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First Financial Northwest, Inc. - Quarter Report: 2019 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, 2019
 
 
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

YES    X   NO      

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



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

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

YES       NO   X   

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock, $0.01 par value per share
 
FFNW
 
The Nasdaq Stock Market, LLC

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 7, 2019, 10,375,325 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)


Part 1. Financial Information

Item 1. Financial Statements
 
March 31, 2019
 
December 31, 2018
Assets
 
(Unaudited)
 
 
Cash on hand and in banks
$
9,366

 
$
8,122

Interest-earning deposits with banks
14,596

 
8,888

Investments available-for-sale, at fair value
138,658

 
142,170

Loans receivable, net of allowance of $13,808 and $13,347
1,051,711

 
1,022,904

Federal Home Loan Bank ("FHLB") stock, at cost
8,041

 
7,310

Accrued interest receivable
4,861

 
4,068

Deferred tax assets, net
1,728

 
1,844

Other real estate owned ("OREO")
454

 
483

Premises and equipment, net
21,370

 
21,331

Bank owned life insurance ("BOLI"), net
30,162

 
29,841

Prepaid expenses and other assets
4,947

 
3,458

Goodwill
889

 
889

Core deposit intangible
1,079

 
1,116

Total assets
$
1,287,862


$
1,252,424

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 
Deposits:
 
 
 
Noninterest-bearing deposits
$
46,026

 
$
46,108

Interest-bearing deposits
909,246

 
892,924

Total deposits
955,272

 
939,032

FHLB advances
163,500

 
146,500

Advance payments from borrowers for taxes and insurance
5,374

 
2,933

Accrued interest payable
478

 
478

Other liabilities
11,554

 
9,743

Total liabilities
1,136,178

 
1,098,686

 
 

 
 
Commitments and contingencies


 


Stockholders' Equity
 

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

 

Common stock, $0.01 par value; authorized 90,000,000 shares; issued and
outstanding 10,457,625 shares at March 31, 2019, and 10,710,656
shares at December 31, 2018
104

 
107

Additional paid-in capital
89,800

 
93,773

Retained earnings
67,568

 
66,343

Accumulated other comprehensive loss, net of tax
(1,838
)
 
(2,253
)
Unearned Employee Stock Ownership Plan ("ESOP") shares
(3,950
)
 
(4,232
)
Total stockholders' equity
151,684

 
153,738

Total liabilities and stockholders' equity
$
1,287,862

 
$
1,252,424


See accompanying selected notes to consolidated financial statements.

3


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

 
Three Months Ended March 31,
 
2019
 
2018
Interest income
 
 
 
Loans, including fees
$
13,281

 
$
13,042

Investments available-for-sale
1,159

 
929

Interest-earning deposits with banks
40

 
38

Dividends on FHLB stock
91

 
104

Total interest income
14,571

 
14,113

Interest expense
 

 
 

Deposits
3,822

 
2,276

FHLB advances and other borrowings
897

 
853

Total interest expense
4,719

 
3,129

Net interest income
9,852

 
10,984

Provision (recapture of provision) for loan losses
400

 
(4,000
)
Net interest income after provision (recapture of provision) for loan losses
9,452

 
14,984

Noninterest income
 

 
 

Net loss on sale of investments
(8
)
 

BOLI income
269

 
249

Wealth management revenue
196

 
99

Deposit related fees
171

 
161

Loan related fees
63

 
134

Other
9

 
3

Total noninterest income
700

 
646

Noninterest expense
 

 
 

Salaries and employee benefits
5,000

 
4,662

Occupancy and equipment
866

 
769

Professional fees
496

 
328

Data processing
518

 
324

OREO related expenses, net
31

 
1

Regulatory assessments
137

 
155

Insurance and bond premiums
105

 
106

Marketing
86

 
107

Other general and administrative
470

 
575

Total noninterest expense
7,709

 
7,027

Income before federal income tax provision
2,443

 
8,603

Federal income tax provision
498

 
1,761

Net income
$
1,945

 
$
6,842

Basic earnings per common share
$
0.19

 
$
0.67

Diluted earnings per common share
$
0.19

 
$
0.66

Basic weighted average number of common shares outstanding
10,118,286

 
10,210,828

Diluted weighted average number of common shares outstanding
10,220,900

 
10,336,566

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,
 
2019
 
2018
Net income
$
1,945

 
$
6,842

Other comprehensive income, before tax:
 
 
 
Unrealized holding gain (loss) on investments available-for-sale
976

 
(1,473
)
Tax (provision) benefit
(205
)
 
309

Reclassification adjustment for net losses realized in income
8

 

Tax provision
(1
)
 

(Loss) gain on cash flow hedge
(460
)
 
663

Tax benefit (provision)
97

 
(139
)
Other comprehensive income (loss), net of tax
415

 
(640
)
Total comprehensive income
$
2,360

 
$
6,202


See accompanying selected notes to consolidated financial statements.



5


FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
(Dollars in thousands except share data)
(Unaudited)

 
Three Months Ended March 31, 2018
 
Shares
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss,
 net of tax
 
Unearned
ESOP
Shares
 
Total Stockholders’ Equity
Balances at December 31, 2017
10,748,437

 
$
107

 
$
94,173

 
$
54,642

 
$
(928
)
 
$
(5,360
)
 
$
142,634

Net income

 

 

 
6,842

 

 

 
6,842

Other comprehensive (loss) income

 

 

 

 
(640
)
 

 
(640
)
Exercise of stock options
10,000

 

 
98

 

 

 

 
98

Issuance of common stock - restricted stock awards, net
20,987

 
1

 

 

 

 

 
1

Compensation related to stock options and restricted stock awards

 

 
83

 

 

 

 
83

Allocation of 28,213 ESOP shares

 

 
173

 

 

 
281

 
454

Cash dividend declared and paid ($0.07 per share)

 

 

 
(717
)
 

 

 
(717
)
Balances at March 31, 2018
10,779,424

 
$
108

 
$
94,527

 
$
60,767

 
$
(1,568
)
 
$
(5,079
)
 
$
148,755

 
Three Months Ended March 31, 2019
 
Shares
 
Common 
Stock
 
Additional 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss,  net of tax
 
Unearned
ESOP
Shares
 
Total
Stockholders' Equity
Balances at December 31, 2018
10,710,656

 
$
107

 
$
93,773

 
$
66,343

 
$
(2,253
)
 
$
(4,232
)
 
$
153,738

Net income

 

 

 
1,945

 

 

 
1,945

Other comprehensive income

 

 

 

 
415

 

 
415

Issuance of common stock - restricted stock awards, net
16,698

 

 
(93
)
 

 

 

 
(93
)
Compensation related to stock options and restricted stock awards

 

 
124

 

 

 

 
124

Allocation of 28,213 ESOP shares

 

 
163

 

 

 
282

 
445

Repurchase and retirement of common stock
(263,800
)
 
(3
)
 
(4,167
)
 

 

 

 
(4,170
)
Canceled common stock - restricted stock awards
(5,929
)
 

 

 

 

 

 

Cash dividend declared and paid ($0.08 per share)

 

 

 
(807
)
 

 

 
(807
)
Beginning balance adjustment from adoption of Topic 842

 

 

 
87

 

 

 
87

Balances at March 31, 2019
10,457,625

 
$
104

 
$
89,800

 
$
67,568

 
$
(1,838
)
 
$
(3,950
)
 
$
151,684


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,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
1,945

 
$
6,842

Adjustments to reconcile net income to net cash provided by
operating activities:
 
 
 
Provision (recapture of provision) for loan losses
400

 
(4,000
)
OREO market value adjustments
29

 

Net amortization of premiums and discounts on investments
193

 
274

Loss on sale of investments available-for-sale
8

 

Depreciation of premises and equipment
427

 
401

Deferred federal income taxes
7

 
19

Allocation of ESOP shares
445

 
454

Stock compensation expense
124

 
84

Increase in cash surrender value of BOLI
(269
)
 
(249
)
Changes in operating assets and liabilities:
 
 
 

(Increase) decrease in prepaid expenses and other assets
(1,912
)
 
2,517

Net increase in advance payments from borrowers for taxes and insurance
2,441

 
1,963

(Increase) decrease in accrued interest receivable
(793
)
 
103

Increase (decrease) in accrued interest payable

 
(56
)
Increase in other liabilities
1,898

 
374

Net cash provided by operating activities
4,943

 
8,726

Cash flows from investing activities:
 

 
 

Proceeds from sales, calls and maturities of investments available-for-sale
2,995

 
2,000

Principal repayments on investments available-for-sale
1,300

 
1,601

Purchases of investments available-for-sale

 
(15,978
)
Net (increase) decrease in loans receivable
(29,207
)
 
1,524

(Purchase) redemption of FHLB stock
(731
)
 
432

Purchase of premises and equipment
(466
)
 
(995
)
Purchase of BOLI
(52
)
 

Net cash used by investing activities
(26,161
)
 
(11,416
)
 
 
 
 
Continued
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

7


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

 
 
 
 
 
Three Months Ended March 31,
 
2019
 
2018
Cash flows from financing activities:
 

 
 

Net increase in deposits
$
16,240

 
$
23,727

Advances from the FHLB
71,500

 
140,000

Repayments of advances from the FHLB
(54,500
)
 
(156,000
)
Proceeds from stock options exercises

 
98

Net share settlement of stock awards
(93
)
 

Repurchase and retirement of common stock
(4,170
)
 

Dividends paid
(807
)
 
(717
)
Net cash provided by financing activities
28,170

 
7,108

Net increase in cash and cash equivalents
6,952

 
4,418

Cash and cash equivalents at beginning of period
17,010

 
16,131

Cash and cash equivalents at end of period
$
23,962

 
$
20,549

 
 
 
 
Supplemental disclosures of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

Interest paid
$
4,719

 
$
3,185

 
 
 
 
Noncash items:
 
 
 

Change in unrealized loss on investments available-for-sale
$
984

 
$
(1,473
)
Change in gain on cash flow hedge
(460
)
 
663


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 Financial Northwest Bank (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 Financial Northwest Bank. Accordingly, the information presented in the consolidated financial statements and accompanying data, relates primarily to First Financial Northwest Bank. First Financial Northwest is a bank holding company, having converted from a savings and loan holding company on March 31, 2015, and as a bank holding company is subject to regulation by the Federal Reserve Bank of San Francisco. First Financial Northwest Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State Department of Financial Institutions (“DFI”).

At March 31, 2019, First Financial Northwest Bank operated in eleven locations in Washington with the headquarters and six branch locations in King County and five branch locations in Snohomish County. The Bank’s primary market area consists of King, Snohomish, Pierce and Kitsap counties, Washington. The Bank has received FDIC approval to open an additional branch in Kirkland, Washington, which is expected to open later in 2019.

The Bank is a portfolio lender, originating and purchasing one-to-four family residential, multifamily, commercial real estate, construction/land development, business, and consumer loans. Loans are primarily funded by deposits from the general public, supplemented by borrowings from the Federal Home Loan Bank of Des Moines (“FHLB”) and deposits raised in the national brokered deposit market.

As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to First Financial Northwest, Inc. and its consolidated subsidiary First Financial Northwest Bank, 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 interim consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC (“2018 Form 10-K”). In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the unaudited interim 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, 2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. 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 allowance for loan and lease losses (“ALLL”), the valuation of other real estate owned (“OREO”) and the underlying collateral of impaired loans, deferred tax assets, the right-of-use asset and lease liability on our operating leases, and the fair value of financial instruments.

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 and purchasing loans for its portfolio. Substantially all income is derived from a diverse base of commercial, multifamily, and residential real estate loans, consumer lending activities, and investments.

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



9


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


Note 3 - Recently Issued Accounting Pronouncements

Recent Accounting Pronouncements Adopted in 2019

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires lessees to recognize on the balance sheet the assets and liabilities arising from operating leases. In July 2018, FASB issued ASU No. 2018-11, Leases (Topic 842) to address the comparative reporting requirements when this ASU is adopted. In March 2019, FASB issued ASU 2019-01, Leases (Topic 842), Codification Improvements. Under these ASUs, a lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. A lessee should include payments to be made in an optional period only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. For a finance lease, interest payments should be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income. For operating leases, the lease cost should be allocated over the lease term on a generally straight-line basis. The Company adopted this ASU on January 1, 2019 and according to ASU 2018-11, elected to recognize the related cumulative-effect adjustment as an adjustment to the opening balance of retained earnings. Adoption of ASU 2016-02 resulted in the addition of a right-of-use asset and lease related to certain banking offices under noncancelable operating lease agreements. The resulting increase did not to have a material impact on the Company’s consolidated financial statements or regulatory capital ratios. For more information see Note 8 ‑ Leases in this report.

In March 2017, FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. The Company adopted this ASU during the quarter ended March 31, 2019 with no material impact on the Company's consolidated financial statements.

Recent Accounting Pronouncements

In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326). This ASU replaces the existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses that have taken place during the reporting period. The measurement of expected credit losses will be based on historical information, current conditions, and reasonable and supportable forecasts that impact the collectability of the reported amount. Available‑for‑sale securities will bifurcate the fair value mark and establish an allowance for credit losses through the income statement for the credit portion of that mark. The interest portion will continue to be recognized through accumulated other comprehensive income or loss. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is adopted. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 15, 2018. The Company is evaluating our current expected loss methodology of our loan and investment portfolios to identify the necessary modifications in accordance with this standard and expects a change in the processes and procedures to calculate the ALLL, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. A valuation adjustment to our ALLL or investment portfolio that is identified in this process will be reflected as a one-time adjustment in equity rather than earnings. We are in the process of compiling historical and industry data that will be used to calculate expected credit losses on our loan portfolio to ensure we are fully compliant with the ASU at the adoption date and are evaluating the potential impact adoption of this ASU will have on our consolidated financial statements. The Company intends to adopt ASU 2016-13 in the first quarter of 2020, and as a result, we expect our allowance for loan losses to increase. Until our evaluation is complete, however, the magnitude of the increase will not be known.
    
