First Northwest Bancorp - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2019



¨	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: 001-36741

FIRST NORTHWEST BANCORP

(Exact name of registrant as specified in its charter)



Washington		46-1259100
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer I.D. Number)

105 West 8th Street, Port Angeles, Washington		98362
(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code:		(360) 457-0461

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, par value $0.01 per share	FNWB	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 ý 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 ý No ¨

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



Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨	Smaller reporting company	x
Emerging growth company	x

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. ý

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

Yes ¨ No ý

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 1, 2019, there were 10,734,332 shares of common stock, $0.01 par value per share, outstanding.

FIRST NORTHWEST BANCORP

FORM 10-Q

TABLE OF CONTENTS



PART 1 - FINANCIAL INFORMATION
	Page
Item 1 - Financial Statements (Unaudited)	3

Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations	39

Item 3 - Quantitative and Qualitative Disclosures About Market Risk	57

Item 4 - Controls and Procedures	57

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings	58

Item 1A - Risk Factors	58

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds	58

Item 3 - Defaults Upon Senior Securities	58

Item 4 - Mine Safety Disclosures	58

Item 5 - Other Information	58

Item 6 - Exhibits	59

SIGNATURES	60

As used in this report, the terms, “we,” “our,” and “us,” and “Company” refer to First Northwest Bancorp ("First Northwest") and its consolidated subsidiary, unless the context indicates otherwise. When we refer to “First Federal” or the “Bank” in this report, we are referring to First Federal Savings and Loan Association of Port Angeles, the wholly owned subsidiary of First Northwest Bancorp.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share information) (Unaudited)



ASSETS	September 30, 2019			December 31, 2018

Cash and due from banks	$	15,659		$	15,430
Interest-bearing deposits in banks	40,822			10,893
Investment securities available for sale, at fair value	251,196			262,967
Investment securities held to maturity, at amortized cost	37,649			43,503
Loans held for sale	2,055			—
Loans receivable (net of allowance for loan losses of $9,443 and $9,533)	841,146			863,852
Federal Home Loan Bank (FHLB) stock, at cost	4,931			6,927
Accrued interest receivable	3,726			4,048
Premises and equipment, net	14,443			15,255
Mortgage servicing rights, net	926			1,044
Bank-owned life insurance, net	29,754			29,319
Prepaid expenses and other assets	8,003			5,520

Total assets	$	1,250,310		$	1,258,758


LIABILITIES AND SHAREHOLDERS' EQUITY

Deposits	$	970,700		$	940,260
Borrowings	85,324			136,552
Accrued interest payable	262			521
Accrued expenses and other liabilities	14,838			8,071
Advances from borrowers for taxes and insurance	1,876			1,090

Total liabilities	1,073,000			1,086,494

Shareholders' Equity
Preferred stock, $0.01 par value, authorized 5,000,000 shares, no shares issued or outstanding	—			—
Common stock, $0.01 par value, authorized 75,000,000 shares; issued and outstanding 10,800,932 shares at September 30, 2019, and 11,170,018 shares at December 31, 2018	108			112
Additional paid-in capital	102,786			105,825
Retained earnings	85,143			81,607
Accumulated other comprehensive loss, net of tax	(672		)	(4,731		)
Unearned employee stock ownership plan (ESOP) shares	(10,055		)	(10,549		)

Total shareholders' equity	177,310			172,264

Total liabilities and shareholders' equity	$	1,250,310		$	1,258,758

See selected notes to the consolidated financial statements.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data) (Unaudited)



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2019			2018			2019		2018
INTEREST INCOME
Interest and fees on loans receivable	$	9,930		$	9,257		$	29,955	$	26,792
Interest on mortgage-backed securities	1,087			1,196			3,536		3,730
Interest on investment securities	921			952			2,900		2,787
Interest on deposits and other	65			50			190		136
FHLB dividends	92			100			268		237

Total interest income	12,095			11,555			36,849		33,682
INTEREST EXPENSE
Deposits	2,141			1,498			6,133		3,608
Borrowings	691			792			2,717		2,678

Total interest expense	2,832			2,290			8,850		6,286

Net interest income	9,263			9,265			27,999		27,396
(RECAPTURE OF) PROVISION FOR LOAN LOSSES	(170		)	197			420		902

Net interest income after (recapture of) provision for loan losses	9,433			9,068			27,579		26,494
NONINTEREST INCOME
Loan and deposit service fees	1,165			1,122			3,605		2,930
Mortgage servicing fees, net of amortization	44			23			143		155
Net gain on sale of loans	655			139			830		456
Net gain (loss) on sale of investment securities	—			(58		)	57		77
Increase in cash surrender value of bank-owned life insurance	147			150			435		448
Other income	70			44			225		241

Total noninterest income	2,081			1,420			5,295		4,307

NONINTEREST EXPENSE
Compensation and benefits	4,771			4,740			14,097		14,296
Data processing	680			676			1,978		1,981
Occupancy and equipment	1,161			1,119			3,409		3,348
Supplies, postage, and telephone	208			211			678		685
Regulatory assessments and state taxes	209			172			573		453
Advertising	197			185			569		799
Professional fees	278			319			907		1,099
FDIC insurance premium	(72		)	76			82		231
FHLB prepayment penalty	344			—			344		—
Other	648			621			1,859		1,800

Total noninterest expense	8,424			8,119			24,496		24,692

INCOME BEFORE PROVISION FOR INCOME TAX	3,090			2,369			8,378		6,109

PROVISION FOR INCOME TAX	580			443			1,582		1,134

NET INCOME	$	2,510		$	1,926		$	6,796	$	4,975

Basic earnings per share	$	0.25		$	0.19		$	0.68	$	0.48

Diluted earnings per share	$	0.25		$	0.19		$	0.68	$	0.47

See selected notes to the consolidated financial statements.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands) (Unaudited)



