchased through September 16, 2014, depending upon market conditions and other factors.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Financial Statement Schedules
 
(a)       Exhibits

46


3.1
 
Articles of Incorporation of First Financial Northwest (1)
3.2
 
Bylaws of First Financial Northwest (1)
4.0
 
Form of stock certificate of First Financial Northwest (1)
10.1
 
Amended Employment Agreement between First Savings Bank Northwest and Joseph W. Kiley III (11)
10.2
 
Form of Change in Control Severance Agreement for Executive Officers (1)
10.3
 
Form of First Savings Bank Employee Severance Compensation Plan (1)
10.4
 
Form of Supplemental Executive Retirement Agreement entered into by First Savings Bank with Victor Karpiak,
 
 
   Harry A. Blencoe, Robert H. Gagnier and Joseph W. Kiley III (1)
10.5
 
Form of Financial Institutions Retirement Fund (1)
10.6
 
Form of 401(k) Retirement Plan (2)
10.7
 
2008 Equity Incentive Plan (3)
10.8
 
Forms of incentive and non-qualified stock option award agreements (4)
10.9
 
Form of restricted stock award agreement (4)
10.9
 
Form of restricted stock award agreement (4)
10.10
 
Memorandum of Understanding with the FDIC and DFI (5)
10.11
 
Settlement Agreement and Mutual Release with the Stilwell Group (6)
10.12
 
Transition Agreement Modification Agreement for Victor Karpiak (6)
10.13
 
Amendment No. 1 to the Settlement and Mutual Release Agreement with the Stilwell Group (7)
10.14
 
Amendment No. 2 to the Settlement and Mutual Release Agreement with the Stilwell Group (8)
10.15
 
Offer Letter, dated June 27, 2013, between First Savings Bank Northwest and Richard P. Jacobson (9)
10.16
 
Separation Agreement between Victor Karpiak, First Financial Northwest and Affiliates (10)
10.17
 
Employment Agreement between First Savings Bank Northwest and Richard P. Jacobson (11)
31.1
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2
 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act 
101.0
 
The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Income Statements; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders' Equity; (5) Consolidated Statements of Cash Flows; and (6) Selected Notes to Consolidated Financial Statements.*
*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
 ____________
(1) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated March 22, 2012.
(2) 
Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, and incorporated herein by reference.
(3) 
Filed as Appendix A to First Financial Northwest’s definitive proxy statement dated April 15, 2008.
(4) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated March 22, 2012.
(5) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated April 2, 2012.
(6) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 20, 2012.
(7) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 17, 2013.
(8) 
Filed as an exhibit to First Financial Northwest's Current Report on Form 8-K dated February 26, 2013.
(9) 
Filed as an exhibit to First Financial Northwest's Current Report on Form 8-K dated July 9, 2013.
(10) 
Filed as an exhibit to First Financial Northwest's Current Report on Form 8-K dated August 23, 2013.
(11) 
Filed as an exhibit to First Financial Northwest's Current Report on Form 8-K dated December 5, 2013.

47


SIGNATURES

Pursuant to the requirements 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.
 
 
FIRST FINANCIAL NORTHWEST, INC. 
 
 
 
 
 
Date: May 8, 2014
By: 
/s/ Joseph W. Kiley III                                             
 
 
Joseph W. Kiley III
 
 
President and Chief Executive Officer (Principal Executive Officer)
Date: May 8, 2014
By: 
/s/ Richard. P. Jacobson                                                    
 
 
Richard P. Jacobson
 
 
Chief Financial Officer (Principal Financial Officer)
 
 
 
Date: May 8, 2014
By: 
/s/ Christine A. Huestis                                           
 
 
Christine A. Huestis
 
 
Vice President and Controller (Principal Accounting Officer)

48


Exhibit Index
 
Exhibit No.

Description
31.1

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 
31.2

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101

The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the qaurter ended March 31, 2014, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Income Statements; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders' Equity; (5) Consolidated Statements of Cash Flows; and (6) Selected Notes to Consolidated Financial Statements

*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

49