In August 2018, FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove certain disclosure requirements regarding transfers between Level 1 and Level 2 of the fair value hierarchy and changes in unrealized gains and losses for recurring Level 3 fair value measurements. In addition, the amendments modified and added certain disclosure requirements for Level 3 fair value measurements. This ASU is effective for fiscal years beginning after December 15, 2019, and early adoption is permitted. Entities are permitted to early adopt any removed or modified disclosures and adopt the additional disclosures at the effective date. Adoption of ASU 2018-13 is not expected to have a material impact on the Company’s consolidated financial statements.


10


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


Note 4 - Investments

Investments available-for-sale are summarized as follows at the dates indicated:
 
March 31, 2019
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
23,967

 
$
89

 
$
(370
)
 
$
23,686

   Freddie Mac
6,310

 
27

 
(18
)
 
6,319

   Ginnie Mae
23,053

 
10

 
(1,050
)
 
22,013

   Other
8,925

 
47

 
(19
)
 
8,953

Municipal bonds
7,619

 
169

 
(21
)
 
7,767

U.S. Government agencies
47,355

 
72

 
(820
)
 
46,607

Corporate bonds
23,491

 
323

 
(501
)
 
23,313

Total
$
140,720

 
$
737

 
$
(2,799
)
 
$
138,658

 
December 31, 2018
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
24,276

 
$
24

 
$
(657
)
 
$
23,643

   Freddie Mac
6,351

 
10

 
(74
)
 
6,287

   Ginnie Mae
23,311

 

 
(1,250
)
 
22,061

   Other
8,983

 
17

 
(21
)
 
8,979

Municipal bonds
10,615

 
49

 
(120
)
 
10,544

U.S. Government agencies
48,190

 
73

 
(825
)
 
47,438

Corporate bonds
23,490

 
399

 
(671
)
 
23,218

Total
$
145,216

 
$
572

 
$
(3,618
)
 
$
142,170

     
The tables below summarize the aggregate fair value and gross unrealized loss by length of time those investment securities have been continuously in an unrealized loss position at the dates indicated:
 
March 31, 2019
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$

 
$

 
$
15,338

 
$
(370
)
 
$
15,338

 
$
(370
)
   Freddie Mac

 

 
3,203

 
(18
)
 
3,203

 
(18
)
   Ginnie Mae

 

 
19,135

 
(1,050
)
 
19,135

 
(1,050
)
   Other
6,008

 
(19
)
 

 

 
6,008

 
(19
)
Municipal bonds

 

 
987

 
(21
)
 
987

 
(21
)
U.S. Government agencies
9,661

 
(114
)
 
30,381

 
(706
)
 
40,042

 
(820
)
Corporate bonds

 

 
6,999

 
(501
)
 
6,999

 
(501
)
Total
$
15,669

 
$
(133
)
 
$
76,043

 
$
(2,666
)
 
$
91,712

 
$
(2,799
)

11


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


 
December 31, 2018
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
5,480

 
$
(32
)
 
$
16,721

 
$
(625
)
 
$
22,201

 
$
(657
)
   Freddie Mac
1,994

 
(23
)
 
3,185

 
(51
)
 
5,179

 
(74
)
   Ginnie Mae
2,867

 
(8
)
 
19,194

 
(1,242
)
 
22,061

 
(1,250
)
   Other
6,008

 
(21
)
 

 

 
6,008

 
(21
)
Municipal bonds
4,161

 
(46
)
 
934

 
(74
)
 
5,095

 
(120
)
U.S. Government agencies
5,985

 
(13
)
 
30,779

 
(812
)
 
36,764

 
(825
)
Corporate bonds

 

 
6,828

 
(671
)
 
6,828

 
(671
)
Total
$
26,495

 
$
(143
)
 
$
77,641

 
$
(3,475
)
 
$
104,136

 
$
(3,618
)

On a quarterly basis, management makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment, recent events specific to the issuer or industry, and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be an other-than-temporary impairment (“OTTI”) are written down to fair value. If the Company intends to sell a debt security, or it is likely that the Company will be required to sell the debt security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the debt security and it is not likely that it will be required to sell the debt security but does not expect to recover the entire amortized cost basis of the debt security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a debt security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the debt security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. At March 31, 2019, and December 31, 2018, the Company had 37 securities and 51 securities in an unrealized loss position, respectively, with 31 of these securities in an unrealized loss position for 12 months or more at both dates. Management does not believe that any individual unrealized loss as of March 31, 2019, or December 31, 2018, represented OTTI. The decline in fair market value of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent to their purchase. Management also reviewed the financial condition of the entities issuing municipal or corporate bonds at March 31, 2019, and December 31, 2018, and determined that an OTTI charge was not warranted.

The amortized cost and estimated fair value of investments available-for-sale at March 31, 2019, 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.
 
March 31, 2019
 
Amortized Cost
 
Fair Value
 
(In thousands)
Due within one year
$
251

 
$
250

Due after one year through five years
7,328

 
7,481

Due after five years through ten years
19,291

 
19,000

Due after ten years
51,595

 
50,956

 
78,465

 
77,687

Mortgage-backed investments
62,255

 
60,971

Total
$
140,720

 
$
138,658



12


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


Under Washington state law, in order to participate in the public funds program the Company is required to pledge eligible securities as collateral in an amount equal to 50% of the public deposits held less the FDIC insured amount. Investment securities with market values of $15.7 million and $15.6 million were pledged as collateral for public deposits at March 31, 2019, and December 31, 2018, respectively, both of which exceeded the collateral requirements established by the Washington Public Deposit Protection Commission.

For the three months ended March 31, 2019, we had calls and sales on investment securities of $3.0 million, generating a net loss of $8,000. For the three months ended March 31, 2018, we had a maturity on one investment security of $2.0 million generating no gain or loss.


Note 5 - Loans Receivable

Loans receivable are summarized as follows at the dates indicated: 
 
March 31, 2019
 
December 31, 2018
 
(In thousands)
One-to-four family residential:
 
 
 
Permanent owner occupied
$
194,648

 
$
194,141

Permanent non-owner occupied
156,684

 
147,825

 
351,332

 
341,966

 
 
 
 
Multifamily
167,843

 
169,355

 
 
 
 
Commercial real estate
384,686

 
373,819

 
 
 
 
Construction/land:
 
 
 

One-to-four family residential
84,191

 
86,604

Multifamily
87,748

 
83,642

Commercial
22,400

 
18,300

Land
6,965

 
6,740

 
201,304

 
195,286

 
 
 
 
Business
33,513

 
30,486

Consumer
14,336

 
12,970

Total loans
1,153,014

 
1,123,882

 
 
 
 
Less:
 
 
 

Loans in process ("LIP") (1)
86,794

 
86,453

Deferred loan fees, net
701

 
1,178

Allowance for loan and lease losses ("ALLL")
13,808

 
13,347

Loans receivable, net
$
1,051,711

 
$
1,022,904

_______________ 
(1) LIP is the amount of committed but undisbursed funds on construction loans.

At March 31, 2019, loans totaling $480.7 million were pledged to secure borrowings from the FHLB of Des Moines compared to $471.4 million at December 31, 2018.
    
Credit Quality Indicators. The Company assigns a risk rating to all credit exposures based on a risk rating system designed to define the basic characteristics and identified risk elements of each credit extension. The Company utilizes a nine‑point risk rating system. A description of the general characteristics of the risk grades is as follows:

13


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



Grades 1 through 5: These grades are considered to be “pass” credits. These include assets where there is virtually no credit risk, such as cash secured loans with funds on deposit with the Bank. Pass credits also include credits that are on 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.

Grade 6: These credits, classified as “special mention”, 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. If left uncorrected, these potential weaknesses may result in deterioration in the Company’s credit position at a future date.

Grade 7: These credits, classified as “substandard”, present a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. These credits have well defined weaknesses which jeopardize the orderly liquidation of the debt and are inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.

Grade 8: These credits are classified as “doubtful” and possess well defined weaknesses which make the full collection or liquidation of the loan highly questionable and improbable. This classification is used where significant risk exposures are perceived but the exact amount of the loss cannot yet be determined due to pending events.

Grade 9: Assets classified as “loss” are considered uncollectible and cannot be justified as a viable asset for the Company. There is little or no prospect of near term recovery and no realistic strengthening action of significance is pending.

As of March 31, 2019, and December 31, 2018, the Company had no loans rated as doubtful or loss. The following tables represent a summary of loans at March 31, 2019, and December 31, 2018 by type and risk category:

 
March 31, 2019
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/ 
Land
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
349,894

 
$
167,843

 
$
384,149

 
$
112,380

 
$
33,513

 
$
14,292

 
$
1,062,071

   Special mention
795

 

 
537

 
2,130

 

 

 
3,462

   Substandard
643

 

 

 

 

 
44

 
687

Total loans
$
351,332

 
$
167,843

 
$
384,686

 
$
114,510

 
$
33,513

 
$
14,336

 
$
1,066,220

_______________

(1) Net of LIP.
 
December 31, 2018
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
339,310

 
$
169,355

 
$
372,690

 
$
108,854

 
$
30,486

 
$
12,926

 
$
1,033,621

   Special mention
1,737

 

 
782

 

 

 

 
2,519

   Substandard
919

 

 
326

 

 

 
44

 
1,289

Total loans
$
341,966

 
$
169,355

 
$
373,798

 
$
108,854

 
$
30,486

 
$
12,970

 
$
1,037,429

_______________

(1) Net of LIP.

14


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



ALLL. When the Company classifies problem assets as either substandard or doubtful, pursuant to Federal regulations, it may establish a specific reserve in an amount deemed prudent to address the risk specifically or may allow the loss to be addressed in the general allowance. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to the particular problem assets. When an insured institution classifies problem assets as a loss, pursuant to Federal regulations, it is required to charge-off such assets in the period in which they are deemed uncollectible. The determination as to the classification of the Company’s assets and the amount of valuation allowances is subject to review by bank regulators, who can require the establishment of additional loss allowances.

Loan grades are used by the Company to identify and track potential problem loans which do not rise to the levels described for substandard, doubtful, or loss. The grades for watch and special mention are assigned to loans which have been criticized based upon known characteristics such as periodic payment delinquency or stale financial information from the borrower and/or guarantors. Loans identified as criticized (watch and special mention) or classified (substandard, doubtful or loss) are subject to problem loan reporting every three months.

The following tables summarize changes in the ALLL and loan portfolio by loan type and impairment method at the dates and for the periods shown: 
 
At or For the Three Months Ended March 31, 2019
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
3,387

 
$
1,680

 
$
4,777

 
$
2,331

 
$
936

 
$
236

 
$
13,347

   Charge-offs

 

 

 

 

 

 

   Recoveries
24

 

 

 

 

 
37

 
61

(Recapture) provision
(379
)
 
(101
)
 
32

 
801

 
94

 
(47
)
 
400

Ending balance
$
3,032

 
$
1,579

 
$
4,809

 
$
3,132

 
$
1,030

 
$
226

 
$
13,808

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ALLL by category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
2,982

 
$
1,579

 
$
4,809

 
$
3,132

 
$
1,030

 
$
226

 
$
13,758

Specific reserve
50

 

 

 

 

 

 
50

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
351,332

 
$
167,843

 
$
384,686

 
$
114,510

 
$
33,513

 
$
14,336

 
$
1,066,220

Loans collectively evaluated for impairment (2)
345,569

 
167,843

 
382,530

 
114,510

 
33,513

 
14,292

 
1,058,257

Loans individually evaluated for impairment (3)
5,763

 

 
2,156

 

 

 
44

 
7,963

____________ 

(1) Net of LIP.
(2) Loans collectively evaluated for general reserves.
(3) Loans individually evaluated for specific reserves.




15


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


 
At or For the Three Months Ended March 31, 2018
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,837

 
$
1,820

 
$
4,418

 
$
2,816

 
$
694

 
$
297

 
$
12,882

   Charge-offs

 

 

 

 

 

 

   Recoveries
4,240

 

 
14

 

 

 

 
4,254

   (Recapture) provision
(3,840
)
 
64

 
58

 
(362
)
 
46

 
34

 
(4,000
)
Ending balance
$
3,237

 
$
1,884

 
$
4,490

 
$
2,454

 
$
740

 
$
331

 
$
13,136

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ALLL by category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
3,168

 
$
1,884

 
$
4,464

 
$
2,454

 
$
740

 
$
331

 
$
13,041

Specific reserve
69

 

 
26

 

 

 

 
95

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
295,895

 
$
190,392

 
$
366,231

 
$
117,554

 
$
24,237

 
$
11,131

 
$
1,005,440

Loans collectively evaluated for impairment (2)
283,866

 
189,264

 
363,059

 
117,554

 
24,237

 
11,038

 
989,018

Loans individually evaluated for impairment (3)
12,029

 
1,128

 
3,172

 

 

 
93

 
16,422

_____________ 

(1) Net of LIP.
(2) Loans collectively evaluated for general reserves.
(3) Loans individually evaluated for specific reserves.