	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2019		2018			2019			2018

NET INCOME	$	2,510	$	1,926		$	6,796		$	4,975

Other comprehensive income (loss), net of tax
Unrealized gain (loss) on securities:
Unrealized holding gain (loss), net of tax provision (benefit) of $181, $(295), $1,095, and $(1,136), respectively	675		(1,117		)	4,104			(4,295		)
Reclassification adjustment for net loss (gain) on sales of securities realized in income, net of taxes of $0, $12, $(12), and $(11), respectively	—		46			(45		)	(39		)

Other comprehensive income (loss), net of tax	675		(1,071		)	4,059			(4,334		)

COMPREHENSIVE INCOME	$	3,185	$	855		$	10,855		$	641

See selected notes to the consolidated financial statements.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

For the Three Months Ended September 30, 2019 and 2018

(Dollars in thousands, except share information) (Unaudited)



	Common Stock					Additional Paid-in Capital			Retained Earnings			Unearned ESOP Shares			Accumulated Other Comprehensive (Loss) Income, Net of Tax			Total Shareholders' Equity
	Shares		Amount

BALANCE, June 30, 2018	11,483,494		$	115		$	108,780		$	79,767		$	(10,879	)	$	(4,836	)	$	172,947

Net income									1,926									1,926
Common stock repurchased	(126,200	)	(1		)	(1,262		)	(813		)							(2,076		)
Restricted stock award forfeitures net of grants	(13,600	)	—			—												—
Restricted stock awards canceled	(18,076	)	(1		)	(292		)										(293		)
Other comprehensive loss, net of tax															(1,071		)	(1,071		)
Share-based compensation						256												256
ESOP shares committed to be released						49						165						214

BALANCE, September 30, 2018	11,325,618		$	113		$	107,531		$	80,880		$	(10,714	)	$	(5,907	)	$	171,903


BALANCE, June 30, 2019	10,925,181		$	109		$	104,064		$	83,795		$	(10,220	)	$	(1,347	)	$	176,401

Net income									2,510									2,510
Common stock repurchased	(131,400	)	(1		)	(1,314		)	(835		)							(2,150		)
Restricted stock award grants net of forfeitures	23,400		—			—												—
Restricted stock awards canceled	(16,249	)	—			(266		)										(266		)
Other comprehensive income, net of tax															675			675
Share-based compensation						251												251
ESOP shares committed to be released						51						165						216
Cash dividends declared and paid ($0.03 per share)									(327		)							(327		)

BALANCE, September 30, 2019	10,800,932		$	108		$	102,786		$	85,143		$	(10,055	)	$	(672	)	$	177,310

See selected notes to the consolidated financial statements.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

For the Nine Months Ended September 30, 2019 and 2018

(Dollars in thousands, except share information) (Unaudited)



	Common Stock					Additional Paid-in Capital			Retained Earnings			Unearned ESOP Shares			Accumulated Other Comprehensive (Loss) Income, Net of Tax			Total Shareholders' Equity
	Shares		Amount

BALANCE, December 31, 2017	11,785,507		$	118		$	111,106		$	78,602		$	(11,208	)	$	(1,573	)	$	177,045

Net income									4,975									4,975
Common stock repurchased	(423,213	)	(4		)	(4,228		)	(2,697		)							(6,929		)
Restricted stock award forfeitures net of grants	(18,600	)	—			—												—
Restricted stock awards canceled	(18,076	)	(1		)	(292		)										(293		)
Other comprehensive loss, net of tax															(4,334		)	(4,334		)
Share-based compensation						788												788
ESOP shares committed to be released						157						494						651

BALANCE, September 30, 2018	11,325,618		$	113		$	107,531		$	80,880		$	(10,714	)	$	(5,907	)	$	171,903


BALANCE, December 31, 2018	11,170,018		$	112		$	105,825		$	81,607		$	(10,549	)	$	(4,731	)	$	172,264

Net income									6,796									6,796
Common stock repurchased	(372,237	)	(4		)	(3,719		)	(2,274		)							(5,997		)
Restricted stock award grants net of forfeitures	19,400		—			—												—
Restricted stock awards canceled	(16,249	)	—			(266		)										(266		)
Other comprehensive income, net of tax															4,059			4,059
Share-based compensation						804												804
ESOP shares committed to be released						142						494						636
Cash dividends declared and paid ($0.09 per share)									(986		)							(986		)

BALANCE, September 30, 2019	10,800,932		$	108		$	102,786		$	85,143		$	(10,055	)	$	(672	)	$	177,310

See selected notes to the consolidated financial statements.



FIRST NORTHWEST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)

	Nine Months Ended September 30,
	2019			2018
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	6,796		$	4,975
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization	1,000			993
Amortization and accretion of premiums and discounts on investments, net	1,373			1,433
(Accretion) amortization of deferred loan fees, net	(822		)	25
Amortization of mortgage servicing rights, net	181			180
Additions to mortgage servicing rights, net	(60		)	(159		)
Net (decrease) increase on the valuation allowance on mortgage servicing rights	(3		)	—
Provision for loan losses	420			902
Allocation of ESOP shares	636			651
Share-based compensation	804			788
Gain on sale of loans, net	(830		)	(456		)
Gain on sale of securities available for sale, net	(57		)	(50		)
Gain on sale of securities held to maturity, net	—			(27		)
Increase in cash surrender value of life insurance, net	(435		)	(448		)
Origination of loans held for sale	(25,050		)	(16,054		)
Proceeds from loans held for sale	23,825			17,107
Change in assets and liabilities:
Decrease (increase) in accrued interest receivable	322			(169		)
Increase in prepaid expenses and other assets	(3,567		)	(412		)
(Decrease) increase in accrued interest payable	(259		)	35
Increase in accrued expenses and other liabilities	6,767			2,600

Net cash from operating activities	11,041			11,914

CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities available for sale	(9,456		)	(63,046		)
Proceeds from maturities, calls, and principal repayments of securities available for sale	21,592			20,164
Proceeds from sales of securities available for sale	3,558			56,683
Proceeds from maturities, calls, and principal repayments of securities held to maturity	5,756			6,010
Proceeds from sales of securities held to maturity	—			2,702
Redemption of FHLB stock	1,996			697
Proceeds from sale of real estate owned and repossessed assets	273			—
Net decrease (increase) in loans receivable	22,837			(61,274		)
Purchase of premises and equipment, net	(188		)	(2,714		)

Net cash from investing activities	46,368			(40,778		)

See selected notes to the consolidated financial statements.



