First Financial Northwest, Inc. - Quarter Report: 2021 September (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

	For the quarterly period ended September 30, 2021

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

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

Yes X No

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

Yes X No

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

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

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

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

Yes No X

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: as of November 5, 2021, 9,350,763 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	3
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64
	Item 4.	Controls and Procedures	67
PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings	68
	Item 1A.	Risk Factors	68
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	68 68
	Item 3.	Defaults upon Senior Securities	68
	Item 4.	Mine Safety Disclosures	68
	Item 5.	Other Information	68
	Item 6.	Exhibits	69
SIGNATURES			70

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollars in thousands, except share data)

Part 1. Financial Information

Item 1. Financial Statements


	September 30, 2021		December 31, 2020
Assets
	(Unaudited)
Cash on hand and in banks	$	7,243	$	7,995
Interest-earning deposits with banks	71,869		72,494
Investments available-for-sale, at fair value	178,061		127,551
Investments held-to-maturity, at amortized cost	2,425		2,418
Loans receivable, net of allowance of $15,057, and $15,174	1,101,669		1,100,582
Federal Home Loan Bank ("FHLB") stock, at cost	6,465		6,410
Accrued interest receivable	5,681		5,508
Deferred tax assets, net	746		1,641
Other real estate owned ("OREO")	—		454
Premises and equipment, net	22,628		22,579
Bank owned life insurance ("BOLI"), net	34,994		33,034
Prepaid expenses and other assets	2,975		1,643
Right of use asset (“ROU”), net	3,838		3,647
Goodwill	889		889
Core deposit intangible, net	719		824
Total assets	$	1,440,202	$	1,387,669

Liabilities and Stockholders' Equity
Deposits:
Noninterest-bearing deposits	$	115,311	$	91,285
Interest-bearing deposits	1,026,425		1,002,348
Total deposits	1,141,736		1,093,633
FHLB advances	120,000		120,000
Advance payments from borrowers for taxes and insurance	5,075		2,498
Lease liability, net	3,994		3,783
Accrued interest payable	206		211

Other liabilities	7,735		11,242
Total liabilities	1,278,746		1,231,367

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 9,483,081 shares at September 30, 2021 and 9,736,875 shares at December 31, 2020	95		97
Additional paid-in capital	78,311		82,095
Retained earnings	84,402		78,003
Accumulated other comprehensive loss, net of tax	(223)		(1,918)
Unearned Employee Stock Ownership Plan ("ESOP") shares	(1,129)		(1,975)
Total stockholders' equity	161,456		156,302
Total liabilities and stockholders' equity	$	1,440,202	$	1,387,669

See accompanying selected notes to consolidated financial statements.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Income Statements

(Dollars in thousands, except per share data)

Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Interest income
Loans, including fees	$	12,508	$	12,847	$	37,772	$	39,504
Investments available-for-sale	814		751		2,400		2,466
Investments held-to-maturity	4		6		20		17
Interest-earning deposits with banks	24		8		53		45
Dividends on FHLB stock	84		82		247		240
Total interest income	13,434		13,694		40,492		42,272
Interest expense
Deposits	1,612		3,206		5,826		11,238
Borrowings	431		400		1,263		1,214
Total interest expense	2,043		3,606		7,089		12,452
Net interest income	11,391		10,088		33,403		29,820
Provision (recapture of provision) for loan losses	100		700		(300)		1,300
Net interest income after provision (recapture of provision) for loan losses	11,291		9,388		33,703		28,520
Noninterest income
Net gain on sale of investments	—		18		—		86
BOLI income	377		269		891		778
Wealth management revenue, net	64		145		391		493
Deposit related fees	228		201		654		560
Loan related fees	300		376		714		865
Other	30		2		86		7
Total noninterest income	999		1,011		2,736		2,789
Noninterest expense
Salaries and employee benefits	4,856		4,880		14,863		14,893
Occupancy and equipment	1,116		987		3,403		3,090
Professional fees	502		371		1,423		1,257
Data processing	626		731		2,003		2,112
OREO related expenses, net	207		1		208		7
Regulatory assessments	121		134		356		405
Insurance and bond premiums	106		116		341		339
Marketing	64		41		116		133
Other general and administrative	735		606		1,938		1,843
Total noninterest expense	8,333		7,867		24,651		24,079
Income before federal income tax provision	3,957		2,532		11,788		7,230
Federal income tax provision	758		450		2,281		1,320
Net income	$	3,199	$	2,082	$	9,507	$	5,910
Basic earnings per common share	$	0.34	$	0.22	$	1.01	$	0.60
Diluted earnings per common share	$	0.34	$	0.21	$	0.99	$	0.60
Basic weighted average number of common shares outstanding	9,314,456		9,661,498		9,412,196		9,788,397
Diluted weighted average number of common shares outstanding	9,446,702		9,675,567		9,514,165		9,811,602

See accompanying selected notes to consolidated financial statements.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Net income	$	3,199	$	2,082	$	9,507	$	5,910
Other comprehensive (loss) income, before tax:
Unrealized holding (losses) gains on investments available-for-sale	(761)		538		(1,192)		2,031
Tax effect	160		(113)		251		(427)
Reclassification adjustment for net gains realized in income	—		(18)		—		(86)
Tax effect	—		4		—		18
Gains (losses) on cash flow hedges	553		343		3,337		(4,264)
Tax effect	(116)		(72)		(701)		896
Other comprehensive (loss) income, net of tax	(164)		682		1,695		(1,832)
Total comprehensive income	$	3,035	$	2,764	$	11,202	$	4,078

See accompanying selected notes to consolidated financial statements.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Dollars in thousands except share data)

(Unaudited)


	Three Months Ended September 30, 2020
	Shares	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net of tax		Unearned ESOP Shares		Total Stockholders’ Equity
Balances at June 30, 2020	10,048,961	$	100	$	85,119	$	75,181	$	(3,885)	$	(2,539)	$	153,976
Net income	—	—		—		2,082		—		—		2,082
Other comprehensive income, net of tax	—	—		—		—		682		—		682

Issuance of common stock - restricted stock awards, net	17,695	—		—		—		—		—		—
Compensation related to stock options and restricted stock awards	—	—		224		—		—		—		224
Allocation of 28,214 ESOP shares	—	—		(21)		—		—		282		261
Repurchase and retirement of common stock	(155,049)	(1)		(1,483)		—		—		—		(1,484)

Cash dividend declared and paid ($0.10 per share)	—	—		—		(963)		—		—		(963)
Balances at September 30, 2020	9,911,607	$	99	$	83,839	$	76,300	$	(3,203)	$	(2,257)	$	154,778

	Nine Months Ended September 30, 2020
	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, 2019	10,252,953	$	103	$	87,370	$	73,321	$	(1,371)	$	(3,104)	$	156,319
Net income	—	—		—		5,910		—		—		5,910
Other comprehensive loss, net of tax	—	—		—		—		(1,832)		—		(1,832)

Issuance of common stock - restricted stock awards, net	33,923	—		(73)		—		—		—		(73)
Compensation related to stock options and restricted stock awards	—	—		367		—		—		—		367
Allocation of 84,642 ESOP shares	—	—		57		—		—		847		904
Repurchase and retirement of common stock	(369,894)	(4)		(3,882)		—		—		—		(3,886)
Canceled common stock - restricted stock awards	(5,375)	—		—		—		—		—		—
Cash dividend declared and paid ($0.30 per share)	—	—		—		(2,931)		—		—		(2,931)
Balances at September 30, 2020	9,911,607	$	99	$	83,839	$	76,300	$	(3,203)	$	(2,257)	$	154,778

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Dollars in thousands except share data)

(Unaudited)


	Three Months Ended September 30, 2021
	Shares	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net of tax		Unearned ESOP Shares		Total Stockholders’ Equity
Balances at June 30, 2021	9,651,180	$	97	$	80,770	$	82,224	$	(59)	$	(1,411)	$	161,621
Net income	—	—		—		3,199		—		—		3,199
Other comprehensive loss, net of tax	—	—		—		—		(164)		—		(164)
Exercise of stock options	2,000	—		22		—		—		—		22
Issuance of common stock - restricted stock awards, net	10,080	—		—		—		—		—		—
Compensation related to stock options and restricted stock awards	—	—		315		—		—		—		315
Allocation of 28,213 ESOP shares	—	—		171		—		—		282		453
Repurchase and retirement of common stock	(180,179)	(2)		(2,967)		—		—		—		(2,969)

Cash dividend declared and paid ($0.11 per share)	—	—		—		(1,021)		—		—		(1,021)
Balances at September 30, 2021	9,483,081	$	95	$	78,311	$	84,402	$	(223)	$	(1,129)	$	161,456

	Nine Months Ended September 30, 2021
	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, 2020	9,736,875	$	97	$	82,095	$	78,003	$	(1,918)	$	(1,975)	$	156,302
Net income	—	—		—		9,507		—		—		9,507
Other comprehensive income, net of tax	—	—		—		—		1,695		—		1,695
Exercise of stock options	6,000	—		64		—		—		—		64
Issuance of common stock - restricted stock awards, net	55,673	1		(39)		—		—		—		(38)
Compensation related to stock options and restricted stock awards	—	—		558		—		—		—		558
Allocation of 84,639 ESOP shares	—	—		381		—		—		846		1,227
Repurchase and retirement of common stock	(312,628)	(3)		(4,748)		—		—		—		(4,751)
Canceled common stock - restricted stock awards	(2,839)	—		—		—		—		—		—
Cash dividend declared and paid ($0.33 per share)	—	—		—		(3,108)		—		—		(3,108)
Balances at September 30, 2021	9,483,081	$	95	$	78,311	$	84,402	$	(223)	$	(1,129)	$	161,456

See accompanying selected notes to consolidated financial statements.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Nine Months Ended September 30,
	2021		2020
Cash flows from operating activities:
Net income	$	9,507	$	5,910
Adjustments to reconcile net income to net cash provided by operating activities:
(Recapture of provision) provision for loan losses	(300)		1,300

Loss on sale of OREO property, net	207		—
Net amortization of premiums and discounts on investments	807		589
Gain on sale of investments available-for-sale	—		(86)
Depreciation of premises and equipment	1,607		1,638
Loss on disposal of premises and equipment	1		—
Deferred federal income taxes	445		110
Allocation of ESOP shares	1,227		904
Stock compensation expense	558		367
BOLI income	(891)		(778)
Annuity income	(20)		(31)
Changes in operating assets and liabilities:
(Increase) decrease in prepaid expenses and other assets	(715)		194
Decrease in ROU	567		491
Increase in advance payments from borrowers for taxes and insurance	2,577		1,821
Increase in accrued interest receivable	(173)		(1,538)
Decrease in lease liability	(547)		(453)
Decrease in accrued interest payable	(5)		(88)
Decrease in other liabilities	(669)		(558)
Net cash provided by operating activities	14,183		9,792
Cash flows from investing activities:

Proceeds from sales of OREO properties	247		—
Proceeds from sales, calls and maturities of investments available-for-sale	10,000		12,082

Principal repayments on investments available-for-sale	13,621		8,991
Purchases of investments available-for-sale	(76,130)		(9,050)

Purchase of investments held-to-maturity	—		(2,375)
Net increase in loans receivable	(787)		(26,822)
(Purchase) sale of FHLB stock	(55)		599
Purchase of premises and equipment	(1,657)		(1,581)

Proceeds from BOLI death benefit settlement	1,086		—

Purchase of BOLI	(2,155)		(70)

Net cash used by investing activities	(55,830)		(18,226)

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Nine Months Ended September 30,
	2021		2020
Cash flows from financing activities:
Net increase in deposits	$	48,103	$	36,148
Advances from the FHLB	—		248,000
Repayments of advances from the FHLB	—		(265,700)
Proceeds from stock options exercises	64		—
Net share settlement of stock awards	(38)		(73)
Repurchase and retirement of common stock	(4,751)		(3,886)
Dividends paid	(3,108)		(2,931)
Net cash provided by financing activities	40,270		11,558

Net (decrease) increase in cash and cash equivalents	(1,377)		3,124
Cash and cash equivalents at beginning of period	80,489		22,990
Cash and cash equivalents at end of period	$	79,112	$	26,114

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest paid	$	7,094	$	12,540
Federal income taxes paid	2,445		1,190




Noncash items:

Change in unrealized (loss) gain on investments available-for-sale	$	(1,192)	$	1,945
Change in unrealized gain (loss) on cash flow hedge	3,337		(4,264)

Initial recognition of ROU	758		2,116
Initial recognition of lease liability	758		2,116

See accompanying selected notes to consolidated financial statements.

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 September 30, 2021, First Financial Northwest Bank operated in fifteen locations in Washington with the headquarters and seven retail branch locations in King County, five retail branch locations in Snohomish County and two retail branches in Pierce County. The Bank’s primary market area consists of King, Snohomish, Pierce and Kitsap counties, Washington.

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 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, 2020, as filed with the SEC (“2020 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 nine months ended September 30, 2021, are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. 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.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 3 - Recently Issued Accounting Pronouncements

Recent Accounting Pronouncements Adopted in 2021

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12). This ASU simplifies the accounting for income taxes by removing (i) the exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or a gain from other items; (ii) the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment, and (iii) the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. The Company adopted this ASU in January 2021 with no material impact on its consolidated financial statements.

In October 2020, the FASB issued ASU 2020-08, “Receivables – Nonrefundable Fees and Other Costs” (“ASU 2020-08”). ASU 2020-08 clarifies that the Company should reevaluate whether a callable debt security is within the scope of paragraph 310-20-35-33 for each reporting period. The Company adopted this ASU in January 2021 with no material impact on its consolidated financial statements.