16


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



Past Due Loans. Loans are considered past due if a scheduled principal or interest payment is due and unpaid for 30 days or more. At March 31, 2019, past due loans were 0.03% of total loans receivable, net of LIP. In comparison, past due loans were 0.08% of total loans receivable, net of LIP at December 31, 2018. The following tables represent a summary of the aging of loans by type at the dates indicated:

 
Loans Past Due as of March 31, 2019
 
 
 
 
 
30-59 Days
 
60-89 Days
 
90 Days and
Greater
 
Total Past
Due
 
Current
 
Total (1) (2)
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
$
107

 
$

 
$

 
$
107

 
$
194,541

 
$
194,648

Non-owner occupied
166

 

 

 
166

 
156,518

 
156,684

Multifamily

 

 

 

 
167,843

 
167,843

Commercial real estate

 

 

 

 
384,686

 
384,686

Construction/land

 

 

 

 
114,510

 
114,510

Total real estate
273

 

 

 
273

 
1,018,098

 
1,018,371

Business

 

 

 

 
33,513

 
33,513

Consumer
44

 

 

 
44

 
14,292

 
14,336

Total loans
$
317

 
$

 
$

 
$
317

 
$
1,065,903

 
$
1,066,220

 ________________ 

(1) There were no loans 90 days and greater past due and still accruing interest at March 31, 2019.
(2) Net of LIP.

 
Loans Past Due as of December 31, 2018
 
 
 
 
 
30-59 Days
 
60-89 Days
 
90 Days and
Greater
 
Total Past
Due
 
Current
 
Total (1) (2)
 
(In thousands)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
Owner occupied
$
223

 
$

 
$
272

 
$
495

 
$
193,646

 
$
194,141

Non-owner occupied

 

 

 

 
147,825

 
147,825

Multifamily

 

 

 

 
169,355

 
169,355

Commercial real estate

 

 
326

 
326

 
373,472

 
373,798

Construction/land

 

 

 

 
108,854

 
108,854

Total real estate
223

 

 
598

 
821

 
993,152

 
993,973

Business

 

 

 

 
30,486

 
30,486

Consumer

 

 

 

 
12,970

 
12,970

Total loans
$
223

 
$

 
$
598

 
$
821

 
$
1,036,608

 
$
1,037,429

_________________ 

(1) There were no loans 90 days and greater past due and still accruing interest at December 31, 2018.
(2) Net of LIP.





17


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


Nonaccrual Loans. The following table is a summary of nonaccrual loans by loan type at the dates indicated:

 
March 31, 2019
 
December 31, 2018
 
(In thousands)
One-to-four family residential
$
107

 
$
382

Commercial real estate

 
326

Consumer
44

 
44

Total nonaccrual loans
$
151

 
$
752


During the three months ended March 31, 2019, interest income that would have been recognized had these nonaccrual loans been performing in accordance with their original terms was $6,000. For the three months ended March 31, 2018, foregone interest on nonaccrual loans was $6,000.

The following tables summarize the loan portfolio by type and payment status at the dates indicated:

 
March 31, 2019
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Performing (2)
$
351,225

 
$
167,843

 
$
384,686

 
$
114,510

 
$
33,513

 
$
14,292

 
$
1,066,069

Nonperforming (3)
107

 

 

 

 

 
44

 
151

Total loans
$
351,332

 
$
167,843

 
$
384,686

 
$
114,510

 
$
33,513

 
$
14,336

 
$
1,066,220

_____________

(1) 
Net of LIP.
(2) 
There were $194.5 million of owner-occupied one-to-four family residential loans and $156.7 million of non-owner occupied one-to-four family residential loans classified as performing.
(3) 
The $107,000 one-to-four family residential loan classified as nonperforming is owner-occupied.
 
December 31, 2018
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total (1)
 
(In thousands)
Performing (2)
$
341,584

 
$
169,355

 
$
373,472

 
$
108,854

 
$
30,486

 
$
12,926

 
$
1,036,677

Nonperforming (3)
382

 

 
326

 

 

 
44

 
752

Total loans
$
341,966

 
$
169,355

 
$
373,798

 
$
108,854

 
$
30,486

 
$
12,970

 
$
1,037,429

_____________

(1) Net of LIP.    
(2) There were $193.8 million of owner-occupied one-to-four family residential loans and $147.8 million of non-owner occupied one-to-four family residential loans classified as performing.
(3) The $382,000 of one-to-four family residential loans classified as nonperforming are all owner-occupied.

Impaired Loans. 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. There were no funds committed to be advanced in connection with impaired loans at either March 31, 2019, or December 31, 2018.

18


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



The following tables present a summary of loans individually evaluated for impairment by loan type at the dates indicated:

 
March 31, 2019
 
Recorded Investment (1)
 
Unpaid Principal Balance (2)
 
Related Allowance
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
$
847

 
$
1,030

 
$

      Non-owner occupied
2,040

 
2,040

 

   Commercial real estate
2,156

 
2,156

 

   Consumer
44

 
72

 

Total
5,087

 
5,298

 

 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
511

 
558

 
18

      Non-owner occupied
2,365

 
2,365

 
32

Total
2,876

 
2,923

 
50

 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
1,358

 
1,588

 
18

      Non-owner occupied
4,405

 
4,405

 
32

   Commercial real estate
2,156

 
2,156

 

   Consumer
44

 
72

 

Total
$
7,963

 
$
8,221

 
$
50

_________________ 

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




19


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


 
December 31, 2018
 
Recorded Investment (1)
 
Unpaid Principal Balance (2)
 
Related Allowance
 
(In thousands)
Loans with no related allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
$
1,308

 
$
1,477

 
$

      Non-owner occupied
2,375

 
2,375

 

   Commercial real estate
2,499

 
2,499

 

   Consumer
87

 
141

 

Total
6,269

 
6,492

 

 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
513

 
560

 
22

      Non-owner occupied
3,126

 
3,148

 
37

   Commercial real estate
241

 
241

 
3

Total
3,880

 
3,949

 
62

 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
  One-to-four family residential:
 
 
 
 
 
      Owner occupied
1,821

 
2,037

 
22

      Non-owner occupied
5,501

 
5,523

 
37

   Commercial real estate
2,740

 
2,740

 
3

   Consumer
87

 
141

 

Total
$
10,149

 
$
10,441

 
$
62

_________________ 

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



20


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



The following table presents the average recorded investment in loans individually evaluated for impairment and the interest income recognized for the three months ended March 31, 2019 and 2018:

 
Three Months Ended March 31, 2019
 
Three Months Ended March 31, 2018
 
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
$
1,078

 
$
15

 
$
1,314

 
$
25

      Non-owner occupied
2,208

 
31

 
7,658

 
127

Multifamily

 

 
1,131

 
18

Commercial real estate
2,328

 
38

 
1,062

 
19

Consumer
66

 
1

 
94

 
2

Total
5,680

 
85

 
11,259

 
191

 
 
 
 
 
 
 
 
Loans with an allowance:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
512

 
9

 
521

 
9

      Non-owner occupied
2,746

 
30

 
3,304

 
47

Commercial real estate
121

 

 
2,121

 
34

Total
3,379

 
39

 
5,946

 
90

 
 
 
 
 
 
 
 
Total impaired loans:
 
 
 
 
 
 
 
   One-to-four family residential:
 
 
 
 
 
 
 
      Owner occupied
1,590

 
24

 
1,835

 
34

      Non-owner occupied
4,954

 
61

 
10,962

 
174

Multifamily

 

 
1,131

 
18

Commercial real estate
2,449

 
38

 
3,183

 
53

Consumer
66

 
1

 
94

 
2

Total
$
9,059

 
$
124

 
$
17,205

 
$
281



Troubled Debt Restructurings. Certain loan modifications are accounted for as troubled debt restructured loans (“TDRs”). At March 31, 2019, the TDR portfolio totaled $7.8 million. At December 31, 2018, the TDR portfolio totaled $9.4 million. At both dates, all TDRs were performing according to their modified repayment terms.

At March 31, 2019, 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 as part of the calculation of the ALLL. No loans accounted for as TDRs were charged-off to the ALLL for the three months ended March 31, 2019 and 2018.


21


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


The following table presents TDR modifications for the periods indicated and their recorded investment prior to and after the modification:

 
Three Months Ended March 31, 2019
 
Three Months Ended March 31, 2018
 
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)
One-to-four family residential
 
 
 
 
 
 
 
 
 
 
 
Principal and interest with interest rate concession and advancement of maturity date
6
 
824

 
824

 

 

 

Advancement of maturity date
3
 
694

 
694

 

 

 

Total
9
 
1,518

 
1,518

 

 

 


TDRs that default after they have been modified are typically evaluated individually on a collateral basis. Any additional impairment is charged to the ALLL. For the three months ended March 31, 2019, and March 31, 2018, no loans that had been modified in the previous 12 months defaulted.     

Note 6 - Other Real Estate Owned

OREO includes properties acquired by the Company through foreclosure and deed in lieu of foreclosure. The following table is a summary of OREO activity during the periods shown: 
 
Three Months Ended March 31,
 
2019
 
2018
 
(In thousands)
Balance at beginning of period
$
483

 
$
483

Market value adjustments
(29
)
 

Balance at end of period
$
454

 
$
483

 
For the three months ended March 31, 2019, there were no OREO properties sold. Based on current appraisals, there were $29,000 in market value adjustments taken on the properties in OREO. For the three months ended March 31, 2018, there were no sales or market value adjustments on our OREO properties. OREO at March 31, 2019, consisted of $454,000 in commercial real estate properties. At March 31, 2019, there were no loans for which formal foreclosure proceedings were in process.

Note 7 - Fair Value

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.
    
    

22


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


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 Company used the following methods to measure fair value on a recurring or nonrecurring basis:

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-earning deposits with banks, FHLB stock, accrued interest receivable and accrued interest 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.

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: The fair value of loans receivable are based on the exit price notion, and are calculated from inputs reflective of current market pricing for similar instruments, to include current origination spreads, liquidity premiums, and credit adjustments. The fair value of nonperforming loans is estimated using the fair value of the underlying collateral.

Derivatives: The fair value of derivatives is based on dealer quotes, pricing models, discounted cash flow methodologies or similar techniques for which the determination of fair value may require significant management judgment or estimation.

Liabilities: The fair value of deposits with no stated maturity, such as statement savings, interest-bearing checking 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.
 

23


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


The tables below present the balances of assets measured at fair value on a recurring basis (there were no transfers between Level 1, Level 2 and Level 3 recurring measurements) at March 31, 2019 and December 31, 2018:
 
Fair Value Measurements at March 31, 2019
 
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)
Investments available-for-sale:
 
 
 
 
 
 
 
Mortgage-backed investments:
 
 
 
 
 
 
 
Fannie Mae
$
23,686

 
$

 
$
23,686

 
$

Freddie Mac
6,319

 

 
6,319

 

Ginnie Mae
22,013

 

 
22,013

 

Other
8,953

 

 
8,953

 

Municipal bonds
7,767

 

 
7,767

 

U.S. Government agencies
46,607

 

 
46,607

 

Corporate bonds
23,313

 

 
23,313

 

Total available-for-sale
investments
138,658

 

 
138,658

 

Derivative fair value asset
1,203

 

 
1,203

 

Total
$
139,861

 
$

 
$
139,861

 
$

 
Fair Value Measurements at December 31, 2018
 
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)
Investments available-for-sale:
 
 
 
 
 
 
 
Mortgage-backed investments:
 
 
 
 
 
 
 
Fannie Mae
$
23,643

 
$

 
$
23,643

 
$

Freddie Mac
6,287

 

 
6,287

 

Ginnie Mae
22,061

 

 
22,061

 

Other
8,979

 

 
8,979

 

Municipal bonds
10,544

 

 
10,544

 

U.S. Government agencies
47,438

 

 
47,438

 

Corporate bonds
23,218

 

 
23,218

 

Total available-for-sale
investments
142,170

 

 
142,170

 

Derivative fair value asset
1,662

 

 
1,662

 

Total
$
143,832

 
$

 
$
143,832

 
$


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.    

    

24


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


The tables below present the balances of assets measured at fair value on a nonrecurring basis at March 31, 2019, and December 31, 2018
 
Fair Value Measurements at March 31, 2019
 
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)
Impaired loans (included in loans
receivable, net)
(1)
$
7,913

 
$

 
$

 
$
7,913

OREO
454

 

 

 
454

Total
$
8,367

 
$

 
$

 
$
8,367

_____________

(1) 
Total fair value of impaired loans is net of $50,000 of specific reserves on performing TDRs.

 
Fair Value Measurements at December 31, 2018
 
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)
Impaired loans (included in loans
receivable, net)
(1)
$
10,087

 
$

 
$

 
$
10,087

OREO
483

 

 

 
483

Total
$
10,570

 
$

 
$

 
$
10,570

_____________

(1)    Total fair value of impaired loans is net of $62,000 of specific reserves on performing TDRs.
 
The fair value of impaired loans reflects the exit price and is calculated using the collateral value method or on a discounted cash flow basis. Inputs used in the collateral value method include appraised values, less estimated costs to sell. Some of these inputs may not be observable in the marketplace. Appraised values may be discounted based on management’s knowledge of the marketplace, subsequent changes in market conditions, or management’s knowledge of the borrower.

OREO properties are measured at the lower of their carrying amount or fair value, less estimated 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 estimated costs to sell, an impairment loss is recognized.