FIRST NORTHWEST BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)

	Nine Months Ended September 30,
	2019			2018
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits	$	30,440		$	46,573
Net decrease in advances from the FHLB	(51,228		)	(22,574		)
Net increase in advances from borrowers for taxes and insurance	786			620
Dividends paid	(986		)	—
Net share settlement of stock awards	(266		)	(293		)
Repurchase of common stock	(5,997		)	(6,929		)

Net cash from financing activities	(27,251		)	17,397

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	30,158			(11,467		)

CASH AND CASH EQUIVALENTS, beginning of period	26,323			36,801

CASH AND CASH EQUIVALENTS, end of period	$	56,481		$	25,334

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings	$	9,109		$	6,251

Income taxes	$	1,210		$	700

NONCASH INVESTING ACTIVITIES
Unrealized gain (loss) on securities available for sale	$	5,142		$	(5,481	)

Loans transferred to real estate owned and repossessed assets, net of deferred loan fees and allowance for loan losses	$	271		$	154

See selected notes to the consolidated financial statements.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation and Critical Accounting Policies

Organization and Nature of business - First Northwest Bancorp, a Washington corporation, became the holding company of First Federal Savings and Loan Association of Port Angeles on January 29, 2015, upon completion of the Bank's conversion from a mutual to stock form of organization (the "Conversion"). In connection with the Conversion, the Company issued an aggregate of 12,167,000 shares of common stock at an offering price of $10.00 per share for gross proceeds of $121.7 million. An additional 933,360 shares of Company common stock and $400,000 in cash were contributed to the First Federal Community Foundation ("Foundation"), a charitable foundation that was established in connection with the Conversion, resulting in the issuance of a total of 13,100,360 shares. The Company received $117.6 million in net proceeds from the stock offering of which $58.4 million were contributed to the Bank upon Conversion.

Pursuant to the Bank's Plan of Conversion (the "Plan") adopted by its Board of Directors, and as approved by its members, the Company established an employee stock ownership plan ("ESOP"). On December 18, 2015, the ESOP completed its open market purchases, with funds borrowed from the Company, of 8% of the common stock issued in the Conversion for a total of 1,048,029 shares.

First Northwest's business activities generally are limited to passive investment activities and oversight of its investment in First Federal. Accordingly, the information set forth in this report, including the consolidated unaudited financial statements and related data, relates primarily to the Bank.

The Bank is a community-oriented financial institution providing commercial and consumer banking services to individuals and businesses in Western Washington State with offices in Clallam, Jefferson, Kitsap, King, and Whatcom counties. These services include deposit and lending transactions that are supplemented with borrowing and investing activities.

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 our audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018. In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial statements in accordance with GAAP have been included. The Company changed its fiscal year end from June 30 to December 31 effective December 31, 2017. Operating results for the three and nine months ended September 30, 2019, are not necessarily indicative of the results that may be expected for future periods.

In preparing the unaudited interim 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 in the near term relate to a determination of the allowance for loan losses ("ALLL"), fair value of financial instruments, and deferred tax assets and liabilities.

Principles of consolidation - The accompanying consolidated financial statements include the accounts of First Northwest Bancorp and its wholly owned subsidiary, First Federal. All material intercompany accounts and transactions have been eliminated in consolidation.

Subsequent Events - The Company has evaluated subsequent events for potential recognition and disclosure and determined there are no such events or transactions requiring recognition or disclosure.

Recently adopted accounting pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU 2016-02 is intended to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the balance sheet and

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

disclosure of key information about leasing arrangements. The ASU requires a lessee to recognize on the balance sheet assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. Unlike current GAAP, which requires that only capital leases be recognized on the balance sheet, the ASC requires that both types of leases be recognized on the balance sheet. For public companies, this update is effective for interim and annual periods beginning after December 15, 2018. The adoption of ASU No. 2016-02 effective January 1, 2019, resulted in a right-of-use asset and corresponding lease obligation liability of $3,919,000. The Corporation chose the effective date as the date of initial application. Consequently, prior period financial information has not been updated or restated. The right-of-use asset is included in other assets and the lease obligation liability is included in other liabilities on the September 30, 2019, consolidated balance sheet.

In August 2017, FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815). This ASU was issued to provide investors better insight to an entity’s risk management hedging strategies by permitting companies to recognize the economic results of hedging strategies in the financial statements. The amendments in this ASU permit hedge accounting for hedging relationships involving non-financial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. This ASU is effective for fiscal years beginning after December 15, 2018, and early adoption is permitted. Adoption of ASU 2017-12 did not have a material impact on the Company’s consolidated financial statements.

In June 2018, FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. These amendments provide specific guidance for transactions for acquiring goods and services from nonemployees and specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The amendments also clarify that Topic 718 does not apply to share-based payments used to effectively provide (i) financing to the issuer or (ii) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers. This guidance is effective for fiscal years beginning after December 15, 2018, and interim periods beginning after December 15, 2020. Early adoption is permitted but not earlier than the adoption of Topic 606. Adoption of this ASU did not have a material effect on the Company's consolidated financial statements as it has not historically issued share-based payments in exchange for goods or services to be consumed within its operations.