Recent Accounting Pronouncements

ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) as amended by ASU 2018-19, ASU 2019-04 and ASU 2019-05, was originally issued in June 2016. 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. This ASU is effective for smaller reporting companies, such as the Company, for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The Company is evaluating its current expected loss methodology on the 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 the ALLL or investment portfolio that is identified in this process will be reflected as a one-time adjustment in equity rather than earnings. ASU 2019-05 issued in April 2019 further provides that entities that have certain financial instruments measured at amortized cost that has credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of Topic 326. The fair value option applies to available-for-sale debt securities. This ASU is effective upon adoption of ASU 2016-13, and should be applied on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition as of the adoption date. The Company is in the process of compiling historical and industry data that will be used to calculate expected credit losses on the loan portfolio to ensure that it is fully compliant with the ASU at the adoption date and is evaluating the potential impact adoption of this ASU will have on its consolidated financial statements. The Company intends to adopt ASU 2016-13 in the first quarter of 2023, and as a result, the ALLL may increase. Until the evaluation is complete, however, the magnitude of the increase will not be known.

ASU No. 2021-06, Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946) issued in August 2021. This ASU outlines the changes in the presentation of information on the balance sheet due to SEC Regulation S-X. This rule was put into place to better identify various items and whether they should appear on the face of the balance sheet or the accompanying notes. The Company intends to adopt ASU 2021-06 in the fourth quarter of 2021 and does not expect the adoption to have a material impact on the Company’s consolidated financial statements.

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:


	September 30, 2021
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Mortgage-backed investments:
Fannie Mae	$	15,175	$	276	$	(64)	$	15,387
Freddie Mac	13,083		166		(322)		12,927
Ginnie Mae	25,744		210		(120)		25,834
Other	5,673		93		(16)		5,750
Municipal bonds	39,545		732		(454)		39,823
U.S. Government agencies	48,165		109		(366)		47,908
Corporate bonds	30,003		632		(203)		30,432
Total	$	177,388	$	2,218	$	(1,545)	$	178,061


	December 31, 2020
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Mortgage-backed investments:
Fannie Mae	$	12,797	$	491	$	—	$	13,288
Freddie Mac	4,116		200		—		4,316
Ginnie Mae	16,513		617		(3)		17,127
Other	10,691		100		(62)		10,729
Municipal bonds	16,483		963		—		17,446
U.S. Government agencies	41,084		88		(537)		40,635
Corporate bonds	24,001		221		(212)		24,010
Total	$	125,685	$	2,680	$	(814)	$	127,551

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:

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	September 30, 2021
	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	$	6,321	$	(64)	$	—	$	—	$	6,321	$	(64)
Freddie Mac	7,953		(322)		—		—		7,953		(322)
Ginnie Mae	15,753		(120)		—		—		15,753		(120)
Other	1,909		(16)		—		—		1,909		(16)
Municipal bonds	22,482		(454)		—		—		22,482		(454)
U.S. Government agencies	6,687		(20)		23,006		(346)		29,693		(366)
Corporate bonds	995		(5)		5,808		(198)		6,803		(203)
Total	$	62,100	$	(1,001)	$	28,814	$	(544)	$	90,914	$	(1,545)


	December 31, 2020
	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	$	—	$	—	$	—	$	—	$	—	$	—
Freddie Mac	—		—		—		—		—		—
Ginnie Mae	—		—		1,311		(3)		1,311		(3)
Other	—		—		5,942		(62)		5,942		(62)
Municipal bonds	—		—		—		—		—		—
U.S. Government agencies	1,716		(11)		30,991		(526)		32,707		(537)
Corporate bonds	—		—		5,794		(212)		5,794		(212)
Total	$	1,716	$	(11)	$	44,038	$	(803)	$	45,754	$	(814)

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. The Company had 49 securities and 20 securities in an unrealized loss position, respectively, with 13 and 18 of these securities in an unrealized loss position for 12 months or more, at both September 30, 2021, and December 31, 2020, respectively. Management does not believe that any individual unrealized loss as of September 30, 2021, or December 31, 2020, 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 September 30, 2021, and December 31, 2020, and determined that an OTTI charge was not warranted.

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The amortized cost and estimated fair value of investments available-for-sale at September 30, 2021, 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.


	September 30, 2021
	Amortized Cost		Fair Value
	(In thousands)
Due within one year	$	398	$	406
Due after one year through five years	8,546		8,605
Due after five years through ten years	26,713		27,145
Due after ten years	82,056		82,007
	117,713		118,163
Mortgage-backed investments	59,675		59,898
Total	$	177,388	$	178,061

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 $21.5 million and $23.4 million were pledged as collateral for public deposits at September 30, 2021, and December 31, 2020, respectively, both of which exceeded the collateral requirements established by the Washington Public Deposit Protection Commission.

For the three months ended September 30, 2021, there were no calls or sales of investment securities. For the nine months ended September 30, 2021, there were $10.0 million in calls or maturities on investment securities with no gain or loss generated. For the three months ended September 30, 2020, there were $2.5 million in sales or maturities on investment securities generating a net gain of $18,000. For the nine months ended September 30, 2020, there were $12.1 million in sales or maturities on investment securities generating a net gain of $86,000.

In January 2020, the Bank purchased three annuity contracts, totaling $2.4 million, to be held long-term to satisfy the benefit obligation associated with certain supplemental executive retirement plan agreements. At September 30, 2021, the annuities were reported as investments held-to-maturity at an amortized cost of $2.4 million on the Company’s Consolidated Balance Sheets. The amortized cost is considered the fair value of the investment.

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Note 5 - Loans Receivable

Loans receivable are disclosed net of loans in process (“LIP”) and are summarized as follows at the dates indicated:


	September 30, 2021		December 31, 2020
	(In thousands)
One-to-four family residential:
Permanent owner occupied	$	184,990	$	206,323
Permanent non-owner occupied	197,686		175,637
	382,676		381,960

Multifamily	143,806		136,694

Commercial real estate	392,356		385,265

Construction/land:
One-to-four family residential	36,213		33,396
Multifamily	47,549		51,215
Commercial	6,189		5,783
Land	11,337		1,813
	101,288		92,207

Business	54,748		80,663
Consumer	42,484		40,621
Total loans	1,117,358		1,117,410

Less:
Deferred loan fees, net	632		1,654
ALLL	15,057		15,174
Loans receivable, net	$	1,101,669	$	1,100,582

At September 30, 2021, loans totaling $543.4 million were pledged to secure borrowings from the FHLB compared to $720.8 million at December 31, 2020. In addition, loans totaling $139.8 million and $127.1 million were pledged to the Federal Reserve Bank of San Francisco to secure a line of credit at September 30, 2021 and December 31, 2020, respectively.

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:

•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 (grade 5), 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.

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•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.

The grades for watch and special mention loans 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. These are loans which have been criticized based upon known characteristics such as periodic payment delinquency, failure to comply with contractual terms of the loan 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.

As of September 30, 2021, and December 31, 2020, the Company had no loans rated as doubtful or loss. The following tables represent a summary of loans at September 30, 2021, and December 31, 2020 by type and risk category:


	September 30, 2021
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Risk Rating:
Pass, grade 1-4	$	380,824	$	141,470	$	328,622	$	99,036	$	54,748	$	42,223	$	1,046,923
Pass, grade 5 (watch)	917		2,336		31,602		2,252		—		34		37,141
Special mention	413		—		21,545		—		—		227		22,185
Substandard	522		—		10,587		—		—		—		11,109
Total loans	$	382,676	$	143,806	$	392,356	$	101,288	$	54,748	$	42,484	$	1,117,358


	December 31, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Risk Rating:
Pass, grade 1-4	$	376,918	$	132,243	$	316,955	$	89,957	$	80,208	$	40,477	$	1,036,758
Pass, grade 5 (watch)	3,914		2,347		52,375		2,250		455		144		61,485
Special mention	601		—		15,935		—		—		—		16,536
Substandard	527		2,104		—		—		—		—		2,631
Total loans	$	381,960	$	136,694	$	385,265	$	92,207	$	80,663	$	40,621	$	1,117,410

ALLL. When the Company classifies problem assets as either substandard or doubtful, pursuant to Federal regulations, or identifies a loan where it is uncertain if the Bank will be able to collect all amounts due according to the contractual terms of the loan, it may establish a specific reserve in an amount deemed prudent to address the risk specifically. 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

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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 allowances for loan losses.

At September 30, 2021, total loans receivable included $22.4 million of loans originated under the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). Although these loans were included in the population of loans collectively evaluated for impairment, no general reserve was allocated to them as these loans are 100% guaranteed by the SBA.

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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 September 30, 2021
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	2,992	$	1,377	$	5,914	$	2,385	$	1,133	$	1,077	$	14,878
Charge-offs	—		—		—		—		—		—		—
Recoveries	79		—		—		—		—		—		79
Provision (recapture)	99		9		127		(128)		(135)		128		100
Ending balance	$	3,170	$	1,386	$	6,041	$	2,257	$	998	$	1,205	$	15,057

	At or For the Nine Months Ended September 30, 2021
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,181	$	1,366	$	6,127	$	2,189	$	1,242	$	1,069	$	15,174
Charge-offs	—		—		—		—		—		—		—
Recoveries	183		—		—		—		—		—		183
(Recapture) provision	(194)		20		(86)		68		(244)		136		(300)
Ending balance	$	3,170	$	1,386	$	6,041	$	2,257	$	998	$	1,205	$	15,057

ALLL by category:
General reserve	$	3,148	$	1,386	$	6,041	$	2,257	$	998	$	1,205	$	15,035
Specific reserve	22		—		—		—		—		—		22

Loans:
Total loans	$	382,676	$	143,806	$	392,356	$	101,288	$	54,748	$	42,484	$	1,117,358
Loans collectively evaluated for impairment	380,268		143,806		366,640		101,288		54,748		42,484		1,089,234
Loans individually evaluated for impairment	2,408		—		25,716		—		—		—		28,124

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(Unaudited)


	At or For the Three Months Ended September 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,134	$	1,559	$	4,849	$	2,257	$	1,065	$	972	$	13,836
Charge-offs	—		—		—		—		—		—		—
Recoveries	2		—		30		—		—		—		32
Provision (recapture)	89		(165)		622		108		(21)		67		700
Ending balance	$	3,225	$	1,394	$	5,501	$	2,365	$	1,044	$	1,039	$	14,568

	At or For the Nine Months Ended September 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,034	$	1,607	$	4,559	$	2,222	$	1,140	$	656	$	13,218
Charge-offs	—		—		—		—		—		—		—
Recoveries	20		—		30		—		—		—		50
Provision (recapture)	171		(213)		912		143		(96)		383		1,300
Ending balance	$	3,225	$	1,394	$	5,501	$	2,365	$	1,044	$	1,039	$	14,568

ALLL by category:
General reserve	$	3,213	$	1,394	$	5,501	$	2,365	$	1,044	$	1,039	$	14,556
Specific reserve	12		—		—		—		—		—		12

Loans:
Total loans	$	391,871	$	142,619	$	389,768	$	99,598	$	85,780	$	40,845	$	1,150,481
Loans collectively evaluated for impairment	389,033		140,515		372,995		99,598		85,780		40,845		1,128,766
Loans individually evaluated for impairment	2,838		2,104		16,773		—		—		—		21,715

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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 September 30, 2021, there were two past due loans or 0.02% of total loans receivable, as compared to five past due loans or 0.24% of total loans receivable at December 31, 2020. The following tables represent a summary of the aging of loans by type at the dates indicated:


	Loans Past Due as of September 30, 2021
	30-59 Days		60-89 Days		90 Days and Greater		Total Past Due		Current		Total (1)
	(In thousands)
Real estate:
One-to-four family residential:
Owner occupied	$	—	$	—	$	—	$	—	$	184,990	$	184,990
Non-owner occupied	—		—		—		—		197,686		197,686
Multifamily	—		—		—		—		143,806		143,806
Commercial real estate	—		—		—		—		392,356		392,356
Construction/land	—				—		—		101,288		101,288
Total real estate	—		—		—		—		1,020,126		1,020,126
Business	—		—		—		—		54,748		54,748
Consumer	227		—		—		227		42,257		42,484
Total loans	$	227	$	—	$	—	$	227	$	1,117,131	$	1,117,358

________________

(1) There were no loans 90 days and greater past due and still accruing interest at September 30, 2021.


	Loans Past Due as of December 31, 2020
	30-59 Days		60-89 Days		90 Days and Greater		Total Past Due		Current		Total (1)
	(In thousands)
Real estate:
One-to-four family residential:
Owner occupied	$	77	$	—	$	—	$	77	$	206,246	$	206,323
Non-owner occupied	159		—		—		159		175,478		175,637
Multifamily	—		—		2,104		2,104		134,590		136,694
Commercial real estate	—		—		—		—		385,265		385,265
Construction/land	—		—		—		—		92,207		92,207
Total real estate	236		—		2,104		2,340		993,786		996,126
Business	275		—		—		275		80,388		80,663
Consumer	38		—		—		38		40,583		40,621
Total loans	$	549	$	—	$	2,104	$	2,653	$	1,114,757	$	1,117,410

_________________

(1) There were no loans 90 days and greater past due and still accruing interest at December 31, 2020.

Nonperforming Loans. When a loan becomes 90 days past due, the Bank generally places the loan on nonaccrual status. Loans may be placed on nonaccrual status prior to being 90 days past due if there is an identified problem that indicates the borrower is unable to meet their scheduled payment obligations. The following table is a summary of nonaccrual loans by loan type at the dates indicated:

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(Unaudited)


	September 30, 2021		December 31, 2020
	(In thousands)

Multifamily	$	—	$	2,104



Total nonaccrual loans	$	—	$	2,104

Nonaccrual loans at December 31, 2020, consisted of one $2.1 million multifamily loan that was in the foreclosure process at that date. Interest income that would have been recognized had the nonaccrual loan been performing in accordance with its original terms was $24,000 and $58,000 for the three and nine months ended September 30, 2020, respectively. In May 2021, subsequent to a payment during the first quarter of 2021, the $2.0 million balance of this nonaccrual multifamily loan paid off. Past interest income of $288,000 was collected and included in interest income for the nine months ending September 30, 2021.