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at March 31, 2019 and December 31, 2018:
 
March 31, 2019
 
Fair Value
 
Valuation Technique
 
Unobservable Input(s)
 
Range (Weighted Average)
 
(Dollars in thousands)
Impaired Loans
$
7,913

 
Market approach
 
Appraised value discounted by market or borrower conditions
 
0.0%
(0.00%)
 
 
 
 
 
 
 
 
OREO
$
454

 
Market approach
 
Appraised value less selling costs
 
0.0% - 6.31%
(6.03%)


25


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


 
December 31, 2018
 
Fair Value
 
Valuation Technique
 
Unobservable Input(s)
 
Range (Weighted Average)
 
(Dollars in thousands)
Impaired Loans
$
10,087

 
Market approach
 
Appraised value discounted by market or borrower conditions
 
0.0%
(0.0%)
 
 
 
 
 
 
 
 
OREO
$
483

 
Market approach
 
Appraised value less selling costs
 
0.0%
(0.0%)

The carrying amounts and estimated fair values of financial instruments were as follows at the dates indicated: 
 
March 31, 2019
 
 
 
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
$
9,366

 
$
9,366

 
$
9,366

 
$

 
$

Interest-earning deposits with banks
14,596

 
14,596

 
14,596

 

 

Investments available-for-sale
138,658

 
138,658

 

 
138,658

 

Loans receivable, net
1,051,711

 
1,041,639

 

 

 
1,041,639

FHLB stock
8,041

 
8,041

 

 
8,041

 

Accrued interest receivable
4,861

 
4,861

 

 
4,861

 

Derivative fair value asset
1,203

 
1,203

 

 
1,203

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 

 
 

 
 
Deposits
432,949

 
432,949

 
432,949

 

 

Certificates of deposit, retail
398,956

 
400,539

 

 
400,539

 

Certificates of deposit, brokered
123,367

 
123,417

 

 
123,417

 

Advances from the FHLB
163,500

 
163,689

 

 
163,689

 

Accrued interest payable
478

 
478

 

 
478

 



26


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


 
December 31, 2018
 
 
 
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
$
8,122

 
$
8,122

 
$
8,122

 
$

 
$

Interest-earning deposits with banks
8,888

 
8,888

 
8,888

 

 

Investments available-for-sale
142,170

 
142,170

 

 
142,170

 

Loans receivable, net
1,022,904

 
1,012,114

 

 

 
1,012,114

FHLB stock
7,310

 
7,310

 

 
7,310

 

Accrued interest receivable
4,068

 
4,068

 

 
4,068

 

Derivative fair value asset
1,662

 
1,662

 

 
1,662

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 

 
 

 
 

 
 

 
 
Deposits
450,033

 
450,033

 
450,033

 

 

Certificates of deposit, retail
391,174

 
390,101

 

 
390,101

 

Certificates of deposit, brokered
97,825

 
97,466

 

 
97,466

 

Advances from the FHLB
146,500

 
146,357

 

 
146,357

 

Accrued interest payable
478

 
478

 

 
478

 


Note 8 - Leases

The Company adopted ASU 2016-02 and ASU 2018-11 using the modified retrospective approach with an effective date of January 1, 2019, and recognized on the consolidated balance sheets a right-of-use asset (“ROU”) included in prepaid expenses and other assets and lease liabilities included in other liabilities. As such, prior year financial statements were not restated under the new standard. At March 31, 2019, the Company had ten operating leases for retail branch locations. The remaining lease terms range from 1.4 to 6.3 years, with most leases carrying optional extensions of 3-5 years. The Company will include optional lease term extensions in the ROU assets and lease liabilities when management believes it is reasonably certain that the term extension will be exercised, and will be determined based on indicators that the Company would have an economic incentive to extend the lease. The Company has elected to not apply ASU 2016-02 to short term leases, which are those that have a term of one year or less. To calculate the present value of lease payments not yet paid, the Company uses the incremental borrowing rate, which is equal to the FHLB advance rate for the term of the lease that was in place at each lease inception.

The minimum monthly lease payments are generally based on square footage of the leased premises, with escalating minimum rent over the lease term. At March 31, 2019, the Company was committed to paying $51,000 per month in minimum monthly lease payments. The minimum monthly lease payment over the initial lease term, including any free rent period, was used to calculate the ROU and lease liability. The Company’s current leases do not include any non-lease components.

Total lease expense included in the Company’s Consolidated Income Statement for the three months ended March 31, 2019, was $175,000. This included the amortized lease expense under ASU 2016-02 combined with variable lease expenses for maintenance or other expenses as defined in the individual lease agreements. The right-of-use asset and lease liability both had a balance of $1.7 million on the Company’s consolidated balance sheet at March 31, 2019, and are amortizing over a weighted-average remaining term of 4.2 years. The weighted-average discount rate used to calculate the present value of future minimum lease payments was 2.96% at March 31, 2019.

    

    

27


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


The following table provides a reconciliation between the undiscounted minimum lease payments at March 31, 2019 and the discounted lease liability at that date:
 
 
March 31, 2019
 
 
(in thousands)
Due through one year
 
$
527

Due after one year through two years
 
471

Due after two years through three years
 
300

Due after three years through four years
 
277

Due after four years through five years
 
176

Due after five years
 
112

Total minimum lease payments
 
1,863

Less: present value discount
 
(118
)
Lease liability
 
$
1,745


The Company has secured a lease for a new retail branch in Kirkland, Washington. The initial lease term is for 65 months and includes options to extend the lease. The minimum rent will be determined at commencement and will increase annually thereafter. This lease was not included in the calculation of discounted lease payments at March 31, 2019.

Note 9 - Derivatives

The Company uses a derivative financial instrument, which qualifies as a cash flow hedge, to manage the risk of changes in future cash flows due to interest rate fluctuations. The hedged instrument is a $50.0 million three-month FHLB advance that will be renewed every three months at the fixed interest rate at that time. The agreement has a five-year term and stipulates that the counterparty will pay the Company interest at three-month LIBOR and the Company will pay fixed interest of 1.34% on the $50.0 million notional amount. The Company pays or receives the net interest amount quarterly and includes this amount as part of interest expense on the Consolidated Income Statement.

Quarterly, the effectiveness evaluation is based upon the fluctuation of the interest the Company pays to the FHLB for the hedge instrument as compared to the three-month LIBOR interest received from the counterparty. At March 31, 2019, the fair value of the cash flow hedge of $1.2 million was reported with other assets. The tax effected amount of $950,000 was included in Accumulated Other Comprehensive Income. There were no amounts recorded in the Consolidated Income Statements for the quarters ended March 31, 2019 or 2018, related to ineffectiveness.

Fair value for this derivative instrument, which generally changes as a result of changes in the level of market interest rates, is estimated based on dealer quotes and secondary market sources.

The following table presents the fair value of this derivative instrument as of March 31, 2019 and December 31, 2018:
 
Balance Sheet Location
 
Fair Value at
March 31, 2019
 
Fair Value at
December 31, 2018
 
(In thousands)
Interest rate swap on FHLB debt
   designated as cash flow hedge
Other Assets
 
$
1,203

 
$
1,662

 
 
 
 
 
 
Total derivatives
 
 
$
1,203

 
$
1,662


    

28


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


The following table presents the effect of this derivative instrument on the Consolidated Statements of Comprehensive Income for the quarters ended March 31, 2019, and December 31, 2018:

 
Balance Sheet Location
 
Amount Recognized in OCI at
March 31, 2019
 
Amount Recognized in
OCI at
December 31, 2018
 
(In thousands)
Interest rate swap on FHLB debt
designated as cash flow hedge
Other assets
 
$
(363
)
 
$
108



Note 10 - Stock-Based Compensation

In June 2016, First Financial Northwest’s shareholders approved the First Financial Northwest, Inc. 2016 Equity Incentive Plan (“2016 Plan”). This plan provides for the granting of incentive stock options (“ISO”), non-qualified stock options (“NQSO”), restricted stock and restricted stock units until June 2026. The 2016 Plan established 1,400,000 shares available to grant with a maximum of 400,000 of these shares available to grant as restricted stock awards. Each share issued as a restricted stock award counts as two shares towards the total shares available to award.

Under the 2016 Plan, the vesting date for each option award or restricted stock award is determined by an award committee and specified in the award agreement. In the case of restricted stock awards granted in lieu of cash payments of directors’ fees, the grant date is used as the vesting date unless the award agreement provides otherwise.

As a result of the approval of the 2016 Plan, the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“2008 Plan”) was frozen and no additional awards will be made. At March 31, 2019, there were no unvested shares of restricted stock awards under the 2008 Plan. At this date, there were 35,000 stock options granted under the 2008 Plan that are expected to vest and be available for exercise, and an additional 280,000 stock options from the 2008 Plan were available for exercise at March 31, 2019, subject to the 2008 Plan provisions. At March 31, 2019, there were 1,207,274 total shares available for grant under the 2016 Plan, including 328,637 shares available to be granted as restricted stock.

For the three months ended March 31, 2019 and 2018, total compensation expense for both the 2008 and 2016 Plans was $124,000 and $84,000, respectively, and the related income tax benefit was $26,000 and $18,000, respectively.

Stock Options

Under the 2008 Plan, stock option awards were 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 5 years, with 20% vesting on the anniversary date of each grant date, and a contractual life of 10 years. Any unexercised stock options 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 and the Bank.

Under the 2016 Plan, the exercise price and vesting period for stock options are determined by the award committee and specified in the award agreement, however, the exercise price shall not be less than the fair market value of a share as of the grant date. Any unexercised stock option will expire 10 years after the award date or sooner in the event of the award recipient’s death, disability, retirement, or termination of service.

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 SEC 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.


29


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


Under certain conditions, a cashless exercise of vested stock options may occur by the option holder surrendering the number of options valued at the current stock price at the time of exercise to cover the total cost to exercise. The surrendered options are canceled and are unavailable for reissue.
        
A summary of the Company’s stock option plan awards and activity for the three months ended March 31, 2019, follows: 

 
For the Three Months Ended March 31, 2019
 
 
 
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, 2019
315,000

 
$
10.34

 
 
 
$
1,615,600

 
$
3.69

Granted
50,000

 
15.80

 
 
 
 
 
5.03

Outstanding at March 31, 2019
365,000

 
11.09

 
5.43
 
1,703,800

 
3.88

Vested and expected to vest assuming a 3% forfeiture rate over the vesting term
362,450

 
11.07

 
5.41
 
1,699,668

 
3.87

Exercisable at March 31, 2019
280,000

 
10.16

 
4.59
 
1,566,070

 
3.61


As of March 31, 2019, there was $323,000 of total unrecognized compensation cost related to nonvested stock options granted under the 2008 and 2016 Plans. The cost is expected to be recognized over the remaining weighted-average vesting period of 3.84 years. There were 50,000 stock options granted under the 2016 Plan during the three months ended March 31, 2019.

Restricted Stock Awards

The 2016 Plan authorizes the grant of restricted stock awards subject to vesting periods or terms as defined by the award committee and specified in the award agreement. Restricted stock awards granted in lieu of cash payments for directors’ fees are subject to immediate vesting on the grant date unless the award agreement provides otherwise.


A summary of changes in nonvested restricted stock awards for the three months ended March 31, 2019, follows: 
 
For the Three Months Ended March 31, 2019
 
Shares
 
Weighted-Average
Grant Date
Fair Value
Nonvested at January 1, 2019
20,987

 
$
15.90

Granted
16,698

 
16.53

Vested
(20,987
)
 
15.90
Nonvested at March 31, 2019
16,698

 
16.53

Expected to vest assuming a 3% forfeiture rate over the vesting term
16,197

 
16.53


As of March 31, 2019, there was $247,000 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 eleven months.

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 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

30


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


dividing net earnings available 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,
 
 
2019
 
2018
 
 
(Dollars in thousands, except share data)
Net income
 
$
1,945

 
$
6,842

Less: Earnings allocated to participating securities
 
(3
)
 
(16
)
Earnings allocated to common shareholders
 
$
1,942

 
$
6,826

 
 
 
 
 
Basic weighted average common shares outstanding
 
10,118,286

 
10,210,828

Dilutive stock options
 
89,718

 
122,465

Dilutive restricted stock grants
 
12,896

 
3,273

Diluted weighted average common shares outstanding
 
10,220,900

 
10,336,566

 
 
 
 
 
Basic earnings per share
 
$
0.19

 
$
0.67

Diluted earnings per share
 
$
0.19

 
$
0.66


Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For the three months ended March 31, 2019, there were 50,000 options to purchase shares of common stock that were omitted from the computation of diluted earnings per share because their effect would be anti-dilutive. For the three months ended March 31, 2018, there no options to purchase shares of common stock that were omitted from the computation of diluted earnings per share because their effect would be anti-dilutive.

Note 12 - Branch Acquisition

On August 25, 2017, First Financial Northwest Bank completed the acquisition of four branches from Opus Bank, a California state-chartered commercial bank. The Branch Acquisition included four retail branches located in Woodinville, Clearview, Lake Stevens, and Smokey Point, Washington. The Bank acquired $74.7 million of retail deposits, prior to the fair value adjustment, one owned bank branch, three leased branches, and certain fixed assets at these branches. The purchase price of the Branch Acquisition paid by the Bank included a deposit premium of 3.125% of the average daily balance of acquired deposits for 20 days prior to the closing date, or $2.5 million; 80% of the fair market value of the owned branch, or $488,000; the net book value of fixed assets, or $56,000; and $14,000 for other pro rations and adjustments as of the closing date. Opus Bank paid the Bank $71.6 million in cash for the difference between these amounts and the total deposits assumed.

The Branch Acquisition was accounted for under the acquisition method of accounting, and accordingly, the assets received and liabilities assumed were recorded at their fair market value as of August 25, 2017. The application of the acquisition method of accounting resulted in recognition of a core deposit intangible asset (“CDI”) of $1.3 million and goodwill of $889,000. The acquired CDI has been determined to have a useful life of approximately ten years and is amortized on an accelerated basis. Goodwill is not amortized but will be evaluated for impairment on an annual basis, or more often if circumstances dictate, to determine if the carrying value remains appropriate. The balance of the CDI and goodwill at March 31, 2019 was $1.1 million and $889,000, respectively.