In July 2018, FASB issued ASU No. 2018-09, Codification Improvements. These amendments provide clarifications and corrections to certain ASC subtopics including the following: 220-10 (Income Statement - Reporting Comprehensive Income - Overall), 470-50 (Debt - Modifications and Extinguishments), 480-10 (Distinguishing Liabilities from Equity - Overall), 718-740 (Compensation - Stock Compensation - Income Taxes), 805-740 (Business Combinations - Income Taxes), 815-10 (Derivatives and Hedging - Overall), and 820-10 (Fair Value Measurement - Overall). Some of the amendments in ASU 2018-09 do not require transition guidance and will be effective upon issuance; however, many of the amendments do have transition guidance with effective dates for annual periods beginning after December 15, 2018. Adoption of ASU 2018-09 did not have a material impact on the Company's consolidated financial statements.

In October 2018, the FASB issued ASU No. 2018-16 Derivatives and Hedging (Topic 815), Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. The amendments in this ASU permit use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the interest rates on direct Treasury obligations of the U.S. government, the London Interbank Offered Rate (LIBOR) swap rate, the Overnight Index Swap (OIS) Rate based on the Fed Funds Effective Rate and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. The amendments in this ASU are required to be adopted concurrently with the amendments in ASU 2017-12. For public companies, this would be for fiscal years, and interim periods within those fiscal years beginning after December 15, 2018. Adoption of ASU 2018-16 did not have a material impact on the Company's consolidated financial statements.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Recently adopted regulatory rule

In August 2018, the Securities and Exchange Commission issued a final rule that amends certain of its disclosure requirements. The rule simplifies various disclosure requirements for public companies including primarily that it (i) eliminates the requirement for public companies to disclose in their filings a schedule of earnings to fixed charges, (ii) requires an analysis of changes in stockholders’ equity for the current and comparative year-to-date interim periods in interim reports, and (iii) reduces the requirements for market price information disclosures in annual reports. These changes are effective for public companies beginning on November 5, 2018. The Company started complying with these new requirements beginning with the Quarterly Report for the period ended March 31, 2019, on Form 10-Q.

Recently issued accounting pronouncements not yet adopted

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Loss, which updates the guidance on recognition and measurement of credit losses for financial assets. The new requirements, known as the current expected credit loss model (CECL) will require entities to adopt an impairment model based on expected losses rather than incurred losses. ASU No. 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Upon adoption, the Company will change processes and procedures to calculate the allowance for loan losses, 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. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available for sale will be replaced with an allowance approach.

Additional updates were issued in ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging (Topic 825), Financial Instruments. This ASU clarifies and improves guidance related to the previously issued standards on credit losses, hedging and recognition and measurement of financial instruments. The amendments provide entities with various measurement alternatives and policy elections related to accounting for credit losses and accrued interest receivable balances. Entities are also able to elect a practical expedient to separately disclose the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements. The amendments clarify that the estimated allowance for credit losses should include all expected recoveries of financial assets and trade receivables that were previously written off and expected to be written off. The amendments also allow entities to use projections of future interest rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments.

In addition, new updates were issued through ASU No. 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief. This amendment allows entities to elect the fair value option on certain financial instruments. On adoption, an entity is allowed to irrevocably elect the fair value option on an instrument-by-instrument basis. This alternative is available for all instruments in the scope of Subtopic 326-20 except for existing held-to-maturity debt securities. If an entity elects the fair value option, the difference between the instrument’s fair value and carrying amount is recognized as a cumulative-effect adjustment.

In October 2019, the FASB confirmed that it will be moving forward with finalizing its proposal to defer the effective date for this guidance for smaller reporting companies from the interim and annual periods beginning after December 15, 2020 to the interim and annual periods beginning after December 15, 2022. For this effective date deferral to take effect, the FASB must issue the final ASU which we expect to be issued in mid-November. Early adoption is permitted for interim and annual periods beginning after December 15, 2018. Upon issuance of the final ASU, we plan to adopt this guidance on January 1, 2023.

The Company is evaluating the provisions of ASU No. 2016-13, ASU No. 2019-04 and ASU No. 2019-05, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. At this time, we cannot reasonably estimate the impact the implementation of these ASUs will have on the Company's consolidated financial statements. The Company's internal project management team continues to review models, work with our third-party vendor, and discuss changes to processes and procedures to ensure the Company is fully compliant with the amendments at the adoption date.

In August 2018, FASB issued ASU No. 2018-13, Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement which removes, modifies, and adds certain disclosure requirements related to fair value measurements in ASC 820. This guidance eliminates certain disclosure requirements for fair value measurements: the amount of and reasons

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

for transfers between Level 1 and Level 2 of the fair value hierarchy, an entity’s policy for the timing of transfers between levels of the fair value hierarchy and an entity’s valuation processes for Level 3 fair value measurements. This guidance also adds new disclosure requirements for public entities: changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements of instruments held at the end of the reporting period, and the range and weighted average of significant unobservable inputs used to develop recurring and nonrecurring Level 3 fair value measurements, including how the weighted average is calculated. Furthermore, this guidance modifies certain requirements which will involve disclosing: transfers into and out of Level 3 of the fair value hierarchy, purchases and issuances of Level 3 assets and liabilities, and information about the measurement uncertainty of Level 3 fair value measurements as of the reporting date. This guidance is effective for public companies in fiscal years beginning after December 15, 2019, with early adoption permitted. This ASU is not expected to have a material impact on the Company's consolidated financial statements.