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


	September 30, 2021
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Performing (1)	$	382,676	$	143,806	$	392,356	$	101,288	$	54,748	$	42,484	$	1,117,358
Nonperforming	—		—		—		—		—		—		—
Total loans	$	382,676	$	143,806	$	392,356	$	101,288	$	54,748	$	42,484	$	1,117,358

_____________

(1) There were $185.0 million of owner-occupied one-to-four family residential loans and $197.7 million of non-owner occupied one-to-four family residential loans classified as performing.


	December 31, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Performing (1)	$	381,960	$	134,590	$	385,265	$	92,207	$	80,663	$	40,621	$	1,115,306
Nonperforming	—		2,104		—		—		—		—		2,104
Total loans	$	381,960	$	136,694	$	385,265	$	92,207	$	80,663	$	40,621	$	1,117,410

_____________

(1) There were $206.3 million of owner-occupied one-to-four family residential loans and $175.6 million of non-owner occupied one-to-four family residential loans classified as performing.

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 or the borrower failing to comply with contractual terms of the loan. At September 30, 2021, and December 31, 2020, there were no commitments to advance funds related to impaired loans.

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(Unaudited)

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


	September 30, 2021
	Recorded Investment (1)		Unpaid Principal Balance (2)		Related Allowance
	(In thousands)
Loans with no related allowance:
One-to-four family residential:
Owner occupied	$	180	$	189	$	—
Non-owner occupied	922		922		—

Commercial real estate	25,716		25,716		—


Total	26,818		26,827		—

Loans with an allowance:
One-to-four family residential:
Owner occupied	496		543		21
Non-owner occupied	810		810		1




Total	1,306		1,353		22

Total impaired loans:
One-to-four family residential:
Owner occupied	676		732		21
Non-owner occupied	1,732		1,732		1

Commercial real estate	25,716		25,716		—


Total	$	28,124	$	28,180	$	22

_________________

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

(2) Contractual loan principal balance.

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	December 31, 2020
	Recorded Investment (1)		Unpaid Principal Balance (2)		Related Allowance
	(In thousands)
Loans with no related allowance:
One-to-four family residential:
Owner occupied	$	274	$	365	$	—
Non-owner occupied	1,031		1,031		—
Multifamily	2,104		2,104		—
Commercial real estate	16,669		16,669		—


Total	20,078		20,169		—

Loans with an allowance:
One-to-four family residential:
Owner occupied	502		549		6
Non-owner occupied	820		820		2




Total	1,322		1,369		8

Total impaired loans:
One-to-four family residential:
Owner occupied	776		914		6
Non-owner occupied	1,851		1,851		2
Multifamily	2,104		2,104		—
Commercial real estate	16,669		16,669		—


Total	$	21,400	$	21,538	$	8

_________________

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

(2) Contractual loan principal balance.

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(Unaudited)

The following table presents the average recorded investment in loans individually evaluated for impairment and the interest income recognized for the three and nine months ended September 30, 2021 and 2020:


	Three Months Ended September 30, 2021				Nine Months Ended September 30, 2021
	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	$	181	$	3	$	227	$	9
Non-owner occupied	926		16		955		47
Multifamily	—		—		1,035		—
Commercial real estate	26,356		192		21,485		662


Total	27,463		211		23,702		718

Loans with an allowance:
One-to-four family residential:
Owner occupied	497		7		499		24
Non-owner occupied	812		13		815		39




Total	1,309		20		1,314		63

Total impaired loans:
One-to-four family residential:
Owner occupied	678		10		726		33
Non-owner occupied	1,738		29		1,770		86
Multifamily	—		—		1,035		—
Commercial real estate	26,356		192		21,485		662


Total	$	28,772	$	231	$	25,016	$	781

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(Unaudited)


	Three Months Ended September 30, 2020				Nine Months Ended September 30, 2020
	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	$	381	$	2	$	407	$	15
Non-owner occupied	1,115		17		1,251		52
Multifamily	2,104		47		2,104		139
Commercial real estate	16,823		144		9,042		519
Construction/land	—		—		7,044		—

Total	20,423		210		19,848		725

Loans with an allowance:
One-to-four family residential:
Owner occupied	502		7		503		23
Non-owner occupied	964		15		1,303		45




Total	1,466		22		1,806		68

Total impaired loans:
One-to-four family residential:
Owner occupied	883		9		910		38
Non-owner occupied	2,079		32		2,554		97
Multifamily	2,104		47		2,104		139
Commercial real estate	16,823		144		9,042		519
Construction/land	—		—		7,044		—

Total	$	21,889	$	232	$	21,654	$	793

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Troubled Debt Restructurings. Certain loan modifications are accounted for as troubled debt restructured loans (“TDRs”). At September 30, 2021, the TDR portfolio totaled $2.4 million. At December 31, 2020, the TDR portfolio totaled $3.9 million. At both dates, all TDRs were performing according to their modified repayment terms.

At September 30, 2021, 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 and nine months ended September 30, 2021 and 2020.

The Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"), signed into law on March 27, 2020, provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. generally up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. To qualify as an eligible loan under the CARES Act, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency by the President or (B) January 1, 2022. At September 30, 2021, four loans totaling $20.1 million had payment deferrals granted under the CARES Act, with total deferral periods granted greater than six months. The $10.5 million loan relationship that was downgraded to substandard during the three months ended June 30, 2021, increased to $10.6 million at September 30, 2021, as a result of draws on an active line-of-credit. Two of these loans with an aggregate $6.6 million at September 30, 2021, secured by a hostel business, are still on deferral. This same relationship also has a $4.0 million loan secured by a facility housing bowling, roller skating and restaurant operations, whose deferral period expired as of September 30, 2021, and subsequently made a payment in October 2021. These three loans represent all of our substandard commercial real estate loans at September 30, 2021. The subsequent impairment analysis on these properties showed no anticipated loss on these loans.

The following table presents TDR modifications during the three and nine months ended September 30, 2021, and the recorded investment prior to and after the modification. There were no TDR modifications during the three and nine months ended September 30, 2020.


	Three Months Ended September 30, 2021					Nine Months Ended September 30, 2021
	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)					(Dollars in thousands)
One-to-four family residential

Advancement of maturity date	3	1,355		1,355		3	1,355		1,355
Commercial real estate:
Advancement of maturity date	—	$	—	$	—	1	$	1,241	$	1,241
Total	3	$	1,355	$	1,355	4	$	2,596	$	2,596

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 and nine months ended September 30, 2021, and September 30, 2020, 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:

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(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(In thousands)				(In thousands)
Balance at beginning of period	$	454	$	454	$	454	$	454


Net proceeds from sale of OREO	(247)		—		(247)		—
Loss on sale of OREO	(207)		—		(207)		—

Balance at end of period	$	—	$	454	$	—	$	454

For the three and nine months ended September 30, 2021, the two remaining OREO properties were sold for $247,000 with a loss of $207,000 included in OREO related expenses, net, on the Company’s Consolidated Income Statements. Prior to the sale, there were no market value adjustments taken on the properties in OREO. For three and nine months ended September 30, 2020 there were no OREO properties sold and no market value adjustments taken on the properties. At September 30, 2021, there were no one-to-four family residential loans for which formal foreclosure proceedings were in process.

Note 7 - Fair Value

The Company measures the fair value of financial instruments for reporting in accordance with Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements. Fair values of assets or liabilities are based on estimates of the exit price, which is the price that would be received to sell an asset or paid to transfer a liability. When available, observable market transactions or market information is used. The fair value estimate of loans receivable was based on similar techniques, with the addition of current origination spreads, liquidity premiums, or credit adjustments. The fair value of nonperforming loans is based on the underlying value of the collateral.

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

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

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

•Level 1 - Quoted prices for identical instruments in active markets.

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

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

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

•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.

•Impaired loans: The fair value of impaired loans is measured using the present value of expected future cash flows discounted at the loan’s effective interest rate. When the sole source of repayment of the loan is the operation or liquidation of the collateral, the fair value is determined using the observable market price less certain completion costs.

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

•Derivatives: The fair value of derivatives is based on pricing models utilizing observable market data and discounted cash flow methodologies for which the determination of fair value may require significant management judgment or estimation.

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The tables below present the balances of assets and liabilities measured at fair value on a recurring basis (there were no transfers between Level 1, Level 2 and Level 3 recurring measurements) at September 30, 2021 and December 31, 2020:


	Fair Value Measurements at September 30, 2021
	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	$	15,387	$	—	$	15,387	$	—
Freddie Mac	12,927		746		12,181		—
Ginnie Mae	25,834		—		25,834		—
Other	5,750		—		5,750		—
Municipal bonds	39,823		—		39,823		—
U.S. Government agencies	47,908		—		47,908		—
Corporate bonds	30,432		—		30,432		—
Total available-for-sale investments	178,061		746		177,315		—
Derivative fair value asset	511		—		511		—
Total	$	178,572	$	746	$	177,826	—


	Fair Value Measurements at December 31, 2020
	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)
Assets:
Investments available-for-sale:
Mortgage-backed investments:
Fannie Mae	$	13,288	$	—	$	13,288	$	—
Freddie Mac	4,316		—		4,316		—
Ginnie Mae	17,127		—		17,127		—
Other	10,729		—		10,729		—
Municipal bonds	17,446		—		17,446		—
U.S. Government agencies	40,635		—		40,635		—
Corporate bonds	24,010		—		24,010		—
Total available-for-sale investments	$	127,551	$	—	$	127,551	—

Liabilities:
Derivative fair value liability	$	2,825	$	—	$	2,825	$	—

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.

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(Unaudited)

The tables below present the balances of assets measured at fair value on a nonrecurring basis at September 30, 2021, and December 31, 2020:


	Fair Value Measurements at September 30, 2021
	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)	$	28,102	$	—	$	—	$	28,102
OREO	—		—		—		—
Total	$	28,102	$	—	$	—	$	28,102

_____________

(1) Total fair value of impaired loans is net of $22,000 of specific reserves on performing TDRs.


	Fair Value Measurements at December 31, 2020
	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)	$	21,392	$	—	$	—	$	21,392
OREO	454		—		—		454
Total	$	21,846	$	—	$	—	$	21,846

_____________

(1) Total fair value of impaired loans is net of $8,000 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.

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at September 30, 2021 and December 31, 2020:

September 30, 2021

Fair Value

Valuation Technique

Unobservable Input(s)

Range (Weighted Average)

(Dollars in thousands)

Impaired Loans

28,102

Market approach

Expected values of future cash flows

0.0%

(0.0%)

OREO

—

Market approach

Estimated selling price less selling costs

0.0%

(0.0%)

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(Unaudited)

December 31, 2020

Fair Value

Valuation Technique

Unobservable Input(s)

Range (Weighted Average)

(Dollars in thousands)

Impaired Loans

21,392

Market approach

Expected values of future cash flows

0.0%

(0.0%)

OREO

454

Market approach

Estimated selling price less selling costs

0.0%

(0.0%)

The carrying amounts and estimated fair values of financial instruments were as follows at the dates indicated:


	September 30, 2021
			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	$	7,243	$	7,243	$	7,243	$	—	$	—
Interest-earning deposits with banks	71,869		71,869		71,869		—		—
Investments available-for-sale	178,061		178,061		746		177,315		—
Investments held-to-maturity	2,425		2,425		—		2,425		—
Loans receivable, net	1,101,669		1,103,924		—		—		1,103,924
FHLB stock	6,465		6,465		—		6,465		—
Accrued interest receivable	5,681		5,681		—		5,681		—
Derivative fair value asset	511		511		—		511		—

Financial Liabilities:
Deposits	840,007		840,007		840,007		—		—
Certificates of deposit, retail	301,729		305,381		—		305,381		—

Advances from the FHLB	120,000		120,003		—		120,003		—
Accrued interest payable	206		206		—		206		—

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(Unaudited)


	December 31, 2020
			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	$	7,995	$	7,995	$	7,995	$	—	$	—
Interest-earning deposits with banks	72,494		72,494		72,494		—		—
Investments available-for-sale	127,551		127,551		—		127,551		—
Investments held-to-maturity	2,418		2,418		—		2,418		—
Loans receivable, net	1,100,582		1,101,559		—		—		1,101,559
FHLB stock	6,410		6,410		—		6,410		—
Accrued interest receivable	5,508		5,508		—		5,508		—


Financial Liabilities:
Deposits	684,057		684,057		684,057		—		—
Certificates of deposit, retail	409,576		418,118		—		418,118		—

Advances from the FHLB	120,000		120,006		—		120,006		—
Accrued interest payable	211		211		—		211		—
Derivative fair value liability	2,825		2,825		—		2,825		—

Note 8 - Leases

The Company follows ASC Topic 842, Leases, recognizing a ROU and related lease liabilities on the Company’s Consolidated Balance Sheets. At September 30, 2021, the Company had 13 operating leases for retail branch locations. The remaining lease terms range from 1.3 years to 9.3 years, with most leases carrying optional extensions of 3-5 years. The Company will include optional lease term extensions in the ROU 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 remaining term of the lease at the time of the lease inception, or at January 1, 2019, for leases in place at that date.

The minimum monthly lease payments are generally based on square footage of the leased premises, with escalating minimum rent over the lease term. At September 30, 2021, the Company was committed to paying $69,000 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 on the Company’s Consolidated Income Statements includes the amortized lease expense under ASC Topic 842, Leases, combined with variable lease expenses for maintenance or other expenses as defined in the individual lease agreements. The following table includes details on these items at and for the three and nine months ended September 30, 2021, and 2020.