Note 13 - Revenue Recognition

In accordance with Topic 606, revenues are recognized when goods or services are transferred to the customer in exchange for the consideration the Company expects to be entitled to receive. To determine the appropriate recognition of revenue for

31


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


transactions within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with the customer; (ii) identify the separate performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the separate performance obligations in the contract; and (v) recognize revenue when the entity satisfies a performance obligation. A contract may not exist if there are doubts as to collectability of the amounts the Company is entitled to in exchange for the goods or services transferred. If a contract is determined to be within the scope of Topic 606, the Company recognizes revenue as it satisfies a performance obligation. The largest portion of the Company’s revenue is from net interest income which is not within the scope of Topic 606.

Disaggregation of Revenue

The following table includes the Company’s noninterest income disaggregated by type of service for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended
 
 
March 31, 2019
 
March 31, 2018
 
 
(In thousands)
Loss on sale of investments (1)
 
$
(8
)
 
$

BOLI change in cash surrender value (1)
 
269

 
249

Wealth management revenue
 
196

 
99

Deposit related fees
 
69

 
63

Debit card and ATM fees
 
102

 
98

Loan related fees
 
47

 
87

Loan interest swap fees
 
16

 
47

Other
 
9

 
3

Total noninterest income
 
$
700

 
$
646

_______________
(1) Not within scope of Topic 606

For the three months ended March 31, 2019, substantially all of the Company’s revenues under the scope of Topic 606 are for performance obligations satisfied at a specified date.

Revenues recognized within scope of Topic 606

Wealth management revenue: Our wealth management revenue consists of commissions received on the investment portfolio managed by Bank personnel but held by a third party. Commissions are earned on brokerage services and advisory services based on contract terms at the onset of a new customer’s investment agreement or quarterly for ongoing services. Commissions are paid by the third party to the Bank when the performance obligation has been completed by both entities.

Deposit related fees: Fees are earned on our deposit accounts for various products or services performed for our customers. Fees include business account fees, non-sufficient fund fees, stop payment fees, wire services, safe deposit box, and others. These fees are recognized on a daily or monthly basis, depending on the type of service.

Debit card and ATM fees: Fees are earned when a debit card issued by the Bank is used or when other bank’s customers use our ATM services. Revenue is recognized at the time the fees are collected from the customer’s account or remitted by the VISA interchange network.

Loan related fees: Noninterest fee income is earned on our loans for servicing or annual fees on certain loan types.

Loan interest swap fees: For loans participating in an interest rate swap agreement, fees are earned at the onset of the agreement and are not contingent on any future performance or term length of the loan itself. The performance obligation is satisfied by entering into the contract and receipt of the fees from the counterparty.

Other: Fees earned on other services, such as merchant services or occasional non-recurring type services, are recognized at the time of the event or the applicable billing cycle.

32


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



Contract Balances

At March 31, 2019, the Company had no contract liabilities where the Company had an obligation to transfer goods or services for which the Company had already received consideration. In addition, the Company had no material performance obligations as of this date.     

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 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; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; 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 of 2010 (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

33



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, 2018 (“2018 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 Financial Northwest Bank (“the Bank”) is a wholly-owned subsidiary of First Financial Northwest, Inc. (“the Company”) and, as such, comprises substantially all of the activity for the Company. First Financial Northwest Bank was a community-based savings bank until February 4, 2016, when the Bank converted to a Washington chartered commercial bank reflecting the commercial banking services it now provides to its customers. The Bank primarily serves King, Pierce, Snohomish, and Kitsap counties, Washington, through its full-service banking office and headquarters in Renton, Washington, as well as five retail branches in King County, Washington and five retail branches in Snohomish County, Washington. The Bank has received FDIC approval to open a new branch in Kirkland, Washington. This additional King County location is expected to open in later in 2019.

The Bank’s business consists predominantly of attracting deposits from the general public, combined with borrowing from the Federal Home Loan Bank of Des Moines (“FHLB”) and raising funds in the wholesale market, then utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land, business, and consumer loans. With the current low interest rate environment, we are not aggressively pursuing longer term assets, but rather are focused on financing shorter term loans, in particular construction/land loans. We anticipate that construction/land lending will continue to be a strong element of our total loan portfolio in future periods. We will continue to take a disciplined approach in our construction/land lending by concentrating our efforts on residential loans to builders known to us, including multifamily loans to developers with proven success in this type of construction. These loans typically mature in six to eighteen months and funding is usually not fully disbursed at origination, therefore the impact to net loans receivable is generally minimal in the short term. We have also geographically expanded our loan portfolio through loan purchases or loan participations of commercial and multifamily real estate loans that are outside of our primary market area. Through our efforts to geographically diversify our loan portfolio with direct loan originations, loan participations, or loan purchases, our portfolio includes loans in 27 other states, including concentrations in California, Utah, Arizona and Oregon of $41.4 million, $16.1 million, $14.6 million and $11.8 million, respectively.

In support of our strategic growth plan, the Bank has developed a national line of business to originate and service aircraft loans. These loans are collateralized by new or used, single-engine piston aircraft to light jets for business or personal use which have demonstrated an acceptable valuation history under industry accepted valuation resources. The underwriting of these loans is primarily based on the asset value of the collateral with secondary emphasis placed on the ability of the borrower to repay the loan. We began originating aircraft loans in the fourth quarter of 2016. At March 31, 2019, our business loans included $11.9 million in fixed and adjustable rate aircraft loans.

Our primary source of revenue is interest income, which is the income that we earn on our loans and investments. Interest expense is the interest that we pay on our deposits and borrowings. Net interest income is the difference between interest income and interest expense. Changes in levels of interest rates affect interest income and interest expense differently and, thus, impacts our net interest income. First Financial Northwest Bank is generally liability-sensitive, meaning our interest-bearing liabilities reprice at a faster rate than our interest-earning assets.

An offset to net interest income is the provision for loan losses which is required to establish the allowance for loan and lease losses (“ALLL”) at a level that adequately provides for probable losses inherent in our loan portfolio. As our loan portfolio increases, or due to an increase for probable losses inherent in our loan portfolio, our ALLL may increase, resulting in a decrease to net interest income. Improvements in loan risk ratings, increases in property values, or receipt of recoveries of amounts previously charged off may partially or fully offset any increase to ALLL due to loan growth or an increase in probable loan losses.

Noninterest income is generated from various loan or deposit fees, increases in the cash surrender value of bank owned life insurance (“BOLI”), and revenue earned on our wealth management brokerage services. This income is increased or partially offset by any net gain or loss on sales of investment securities.

34




Our noninterest expenses consist primarily of salaries and employee benefits, professional fees, regulatory assessments, occupancy and equipment, and other general and administrative expenses. Salaries and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement, and other employee benefits. Professional fees include legal services, auditing and accounting services, computer support services, and other professional services in support of strategic plans. 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. Also included in noninterest expense is the change to the Company’s unfunded commitment reserve which is reflected in general and administrative expenses. This unfunded commitment reserve expense can vary significantly each quarter, based on the amount believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities, and reflects changes in the amounts that the Company has committed to fund but has not yet disbursed.

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 by using different assumptions. These policies govern the ALLL, the valuation of OREO, and the calculation of deferred taxes, the right-of-use asset and lease liability on our operating leases, fair values, and other-than-temporary impairments on the market value of investments and derivatives. 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 in the 2018 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 2018 Form 10-K.

Comparison of Financial Condition at March 31, 2019 and December 31, 2018

Total assets were $1.29 billion at March 31, 2019, an increase of 2.8%, from $1.25 billion at December 31, 2018. The following table details the $35.4 million net change in the composition of our assets at March 31, 2019 from December 31, 2018.
 
Balance at
March 31, 2019
 
Change from December 31, 2018
 
Percent Change
 
(Dollars in thousands)
Cash on hand and in banks                                           
$
9,366

 
$
1,244

 
15.3
 %
Interest-earning deposits with banks                                           
14,596

 
5,708

 
64.2

Investments available-for-sale, at fair value
138,658

 
(3,512
)
 
(2.5
)
Loans receivable, net                                           
1,051,711

 
28,807

 
2.8

FHLB stock, at cost                                
8,041

 
731

 
10.0

Accrued interest receivable
4,861

 
793

 
19.5

Deferred tax assets, net
1,728

 
(116
)
 
(6.3
)
OREO
454

 
(29
)
 
(6.0
)
Premises and equipment, net
21,370

 
39

 
0.2

BOLI, net
30,162

 
321

 
1.1

Prepaid expenses and other assets
4,947

 
1,489

 
43.1

Goodwill
889

 

 

Core deposit intangible
1,079

 
(37
)
 
(3.3
)
Total assets                                
$
1,287,862

 
$
35,438

 
2.8
 %

Interest-earning deposits with banks. Our interest-earning deposits with banks, consisting primarily of funds held at the Federal Reserve Bank of San Francisco (“FRB”), increased by $5.7 million from December 31, 2018, to March 31, 2019. These funds fluctuate based on our funding needs. Growth in our customer deposits late in the three months ended March 31, 2019 resulted in an increase to our cash held at the FRB.

Investments available-for-sale. Our investments available-for-sale portfolio decreased by $3.5 million during the three months ended March 31, 2019. During this period, we sold $3.0 million of municipal bonds and had a $30,000 call on a U.S. government agency bond. At March 31, 2019, corporate bonds issued by financial institutions represented $23.3 million, or 16.8% of our investments available-for-sale and municipal bonds represented $7.8 million, or 5.6% of our investments available-for-sale.

The effective duration of the investments available-for-sale at March 31, 2019, was 2.78% as compared to 3.00% at December 31, 2018. Effective duration is a measure that attempts to quantify the anticipated percentage change in the value of

35



an investment security (or portfolio) in the event of a 100 basis point change in market yields. Since the Bank’s portfolio includes securities with embedded options (including call options on bonds and prepayment options on mortgage-backed securities), management believes that effective duration is an appropriate metric to use as a tool when analyzing the Bank’s investment securities portfolio, as effective duration incorporates assumptions relating to such embedded options, including changes in cash flow assumptions as interest rates change.

Loans receivable. Net loans receivable increased by $28.8 million to $1.05 billion at March 31, 2019, as compared to December 31, 2018. Loan originations of $67.8 million were supplemented with $17.6 million of loan purchases, discussed below, to offset loan repayments and continue to grow our loan portfolio. During the three months ended March 31, 2019, our one‑to‑four family portfolio increased by $9.4 million and our commercial real estate portfolio increased by $10.9 million. In addition, total construction/land loans increased by $6.0 million, business loans increased by $3.0 million and consumer loans increased by $1.4 million. Partially offsetting these increases, multifamily loans decreased by $1.5 million as pay downs and payoffs outpaced new loan originations for these loan types.

Our loan concentrations remained stable at March 31, 2019 as compared to December 31, 2018. At these dates, the Bank’s construction loans totaled 87.5% and 81.9% of total capital, respectively, and total non-owner occupied commercial real estate was 460.9% and 451.8% of total capital, respectively. The Bank has set aggregate concentration guidelines that total commercial real estate, including residential, non‑residential, and construction, should not exceed 550% of total risk-based capital. Our concentration guideline for construction/land loans is to limit these loans to 100% of total risk-based capital. The concentration of construction/land loans is calculated using the funded balance of these loans and consequently can fluctuate based on the timing of construction draws and loan payoffs. Management reviews estimated construction draws and loan payoffs and adjusts loan originations based on these estimates to achieve compliance with our construction guidelines. Our commercial and multifamily real estate and construction/land loan portfolios are subject to ongoing credit reviews performed by both independent loan review staff, as well as an external third-party review firm to assist with identifying potential adverse trends and risks in the portfolio allowing management to initiate timely corrective action, as necessary. Such reviews also assist with ensuring loan risk grades are accurately assigned and thereby properly accounted for in the ALLL. The review places emphasis on large borrowing relationships, stress testing, compliance with loan covenants, as well as other risk factors warranting enhanced review.


36



The following table presents a breakdown of our commercial and construction loan portfolio by collateral type at March 31, 2019 and December 31, 2018:

 
March 31, 2019
 
December 31, 2018
 
(In thousands)
Multifamily real estate:
 
 
 
Multifamily, general
$
153,835

 
$
155,279

Micro-unit apartments
14,008

 
14,076

Total multifamily real estate
167,843

 
169,355

 
 
 
 
Commercial real estate:
 
 
 
Retail
146,864

 
131,222

Office
99,639

 
100,495

Storage
36,283

 
32,462

Motel
27,882

 
28,035

Warehouse
18,274

 
25,398

Nursing home (1)
16,243

 
16,315

Mobile home park
15,697

 
16,003

Other non-residential
23,804

 
23,889

Total commercial real estate
384,686

 
373,819

 
 
 
 
Construction/land:
 
 
 
One-to-four family residential
84,191

 
86,604

Multifamily
87,748

 
83,642

Commercial
22,400

 
18,300

Land
6,965

 
6,740

Total construction/land
201,304

 
195,286

Total multifamily, commercial and construction/land loans
$
753,833

 
$
738,460

____________
(1) LIP for nursing home loans at December 31, 2018 was $21,000. There was no LIP on these loans at March 31, 2019.

The LIP related to our construction/land loans increased by $341,000 as originations during the three months ended March 31, 2019 outpaced draws on these loans. Included in total construction/land loans at March 31, 2019, are $72.3 million of multifamily loans, $22.4 million of commercial real estate loans and $4.1 million of one-to-four family loans that will roll over to permanent loans at the completion of their construction period in accordance with the terms of the construction/land loan. At December 31, 2018, construction/land loans included $66.6 million of multifamily loans, $18.3 million of commercial real estate loans and $1.7 million of one-to-four family loans that roll over to permanent loans in accordance with the terms of the construction/land loan.