In August 2018, FASB issued ASU No. 2018-15 Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract to provide guidance on implementation costs incurred in a cloud computing arrangement that is a service contract. The ASU aligns the accounting for such costs with the guidance on capitalizing costs associated with developing or obtaining internal-use software. Specifically, the ASU amends ASC 350 to include in its scope implementation costs of such arrangements that are service contracts and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized. This ASU, which is effective for fiscal years beginning after December 15, 2019, is not expected to have a material impact on the Company’s financial statements.

Reclassifications - 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 net income or shareholders' equity.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 2 - Securities

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale and held-to-maturity at September 30, 2019 are summarized as follows:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(In thousands)
Available for Sale
Municipal bonds	$	10,337	$	69	$	—		$	10,406
U.S. government agency issued asset-backed securities (ABS agency)	25,934		—		(668		)	25,266
Corporate issued asset-backed securities (ABS corporate)	37,864		—		(768		)	37,096
Corporate issued debt securities (Corporate debt)	9,986		—		(350		)	9,636
U.S. Small Business Administration securities (SBA)	29,729		125		(39		)	29,815
Mortgage-backed securities:
U.S. government agency issued mortgage-backed securities (MBS agency)	128,937		1,025		(236		)	129,726
Corporate issued mortgage-backed securities (MBS corporate)	9,284		—		(33		)	9,251

Total securities available for sale	$	252,071	$	1,219	$	(2,094	)	$	251,196

Held to Maturity
Municipal bonds	$	7,041	$	58	$	—		$	7,099
SBA	138		—		—			138
Mortgage-backed securities:
MBS agency	30,470		1,342		(14		)	31,798

Total securities held to maturity	$	37,649	$	1,400	$	(14	)	$	39,035

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The amortized cost, gross unrealized gains and losses, and estimated fair value of securities classified as available-for-sale and held-to-maturity at December 31, 2018, are summarized as follows:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(In thousands)
Available for Sale
Municipal bonds	$	882	$	—	$	(13	)	$	869
ABS agency	26,125		—		(373		)	25,752
ABS corporate	37,897		—		(1,174		)	36,723
Corporate debt	9,986		98		(196		)	9,888
SBA	35,936		23		(289		)	35,670
Mortgage-backed securities:
MBS agency	147,205		12		(3,762		)	143,455
MBS corporate	10,953		—		(343		)	10,610

Total securities available for sale	$	268,984	$	133	$	(6,150	)	$	262,967

Held to Maturity
Municipal bonds	$	11,919	$	43	$	—		$	11,962
SBA	302		—		(1		)	301
Mortgage-backed securities:
MBS agency	31,282		40		(595		)	30,727

Total securities held to maturity	$	43,503	$	83	$	(596	)	$	42,990

The following shows the unrealized gross losses and fair value of the investment portfolio by length of time that individual securities in each category have been in a continuous loss position as of September 30, 2019:



	Less Than Twelve Months					Twelve Months or Longer					Total
	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value
	(In thousands)
Available for Sale
ABS agency	$	(462	)	$	14,259	$	(206	)	$	11,006	$	(668	)	$	25,265
ABS corporate	—			—		(768		)	37,096		(768		)	37,096
Corporate debt	(89		)	4,911		(261		)	4,725		(350		)	9,636
SBA	—			—		(39		)	8,867		(39		)	8,867
Mortgage-backed securities:
MBS agency	—			—		(236		)	37,175		(236		)	37,175
MBS corporate	—			—		(33		)	9,251		(33		)	9,251

Total available for sale	$	(551	)	$	19,170	$	(1,543	)	$	108,120	$	(2,094	)	$	127,290

Held to Maturity
SBA	$	—		$	—	$	—		$	63	$	—		$	63
Mortgage-backed securities:
MBS agency	—			—		(14		)	1,592		(14		)	1,592

Total held to maturity	$	—		$	—	$	(14	)	$	1,655	$	(14	)	$	1,655

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



	Less Than Twelve Months					Twelve Months or Longer					Total
	Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value
	(In thousands)
Available for Sale
Municipal bonds	$	(8	)	$	757	$	(5	)	$	110	$	(13	)	$	867
ABS agency	(302		)	23,286		(71		)	2,466		(373		)	25,752
ABS corporate	(571		)	14,527		(603		)	22,196		(1,174		)	36,723
Corporate debt	—			—		(196		)	4,791		(196		)	4,791
SBA	(44		)	13,400		(245		)	13,089		(289		)	26,489
Mortgage-backed securities:
MBS agency	(28		)	17,996		(3,734		)	120,617		(3,762		)	138,613
MBS corporate	—			—		(343		)	10,610		(343		)	10,610

Total available for sale	$	(953	)	$	69,966	$	(5,197	)	$	173,879	$	(6,150	)	$	243,845

Held to Maturity
SBA	$	(1	)	$	—	$	—		$	301	$	(1	)	$	301
Mortgage-backed securities:
MBS agency	(70		)	6,241		(525		)	18,073		(595		)	24,314

Total held to maturity	$	(71	)	$	6,241	$	(525	)	$	18,374	$	(596	)	$	24,615

The Company may hold certain investment securities in an unrealized loss position that are not considered other than temporarily impaired ("OTTI"). At September 30, 2019 and December 31, 2018, there were 37 and 69 investment securities in an unrealized loss position, respectively.

We believe that the unrealized losses on our investment securities relate principally to the general change in interest rates and market demand, and not credit quality, that has occurred since the initial purchase, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future. Certain investments in a loss position are guaranteed by government entities or government sponsored entities. The Company does not intend to sell the securities in an unrealized loss position and believes it is not likely it will be required to sell these investments prior to a market price recovery or maturity.

There were no OTTI losses during the three and nine months ended September 30, 2019 and 2018.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The amortized cost and estimated fair value of investment securities by contractual maturity are shown in the following tables at the dates indicated. Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties; therefore, these securities are shown separately.