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(Unaudited)


	September 30, 2021			September 30, 2020
	(dollars in thousands)
Lease expense, quarter-to-date	$	276		$	226
Lease expense, year-to-date	794			669
Right-of-use asset	3,838			3,834
Lease liability	3,994			3,942

Weighted average remaining term, years	6.4 years			4.3 years
Weighted average discount rate	1.91		%	2.13		%

The following table provides a reconciliation between the undiscounted minimum lease payments at September 30, 2021 and the discounted lease liability at that date:


	September 30, 2021
	(in thousands)
Due through one year	$	835
Due after one year through two years	769
Due after two years through three years	645
Due after three years through four years	557
Due after four years through five years	373
Due after five years	1,074
Total minimum lease payments	4,253
Less: present value discount	259
Lease liability	$	3,994

Note 9 - Derivatives

The Company uses derivative financial instruments, in particular, interest rate swaps, which qualify as cash flow hedges, to manage the risk of changes in future cash flows due to interest rate fluctuations. At September 30, 2021, the Company held six interest rate swap agreements with initial terms of four to eight years, and total notional amount of $120.0 million. In addition, at that date, the Company held two forward-starting interest rate swap agreements with terms of seven and eight years and a total notional amount of $25.0 million. Under the current agreements, the Company pays a weighted-average fixed interest rate of 1.22% monthly and in exchange receives variable rate amounts from the interest rate swap counter party based on one-month or three-month LIBOR, based on the swap agreement’s stated rate reset date. On the forward-starting agreements, the Company will pay a weighted average fixed rate of 0.80% and in exchange receives variable rate amounts from the interest rate swap counter party based on three-month LIBOR. Concurrent with each interest rate swap start dates, the Company secured fixed rate FHLB advances, for the notional amount of the swap, that mature and are renewed at one-month or three-month cycles based on the rate reset dates of the interest rate swap agreement. The Company pays or receives the net interest to the counter party amount monthly or quarterly, based on the respective hedge agreement, and includes this amount as part of its interest expense on the Company’s Consolidated Income Statement.

Quarterly, the effectiveness evaluation is based upon the fluctuation of the fixed rate interest the Company pays to the FHLB for the period compared to the one-month or three-month LIBOR interest received from the counterparty. At September 30, 2021, a $511,000 net fair value gain of the cash flow hedges was reported with other assets on the Company’s Consolidated Balance Sheet. The tax effected amount of $404,000 was included in accumulated other comprehensive income on the Company’s Consolidated Balance Sheet. There were no amounts recorded on the Consolidated Income Statements for the quarters ended September 30, 2021 or 2020, related to ineffectiveness.

Fair value for these derivative instruments, 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.

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(Unaudited)

The following table presents the fair value of these derivative instruments as of September 30, 2021 and December 31, 2020:


	Balance Sheet Location	Fair Value at September 30, 2021		Fair Value at December 31, 2020
	(In thousands)
Interest rate swaps on FHLB debt designated as a cash flow hedge	Other Assets/(Other Liabilities)	$	511	$	(2,825)

The following table presents the net unrealized gains and losses, net of tax, from these derivative instruments included on the Consolidated Statements of Comprehensive Income at the dates indicated:


	Amount Recognized in OCI for the three months ended September 30, 2021		Amount Recognized in OCI for the three months ended September 30, 2020		Amount Recognized in OCI for the nine months ended September 30, 2021		Amount Recognized in OCI for the nine months ended September 30, 2020
	(In thousands)
Interest rate swaps on FHLB debt designated as a cash flow hedge	$	437	$	271	$	2,636	$	(3,368)

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 September 30, 2021, there were 307,000 stock options from the 2008 Plan vested and available for exercise, subject to the 2008 Plan provisions. At September 30, 2021, there were 1,060,922 total shares available for grant under the 2016 Plan, including 230,461 shares available to be granted as restricted stock.

For the three months ended September 30, 2021 and 2020, total compensation expense for both the 2008 Plan and 2016 Plan was $315,000 and $224,000, respectively, and the related income tax benefit was $66,000 and $47,000, respectively.

For the nine months ended September 30, 2021 and 2020, total compensation expense for both the 2008 Plan and 2016 Plan was $558,000 and $367,000, respectively, and the related income tax benefit was $117,000 and $77,000, 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 five years, with 20% vesting on the anniversary date of each grant date, and a contractual life of ten 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

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(Unaudited)

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.

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 and nine months ended September 30, 2021, follows:


	For the Three Months Ended September 30, 2021
	Shares	Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value		Weighted-Average Grant Date Fair Value
Outstanding at July 1, 2021	309,000	$	10.33		$	1,473,070	$	3.68

Exercised	(2,000)	10.77			11,120		4.16


Outstanding at September 30, 2021	307,000	10.33		2.22	1,854,300		3.68
Vested and expected to vest assuming a 3% forfeiture rate over the vesting term	307,000	10.33		2.22	1,854,300		3.68
Exercisable at September 30, 2021	307,000	10.33		2.22	1,854,300		3.68


	For the Nine Months Ended September 30, 2021
	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, 2021	313,000	$	10.34		$	397,890	$	3.69

Exercised	(6,000)	$	10.77		23,500		$	4.16


Outstanding at September 30, 2021	307,000	10.33		2.22	1,854,300		3.68
Vested and expected to vest assuming a 3% forfeiture rate over the vesting term	307,000	10.33		2.22	1,854,300		3.68
Exercisable at September 30, 2021	307,000	10.33		2.22	1,854,300		3.68

As of September 30, 2021, there was no unrecognized compensation cost related to nonvested stock options. There were no stock options granted during the nine months ended September 30, 2021.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 and nine months ended September 30, 2021, follows:


	For the Three Months Ended September 30, 2021
	Shares	Weighted-Average Grant Date Fair Value
Nonvested at July 1, 2021	44,426	$	13.78
Granted	10,080	16.37
Vested	(10,080)	16.37


Nonvested at September 30, 2021	44,426	13.78
Expected to vest assuming a 3% forfeiture rate over the vesting term	43,093	13.78


	For the Nine Months Ended September 30, 2021
	Shares	Weighted-Average Grant Date Fair Value
Nonvested at January 1, 2021	16,228	$	13.61
Granted	55,673	14.25
Vested	(27,475)	14.63


Nonvested at September 30, 2021	44,426	13.78
Expected to vest assuming a 3% forfeiture rate over the vesting term	43,093	13.78

As of September 30, 2021, there was $259,000 of total unrecognized compensation costs related to nonvested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining five month vesting period.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 11 - Accumulated Other Comprehensive Income

The table below presents the changes in accumulated OCI after-tax for the three and nine months ended September 30, 2021 and 2020.


	Unrealized Gains and Losses on Available-for-Sale Securities		Gains and Losses on Cash Flow Hedges		Total
	(In thousands)
Balance June 30, 2020	$	(582)	$	(3,303)	$	(3,885)
Other comprehensive income before reclassifications	425		271		696
Amounts reclassified from accumulated other comprehensive income	(14)		—		(14)
Net other comprehensive income	411		271		682
Balance September 30, 2020	$	(171)	$	(3,032)	$	(3,203)

Balance December 31, 2019	$	(1,707)	$	336	$	(1,371)
Other comprehensive income (loss) before reclassifications	1,604		(3,368)		(1,764)
Amounts reclassified from accumulated other comprehensive income	(68)		—		(68)
Net other comprehensive income (loss)	1,536		(3,368)		(1,832)
Balance September 30, 2020	$	(171)	$	(3,032)	$	(3,203)

Balance June 30, 2021	$	(26)	$	(33)	$	(59)
Other comprehensive (loss) income before reclassifications	(601)		437		(164)

Net other comprehensive (loss) income	(601)		437		(164)
Balance September 30, 2021	$	(627)	$	404	$	(223)

Balance December 31, 2020	$	314	$	(2,232)	$	(1,918)
Other comprehensive (loss) income before reclassifications	(941)		2,636		1,695

Net other comprehensive (loss) income	(941)		2,636		1,695
Balance September 30, 2021	$	(627)	$	404	$	(223)

Note 12 - 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. Certain of the Company’s nonvested restricted stock awards qualify as participating securities.

Net income is allocated between the common stock and participating securities pursuant to the two-class method, based on their rights to receive dividends, participate in earnings, or absorb losses. Basic earnings per common shares is computed by dividing net earnings 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:

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
	(Dollars in thousands, except share data)
Net income	$	3,199	$	2,082	$	9,507	$	5,910
Less: Earnings allocated to participating securities	(15)		(3)		(43)		(9)
Earnings allocated to common shareholders	$	3,184	$	2,079	$	9,464	$	5,901

Basic weighted average common shares outstanding	9,314,456		9,661,498		9,412,196		9,788,397
Dilutive stock options	109,453		10,988		89,108		20,755
Dilutive restricted stock grants	22,793		3,081		12,861		2,450
Diluted weighted average common shares outstanding	9,446,702		9,675,567		9,514,165		9,811,602

Basic earnings per share	$	0.34	$	0.22	$	1.01	$	0.60
Diluted earnings per share	$	0.34	$	0.21	$	0.99	$	0.60

Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For the three and nine months ended September 30, 2021, there were 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. For the three and nine months ended September 30, 2020, there were 228,000 and 203,000 options to purchase shares of common stock, respectively, omitted from the computation because their effect would be anti-dilutive.

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 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 and nine months ended September 30, 2021 and 2020:

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


	Three Months Ended				Nine Months Ended
	September 30, 2021		September 30, 2020		September 30, 2021		September 30, 2020
	(In thousands)
Gain on sale of investments (1)	$	—	$	18	$	—	$	86
BOLI income (1)	377		269		891		778
Wealth management revenue	64		145		391		493
Deposit related fees	75		76		221		222
Debit card and ATM fees	153		125		433		338
Loan related fees	300		376		714		846
Loan interest rate swap fees	—		—		—		19
Other	30		2		86		7
Total noninterest income	$	999	$	1,011	$	2,736	$	2,789

_______________

(1) Not within scope of Topic 606

For the three and nine months ended September 30, 2021 and 2020, 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. Fees are also earned on the prepayment of certain loans, and are recognized at the time the loan is paid off.

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.

Contract Balances

At September 30, 2021, 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.

Note 14 - Subsequent Events

Between November 3, 2021, and November 8, 2021, the Company repurchased 132,942 shares of common stock and completed a trade for 120,000 shares scheduled to settle on November 10, 2021, under the current stock repurchase plan that expires on February 15, 2022. These repurchases bring the total shares repurchased under this plan to 297,284 as of November 10, 2021, at an average price of $16.74 per share, leaving 178,716 shares available for repurchase.

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 effect of the COVID-19 pandemic, including on our credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate customers, including economic activity, employment levels and market liquidity;

•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;

•uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks;

•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 (“FRB”) 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 a 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 issues and details of the implementation of new accounting methods; including as a result of the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") and the Consolidated Appropriations Act, 2021 (“CAA, 2021”);

•the economic impact of war or any terrorist activities; and

•other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services, including as a result of the CARES Act, the CAA, 2021 and recent COVID-19 vaccination efforts, and other risks detailed in our Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K”) and our other filings with the U.S. Securities and Exchange Commission (“SEC”).

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.

As used throughout this report, the terms “Company”, “we”, “our”, or “us” refer to First Financial Northwest, Inc. and its consolidated subsidiaries, including First Financial Northwest Bank and First Financial Diversified Corporation.

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 seven retail branches in King County, Washington, five retail branches in Snohomish County, Washington, and two retail branches in Pierce County, Washington.

The Bank’s business consists predominantly of attracting deposits from the general public, combined with borrowing from the FHLB and raising funds in the wholesale market (including brokered deposits), then utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land, business, and consumer 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 12 to 24 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 and consumer 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 43 other states and the District of Columbia, with the largest concentrations at September 30, 2021, in California, Oregon, Texas, Florida and Alabama of $38.5 million, $12.1 million, $10.6 million, $8.7 million and $8.1 million, respectively.

The Bank’s strategic initiatives seek to diversify our loan portfolio and broaden growth opportunities with our current risk tolerance levels and asset/liability objectives. The Bank has created an SBA department, and has affiliated with an SBA partner to process our SBA loans while the Bank retains the credit decisions. This enables us to be active in lending to small businesses until our volumes are high enough to support the investment in necessary infrastructure. When volumes support our becoming an SBA preferred lender, we will apply for that status which would provide the Bank with delegated loan approval as well as closing and most servicing and liquidation authority, enabling the Bank to make loan decisions more rapidly. In addition, the Bank plans to increase originations of the business loan portfolio, which may include business lines of credit, business term loans or equipment financing. In conjunction with the growth of business loans, the Bank seeks to service these customers with their business deposits as well.

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 currently asset-sensitive, meaning our interest-earning assets reprice at a faster rate than our interest-bearing liabilities. The Bank had a modest improvement in the net interest margin over the last year. The cost of funds has declined substantially due to the higher levels of noninterest-bearing deposits, the repricing of retail certificates of deposit at much lower market rates, and the payoff of all brokered certificates of deposit. During the quarter ended September 30, 2021, loan yields increased slightly, compared to the same quarter last year, primarily as a result of recognition of unamortized deferred fee income on Paycheck Protection Program (“PPP”) loans forgiven and repaid by the SBA. The Company expects the ongoing low interest rate environment to continue to put downward pressure on loan yields and the yields on other floating rate interest earning assets as well. Further, because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, until the pandemic subsides, the Company expects its net interest income and net interest margin may be adversely affected in the near term, if not longer.

An offset to net interest income is the provision for loan losses which is required to establish the 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 after the provision. 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 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.