To assist in our strategic initiatives for loan growth and to achieve geographic diversification, the Bank will originate and purchase loans and utilize loan participations with the underlying collateral located within areas of Washington State outside our primary market area or in other states. The Bank’s goal with respect to loan participations is to locate a selling bank that is unable to make an entire loan due to legal or lending concentration limitations. Sellers of these loans are reviewed for management/lending experience, financial condition, asset quality metrics, and regulatory matters. Loans acquired through participation or purchase must meet the Bank’s underwriting standards. During the three months ended March 31, 2019, the Bank purchased $17.6 million of loans that included $16.6 million of commercial real estate loans secured by properties located outside of Washington State, and $1.0 million of consumer loans secured by automobiles to borrowers located in Washington and other states.
 
The majority of our loan portfolio continues to be secured by properties located in our primary market area, however a significant amount is secured by properties in other areas of Washington, in California, and in other states. At March 31, 2019,

37



total loans secured by collateral located in California represented 3.9% of our total loans, net of LIP and total loans secured by collateral located outside the states of California and Washington represented 9.9% of our total loans, net of LIP. The following table details geographic concentrations in our loan portfolio, net of LIP:

 
 
At March 31, 2019
 
 
One-to-Four Family Residential
 
Multifamily
 
Commercial Real Estate
 
Construction/Land
 
Business
 
Consumer
 
Total
 
 
(In thousands)
King County
 
$
276,890

 
$
98,495

 
$
197,833

 
$
101,461

 
$
12,975

 
$
11,722

 
$
699,376

Pierce County
 
32,145

 
5,076

 
26,957

 
8,761

 

 
842

 
73,781

Snohomish County
 
23,596

 
3,248

 
21,037

 
1,910

 
2,952

 
315

 
53,058

Kitsap County
 
5,815

 
1,484

 
777

 
2,241

 

 

 
10,317

Other Washington Counties
9,775

9,460

 
25,172

 
46,290

 
137

 
1,283

 
491

 
82,833

California
 
2,717

 
17,606

 
19,862

 

 
1,120

 
105

 
41,410

Outside Washington
and California
(1)
 
709

 
16,762

 
71,930

 

 
15,183

 
861

 
105,445

Total loans, net of LIP
 
$
351,332

 
$
167,843

 
$
384,686

 
$
114,510

 
$
33,513

 
$
14,336

 
$
1,066,220

_______________
(1) Includes loans in Oregon, Arizona, Utah and 23 other states.

Our five largest borrowing relationships, which represent 7.9% of our net loans, increased by $4.6 million to $84.5 million at March 31, 2019, from $79.9 million at December 31, 2018. The total number of loans represented by this group of borrowers remained relatively stable with 20 loans at March 31, 2019, and 19 loans at December 31, 2018. At March 31, 2019, all five borrowers were current on their loan payments. We monitor the performance of these borrowing relationships very closely due to their concentration risk in relation to the entire loan portfolio.

The following table details our five largest lending relationships at March 31, 2019:

Borrower (1)
 
Number
of Loans
 
One-to-Four Family
Residential
(2)
 
Multifamily
 
Commercial
Real Estate
 
Construction/Land
 
Business
 
Consumer
 
Aggregate
Balance of
Loans (3)
 
 
(Dollars in thousands)
Real estate investor
 
5

 
$

 
$
8,574

 
$
13,194

 
$

 
$

 
$

 
$
21,768

Real estate investor
 
3

 
420

 

 
18,952

 

 

 

 
19,372

Real estate investor
 
6

 
441

 

 
14,468

 

 

 
30

 
14,939

Real estate investor
 
3

 

 

 

 
3,120

 
11,149

 

 
14,269

Real estate investor
 
3

 

 
5,054

 

 
9,109

 

 

 
14,163

Total
 
20

 
$
861

 
$
13,628

 
$
46,614

 
$
12,229

 
$
11,149

 
$
30

 
$
84,511

________
(1)
The composition of borrowers represented in the table may change between periods.
(2) 
All of the one-to-four family residential loans for these borrowers are for owner occupied properties. The commercial real estate loans are for non-owner occupied properties.
(3) 
Net of LIP.


38



The ALLL increased to $13.8 million at March 31, 2019, from $13.3 million at December 31, 2018, and represented 1.30% and 1.29% of total loans receivable, net of LIP at March 31, 2019, and December 31, 2018, respectively. The ALLL consists of two components, the general allowance and the specific reserves. The increase in the ALLL was primarily the result of growth in our loan portfolio with a $473,000 increase in the general reserve. Specific reserves decreased $12,000 as a result of a decrease in the balance of our impaired loans. For additional information, see “Comparison of Operating Results for the Three Months Ended March 31, 2019 and 2018 - Provision for Loan Losses” discussed below.

We believe that the ALLL at March 31, 2019, 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 losses 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.

As we work with our borrowers that face difficult financial circumstances, we explore various 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. Certain loan modifications are accounted for as troubled debt restructured loans (“TDRs”). These modifications have included a reduction in interest rate on the loan for a period of time, advancing 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 considered to be in the Bank’s best interest.
    
The following table presents a breakdown of our TDRs at the dates indicated, all of which were performing:
 
March 31, 2019
 
December 31, 2018
 
Three Month Change
 
(Dollars in thousands)
Performing TDRs:
 
 
 
 
 
One-to-four family residential
$
5,656

 
$
6,941

 
$
(1,285
)
Commercial real estate
2,156

 
2,415

 
(259
)
Consumer

 
43

 
(43
)
Total performing TDRs
7,812

 
9,399

 
(1,587
)
Total TDRs
$
7,812

 
$
9,399

 
$
(1,587
)
% TDRs classified as performing
100.0
%
 
100.0
%
 
 

Our TDRs decreased $1.6 million at March 31, 2019, compared to December 31, 2018, as a result of principal repayments and loan payoffs. At March 31, 2019, there were no TDRs on nonaccrual status. In addition, there were no committed but undisbursed funds in connection with our TDRs and impaired loans. The largest TDR relationship at March 31, 2019, totaled $1.3 million and was secured by a non-owner occupied commercial property located in King County.

Loans are considered past due if a scheduled principal or interest payment is due and unpaid for 30 days or more. At March 31, 2019, total past due loans represented 0.03% of total loans receivable, as compared to 0.08% at December 31, 2018.
    
Nonperforming assets decreased by $630,000 during the first three months of 2019, primarily as a result of payoffs of two nonaccrual loans totaling $597,000. The following table presents detailed information on our nonperforming assets at the dates indicated:


39



 
March 31, 2019
 
December 31, 2018
 
Three Month Change
 
(Dollars in thousands)
Nonperforming loans:
 
 
 
 
 
  One-to-four family residential
$
107

 
$
382

 
$
(275
)
  Commercial real estate

 
326

 
(326
)
  Consumer
44

 
44

 

Total nonperforming loans
151

 
752

 
(601
)
 
 
 
 
 
 
OREO
454

 
483

 
(29
)
Total nonperforming assets (1)
$
605

 
$
1,235

 
$
(630
)
 
 
 
 
 
 
Nonperforming assets as a
percent of total assets
0.05
%
 
0.10
%
 
 
____________ 
(1) The difference between nonperforming assets reported above, and the totals reported by other industry sources, is due to their inclusion of all TDRs as nonperforming loans, although 100.0% of our TDRs were performing in accordance with their restructured terms at March 31, 2019.

Nonaccrual loans are loans that are 90 days or more delinquent or other loans which, in management's opinion, the borrower is unable to meet scheduled payment obligations. The largest nonaccrual loan at March 31, 2019 was a $107,000 owner occupied, single-family residence located in Snohomish County. Also included in nonaccrual loans at March 31, 2019, was a $44,000 home equity second mortgage secured by a non-owner occupied single family residence in King County. At March 31, 2019, both of these loans were current on their loan payments.

We continue to focus our efforts on working with borrowers to bring their loans current or converting nonaccrual loans to OREO and subsequently selling the properties. By taking ownership of these properties, we can generally convert nonearning assets into earning assets on a more timely basis than which may otherwise be the case. Our success in this area is reflected by the low ratio of our nonperforming assets as a percent of total assets of 0.05% at March 31, 2019, and 0.10% at December 31, 2018, as well as the minimal amount of OREO held at March 31, 2019.

OREO. OREO includes properties acquired by the Bank through foreclosure or acceptance of a deed in lieu of foreclosure. At March 31, 2019, and December 31, 2018, OREO was $454,000 and $483,000, respectively, and consisted of two undeveloped commercial lots located in Pierce County. During the three months ended March 31, 2019, a $29,000 write-down was recognized on these properties as the result of an updated valuation analysis.

Intangible assets. The balance of goodwill was $889,000 at both March 31, 2019 and December 31, 2018. Goodwill was calculated as the excess purchase price of the branches acquired in August 2017 (the “Branch Acquisition”) over the fair value of the assets acquired and liabilities assumed.

The core deposit intangible (“CDI”) recorded as part of the Branch Acquisition represents the fair value of the customer relationships on the acquired noninterest-bearing checking, interest-bearing checking, savings, and money market accounts. The CDI balance was $1.1 million at March 31, 2019 and December 31, 2018. The initial ratio of CDI to the acquired balances of core deposits was 2.23%. This amount amortizes into noninterest expense on an accelerated basis over ten years.
    
Deposits. During the first three months of 2019, deposits increased $16.2 million to $955.3 million at March 31, 2019, compared to $939.0 million at December 31, 2018. Deposit accounts consisted of the following:

40



 
March 31, 2019
 
Change from December 31, 2018
 
Percent Change
 
(Dollars in thousands)
Noninterest-bearing
$
46,026

 
$
(82
)
 
(0.2
)%
Interest-bearing checking
51,096

 
11,017

 
27.5

Statement savings
23,770

 
(1,029
)
 
(4.1
)
Money market
312,057

 
(26,990
)
 
(8.0
)
Certificates of deposit, retail
398,956

 
7,782

 
2.0

Certificates of deposit, brokered
123,367

 
25,542

 
26.1

 
$
955,272

 
$
16,240

 
1.7

 
Our retail deposits decreased by $9.3 million during the three months ended March 31, 2019. Money market accounts declined by $27.0 million as a number of customers actively used their account funds for project development or home purchases during the quarter. Partially offsetting this decrease, interest-bearing checking accounts increased by $11.0 million as these accounts continue to increase steadily in response to our customer expansion and marketing efforts. Also contributing to the increase in funds, retail certificates of deposit increased by $7.8 million as the Bank competitively priced select terms of these products for funding purposes.

To further assist in our funding needs, our portfolio of brokered certificates of deposits increased by $25.5 million to $123.4 million at March 31, 2019, from $97.8 million at December 31, 2018. This increase was primarily the result of an opportunity to raise funds in the brokered deposit market at an interest rate of 2.34% for three months, commencing in early March 2019. The Bank raised $35.0 million on those terms and used the funds to pay down overnight FHLB advances that cost approximately 2.60%. While brokered certificates of deposit may carry a higher cost than our retail certificates, their remaining maturity periods of up to 4.5 years, along with the enhanced call features on a portion of these deposits, assist us in our efforts to manage interest rate risk.

At March 31, 2019 and December 31, 2018, we held $25.7 million and $28.5 million in public funds, respectively, primarily in retail certificates of deposit and money market accounts.

Advances. We use advances from the FHLB as an alternative funding source to manage interest rate risk and to leverage our balance sheet. Total FHLB advances were $163.5 million at March 31, 2019, a $17.0 million increase from $146.5 million at December 31, 2018. At March 31, 2019, the Bank had $108.5 million in borrowings that are due in less than one year and $55.0 million in borrowings that are due in two to three years. Our long-term advances at March 31, 2019, consisted of three Member Option Variable Rate advances that reprice quarterly and allow prepayment without penalties at the repricing date. In addition, we held $48.5 million in overnight FHLB advances at that date. The repayment option on our Member Option Variable Rate advances and short term nature of overnight FHLB advances provides us flexibility to adjust the level of our borrowings as our customer deposit balances grow consistent with our asset/liability objectives. Our FHLB advances also include a $50.0 million fixed rate three‑month advance that renews quarterly at the fixed interest rate in effect at that time designated as a cash flow hedge, as described below.

Cash Flow Hedge. To assist in managing interest rate risk, the Bank entered into a five-year, $50 million notional, pay fixed, receive floating cash flow hedge or interest rate swap with a qualified institution on October 25, 2016. Under the terms of the Cash Flow Hedge agreement, the Bank pays a fixed rate of 1.34% for five years and, in turn, receives an interest payment based on the three-month LIBOR index, which resets quarterly. Concurrently, the Bank borrowed a $50.0 million fixed rate three-month advance that will be renewed quarterly at the fixed interest rate in effect at that time. A change in the fair value of the cash flow hedge is recognized as an other asset or other liability on the balance sheet with the tax-effected portion of the change included in other comprehensive income. At March 31, 2019, we recognized a $1.2 million fair value asset as a result of the increase in the market value of the hedge agreement.

Stockholders’ Equity. Total stockholders’ equity decreased $2.0 million during the first three months of 2019 to $151.7 million at March 31, 2019, from $153.7 million at December 31, 2018. The decrease was primarily the result of common stock repurchases of $4.2 million as well as $807,000 in cash dividends paid to shareholders. Partially offsetting these decreases, net income of $1.9 million was recognized for the three months ended March 31, 2019. In addition, other comprehensive income increased by $415,000, primarily due to improvements in the fair market value of our available-for-sale investments. Stock based compensation resulted in a $569,000 increase to equity. New restricted stock awards resulted in 16,698 shares being issued, and the net settlement of previously granted restricted stock that vested during the three months ended March 31, 2019, resulted in the cancellation of 5,929 shares.