	September 30, 2019
	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
	(In thousands)
Mortgage-backed securities:
Due within one year	$	—	$	—	$	—	$	—
Due after one through five years	7,082		7,149		354		358
Due after five through ten years	11,071		11,089		1,597		1,583
Due after ten years	120,068		120,739		28,519		29,857

Total mortgage-backed securities	138,221		138,977		30,470		31,798

All other investment securities:
Due within one year	—		—		—		—
Due after one through five years	—		—		1,094		1,112
Due after five through ten years	44,838		44,367		6,085		6,125
Due after ten years	69,012		67,852		—		—

Total all other investment securities	113,850		112,219		7,179		7,237

Total investment securities	$	252,071	$	251,196	$	37,649	$	39,035



	December 31, 2018
	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
	(In thousands)
Mortgage-backed securities:
Due within one year	$	—	$	—	$	—	$	—
Due after one through five years	7,204		7,089		578		569
Due after five through ten years	11,862		11,637		2,035		1,978
Due after ten years	139,092		135,339		28,669		28,180

Total mortgage-backed securities	158,158		154,065		31,282		30,727

All other investment securities:
Due within one year	—		—		—		—
Due after one through five years	—		—		734		741
Due after five through ten years	19,564		19,362		6,728		6,743
Due after ten years	91,262		89,540		4,759		4,779

Total all other investment securities	110,826		108,902		12,221		12,263

Total investment securities	$	268,984	$	262,967	$	43,503	$	42,990

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Sales of securities available-for-sale for the periods shown are summarized as follows:



	Three Months Ended September 30,					Nine Months Ended September 30,
	2019		2018			2019		2018
	(In thousands)
Proceeds from sales	$	—	$	1,979		$	3,558	$	56,683
Gross realized gains	—		—			57		233
Gross realized losses	—		(58		)	—		(183		)

During the nine months ended September 30, 2018, the Bank sold certain held to maturity investments that had substantially reached maturity, allowing us to sell the securities without tainting the remaining held to maturity securities portfolio. The held-to-maturity designation of the remaining securities is unchanged. Gross proceeds on the sale of these securities totaled $2.7 million with gross realized gains and losses of $32,000 and $5,000, respectively.

Note 3 - Loans Receivable

Loans receivable consisted of the following at the dates indicated:



	September 30, 2019			December 31, 2018
	(In thousands)
Real Estate:
One-to-four family	$	302,337		$	336,178
Multi-family	62,173			82,331
Commercial real estate	254,058			253,235
Construction and land	64,954			54,102
Total real estate loans	683,522			725,846

Consumer:
Home equity	36,898			37,629
Auto and other consumer	111,312			87,357
Total consumer loans	148,210			124,986

Commercial business loans	14,325			18,898

Total loans	846,057			869,730

Less:
Net deferred loan fees	117			292
Premium on purchased loans, net	(4,649		)	(3,947		)
Allowance for loan losses	9,443			9,533

Total loans receivable, net	$	841,146		$	863,852

Allowance for Loan Losses. The Company maintains a general allowance for loan losses based on evaluating known and inherent risks in the loan portfolio, including management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. The reserve is an estimate based upon factors and trends identified by management at the time the financial statements are prepared.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables summarize changes in the ALLL and loan portfolio by segment and impairment method for the periods shown:



	At or For the Three Months Ended September 30, 2019
	One-to- four family			Multi-family			Commercial real estate		Construction and land		Home equity			Auto and other consumer			Commercial business			Unallocated			Total
	(In thousands)
ALLL:
Beginning balance	$	3,417		$	651		$	2,357	$	711	$	465		$	1,790		$	171		$	169		$	9,731
(Recapture of) provision for loan losses	(307		)	(64		)	47		16		(30		)	192			(13		)	(11		)	(170		)
Charge-offs	—			—			—		—		—			(237		)	1			—			(236		)
Recoveries	1			—			—		1		23			93			—			—			118
Ending balance	$	3,111		$	587		$	2,404	$	728	$	458		$	1,838		$	159		$	158		$	9,443



	At or For the Nine Months Ended September 30, 2019
	One-to- four family			Multi-family			Commercial real estate		Construction and land		Home equity			Auto and other consumer			Commercial business			Unallocated			Total
	(In thousands)
ALLL:
Beginning balance	$	3,297		$	762		$	2,289	$	585	$	480		$	1,611		$	334		$	175		$	9,533
Provision for loan losses	(190		)	(175		)	115		142		(66		)	785			(174		)	(17		)	420
Charge-offs	—			—			—		—		—			(785		)	(3		)	—			(788		)
Recoveries	4			—			—		1		44			227			2			—			278
Ending balance	$	3,111		$	587		$	2,404	$	728	$	458		$	1,838		$	159		$	158		$	9,443



	At September 30, 2019
	One-to- four family		Multi-family		Commercial real estate		Construction and land		Home equity		Auto and other consumer		Commercial business		Unallocated		Total
	(In thousands)
Total ALLL	$	3,111	$	587	$	2,404	$	728	$	458	$	1,838	$	159	$	158	$	9,443
General reserve	3,080		586		2,394		728		454		1,735		153		158		9,288
Specific reserve	31		1		10		—		4		103		6		—		155

Total loans	$	302,337	$	62,173	$	254,058	$	64,954	$	36,898	$	111,312	$	14,325	$	—	$	846,057
Loans collectively evaluated ⁽¹⁾	299,496		62,065		252,152		64,925		36,619		110,836		14,059		—		840,152
Loans individually evaluated ⁽²⁾	2,841		108		1,906		29		279		476		266		—		5,905


⁽¹⁾ Loans collectively evaluated for general reserves.
⁽²⁾ Loans individually evaluated for specific reserves.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