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.

COVID-19 Related Information

In response to the COVID-19 pandemic, the Bank is committed to providing assistance to its customers. Under the CARES Act, the Bank provided certain loan modifications. In addition, the Bank participated in the PPP as a lender. Some of the PPP loans we originated were for our existing customers, however we also provided PPP loans to those in our community who have not had a banking relationship with us in the past. The initial deadline for PPP loan applications to the SBA was August 8, 2020. Under this program, we funded 462 applications totaling $52.1 million of loans in our market areas and began processing applications for loan forgiveness in the fourth quarter of 2020. The CAA, 2021 renewed and extended the PPP, which ended on May 31, 2021. Under the second round of PPP funding, the Bank originated 261 PPP loans with an aggregate balance of $25.6 million. As of September 30, 2021, there were 198 PPP loans outstanding totaling $22.4 million as compared

to 372 PPP loans totaling $41.3 million at December 31, 2020. The SBA released a simplified forgiveness process for PPP loans of $150,000 or less. At September 30, 2021, 149 PPP loans have an outstanding balance of $150,000 or less, totaling $7.3 million, or 32.7% of PPP loans outstanding. Of these PPP loans, 93 loans totaling $2.0 million, or 9.1% of outstanding PPP loans, have a balance of $50,000 or less.

The CARES Act and related bank regulatory guidance provided that short-term modifications of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term modifications (e.g. generally up to 6 months) such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. To qualify as an eligible loan under the CARES Act, as amended by the CAA, 2021, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency by the President or (B) January 1, 2022. The primary method of relief granted by the Company is to allow the borrower to defer their loan payments for three to six months. Certain borrowers are allowed to pay interest only or have payment deferrals for periods longer than six months depending upon their specific circumstances. Deferred principal and interest amounts are added as a balloon payment due at the original maturity date or payoff of the loan.

As of September 30, 2021, total loans with modifications granted under the CARES Act were $20.1 million, or 1.8% of total loans outstanding, a decrease from $45.2 million, or 4.0% of total loans outstanding at December 31, 2020. At September 30, 2021, $96.6 million of total loans receivable that previously received a loan modification had resumed making normal scheduled loan payments. As of September 30, 2021, all $20.1 million of loans in deferral had been granted modifications of greater than six months. The $10.5 million of loans downgraded to substandard during the three months ended June 30, 2021, increased to $10.6 million at September 30, 2021, as a result of draws on an active line-of-credit. Two of these loans with an aggregate $6.6 million at September 30, 2021, secured by a hostel business, are still on deferral, and represent the balance of hotel/motel loans on deferral at that date. This same relationship also has a $4.0 million loan secured by a facility housing bowling, roller skating and restaurant operations, whose deferral period expired as of September 30, 2021, and subsequently made a payment in October 2021. The impairment analysis on these properties showed no anticipated loss on these loans.

The following table shows the current balance of loans in a COVID-19 pandemic relief modification in accordance with the CARES Act:


	As of September 30, 2021
	Balance of loans deferred more than 6 months		Total deferrals		Total loans September 30, 2021		% of loans on deferral as of September 30, 2021
	(Dollars in thousands)
One-to-four family residential	$	—	$	—	$	382,676	—	%
Multifamily	—		—		143,806		—
Commercial real estate:
Office	7,153		7,153		89,622		8.0
Retail	—		—		124,439		—
Mobile home park	—		—		20,838		—
Hotel/motel	6,614		6,614		65,210		10.1
Nursing home	6,368		6,368		12,784		49.8
Warehouse	—		—		16,999		—
Storage	—		—		33,163		—
Other non-residential	—		—		29,301		—
Total Commercial real estate	20,135		20,135		392,356		5.1
Construction/land	—		—		101,288		—
Business:
Aircraft	—		—		6,322		—
SBA	—		—		862		—
PPP	—		—		22,379		—
Other business	—		—		25,185		—
Total business	—		—		54,748		—
Consumer:
Classic/collectible auto	—		—		32,803		—
Other consumer	—		—		9,681		—
Total consumer	—		—		42,484		—
Total loans with COVID-19 pandemic modifications	$	20,135	$	20,135	$	1,117,358	1.8	%

Prior to their modifications, the loans included in the above table were current on their loan payments. The Bank is monitoring its loan portfolio for delinquencies of loans that have not requested modifications under the CARES Act.

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 2020 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 2020 Form 10-K.

Comparison of Financial Condition at September 30, 2021 and December 31, 2020

Total assets were $1.44 billion at September 30, 2021, an increase of 3.8%, from $1.39 billion at December 31, 2020. The following table details the $52.5 million net change in the composition of our assets at September 30, 2021 from December 31, 2020.


	Balance at September 30, 2021		Balance at December 31, 2020		Change from December 31, 2020		Percent Change
	(Dollars in thousands)
Cash on hand and in banks	$	7,243	$	7,995	$	(752)	(9.4)	%
Interest-earning deposits with banks	71,869		72,494		(625)		(0.9)
Investments available-for-sale, at fair value	178,061		127,551		50,510		39.6
Investment held-to-maturity	2,425		2,418		7		0.3
Loans receivable, net	1,101,669		1,100,582		1,087		0.1
FHLB stock, at cost	6,465		6,410		55		0.9
Accrued interest receivable	5,681		5,508		173		3.1
Deferred tax assets, net	746		1,641		(895)		(54.5)
OREO	—		454		(454)		(100.0)
Premises and equipment, net	22,628		22,579		49		0.2
BOLI	34,994		33,034		1,960		5.9
Prepaid expenses and other assets	2,975		1,643		1,332		81.1
ROU, net	3,838		3,647		191		5.2
Goodwill	889		889		—		—
Core deposit intangible, net	719		824		(105)		(12.7)
Total assets	$	1,440,202	$	1,387,669	$	52,533	3.8	%

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”), remained relatively stable, decreasing by $625,000 during the nine months ended September 30, 2021.

Investments available-for-sale. Our investments available-for-sale portfolio increased by $50.5 million during the nine months ended September 30, 2021. During this period, the Bank invested excess liquidity into higher yielding assets by purchasing 39 available-for sale investment securities that included $34.3 million of fixed rate securities and $38.1 million of variable rate securities. The purchases included $28.7 million in mortgage-backed securities, $21.1 million of municipal bonds and $12.7 million of U.S. Government agency securities. In addition, $10.0 million of subordinated debt corporate bonds were purchased during the nine months ended September 30, 2021. These purchases have an expected weighted average yield of 1.41%. During the nine months ended September 30, 2021, $4.0 million of investments were called or paid-off early and $6.0 million of investments matured.

The effective duration of the investments available-for-sale at September 30, 2021, was 3.69% as compared to 2.55% at December 31, 2020. Effective duration measures the anticipated percentage change in the value of 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 $1.1 million during the nine months ended September 30, 2021. primarily due to a $1.0 million decrease in net deferred loan fees and a $117,000 decrease in the ALLL that offset total loans.

Total loans receivable remained stable with a decrease of $52,000 during the nine months ended September 30, 2021, as payoffs and forgiveness of PPP loans contributed to a $25.9 million decrease in business loans. Mostly offsetting this decrease, construction/land loans increased $9.1 million, multifamily and commercial real estate loans each increased $7.1 million, and consumer loans increased $1.9 million. One-to-four family loans remained stable with a $716,000 increase.

At September 30, 2021 and December 31, 2020, the Bank’s construction/land loans totaled 67.1% and 61.6% of total capital, respectively, and total non-owner occupied commercial real estate was 389.6% and 390.1% of total capital, respectively. The Bank has set aggregate concentration guidelines that total commercial real estate, including residential, non-residential, and construction/land loans, 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.

The following table presents a breakdown of our multifamily, commercial and construction loans by collateral type at September 30, 2021 and December 31, 2020. Total commercial real estate loans and construction/land loans are net of $172,000 and $52.2 million of LIP, respectively, at September 30, 2021, as compared to no commercial LIP and construction/land loans net of $59.8 million of LIP at December 31, 2020.


	September 30, 2021		December 31, 2020
	(In thousands)
Multifamily residential:
Micro-unit apartments	$	8,220	$	11,366
Other multifamily	135,586		125,328
Total multifamily residential	143,806		136,694

Non-residential:
Office	89,622		84,311
Retail	124,439		114,117
Mobile home park	20,838		28,094
Hotel / motel	65,210		69,304
Nursing home	12,784		12,868
Warehouse	16,999		17,484
Storage	33,163		33,671
Other non-residential	29,301		25,416
Total non-residential	392,356		385,265

Construction/land:
One-to-four family residential	36,213		33,396
Multifamily	47,549		51,215
Commercial	6,189		5,783
Land	11,337		1,813
Total construction/land	101,288		92,207
Total multifamily residential, non-residential and construction/land loans	$	637,450	$	614,166

Included in total construction/land loans at September 30, 2021, are $47.5 million of multifamily loans and $6.2 million of commercial real estate 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, 2020, construction/land loans included $51.2 million of multifamily loans and $5.8 million of commercial real estate 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 and risk guidelines. During the nine months ended September 30, 2021, the Bank purchased $48.5 million of loans and loan participations to borrowers located in Washington and other states, including $24.4 million of commercial real estate loans and $14.3 million of consumer loans secured by classic/collectible automobiles.

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 September 30, 2021, total loans secured by collateral located in California represented 3.4% of our total loans, and total loans secured by collateral located outside the states of California and Washington represented 9.5% of our total loans. The following table details geographic concentrations in our loan portfolio:


	At September 30, 2021
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/Land		Business		Consumer		Total
	(In thousands)
King County	$	287,247	$	76,783	$	223,556	$	98,210	$	33,601	$	9,614	$	729,011
Pierce County	36,850		13,062		25,312		—		1,419		351		76,994
Snohomish County	31,175		8,539		14,034		826		12,386		791		67,751
Kitsap County	5,768		5		292		2,252		209		—		8,526
Other Washington Counties	17,448		30,031		41,915		—		800		123		90,317
California	2,575		9,732		18,944		—		445		6,772		38,468
Outside Washington and California (1)	1,613		5,654		68,303		—		5,888		24,833		106,291
Total loans	$	382,676	$	143,806	$	392,356	$	101,288	$	54,748	$	42,484	$	1,117,358

_______________

(1) Includes loans in Oregon, Texas, Florida and Alabama of $12.1 million, $10.6 million, $8.7 million and $8.1 million, respectively, and loans in 38 other states and the District of Columbia.

The ALLL decreased to $15.1 million at September 30, 2021, from $15.2 million at December 31, 2020, and represented 1.35% and 1.36% of total loans receivable at September 30, 2021, and December 31, 2020, respectively. The ALLL consists of two components, the general allowance and the specific reserves. The ALLL general allowance decreased as a primary result of the improved economic outlook and the expanding availability of the COVID-19 vaccine, as the expected economic impact of the COVID-19 pandemic to the credit quality of our loan portfolio has diminished this year. In addition, loans made to a single lending relationship with a balance of $10.6 million at September 30, 2021, secured by a bowling, roller skating, and restaurant location, and a separate hostel business, were moved to impaired status, resulting in these loans being evaluated for specific reserves and omitted from the general reserve calculation. Our individual evaluation of these loans indicated no additional specific reserve was needed. These reductions to the general allowance were partially offset by the downgrade to special mention of $6.5 million in loans secured by medical rehabilitation facilities and an increase in construction/land loans. Loans evaluated for specific reserves increased by $6.7 million, as a result of the $10.6 million of loans mentioned above, partially offset by payoffs and pay downs of impaired loans. The $22.4 million balance of PPP loans was

omitted from the ALLL calculation at September 30, 2021, as these loans are fully guaranteed by the SBA. Management expects that the great majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reimburse the Bank for the amount forgiven.

At September 30, 2021, total specific reserves increased by $14,000 since December 31, 2020 as a result of the extension of maturity on an existing TDR. For additional information, see “Comparison of Operating Results for the Nine Months Ended September 30, 2021, and 2020 - Provision for Loan Losses” discussed below.

We believe that the ALLL at September 30, 2021, 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. Uncertainties relating to our ALLL are heightened as a result of the risks surrounding the COVID-19 pandemic as described in further detail in Part 1, Item 1A of our 2020 Form 10-K.

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 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. As discussed above, loans modified in accordance with the CARES Act and related bank regulatory guidance are not considered TDRs.

The following table presents a breakdown of our TDRs at the dates indicated, all of which were performing and on accrual status:


	September 30, 2021			December 31, 2020			Nine Month Change
	(Dollars in thousands)








Performing TDRs:
One-to-four family residential	$	2,408		$	2,627		$	(219)

Commercial real estate	—			1,242			(1,242)



Total TDRs	$	2,408		$	3,869		$	(1,461)
% TDRs classified as performing	100.0		%	100.0		%

Our TDRs decreased $1.5 million at September 30, 2021, compared to December 31, 2020 partially as a result of principal repayments. In addition, a $1.2 million TDR secured by a commercial property located in King County was refinanced at market rate and terms and, therefore, is no longer classified as a TDR. At September 30, 2021, there were no committed but undisbursed funds in connection with our TDRs. The largest TDR relationship at September 30, 2021, totaled $922,000 and was secured by a 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 September 30, 2021, total past due loans were $227,000, representing 0.02% of total loans receivable, and at December 31, 2020, were $2.7 million, representing 0.24% of total loans receivable.

Nonperforming assets decreased to none during the nine months ended September 30, 2021 as a result of the payoffs of the nonaccrual loan and sale of the OREO properties. The following table presents detailed information on our nonperforming assets at the dates indicated:


	September 30, 2021			December 31, 2020			Nine Month Change
	(Dollars in thousands)
Nonaccrual loans:

Multifamily	$	—		$	2,104		$	(2,104)



Total nonaccrual loans	—			2,104			(2,104)

OREO	—			454			(454)
Total nonperforming assets (1)	$	—		$	2,558		$	(2,558)
Nonperforming assets as a percent of total assets	—		%	0.18		%

____________

(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 September 30, 2021.