41




As part of the strategy to increase shareholder value, the Company’s Board of Directors authorized a stock repurchase plan that began on November 5, 2018 and expires on May 3, 2019. The plan authorizes the repurchase of up to 550,000 shares of the Company’s stock in accordance with a plan established under the guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934 as administered through an independent broker. For the three months ended March 31, 2019, the Company repurchased 263,800 shares at an average cost of $15.76 per share. From the onset of the plan on November 5, 2018 through March 31, 2019, the Company has repurchased a total of 467,700 shares at an average cost of $15.62 per share.

The following table shows cash dividends paid per share and the related dividend payout ratio for the periods indicated:
 
Three Months Ended March 31,
 
2019
 
2018
 
 
 
 
Dividend declared per common share
$
0.08

 
$
0.07

Dividend payout ratio (1)
42.1
%
 
10.5
%
______________
(1) Dividends paid per common share divided by basic earnings per common share.     

Comparison of Operating Results for the Three Months Ended March 31, 2019 and 2018

General. Net income for the three months ended March 31, 2019, was $1.9 million, or $0.19 per diluted share as compared to net income of $6.8 million, or $0.66 per diluted share for the three months ended March 31, 2018. The $4.9 million decrease in net income during the three months ended March 31, 2019, was primarily the result of a $400,000 provision for loan losses compared to a recapture of provision for loan losses of $4.0 million and $1.1 million decrease in net interest income as compared to the three months ended March 31, 2018.

Net Interest Income. Net interest income for the three months ended March 31, 2019, decreased $1.1 million to $9.9 million from $11.0 million for the three months ended March 31, 2018. The decrease was due primarily to the receipt of an additional $1.0 million in loan interest income during the first three months of 2018 from the payoff of the remaining balances on previously charged off loans.

Interest income increased by $458,000 for the three months ended March 31, 2019, as compared to the same period in 2018, primarily as a result of a $37.5 million increase in the average balance of our interest-earning assets. Average loans receivable increased by $46.2 million, and was partially offset by a $1.8 million decrease in investments available-for-sale and a $5.2 million decrease in average interest-earning deposits, as lower yielding assets were converted to higher yielding loans. In addition, the average balance of FHLB stock decreased by $1.7 million as our required activity stock decreased due to lower average FHLB advances outstanding.

The average yield on our interest-earning assets was unchanged for the three months ended March 31, 2019 and 2018, remaining at 4.98% as the 15 basis point decrease in the average yield on our loan portfolio was offset by yield increases in our investments available‑for‑sale and interest-earning deposits. However, the 5.37% average yield on loans for the three months ended March 31, 2018 was unusually high as a result of the $1.0 million in interest received from the payoff of certain previously charged off loans, and no such additional interest recognized in the three months ended March 31, 2019. Loan originations during the same period in the prior year were generally made at higher market rates as compared to the existing loan portfolio. In addition, the volume of variable rate loans increased to 53.8% at March 31, 2019, from 50.2% at March 31, 2018, thereby generating higher yields from market rate increases over the past year.

Interest expense increased by $1.6 million for the three months ended March 31, 2019, as compared to the same period in 2018, primarily as a result of increases in the cost of interest-bearing liabilities, in particular money market deposits, certificates of deposit and FHLB advances. In response to market rate increases, the average cost of our interest-bearing deposits increased by 61 basis points and the average cost of our FHLB advances increased by 60 basis points for the three months ended March 31, 2019, as compared to the same period in 2018. Also contributing to the increase in interest expense during these periods, the average balance of our interest-bearing deposits increased by $76.8 million, with $50.5 million of this from growth in our retail operations and $26.3 million from an increase in brokered certificates of deposit. Money market interest expense increased by $313,000 as a result of a 42 basis point increase in the average cost of these funds partially offset by a $9.7 million decrease in the average balance of these deposits. The cost of retail and brokered certificates of deposit increased by 78 and 63 basis points,

42



respectively, as the growth in the rates needed to compete for these deposits in the marketplace have increased in response to increases in the Federal Funds targeted rate. The growth in our retail and brokered deposits more than met our funding needs, allowing the Bank to pay down certain FHLB advances resulting in a $47.6 million decrease in the average balance of these borrowings for the three months ended March 31, 2019, as compared to the same period in 2018.

The Company’s net interest margin and interest rate spread decreased by 59 basis points and 51 basis points, respectively, primarily due to increases in our cost of funds as our interest‑bearing liabilities generally reprice faster than our interest-earning assets in response to changes in market interest rates. For more information on this, see “How We Measure the Risk of Interest Rate Changes” in Item 3 of this report.

The following table details the change in net interest income due to changes in yield or cost, or changes in the average balance of the related asset or liability:
 
Three Months Ended March 31, 2019
Compared to March 31, 2018
Net Change in Interest
 
Rate
 
Volume
 
Total
 
(In thousands)
Interest-earning assets:
 
 
 
 
 
   Loans receivable, net
$
(372
)
 
$
611

 
$
239

   Investments available-for-sale
242

 
(12
)
 
230

   Interest-earning deposits with banks
19

 
(17
)
 
2

   FHLB stock
5

 
(18
)
 
(13
)
Total net change in income on interest-earning assets
(106
)
 
564

 
458

 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
   Interest-bearing demand
(6
)
 
2

 
(4
)
   Statement savings

 
(1
)
 
(1
)
   Money market
336

 
(23
)
 
313

   Certificates of deposit, retail
760

 
205

 
965

   Certificates of deposit, brokered
160

 
113

 
273

   Advances from the FHLB
239

 
(195
)
 
44

Total net change in expense on interest-bearing liabilities
1,489

 
101

 
1,590

Total net change in net interest income
$
(1,595
)
 
$
463

 
$
(1,132
)

    

43



The following table compares detailed average balances, related interest income or interest expense, associated yields and rates, and the resulting net interest margin for the three months ended March 31, 2019 and 2018. Nonaccrual loans are included in the average balance of net loans receivable and are considered to carry a zero yield.
 
Three Months Ended March 31,
 
2019
 
2018
 
Average
Balance
 
Interest Earned / Paid
 
Yield /
Cost
 
Average
Balance
 
Interest Earned / Paid
 
Yield /
Cost
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
 
 
 
 
Loans receivable, net                                           
$
1,031,994

 
$
13,281

 
5.22
%
 
$
985,799

 
$
13,042

 
5.37
%
Investments available-for-sale
140,433

 
1,159

 
3.35

 
142,236

 
929

 
2.65

Interest-earning deposits with banks                                          
6,484

 
40

 
2.50

 
11,717

 
38

 
1.32

FHLB stock                      
7,888

 
91

 
4.68

 
9,593

 
104

 
4.40

Total interest-earning assets                                                      
1,186,799

 
14,571

 
4.98

 
1,149,345

 
14,113

 
4.98

Noninterest earning assets
72,103

 
 
 
 
 
69,073

 
 
 
 
Total average assets
$
1,258,902

 
 
 
 
 
$
1,218,418

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
$
42,579

 
$
18

 
0.17
%
 
$
38,350

 
$
22

 
0.23
%
Statement savings
24,146

 
8

 
0.13

 
27,342

 
9

 
0.13

Money market
320,411

 
1,078

 
1.36

 
330,141

 
765

 
0.94

Certificates of deposit, retail
392,337

 
2,120

 
2.19

 
333,130

 
1,155

 
1.41

Certificates of deposit, brokered
101,787

 
598

 
2.38

 
75,488

 
325

 
1.75

Total interest-bearing deposits
881,260

 
3,822

 
1.76

 
804,451

 
2,276

 
1.15

Advances from the FHLB and other borrowings
160,950

 
897

 
2.26

 
208,544

 
853

 
1.66

Total interest-bearing liabilities
1,042,210

 
4,719

 
1.84

 
1,012,995

 
3,129

 
1.25

Noninterest bearing liabilities
63,842

 
 
 
 
 
60,637

 
 
 
 
Average equity
152,850

 
 
 
 
 
144,786

 
 
 
 
Total average liabilities and equity
$
1,258,902

 
 
 
 
 
$
1,218,418

 
 
 
 
Net interest income
 
 
$
9,852

 
 
 
 
 
$
10,984

 
 
Net interest margin
 
 
 
 
3.37
%
 
 
 
 
 
3.88
%

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 reserves. The general reserve is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, the prevailing economy, 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 reserve component is created when management believes that the collectability of a specific loan has been impaired and a loss is probable or a concession is granted that reduces the value of the loan. The specific reserves are computed using discounted cash flows, 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 if future events differ from current estimates.

During the three months ended March 31, 2019, management evaluated the adequacy of the ALLL and concluded that a provision for loan losses in the amount of $400,000 was appropriate, primarily as a result of a $28.8 million increase in total loans receivable, net of LIP. In comparison, during the three months ended March 31, 2018, a $4.0 million recapture of provision for

44



loan losses was recognized as a result of $4.3 million in recoveries received on previously charged off loans, partially offset by an increase to the allowance for loan losses related to the $2.7 million increase in the balance of our total loans receivable, net of LIP.

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,
 
2019

2018
 
(Dollars in thousands)
Total loans receivable, net of LIP, end of period
$
1,066,220

 
$
1,005,440

Average loans receivable during period
1,031,994

 
985,799

ALLL balance at beginning of period
13,347

 
12,882

Provision (recapture) for loan losses
400

 
(4,000
)
Charge-offs:
 
 
 
Total charge-offs

 

Recoveries:
 
 
 
One-to-four family
24

 
4,240

Commercial real estate

 
14

Consumer
37

 

Total recoveries
61

 
4,254

Net recovery
61

 
4,254

ALLL balance at end of period
$
13,808

 
$
13,136

ALLL as a percent of total loans, net of LIP
1.30
%
 
1.31
%
Ratio of net recoveries to average net loans receivable
0.01

 
1.75


Noninterest Income. Noninterest income increased $54,000 to $700,000 for the quarter ended March 31, 2019, from $646,000 for the quarter ended March 31, 2018. The following table provides a detailed analysis of the changes in the components of noninterest income:
 
Three Months Ended March 31, 2019
 
Change from Three Months Ended
March 31, 2018
 
Percent Change
 
(Dollars in thousands)
Net loss on sale of investments
$
(8
)
 
$
(8
)
 
 %
BOLI change in cash surrender value
269

 
20

 
8.0

Wealth management revenue
196

 
97

 
98.0

Deposit related fees
171

 
10

 
6.2

Loan related fees
63

 
(71
)
 
(53.0
)
Other           
9

 
6

 
200.0

Total noninterest income                                           
$
700

 
$
54

 
8.4
 %

During the three months ended March 31, 2019, as compared to the three months ended March 31, 2018, wealth management revenue increased by $97,000 as a result of an increase in the total assets managed by our wealth management division and regular fluctuations in the timing and mix of commissions received on serviced accounts. Noninterest income from our BOLI policies increased as a result of annual dividends received during the three months ended March 31, 2019, as compared to lower income for the three months ended March 31, 2018 as policy expenses were deducted from earnings over the first year subsequent to the purchase date of certain policies in 2017.


45



Partially offsetting these increases, loan related fees decreased $71,000 for the three months ended March 31, 2019 as compared to the same period in 2018, primarily as a result of additional fees collected on interest rate swap agreements and other loan fees collected in the first three months of 2018.

Noninterest Expense. Noninterest expense increased $682,000 to $7.7 million for the three months ended March 31, 2019, from $7.0 million for the comparable period in 2018.

The following table provides a detailed analysis of the changes in the components of noninterest expense:
 
Three Months Ended March 31, 2019
 
Change from Three Months Ended
March 31, 2018
 
Percent Change
 
(Dollars in thousands)
Salaries and employee benefits
$
5,000

 
$
338

 
7.3
 %
Occupancy and equipment                                           
866

 
97

 
12.6

Professional fees                                
496

 
168

 
51.2

Data processing                                
518

 
194

 
59.9

OREO related expenses, net
31

 
30

 
3,000.0

Regulatory assessments
137

 
(18
)
 
(11.6
)
Insurance and bond premiums                                           
105

 
(1
)
 
(0.9
)
Marketing
86

 
(21
)
 
(19.6
)
Other general and administrative
470

 
(105
)
 
(18.3
)
Total noninterest expense                                           
$
7,709

 
$
682

 
9.7
 %

Expenses for salaries and employee benefits increased $338,000 for the three months ended March 31, 2019, as compared to the same period in 2018, as a result of annual employee salary increases and increased staff to support of our growth and the development of new products. In addition to the impact on employee expenses, the increase in the number of our branch locations over the last year resulted in a $97,000 increase in occupancy and equipment expenses. Professional fees for legal, accounting and other services increased by $168,000 in support of our expanded operations and additional tax planning research to maximize our benefit from the 2017 Tax Act. Data processing expense increased by $194,000 as a result of additional core processor fees and computer software to support growth and improve our network security.

Partially offsetting these increases, other general and administrative expenses decreased by $105,000 for the three months ended March 31, 2019 as a result of the receipt of $125,000 from an insurance claim related to the $225,000 fraud loss reported in the fourth quarter of 2018.

Federal Income Tax Expense. Income before federal income taxes decreased by $6.2 million for the three months ended March 31, 2019 as compared to the same period in 2018 due to lower pre-tax net income, resulting in a $1.3 million decrease in the provision for income taxes for the three months ended March 31, 2019. We recorded federal income tax provisions of $498,000 and $1.8 million for the three months ended March 31, 2019, and 2018, respectively.