	At or For the Three Months Ended September 30, 2018
	One-to- four family			Multi-family			Commercial real estate			Construction and land		Home equity			Auto and other consumer			Commercial business			Unallocated		Total
ALLL:	(In thousands)
Beginning balance	$	3,050		$	841		$	2,160		$	514	$	642		$	1,332		$	716		$	27	$	9,282
Provision for loan losses	3			(31		)	(47		)	28		(81		)	179			(31		)	177		197
Charge-offs	(2		)	—			—			—		—			(265		)	—			—		(267		)
Recoveries	2			—			—			—		7			114			—			—		123
Ending balance	$	3,053		$	810		$	2,113		$	542	$	568		$	1,360		$	685		$	204	$	9,335



	At or For the Nine Months Ended September 30, 2018
	One-to- four family			Multi-family		Commercial real estate		Construction and land			Home equity			Auto and other consumer			Commercial business		Unallocated			Total
ALLL:	(In thousands)
Beginning balance	$	3,061		$	648	$	1,847	$	648		$	787		$	712		$	265	$	792		$	8,760
Provision for loan losses	6			162		266		(107		)	(242		)	986			419		(588		)	902
Charge-offs	(18		)	—		—		—			—			(522		)	—		—			(540		)
Recoveries	4			—		—		1			23			184			1		—			213
Ending balance	$	3,053		$	810	$	2,113	$	542		$	568		$	1,360		$	685	$	204		$	9,335



	At December 31, 2018
	One-to- four family		Multi-family		Commercial real estate		Construction and land		Home equity		Auto and other consumer		Commercial business		Unallocated		Total
	(In thousands)
Total ALLL	$	3,297	$	762	$	2,289	$	585	$	480	$	1,611	$	334	$	175	$	9,533
General reserve	3,262		761		2,281		584		474		1,552		168		175		9,257
Specific reserve	35		1		8		1		6		59		166		—		276

Total loans	$	336,178	$	82,331	$	253,235	$	54,102	$	37,629	$	87,357	$	18,898	$	—	$	869,730
Loans collectively evaluated ⁽¹⁾	333,062		82,221		251,263		54,058		37,002		87,113		18,453		—		863,172
Loans individually evaluated ⁽²⁾	3,116		110		1,972		44		627		244		445		—		6,558


⁽¹⁾ Loans collectively evaluated for general reserves.
⁽²⁾ Loans individually evaluated for specific reserves.

Impaired loans. A loan is considered impaired when First Federal has determined that it may be unable to collect payments of principal or interest when due under the contractual terms of the loan. Impairment is measured on a loan-by-loan basis for all loans in the portfolio except smaller balance homogeneous loans and certain qualifying troubled debt restructuring ("TDR") loans.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents a summary of loans individually evaluated for impairment by portfolio segment at the dates indicated:



	September 30, 2019						December 31, 2018
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
	(In thousands)
With no allowance recorded:
One-to-four family	$	235	$	270	$	—	$	306	$	339	$	—
Commercial real estate	1,256		1,332		—		1,308		1,374		—
Construction and land	—		—		—		—		1		—
Home equity	49		143		—		330		478		—
Auto and other consumer	—		360		—		—		276		—
Commercial business	—		—		—		—		3		—
Total	1,540		2,105		—		1,944		2,471		—

With an allowance recorded:
One-to-four family	2,606		2,817		31		2,810		3,085		35
Multi-family	108		108		1		110		110		1
Commercial real estate	650		650		10		664		663		8
Construction and land	29		63		—		44		71		1
Home equity	230		290		4		297		364		6
Auto and other consumer	476		622		103		244		244		59
Commercial business	266		266		6		445		445		166
Total	4,365		4,816		155		4,614		4,982		276

Total impaired loans:
One-to-four family	2,841		3,087		31		3,116		3,424		35
Multi-family	108		108		1		110		110		1
Commercial real estate	1,906		1,982		10		1,972		2,037		8
Construction and land	29		63		—		44		72		1
Home equity	279		433		4		627		842		6
Auto and other consumer	476		982		103		244		520		59
Commercial business	266		266		6		445		448		166
Total	$	5,905	$	6,921	$	155	$	6,558	$	7,453	$	276

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents a summary of loans individually evaluated for impairment by portfolio segment at the dates indicated:



	Three Months Ended				Nine Months Ended
	September 30, 2019				September 30, 2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In thousands)
With no allowance recorded:
One-to-four family	$	236	$	4	$	243	$	8
Commercial real estate	1,260		15		1,278		39
Home equity	52		14		144		30
Auto and other consumer	—		10		—		14
Commercial business	—		1		—		4
Total	1,548		44		1,665		95

With an allowance recorded:
One-to-four family	2,891		64		2,850		146
Multi-family	108		1		109		4
Commercial real estate	651		8		657		23
Construction and land	52		2		57		2
Home equity	289		6		297		14
Auto and other consumer	394		9		324		16
Commercial business	266		2		299		9
Total	4,651		92		4,593		214

Total impaired loans:
One-to-four family	3,127		68		3,093		154
Multi-family	108		1		109		4
Commercial real estate	1,911		23		1,935		62
Construction and land	52		2		57		2
Home equity	341		20		441		44
Auto and other consumer	394		19		324		30
Commercial business	266		3		299		13
Total	$	6,199	$	136	$	6,258	$	309

Interest income recognized on a cash basis on impaired loans for the three and nine months ended September 30, 2019, was $99,000 and $271,000, respectively.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the average recorded investment in loans individually evaluated for impairment and the related interest income recognized for the periods shown:



	Three Months Ended				Nine Months Ended
	September 30, 2018				September 30, 2018
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In thousands)
With no allowance recorded:
One-to-four family	$	401	$	9	$	405	$	12
Commercial real estate	1,334		13		2,148		34
Construction and land	—		—		1,658		—
Home equity	344		3		353		3
Auto and other consumer	—		7		—		11
Total	2,079		32		4,564		60