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. There were no nonaccrual loans at September 30, 2021, as the $2.0 million remaining nonaccrual loan paid off in May 2021. No loss was incurred on the payoff of this loan.

We continue to focus our efforts on working with borrowers to bring their past due loans current. By taking ownership of the underlying collateral if needed, we can generally convert non-earning 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 elimination of our nonperforming assets at September 30, 2021. At December 31, 2020, the ratio of nonperforming assets as a percent of total assets was 0.18%.

OREO. OREO includes properties acquired by the Bank through foreclosure or acceptance of a deed in lieu of foreclosure. During the third quarter of 2021, our remaining two OREO properties were sold. The sale of these properties, previously carried at a balance of $454,000 at December 31, 2020, resulted in recognition of a $207,000 loss.

Intangible assets. The balance of goodwill was $889,000 at both September 30, 2021 and December 31, 2020. 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 demand, interest-bearing demand, savings, and money market accounts. The CDI balance was $719,000 at September 30, 2021 and $824,000 at December 31, 2020. The initial ratio of CDI to the acquired balances of core deposits was 2.23%. The CDI amortizes into noninterest expense on an accelerated basis over ten years.

Deposits. During the first nine months of 2021, deposits increased $48.1 million to $1.14 billion at September 30, 2021, compared to $1.09 billion at December 31, 2020. Deposit accounts consisted of the following:


	Balance at September 30, 2021		Balance at December 31, 2020		Change from December 31, 2020		Percent Change
	(Dollars in thousands)
Noninterest-bearing demand	$	115,311	$	91,285	$	24,026	26.3	%
Interest-bearing demand	104,761		108,182		(3,421)		(3.2)
Statement savings	23,024		19,221		3,803		19.8
Money market	596,911		465,369		131,542		28.3
Certificates of deposit, retail	301,729		409,576		(107,847)		(26.3)

	$	1,141,736	$	1,093,633	$	48,103	4.4

Money market accounts increased by $131.5 million as many depositors moved out of maturing certificates of deposit and into money market accounts. In addition, noninterest-bearing demand accounts and statement savings increased by $24.0 million and $3.8 million, respectively. Partially offsetting these increases, retail certificates of deposit decreased $107.8 million as management elected to utilize liquidity gained from lower cost deposits to reduce its balances of higher cost certificates of deposit in a managed reduction of these funds. In addition, interest-bearing demand deposits decreased $3.4 million.

At September 30, 2021 and December 31, 2020, we held $55.4 million and $59.2 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, to leverage our balance sheet and to supplement our deposits. Total FHLB advances were $120.0 million at both September 30, 2021, and December 31, 2020. At September 30, 2021, the Bank’s advances included $60.0 million of fixed-rate three-month advances that renew quarterly, and $60.0 million of fixed-rate one-month advances that renew monthly, all of which are utilized in cash flow hedge agreements, as described below. At September 30, 2021, all of our FHLB advances were due to reprice in less than two months. At that date, there were no FHLB Fed Funds short-term borrowings.

Cash Flow Hedge. To assist in our interest rate risk management efforts, the Bank has entered into multiple interest rate swap agreements with qualified institutions. Each interest rate swap agreement qualifies as a cash flow hedge of the variability of future interest payments attributable to the changes in one-month or three-month LIBOR rates. The objective of the cash flow hedge is to offset the variability of cash flows due to the rollover of the Bank’s FHLB, or other fixed rate advances, for one-month or three-months, respectively, for the term of the agreement. The agreements allow for a substitute index to be used if LIBOR is unavailable.

The following table presents details of the Bank’s interest rate swap agreements as of September 30, 2021. For each interest rate swap agreement listed, the Bank has secured a fixed-rate FHLB advance for the notional amount that reprices at the same frequency as the corresponding interest-rate swap. The Bank pays a fixed interest rate to the counterparty and in return, receives a floating interest rate based on the index noted in the below table. The original term of these interest rate swap agreements range from four to eight years.

Notional amount

Start Date

Maturity Date

Fixed rate paid to counterparty

Index rate received from counterparty

Repricing Frequency

(Dollars in thousands)

50,000

10/25/2016

10/25/2021

1.340

3-month LIBOR

quarterly

15,000

9/27/2019

9/27/2024

1.440

1-month LIBOR

monthly

10,000

11/20/2019

11/20/2023

1.585

3-month LIBOR

quarterly

15,000

3/2/2020

3/2/2026

0.911

1-month LIBOR

monthly

15,000

3/2/2020

3/2/2027

0.937

1-month LIBOR

monthly

15,000

3/2/2020

3/2/2028

0.984

1-month LIBOR

monthly

15,000

10/25/2021

10/25/2028

0.793

3-month LIBOR

quarterly

10,000

10/25/2021

10/25/2029

0.800

3-month LIBOR

quarterly

Interest rate swap agreements in the above table with start dates in 2021 are forward-starting contracts. The Bank secured two fixed-rate FHLB advances on October 25, 2021 for $15.0 million and $10.0 million, which will be renewed quarterly. These forward-starting contracts partially replaced the $50.0 million notional interest rate swap that matured on October 25, 2021. At that date, the Bank repaid the remaining $25.0 million to the FHLB, resulting in $95.0 million in outstanding advances.

A change in the net fair value of these cash flow hedges 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 September 30, 2021 our cash flow hedges were in a fair value gain position with $511,000 recognized in other assets. At December 31, 2020, our cash flow hedges were in a fair value loss position and a $2.8 million net fair value liability was recognized in other liabilities.

Stockholders’ Equity. Total stockholders’ equity increased $5.2 million during the first nine months of 2021, to $161.5 million at September 30, 2021, from $156.3 million at December 31, 2020. Increases to stockholders’ equity included $9.5 million net income, $1.8 million from stock-based compensation and $1.7 million in other comprehensive income, net of tax, as a result of improved market values of our derivatives partially offset by a decline in the fair value of our investments available-for-sale. Partially offsetting these increases, stockholders’ equity decreased by $4.8 million from the repurchase of 312,628 shares of common stock and $3.1 million in cash dividends paid. As part of the strategy to increase shareholder value, the Company’s Board of Directors authorized a stock repurchase plan that began on February 1, 2021, for the repurchase of up to 486,000 shares of the Company’s stock. At this repurchase plan’s expiration on August 13, 2021, the Company had repurchased 268,286 shares at an average price of $14.97 per share. In addition, the Board of Directors authorized a stock repurchase plan that began on August 16, 2021, which expires on February 15, 2022. This plan authorizes the repurchase of up to 476,000 shares. At September 30, 2021, the Company had repurchased 44,342 shares under this repurchase plan at an average price of $16.32 per share. At that date, 431,658 shares were available for purchase under this repurchase plan.

The following table shows cash dividends paid per share and the related dividend payout ratio for the periods indicated:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2021			2020			2021			2020

Dividend declared per common share	$	0.11		$	0.10		$	0.33		$	0.30
Dividend payout ratio (1)	32.4		%	45.5		%	32.7		%	50.0		%

______________

(1) Dividends paid per common share divided by basic earnings per common share.

Comparison of Operating Results for the Three Months Ended September 30, 2021 and 2020

General. Net income for the three months ended September 30, 2021, was $3.2 million, or $0.34 per diluted share compared to $2.1 million, or $0.21 per diluted share for the three months ended September 30, 2020. The $1.1 million increase in net income during the three months ended September 30, 2021, was primarily a result of the $1.6 million decrease in interest expense that more than offset a $260,000 decrease in interest income. In addition, a $100,000 provision for loan losses was recognized for the three months ended September 30, 2021, as compared to a $700,000 provision for loan losses for the three months ended September 30, 2020.

Net Interest Income. Net interest income for the three months ended September 30, 2021, increased $1.3 million to $11.4 million from $10.1 million for the three months ended September 30, 2020, due to the decrease in interest expense outpacing the decrease in interest income.

Interest income decreased by $260,000 for the three months ended September 30, 2021, as compared to the same period in 2020, primarily as a combined result of a decrease in average loans receivable and decrease in yield on available-for-sale investments. Loan interest income decreased $339,000 for the three months ended September 30, 2021, as compared to the same period in 2020, primarily due to a $43.6 million decrease in the average balance of net loans receivable. Partially offsetting this decrease, the average yield increased slightly to 4.54% for the three months ended September 30, 2021, from 4.49% for the three months ended September 30, 2020.

Interest income from investments available-for-sale increased $63,000, primarily due to a $56.0 million increase in the average balance of available-for-sale investments as excess cash liquidity earning a nominal yield was invested into this higher earning asset. Partially offsetting this increase, the average yield on these investments decreased to 1.75% for the three months ended September 30, 2021, as compared to 2.32% for the three months ended September 30, 2020.

Interest income from interest-earning deposits remained steady with a $16,000 increase for the three months ended September 30, 2021, as compared to the three months ended September 30, 2020. During these comparative periods, the average yield increased nominally to 0.14% for the three months ended September 30, 2021, from 0.10% for the three months ended September 30, 2020. In addition, an increase in customer deposits outpaced the growth in other interest-earning assets, resulting in a $35.9 million increase in the average balance of interest-earning deposits for the three months ended September 30, 2021, as compared to the same period in 2020.

The decrease in interest income was more than offset by a $1.6 million decrease in deposit interest expense for the three months ended September 30, 2021, as compared to the three months ended September 30, 2020. The average rate paid on interest-bearing deposits decreased to 0.63% for the three months ended September 30, 2021, as compared to 1.27% for the three months ended September 30, 2020. The decrease in our cost of funds was a combined result of the declining interest rate environment and an increase in lower-cost deposits. Growth in our branch network allowed us to redeem our higher cost brokered deposits last year, resulting in a $16,000 decrease in interest expense for brokered certificates of deposit to none for the three months ended September 30, 2021. Our cost of funds was also impacted favorably by a 35 basis point decrease in the cost of money market accounts for the three months ended September 30, 2021, as compared to the three months ended September 30, 2020, partially offset by a $143.3 million increase in the average balance of money market accounts for the comparative periods. As we continued to grow our lower cost deposits, maturing retail certificates of deposit were allowed to runoff or shift to non-maturity deposit accounts, resulting in a $1.2 million reduction in interest expense for these deposits for the three months ended September 30, 2021, as compared to the same period in 2020, reflecting both a 65 basis point decrease in the average cost of these deposits and a $120.3 million decrease in their average balance.

Our cost of borrowings increased $31,000 for the three months ended September 30, 2021, as compared to the same period in 2020. The increase in our customer deposits met our funding needs, allowing us to eliminate our need for short-term borrowings from the FHLB, resulting in a $4.5 million decrease in the average balance of these borrowings for the three months ended September 30, 2021. During this period, the Company maintained $120.0 million in FHLB advances tied to interest rate swap agreements. In comparison, for the three months ended September 30, 2020, the Company had an average balance of $124.5 million in FHLB advances that included the FHLB advances tied to interest rate swap agreements and FHLB Fed Funds short-term borrowings. Our average cost of these borrowings increased to 1.42% for the three months ended September 30, 2021, from 1.28% for the three months ended September 30, 2020, due to the use of lower rate advances offered by the FHLB during the early months of the COVID-19 pandemic in 2020.

The Company’s net interest margin increased to 3.33% for the three months ended September 30, 2021, from 3.07% for the three months ended September 30, 2020. This increase was primarily due to the 56 basis point reduction in our average cost of interest bearing liabilities outpacing the 23 basis point reduction in our average yield on interest earning assets between periods. 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 September 30, 2021 Compared to September 30, 2020 Net Change in Interest
	Rate		Volume		Total
	(In thousands)
Interest-earning assets:
Loans receivable, net	$	154	$	(493)	$	(339)
Investments available-for-sale	(263)		326		63
Investments held-to-maturity	(2)		—		(2)
Interest-earning deposits with banks	7		9		16
FHLB stock	4		(2)		2
Total net change in income on interest-earning assets	(100)		(160)		(260)

Interest-bearing liabilities:
Interest-bearing demand	(58)		3		(55)
Statement savings	(2)		1		(1)
Money market	(511)		232		(279)
Certificates of deposit, retail	(518)		(645)		(1,163)
Certificates of deposit, brokered	—		(96)		(96)
Borrowings	46		(15)		31
Total net change in expense on interest-bearing liabilities	(1,043)		(520)		(1,563)
Total net change in net interest income	$	943	$	360	$	1,303

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 September 30, 2021 and 2020. Nonaccrual loans are included in the average balance of net loans receivable and are considered to carry a zero yield.