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, cash flow from the loan and investment portfolios, advances from the FHLB, and to a lesser extent, brokered certificates of deposit. These funds, together with equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. At March 31, 2019, retail certificates of deposit of $169.9 million and brokered certificates of deposit of $68.7 million were scheduled to mature in one year or less. Management’s practice is to maintain deposit rates at levels that are competitive with other local financial institutions. 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

46



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 or the FRB, which are collateral dependent, wholesale funding, national certificates of deposit listing services, brokered deposits, federal funds purchased and dealer repurchase agreements, as well as other short-term alternatives. We may also liquidate assets to meet our funding needs. The balance of our investments available-for-sale decreased $3.5 million to $138.7 million at March 31, 2019, from December 31, 2018, and represents a ready source of cash if needed. The balance of our interest-earning deposits with banks increased by $5.7 million to $14.6 million at March 31, 2019, from December 31, 2018, as a result of fluctuations in our funding needs for loans receivable and retail deposits. At March 31, 2019, the Bank maintained credit facilities with the FHLB totaling $562.8 million, with an outstanding balance of $163.5 million. As further funding sources, we also had the ability to borrow $95.8 million from the FRB and $35.0 million from unused lines of credit with other financial institutions, with no balance outstanding at March 31, 2019. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q.

To assist in our funds acquisition and interest rate risk management efforts, management utilizes the national brokered deposit market and maintained a balance at March 31, 2019, of $123.4 million of brokered certificates of deposit. In contrast to most retail certificate of deposit offerings which provide the depositor with an option to withdraw their funds prior to maturity, subject to an early withdrawal penalty, many of our certificates of deposit acquired in the brokered market limits the depositor ability to withdraw the funds before the end of the term (except in the case of death or adjudication of incompetence of a depositor) which greatly reduces early redemption risk associated with retail deposits. This strategy may include, but is not necessarily limited to, raising longer term deposits (with terms greater than three years) that assist the Bank in its interest rate risk management efforts. At March 31, 2019, brokered certificates of deposit had a remaining maturity of up to 4.5 years. Some of these certificates also provide the Bank the option to redeem the deposit after six months, a favorable distinction compared to retail certificate of deposit terms that are offered in our local market. With these redemption limitations and call features, the cost of these brokered deposits is generally higher than our retail certificate of deposit offerings. Consequently, as we increase our brokered deposits, our cost of funds may increase.

First Financial Northwest is a separate legal entity from the Bank and, on a stand-alone level, must provide for its own liquidity and pay its own operating expenses and cash dividends. First Financial Northwest's primary sources of funds consist of dividends from the Bank, although there are regulatory requirements related to the ability of the Bank to pay dividends. At March 31, 2019, the Company (on an unconsolidated basis) had liquid assets of $18.3 million and short-term liabilities of $205,000.

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 (“ALCO”) 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, 2019 and December 31, 2018, 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 the 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.
    

47



The following table summarizes our outstanding commitments to advance additional amounts pursuant to outstanding lines of credit and to disburse funds related to our construction loans at March 31, 2019:
 
 
 
Amount of Commitment Expiration
 
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                                                      
$
4,545

 
$
4,315

 
$
230

 
$

 
$

Unused portion of lines of credit                                                      
36,588

 
10,390

 
7,660

 
2,364

 
16,174

Undisbursed portion of construction loans
86,794

 
48,202

 
38,592

 

 

Total commitments
$
127,927

 
$
62,907

 
$
46,482

 
$
2,364

 
$
16,174


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

As of March 31, 2019, the Bank had ten operating leases with remaining terms of 17 months to 6 years which carry minimum lease payments of $51,000 per month. All ten leases offer extension periods, and include a new leased branch in Kent, Washington, which opened in the first quarter of 2019, as well as a new lease secured for a branch office expected to open later in 2019 in Kirkland, Washington.
    
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.

Capital

At March 31, 2019, stockholders’ equity totaled $151.7 million, or 11.8% of total assets. Our book value per share of common stock was $14.50 at March 31, 2019, compared to $14.35 at December 31, 2018. Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a “well-capitalized” status in accordance with regulatory standards.

As of March 31, 2019, the Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory capital guidelines of the FDIC. Effective September 30, 2018, the Bank is no longer required to file consolidated capital ratios as part of the Federal Reserve Bank’s regulatory filings. The following table provides the Bank’s capital requirements and actual results.

 
At March 31, 2019
 
Actual
 
For Minimum Capital Adequacy Purposes
 
To be Categorized as “Well Capitalized”
 
 Amount
 
Ratio
 
 Amount
 
Ratio
 
 Amount
 
Ratio
 
 (Dollars in thousands)
Tier I leverage capital (to average assets)
$
129,415

 
10.28
%
 
$
50,344

 
4.00
%
 
$
62,930

 
5.00
%
Common equity tier I ("CET1") (to risk-weighted assets)
129,415

 
13.13

 
44,352

 
4.50

 
64,064

 
6.50

Tier I risk-based capital (to risk-weighted assets)
129,415

 
13.13

 
59,136

 
6.00

 
78,848

 
8.00

Total risk-based capital (to risk-weighted assets)
141,759

 
14.38

 
78,848

 
8.00

 
98,560

 
10.00


In addition to the minimum CET1, Tier I total capital and leverage ratios, the Bank is required to maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. At March 31, 2019, the Bank’s capital conservation buffer was 6.38%.



48



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 interest rate spread by managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate risk, credit risk, and profitability. The policy established an Investment, Asset/Liability 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 Committee 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 are originating shorter term higher yielding loans, whenever possible;
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;
we have added adjustable-rate loans to our loan portfolio;
we utilize brokered certificates of deposit with a call option as a funding source; and
we have utilized an interest rate swap to effectively fix the rate on $50.0 million of FHLB advances.

We have evaluated the use of derivative instruments to limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and to lower our cost of borrowing while taking into account variable interest rate risk. On October 25, 2016, the Bank entered into a Cash Flow Hedge agreement to effectively fix the rate for five years on $50.0 million of short-term FHLB advances. We are using this interest rate swap as a tool to lower the cost of certain FHLB advances as compared to the fixed rates offered by the FHLB for its longer term advances. At March 31, 2019, pursuant to the Cash Flow Hedge agreement we held a $50.0 million notional pay fixed, receive floating cash flow hedge. The Bank pays a fixed rate of 1.34% for five years and in turn, receives an interest payment based on three-month LIBOR, which resets quarterly. The hedge instrument is a $50.0 million FHLB fixed-rate three-month advance that is renewed at the fixed rate at maturity. Entering into this hedge agreement has allowed the Bank to secure fixed rate funding at a lower cost than a traditional five-year fixed rate FHLB advance. We will continue to review similar instruments and may utilize them for interest rate risk management in the future.

Interest rate contracts, however, may expose us to the risk of loss associated with variations in the spread between the interest rate contract and the hedged item. In addition, these contracts carry volatility risk that the expected uncertainty relating to the price of the underlying asset differs from what is anticipated. If any interest rate swaps we enter into prove ineffective, it could

49



result in volatility in our operating results, including potential losses, which could have a material adverse effect on our results of operations and cash flows.

Brokered Deposits. Management utilizes the national brokered deposit market as an additional source of funds and to assist efforts in managing interest rate risk. Utilizing brokered deposits might result in increased regulatory scrutiny, as such deposits are not viewed as favorably as core retail deposits and there can be no assurance that the Bank will be allowed to include brokered deposits in its deposit mix in the future. While management will attempt to weigh the benefits of brokered deposits against the costs and risks, there can be no assurance that its conclusions will necessarily be aligned with those of the Bank’s regulators.

How We Measure the Risk of Interest Rate Changes. We monitor our interest rate sensitivity on a quarterly basis by measuring the impact of changes to net interest income in multiple rate environments. Management retains the services of a third party consultant with over 30 years of experience in asset-liability management to assist in its interest rate risk and asset-liability management. Management uses various assumptions to evaluate the sensitivity of the market value of our assets and liabilities 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 results differ 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 53.8% of our total loans, net of LIP, were adjustable-rate loans at March 31, 2019. At that date, $259.9 million, or 45.3% of these loans were at their floor, with a weighted-average interest rate of 4.46%.

The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates. However, 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.

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 deposit rates can be maintained with rate adjustments 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 observed in the past that our deposit accounts during changing rate environments have relatively lower volatility and less than market rate changes. 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 and 200 basis points. A decline by 300 basis points were not reported as the current targeted federal funds rate is between 2.25% and 2.50%.

The following table illustrates the estimated change in our net interest income over the next 12 months from March 31, 2019, 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.

50



    
Net Interest Income Change at March 31, 2019
Basis Point Change in Rates
 
Net Interest Income
 
% Change
(Dollars in thousands)
+300
 
$
37,311

 
(0.78
)%
+200
 
37,425

 
(0.48
)
+100
 
37,613

 
0.02

Base
 
37,606

 

(100)
 
38,270

 
1.77

(200)
 
38,164

 
1.48


The following table illustrates the change in our net portfolio value (“NPV”) at March 31, 2019, 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 (1)
 
Portfolio Value of Assets
 
Value of
Rates
 
Amount
 
$ Change (2)
 
% Change
 
NPV Ratio (3)
 
% Change (4)
 
Assets (5)
 
 
(Dollars in thousands)
+300
 
$
125,020

 
$
(34,567
)
 
(21.66
)%
 
10.45
%
 
(2.69
)%
 
$
1,196,933

+200
 
136,453

 
(23,134
)
 
(14.50
)
 
11.14

 
(1.80
)
 
1,225,328

+100
 
149,570

 
(10,017
)
 
(6.28
)
 
11.91

 
(0.78
)
 
1,256,072

Base
 
159,587

 

 

 
12.42

 

 
1,284,526

(100)
 
165,898

 
6,311

 
3.95

 
12.67

 
0.49

 
1,309,012

(200)
 
163,790

 
4,203

 
2.63

 
12.31

 
0.33

 
1,330,354

_____________ 

(1) 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 the market value of 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.
(2) The increase or decrease in net portfolio value at the indicated interest rates compared to the net portfolio value assuming no change in interest rates.
(3) Net portfolio value divided by the market value of assets.
(4) The increase or decrease in the net portfolio value divided by the market value of assets.
(5) 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, 2019, other than the interest rate swap we entered into through the Cash Flow Hedge agreement, we did not have any derivative financial instruments or trading accounts for any class of financial instruments, nor have we engaged in any other hedging activities or purchased off-balance sheet derivative instruments. However, we continue to review such instruments

51



and may utilize them for interest rate risk management in the future. 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. Furthermore, projections of any evaluation of effectiveness to future periods 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, 2019, 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, 2019, 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 our 2018 Form 10-K.

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

(a)     Not applicable

(b)     Not applicable


(c)    The following table summarizes First Financial Northwest’s common stock repurchases during the three months ended March 31, 2019, under the repurchase plan effective November 5, 2018 through May 3, 2019:

52



Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Repurchased as Part of Publicly Announced Plan
 
Maximum Number of Shares that May Yet Be Repurchased Under the Plan
January 1 - January 31, 2019
 
124,900

 
$
15.68

 
124,900

 
221,200

February 1 - February 28, 2019
 
71,300

 
15.78

 
71,300

 
149,900

March 1 - March 31, 2019
 
67,600

 
15.90

 
67,600

 
82,300

 
 
263,800

 
15.76

 
263,800

 
82,300

    
On October 25, 2018, the Board of Directors authorized the repurchase of up to 550,000 shares of the Company’s common stock, or 5% of the Company’s outstanding shares. The plan allows for the repurchase from November 5, 2018 through May 3, 2019, under a pre-arranged stock trading plan in accordance with guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. Repurchases under the Company’s Rule 10b5-1 plan are administered through an independent broker subject to SEC requirements as well as a certain price, market volume, and timing constraints as specified in the plan. At March 31, 2019, the Company had repurchased a total of 467,700 shares since the onset of the plan on November 5, 2018, at an average price of $15.62 per share.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

53




Item 6. Exhibits and Financial Statement Schedules
 
(a)       Exhibits
 
3.1

 
3.2

 
4.0

 
10.1

 
10.2

 
10.3

 
10.4

 
10.5

 
10.6

 
10.7

 
10.8

 
10.9

 
10.10

 
10.11

 
10.12

 
10.13

 
10.14

 
10.15

 
31.1

 
31.2

 
32

 
101

 
The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, 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.

 _____________
(1) 
Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-1 on June 6, 2007 (333-143539)
(2) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated April 3, 2019.
(3) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 5, 2013.
(4) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated September 9, 2014.
(5) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 11, 2017.
(6) 
Filed as Appendix A to First Financial Northwest’s definitive proxy statement dated April 15, 2008.
(7) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated June 15, 2016.
(8) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 1, 2008.
(9) 
Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for March 31, 2018 filed on May 8, 2018.
(10) 
Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-8 on June 15, 2016 (333-212029)
(11) 
Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for September 30, 2018 filed November 7, 2018.
(12) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 20, 2018.
(13) 
Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 3, 2019.


54



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 9, 2019
By: 
/s/ Joseph W. Kiley III
 
 
Joseph W. Kiley III
 
 
President and Chief Executive Officer (Principal Executive Officer)
Date: May 9, 2019
By: 
/s/ Richard P. Jacobson
 
 
Richard P. Jacobson
 
 
Executive Vice President and Chief Financial Officer (Principal Financial Officer)
 
 
 
Date: May 9, 2019
By: 
/s/ Christine A. Huestis
 
 
Christine A. Huestis
 
 
Vice President and Controller (Principal Accounting Officer)

55




Exhibit Index

Exhibit No.
 
Description
31.1

 
31.2

 
32

 
101

 
The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, 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.




56