	Three Months Ended September 30,
	2021						2020
	Average Balance		Interest Earned / Paid		Yield / Cost		Average Balance		Interest Earned / Paid		Yield / Cost
	(Dollars in thousands)
Assets
Loans receivable, net	$	1,094,124	$	12,508	4.54	%	$	1,137,742	$	12,847	4.49	%
Investments available-for-sale	184,840		814		1.75		128,885		751		2.32
Investments held-to-maturity	2,421		4		0.66		2,399		6		0.99
Interest-earning deposits with banks	68,618		24		0.14		32,701		8		0.10
FHLB stock	6,465		84		5.15		6,592		82		4.95
Total interest-earning assets	1,356,468		13,434		3.93		1,308,319		13,694		4.16
Noninterest earning assets	80,333						75,417
Total average assets	$	1,436,801					$	1,383,736

Liabilities and Stockholders' Equity
Interest-bearing demand	$	108,578	$	21	0.08	%	$	104,911	$	76	0.29	%
Statement savings	22,939		2		0.03		19,312		3		0.06
Money market	568,494		409		0.29		425,172		688		0.64
Certificates of deposit, retail	316,529		1,180		1.48		436,822		2,343		2.13
Certificates of deposit, brokered	—		—		—		16,301		96		2.34
Total interest-bearing deposits	1,016,540		1,612		0.63		1,002,518		3,206		1.27
Borrowings	120,000		431		1.42		124,543		400		1.28
Total interest-bearing liabilities	1,136,540		2,043		0.71		1,127,061		3,606		1.27
Noninterest bearing liabilities	138,369						101,687
Average equity	161,892						154,988
Total average liabilities and equity	$	1,436,801					$	1,383,736
Net interest income			$	11,391					$	10,088
Net interest margin					3.33	%					3.07	%

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 September 30, 2021, management evaluated the adequacy of the ALLL and concluded that a $100,000 provision for loan losses was appropriate. This provision was primarily attributed to the growth in net loans receivable, partially offset by recoveries received during the quarter, and reflects modest changes in the composition of the loan portfolio during the three months ended September 30, 2021, including a slight decline in construction/land loans. In comparison, a $700,000 provision for loan losses was recognized for the three months ended September 30, 2020, primarily the result of the downgrade of $26.8 million of commercial real estate loans combined with increases in forecasted credit deterioration for all loan categories in response to then uncertain economic disruption caused by the COVID-19 pandemic, with higher potential impact allocated to commercial real estate and construction/land portfolios. As of September 30, 2021, the improved economic outlook and expanding availability of the COVID-19 vaccine, has diminished the expected economic impact of the COVID-19 pandemic to the credit quality of our loan portfolio. For more information, see Note 5 - Loans Receivable--ALLL.

The following table summarizes selected financial data related to our ALLL and loan portfolio.


	At or For the Three Months Ended September 30,
	2021			2020
	(Dollars in thousands)
Total loans receivable, end of period	$	1,117,358		$	1,150,481
Average loans receivable during period	1,094,124			1,137,742
ALLL balance at beginning of period	14,878			13,836
Provision for loan losses	100			700
Charge-offs:



Total charge-offs	—			—
Recoveries:
One-to-four family	79			2

Commercial real estate	—			30



Total recoveries	79			32
Net recovery	79			32
ALLL balance at end of period	$	15,057		$	14,568
ALLL as a percent of total loans	1.35		%	1.27		%
Ratio of net recoveries to average net loans receivable, annualized	0.03			0.01

Noninterest Income. Noninterest income decreased $12,000 to $999,000 for the quarter ended September 30, 2021, as compared to the quarter ended September 30, 2020.

The following table provides a detailed analysis of the changes in the components of noninterest income:


	Three Months Ended September 30, 2021		Change from Three Months Ended September 30, 2020		Percent Change
	(Dollars in thousands)
Net gain on sale of investments	$	—	$	(18)	(100.0)	%
BOLI income	377		$	108	40.1
Wealth management revenue	64		(81)		(55.9)
Deposit related fees	228		27		13.4
Loan related fees	300		(76)		(20.2)
Other	30		28		1,400.0
Total noninterest income	$	999	$	(12)	(1.2)

During the three months ended September 30, 2021, as compared to the three months ended September 30, 2020, loan related fee income decreased $76,000, primarily due to a $143,000 decrease in loan prepayment fees, partially offset by a $75,000 increase in annual maintenance fees on a certain line-of-credit. Wealth management revenue decreased $81,000 during the three months ended September 30, 2021, as compared to the same period in 2020, as a combined result of timing changes in the nature of revenue and a reduction in sales personnel. These decreases in noninterest income were partially offset by a $108,000 increase in BOLI as a result of $161,000 in death benefit proceeds.

Noninterest Expense. Noninterest expense increased $466,000 to $8.3 million for the three months ended September 30, 2021, from $7.9 million for the three months ended September 30, 2020.

The following table provides a detailed analysis of the changes in the components of noninterest expense:


	Three Months Ended September 30, 2021		Change from Three Months Ended September 30, 2020		Percent Change
	(Dollars in thousands)
Salaries and employee benefits	$	4,856	$	(24)	(0.5)	%
Occupancy and equipment	1,116		129		13.1
Professional fees	502		131		35.3
Data processing	626		(105)		(14.4)
OREO related expenses, net	207		206		20,600.0
Regulatory assessments	121		(13)		(9.7)
Insurance and bond premiums	106		(10)		(8.6)
Marketing	64		23		56.1
Other general and administrative	735		129		21.3
Total noninterest expense	$	8,333	$	466	5.9

Noninterest expense increased $466,000 during the three months ended September 30, 2021, primarily due to a $207,000 loss from the sale of two OREO properties. In addition, professional fees increased $131,000 and occupancy and equipment and other general administrative costs both increased $129,000. Partially offsetting these increases, data processing expense decreased $105,000. In addition, salary and employee benefits decreased $24,000 for the three months ended September 30, 2021, as compared to the same period in 2020.

Federal Income Tax Expense. The federal income tax provision increased by $380,000 to $758,000 for the three months ended September 30, 2021, as compared to $450,000 for the same period in 2020, primarily due to a $1.4 million increase in income before federal income taxes.

Comparison of Operating Results for the Nine Months Ended September 30, 2021 and 2020

General. Net income for the nine months ended September 30, 2021 was $9.5 million, or $0.99 per diluted share as compared to net income of $5.9 million, or $0.60 per diluted share for the nine months ended September 30, 2020. The increase during the nine months ended September 30, 2021, as compared to the same period last year was primarily the result of a $3.6 million increase in net interest income. In addition, a $300,000 recapture of provision for loan losses was recognized for the nine months ended September 30, 2021, as compared to a $1.3 million provision for loan losses for the nine months ended September 30, 2020.

Net Interest Income. Net interest income for the nine months ended September 30, 2021 was $33.4 million, as compared to $29.8 million for the same period in 2020, with decreases in interest income and interest expense of $1.8 million and $5.4 million, respectively.

Interest income decreased by $1.8 million for the nine months ended September 30, 2021, as compared to the same period in 2020, primarily due to a $1.7 million decrease in loan interest income. Yields on loans continue to decline as loans are originated or refinanced at lower rates or adjust downward in this continued low interest rate environment, resulting in an 11 basis point decrease in our average loan yield for the nine months ended September 30, 2021, as compared to the same period in 2020. In addition, the average balance of net loans receivable decreased $23.6 million between the comparative periods.

Further contributing to the decrease in interest income, investments available-for-sale interest income decreased $66,000, primarily as a result of a decrease in average yield to 1.86% for the nine months ended September 30, 2021, from 2.49% for the nine months ended September 30, 2020. Partially offsetting this decrease, the average balance of these investments increased $40.3 million for the nine months ended September 30, 2021, as compared to the same period in 2020, as excess cash liquidity earning a nominal yield was invested in higher earning assets.

Interest income from interest-earning deposits remained stable with an $8,000 increase for the nine months ended September 30, 2021, as compared to the same period in 2020, with a decrease in average yield to 0.11% from 0.24%, offset by a $36.9 million increase in the average balance of these funds between these comparative periods.

The decrease in interest income was more than offset by a $5.4 million decrease in interest expense for the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020. The average cost of interest-bearing deposits decreased 75 basis points between the periods, as a combined result of the declining interest rate environment and an increase in lower-cost demand deposits. Growth in our branch network allowed us to repay all of our higher cost brokered deposits in 2020, resulting in a $661,000 decrease to interest expense between these comparative periods. Interest expense for retail certificates of deposit and money market accounts decreased $2.8 million and $1.8 million, respectively, primarily due to a 55 basis point reduction in the average cost of retail certificates of deposit and an 68 basis point reduction in the average cost of money market accounts between the comparative periods. The shift in deposits from brokered and retail certificates of deposit to lower cost money market and demand accounts also contributed to the overall decrease in cost of deposits.

Interest expense on borrowings remained stable with a $49,000 increase for the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020. The average cost of these funds increased to 1.41% for the nine months ended September 30, 2021, from 1.28% for the nine months ended September 30, 2020, as borrowed funds in 2020 also included lower cost overnight advances. The increase in interest expense as a result of the higher cost was partially offset by the $6.6 million reduction in the average balance of our borrowings as there were no overnight borrowings in 2021.

The Company’s net interest margin increased to 3.34% for the nine months ended September 30, 2021, from 3.10% for the nine months ended September 30, 2020. For the nine months ended September 30, 2021, the combination of $394,000 of interest and late fees recognized in the payoff of the $2.0 million nonaccrual multifamily loan in the second quarter of 2021, and a $1.1 million increase in net deferred fee income from PPP loans forgiven and repaid more than offset the negative impact to our net interest margin from the continued low rate environment. 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:


	Nine Months Ended September 30, 2021 Compared to September 30, 2020 Net Change in Interest
	Rate		Volume		Total
	(In thousands)
Interest-earning assets:
Loans receivable, net	$	(899)	$	(833)	$	(1,732)
Investments available-for-sale	(816)		750		(66)
Investments held-to-maturity	2		1		3
Interest-earning deposits with banks	(59)		67		8
FHLB stock	14		(7)		7
Total net change in income on interest-earning assets	(1,758)		(22)		(1,780)

Interest-bearing liabilities:
Interest-bearing demand	(198)		51		(147)
Statement savings	(10)		2		(8)
Money market	(2,681)		882		(1,799)
Certificates of deposit, retail	(1,465)		(1,332)		(2,797)
Certificates of deposit, brokered	—		(661)		(661)
Borrowings	112		(63)		49
Total net change in expense on interest-bearing liabilities	(4,242)		(1,121)		(5,363)
Total net change in net interest income	$	2,484	$	1,099	$	3,583

The following table compares detailed average balances, associated yields and rates, and the resulting changes in interest and dividend income or expense for the nine months ended September 30, 2021 and 2020. Nonaccrual loans are included in the average balance of net loans receivable and are considered to carry a zero yield.


	Nine Months Ended September 30,
	2021						2020
	Average Balance		Interest Earned / Paid		Yield or Cost		Average Balance		Interest Earned / Paid		Yield or Cost
	(Dollars in thousands)
Assets
Loans receivable, net	$	1,095,380	$	37,772	4.61	%	$	1,118,987	$	39,504	4.72	%
Investments available-for-sale	172,889		2,400		1.86		132,553		2,466		2.49
Investments held-to-maturity	2,417		20		1.11		2,279		17		1.00
Interest-earning deposits with banks	61,722		53		0.11		24,777		45		0.24
FHLB stock	6,454		247		5.12		6,648		240		4.82
Total interest-earning assets	1,338,862		40,492		4.04		1,285,244		42,272		4.39
Noninterest earning assets	79,674						74,863
Total average assets	$	1,418,536					$	1,360,107

Liabilities and Stockholders' Equity
Interest-bearing demand	$	106,857	$	70	0.09	%	$	86,456	$	217	0.34	%
Statement savings	21,201		4		0.03		18,160		12		0.09
Money market	525,615		1,216		0.31		406,705		3,015		0.99
Certificates of deposit, retail	356,707		4,536		1.70		435,906		7,333		2.25
Certificates of deposit, brokered	—		—		—		40,219		661		2.20
Total interest-bearing deposits	1,010,380		5,826		0.77		987,446		11,238		1.52
Borrowings	120,165		1,263		1.41		126,793		1,214		1.28
Total interest-bearing liabilities	1,130,545		7,089		0.84		1,114,239		12,452		1.49
Noninterest bearing liabilities	127,997						90,340
Average equity	159,994						155,528
Total average liabilities and equity	$	1,418,536					$	1,360,107
Net interest income			$	33,403					$	29,820
Net interest margin					3.34	%					3.10	%

Provision for Loan Losses. During the nine months ended September 30, 2021, management evaluated the adequacy of the ALLL and concluded that a recapture of provision for loan losses in the amount of $300,000 was appropriate for the period. This recapture was primarily attributed to improvements to qualitative economic factors utilized to calculate our general reserves for the ALLL related to the COVID-19 pandemic based upon the improving financial conditions and economic outlook that existed as of September 30, 2021, and net recoveries of $183,000. Partially offsetting this recapture of provision were modest changes in the composition of the loan portfolio, including a $9.1 million increase in construction/land loans and $6.5 million of loans secured by medical rehabilitation facilities that were downgraded to special mention. In comparison, a $1.3 million provision for loan losses was recognized for the nine months ended September 30, 2020, primarily due to COVID-19 related adjustments to economic factors considered in evaluating the ALLL against the probable losses inherent in the loan portfolio, along with reduction in loan grades on a portion of our commercial real estate portfolio, including $26.8 million in loans that were downgraded due in large part to the ongoing COVID-19 pandemic.

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 Nine Months Ended September 30,
	2021			2020
	(Dollars in thousands)
Total loans receivable, end of period	$	1,117,358		$	1,150,481
Average loans receivable during period	1,095,380			1,118,987
ALLL balance at beginning of period	15,174			13,218
Provision (recapture of provision) for loan losses	(300)			1,300
Charge-offs:



Total charge-offs	—			—
Recoveries:
One-to-four family	183			20

Commercial real estate	—			30



Total recoveries	183			50
Net recovery	183			50
ALLL balance at end of period	$	15,057		$	14,568
ALLL as a percent of total loans	1.35		%	1.27		%
Ratio of net recoveries to average net loans receivable, annualized	0.02			0.01

Noninterest Income. Noninterest income decreased by $53,000 to $2.7 million for the nine months ended September 30, 2021, as compared to $2.8 million for the same period in 2020. The following table provides a detailed analysis of the changes in the components of noninterest income:


	Nine Months Ended September 30, 2021		Change from Nine Months Ended September 30, 2020		Percent Change
	(Dollars in thousands)
Net gain on sale of investments	$	—	$	(86)	(100.0)	%
BOLI income	891		113		14.5
Wealth management revenue	391		(102)		(20.7)
Deposit related fees	654		94		16.8
Loan related fees	714		(151)		(17.5)
Other	86		79		1,128.6
Total noninterest income	$	2,736	$	(53)	(1.9)	%

Noninterest income from loan related fees decreased by $151,000 for the nine months ended September 30, 2021, as compared to the same period in 2020, primarily as a result of a $193,000 decrease in loan prepayment fees on certain commercial real estate loans and a $19,000 decrease in interest rate swap fees on loans where certain commercial loan customers participate in an interest rate swap with a third party broker institution and the Bank receives a fee that is recognized as other noninterest income at the time the loan is originated, partially offset by a $78,000 increase in annual line-of-credit fees. Further contributing to the decrease in noninterest income, wealth management fees decreased $102,000 for the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020, as a result of a reduction in sales staff and timing differences in revenue recognition. In addition, the Company had no sales of investment securities during the nine months ended September 30, 2021, while sales of investment securities during the nine months ended September 30, 2020 resulted in an $86,000 net gain. Partially offsetting these decreases in noninterest income between the comparative periods, deposit related fees increased $94,000, primarily from debit card related service fees reflecting increased usage as the economy improves in our markets. In addition, BOLI income increased $113,000 primarily as a result of $161,000 in death benefit proceeds.

Noninterest Expense. Noninterest expense increased $572,000 to $24.7 million to for the nine months ended September 30, 2021, as compared to $24.1 million for the same period in 2020.

The following table provides a detailed analysis of the changes in the components of noninterest expense:


	Nine Months Ended September 30, 2021		Change from Nine Months Ended September 30, 2020		Percent Change
	(Dollars in thousands)
Salaries and employee benefits	$	14,863	$	(30)	(0.2)	%
Occupancy and equipment	3,403		313		10.1
Professional fees	1,423		166		13.2
Data processing	2,003		(109)		(5.2)
OREO related expenses, net	208		201		2,871.4
Regulatory assessments	356		(49)		(12.1)
Insurance and bond premiums	341		2		0.6
Marketing	116		(17)		(12.8)
Other general and administrative	1,938		95		5.2
Total noninterest expense	$	24,651	$	572	2.4

During the nine months ended September 30, 2021, as compared to the same period in 2020, occupancy and equipment expense increased $313,000 with the addition of two branch locations during the last six months of 2020. In addition, the loss on sale of two OREO properties resulted in a $201,000 increase in OREO related expenses. Professional fees also increased $166,000 for the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020, due to outsourcing of select services. Partially offsetting these increases, data processing expense decreased $109,000. In addition, regulatory assessments decreased by $49,000 during the nine months ended September 30, 2021, as compared to the same period in 2020, as PPP loans are excluded from our asset base for calculation of our FDIC assessment.

Federal Income Tax Expense. The federal income tax provision increased $961,000 to $2.3 million for the nine months ended September 30, 2021, as compared to $1.3 million for the nine months ended September 30, 2020, primarily as a result of a $4.6 million increase in income before federal income taxes for the nine months ended September 30, 2021, as compared to the same period in 2020. In addition, the effective tax rate was increased to 19.4% for the nine months ended September 30, 2021, as a result of lower tax benefits from certain stock compensation due to an increase in the Company’s stock price. In comparison, the effective tax rate for the nine months ended September 30, 2020, was 18.3%.

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 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 September 30, 2021, retail certificates of deposit of $159.9 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 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 increased $50.5 million to $178.1 million at September 30, 2021, from $127.6 million at December 31, 2020, and represents a ready source of cash if needed. The balance of our interest-earning deposits with banks decreased by $625,000 to $71.9 million at September 30, 2021, from $72.5 million at December 31, 2020. At September 30, 2021, the Bank maintained credit facilities with the FHLB totaling $643.8 million, subject to qualifying collateral limits that reduced our pledged collateral capacity to $410.0 million, with an outstanding balance of $120.0 million. As further funding sources, we also had the ability to borrow $94.0 million from the FRB, and $75.0 million from lines of credit with other financial institutions, with no balance outstanding from these sources at September 30, 2021. 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 from time to time the national brokered deposit market. Due to adequate funding from other sources, at September 30, 2021, the Bank did not hold any 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, 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 compared to retail deposits. This callable option available on certain brokered certificates of deposit to redeem the deposit after six months is 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, if 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 September 30, 2021, the Company (on an unconsolidated basis) had liquid assets of $11.3 million and short-term liabilities of $335,000.

On a monthly basis, we estimate our future liquidity sources and needs. 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 September 30, 2021 and December 31, 2020, 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.

At September 30, 2021, the Bank had no commitments to originate loans. The following table summarizes our commitments to advance additional amounts pursuant to outstanding lines of credit and to disburse funds related to our construction loans or certain commercial loans at September 30, 2021:


			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)

Unused portion of lines of credit	$	33,833	$	6,670	$	10,632	$	1,388	$	15,143
Undisbursed portion of construction and commercial loans	52,323		34,931		17,392		—		—
Total commitments	$	86,156	$	41,601	$	28,024	$	1,388	$	15,143

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

As of September 30, 2021, the Bank had thirteen operating leases with remaining terms of 1.3 years to 9.3 years which carry minimum lease payments of $69,000 per month. All of the lease agreements offer extension periods.

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 claims and legal actions 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 September 30, 2021, stockholders’ equity totaled $161.5 million, or 11.2% of total assets. Our book value per share of common stock was $17.03 at September 30, 2021, compared to $16.05 at December 31, 2020. 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 September 30, 2021, the Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory capital guidelines of the FDIC. The following table provides the Bank’s capital requirements and actual results.


	At September 30, 2021
	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)	$	146,141	10.19	%	$	57,381	4.00	%	$	71,726	5.00	%
Common equity tier I ("CET1") (to risk- weighted assets)	146,141		14.25		46,163		4.50		66,681		6.50
Tier I risk-based capital (to risk-weighted assets)	146,141		14.25		61,551		6.00		82,068		8.00
Total risk-based capital (to risk-weighted assets)	158,996		15.50		82,068		8.00		102,585		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 September 30, 2021, the Bank’s capital conservation buffer was 7.5%.

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 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;

•we have utilized interest rate swaps to effectively fix the rate on certain FHLB advances; and

•we have emphasized attracting non-interest bearing deposits as a source of funds.

We have evaluated the use of derivative instruments to limit the impact of interest rate changes on earnings and cash flows and to lower our cost of borrowing while taking into account various elements of interest rate risk. We are using interest rate swaps which qualify as a cash flow hedge 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 September 30, 2021, the Bank held six interest rate swap agreements with a total notional amount of $120.0 million and a weighted-average fixed interest rate of 1.22%. Under the interest rate agreements, the Bank pays a fixed interest rate, and receives a floating rate based on 1-month or 3-month LIBOR rates to coincide with each agreement’s reset frequency for an original term of four to eight years. Concurrently at the onset of each interest rate agreement, the Bank secured a fixed rate FHLB advance that resets to market rate on the same cycle as the corresponding interest rate swap agreement. In addition, the Bank has entered into two, forward starting interest rate swap agreements with a start date of October 25, 2021, a total notional amount of $25.0 million, and a weighted-average interest rate of 0.80%. These interest rate agreements are intended to partially replace the $50.0 million notional amount interest rate swap that matures on that date. Entering into these agreements 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 continue to 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 swap we enter into proves ineffective, it could 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 nearly 40 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 in conjunction with market rates. Approximately 54.1% of our total loans were adjustable-rate loans at September 30, 2021. At that date, $410.7 million, or 67.9% of these loans were at their floor, with a weighted-average interest rate of 4.41%. A portion of these loans are set to reprice at defined time intervals. Adjustable rate loans that are based on prime rate plus a specified margin recalculate each time the prime rate changes. When the floor rate is above a prime rate based loan’s fully indexed rate, the Bank will not receive the benefit of an increasing market rates until prime rate increases enough where the fully indexed rate exceeds the loans floor rate. At September 30, 2021, the Bank’s net loans receivable included $120.3 million of prime based loans, of which $107.1 million were at a floor rate that exceeded their fully indexed rate. The following table shows the rate increase that would need to occur on these loans before the Bank receives the benefit of a floating rate:


	September 30, 2021
Increase in prime rate:	(Dollars in thousands)
0 - 25 bps	$	7,358
26 - 50 bps	12,455
51 - 75 bps	10,649
76 - 100 bps	39,575
101 - 150 bps	24,681
151 - 200 bps	5,897
> 200 bps	6,443
	$	107,058

The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates, although this result is subject to the risk that borrowers may refinance these loans during 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. 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 to monitor interest rate risk 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. In the event of a significant change in interest rates, however, prepayment and early withdrawal levels would likely deviate from those assumed.

Our income simulation model examines changes in net interest income in which interest rates were assumed to remain at their base level, instantaneously increase by 100, 200 and 300 basis points or decline immediately by 100 basis points. A decline by 200 or 300 basis points were not reported as the current targeted federal funds rate is between 0.00% and 0.25%.

The following table illustrates the estimated change in our net interest income over the next 12 months from September 30, 2021, 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 the Bank might take to counter the effect of that interest rate movement.


Net Interest Income Change at September 30, 2021
Basis Point Change in Rates	Net Interest Income	% Change
(Dollars in thousands)
+300	$45,842	3.19%
+200	44,837	0.93
+100	44,270	(0.34)
Base	44,423	—
(100)	43,878	(1.23)

The following table illustrates the change in our net portfolio value (“NPV”) at September 30, 2021, 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	$	196,871	$	(15,591)	(7.34)	%	14.43	%	(1.08)	%	$	1,364,231
+200	201,871		(10,591)		(4.98)		14.51		(0.73)		1,390,833
+100	208,639		(3,823)		(1.80)		14.69		(0.26)		1,420,627
Base	212,462		—		—		14.66		—		1,449,051
(100)	202,545		(9,917)		(4.67)		13.79		(0.68)		1,468,949

_____________

(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 September 30, 2021, other than the interest rate swap agreements we have entered into, 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 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 September 30, 2021, 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 September 30, 2021, 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 1, Item 1A of our 2020 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 September 30, 2021:


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
July 1 - July 31, 2021	—	$	—	—	353,551
August 1 - August 31, 2021	159,551	16.46		159,551	452,286
September 1 - September 30, 2021	20,628	16.29		20,628	431,658
	180,179	16.44		180,179

On February 1, 2021, the Company began repurchasing shares of common stock under the repurchase plan approved by the Company’s Board of Directors on December 21, 2020. The plan authorized the repurchase of up to 486,000 shares of the Company’s common stock, or approximately 5% of the Company’s outstanding shares on the open market or in privately negotiated transactions, in accordance with Rule 10b-18 of the Securities and Exchange Act of 1934, as amended. At the expiration of the plan on August 13, 2021, the Company had repurchased 268,286 shares under this plan at an average price of $14.97 per share. On August 16, 2021, the Company’s Board of Directors approved a repurchase plan authorizing the repurchase of up to 476,000, or approximately 5% of the Company’s outstanding shares on the open market or in privately negotiated transactions, in accordance with Rule 10b-18 of the Securities and Exchange Act of 1934, as amended. This repurchase plan commenced August 16, 2021, and will expire no later than February 15, 2022. At September 30, 2021, 44,342 shares had been purchased at an average price of $16.32 per share. At that date, 431,658 share were available for repurchase under this plan. For information on repurchases after September 30, 2021, see Note 14 of the Notes to Consolidated Financial Statements contained in Part 1. Item 1 of this report.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Financial Statement Schedules

(a) Exhibits


3.1						Articles of Incorporation of First Financial Northwest (1)
3.2						Amended and Restated Bylaws of First Financial Northwest (2)
4.1						Form of stock certificate of First Financial Northwest (1)
10.1						Amended Employment Agreement between First Financial Northwest Bank and Joseph W. Kiley III (3)
10.2						Form of Change in Control Severance Agreement for Executive Officers (4)
10.3						Amended Executive Supplemental Retirement Plan Participation Agreement with Joseph W. Kiley III (5)
10.4						2008 Equity Incentive Plan (6)
10.5						2016 Equity Incentive Plan (7)
10.6						Forms of incentive and non-qualified stock option award agreements under the 2008 Equity Incentive Plan (8)
10.7						Form of restricted stock award agreement under the 2008 Equity Incentive Plan (8)
10.8						Employment Agreement between First Financial Northwest Bank and Richard P. Jacobson (2)
10.9						Form of restricted stock award agreement under the 2016 Equity Incentive Plan (9)
10.10						Form of incentive stock option award agreement under the 2016 Equity Incentive Plan (10)
10.11						Form of non-qualified stock option award agreement under the 2016 Equity Incentive Plan (10)
10.12						Form of restricted stock award agreement under the 2016 Equity Incentive Plan (11)
10.16						Supplemental Executive Retirement Plan Agreement for Joseph W. Kiley III (12)
10.17						Supplemental Executive Retirement Plan Agreement for Richard P. Jacobson (13)
31.1						Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2						Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32						Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101						The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021, 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 May 15, 2020.

(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 January 15, 2020.

(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 January 15, 2020.

(13)Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 15, 2020.

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: November 9, 2021	By:	/s/Joseph W. Kiley III
		Joseph W. Kiley III
		President and Chief Executive Officer (Principal Executive Officer)


Date: November 9, 2021	By:	/s/Richard P. Jacobson
		Richard P. Jacobson
		Executive Vice President and Chief Financial Officer (Principal Financial Officer)

Date: November 9, 2021	By:	/s/Christine A. Huestis
		Christine A. Huestis
		First Vice President and Controller (Principal Accounting Officer)