With an allowance recorded:
One-to-four family	2,978		74		3,046		156
Multi-family	112		1		113		4
Commercial real estate	708		9		763		26
Construction and land	71		5		57		6
Home equity	266		7		274		16
Auto and other consumer	76		3		98		4
Commercial business	852		14		796		50
Total	5,063		113		5,147		262

Total impaired loans:
One-to-four family	3,379		83		3,451		168
Multi-family	112		1		113		4
Commercial real estate	2,042		22		2,911		60
Construction and land	71		5		1,715		6
Home equity	610		10		627		19
Auto and other consumer	76		10		98		15
Commercial business	852		14		796		50
Total	$	7,142	$	145	$	9,711	$	322

Interest income recognized on a cash basis on impaired loans for the three and nine months ended September 30, 2018, was $101,000 and $278,000, respectively.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the recorded investment in nonaccrual loans by class of loan at the dates indicated:



	September 30, 2019		December 31, 2018
	(In thousands)
One-to-four family	$	586	$	759
Commercial real estate	116		133
Construction and land	29		44
Home equity	116		369
Auto and other consumer	475		245
Commercial business	—		173

Total nonaccrual loans	$	1,322	$	1,723

Past due loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. There were no loans past due 90 days or more and still accruing interest at September 30, 2019 and December 31, 2018.

The following table presents past due loans, net of partial loan charge-offs, by class, as of September 30, 2019:



	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans
	(In thousands)
Real Estate:
One-to-four family	$	—	$	510	$	26	$	536	$	301,801	$	302,337
Multi-family	—		—		—		—		62,173		62,173
Commercial real estate	—		—		—		—		254,058		254,058
Construction and land	—		33		—		33		64,921		64,954
Total real estate loans	—		543		26		569		682,953		683,522

Consumer:
Home equity	208		25		—		233		36,665		36,898
Auto and other consumer	1,148		496		177		1,821		109,491		111,312
Total consumer loans	1,356		521		177		2,054		146,156		148,210

Commercial business loans	—		—		—		—		14,325		14,325

Total loans	$	1,356	$	1,064	$	203	$	2,623	$	843,434	$	846,057

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents past due loans, net of partial loan charge-offs, by class, as of December 31, 2018:



	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans
	(In thousands)
Real Estate:
One-to-four family	$	289	$	176	$	164	$	629	$	335,549	$	336,178
Multi-family	—		—		—		—		82,331		82,331
Commercial real estate	—		—		—		—		253,235		253,235
Construction and land	35		14		31		80		54,022		54,102
Total real estate loans	324		190		195		709		725,137		725,846

Consumer:
Home equity	97		30		9		136		37,493		37,629
Auto and other consumer	471		92		—		563		86,794		87,357
Total consumer loans	568		122		9		699		124,287		124,986

Commercial business loans	923		—		—		923		17,975		18,898

Total loans	$	1,815	$	312	$	204	$	2,331	$	867,399	$	869,730

Credit quality indicator. Federal regulations provide for the classification of lower quality loans and other assets, such as debt and equity securities, as substandard, doubtful, or loss; risk ratings 6, 7, and 8 in our 8-point risk rating system, respectively. An asset is considered substandard if it is inadequately protected by the current net worth and pay capacity of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that First Federal will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions, and values. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

When First Federal classifies problem assets as either substandard or doubtful, it may establish a specific allowance to address the risk specifically or allow the loss to be addressed in the general allowance. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities but that, unlike specific allowances, have not been specifically allocated to particular problem assets. When an insured institution classifies problem assets as a loss, it is required to charge off such assets in the period in which they are deemed uncollectible. Assets that do not currently expose First Federal to sufficient risk to warrant classification as substandard or doubtful but do possess identified weaknesses are designated as either watch or special mention assets; risk ratings 4 and 5 in our risk rating system, respectively. Loans not otherwise classified are considered pass graded loans and are rated 1-3 in our risk rating system.

Additionally, First Federal categorizes loans as performing or nonperforming based on payment activity. Loans that are more than 90 days past due and nonaccrual loans are considered nonperforming.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table represents the internally assigned grade as of September 30, 2019, by class of loans:



	Pass		Watch		Special Mention		Substandard		Total
	(In thousands)
Real Estate:
One-to-four family	$	297,192	$	2,913	$	1,142	$	1,090	$	302,337
Multi-family	61,767		—		406		—		62,173
Commercial real estate	246,300		3,447		2,999		1,312		254,058
Construction and land	63,272		1,541		112		29		64,954
Total real estate loans	668,531		7,901		4,659		2,431		683,522

Consumer:
Home equity	36,055		536		27		280		36,898
Auto and other consumer	107,432		2,721		598		561		111,312
Total consumer loans	143,487		3,257		625		841		148,210

Commercial business loans	12,356		354		266		1,349		14,325

Total loans	$	824,374	$	11,512	$	5,550	$	4,621	$	846,057

The following table represents the internally assigned grade as of December 31, 2018, by class of loans:



	Pass		Watch		Special Mention		Substandard		Total
	(In thousands)
Real Estate:
One-to-four family	$	330,476	$	3,767	$	957	$	978	$	336,178
Multi-family	82,221		—		110		—		82,331
Commercial real estate	244,919		6,281		663		1,372		253,235
Construction and land	51,480		2,578		—		44		54,102
Total real estate loans	709,096		12,626		1,730		2,394		725,846

Consumer:
Home equity	36,559		465		123		482		37,629
Auto and other consumer	85,579		1,310		151		317		87,357
Total consumer loans	122,138		1,775		274		799		124,986

Commercial business loans	16,520		1,733		472		173		18,898

Total loans	$	847,754	$	16,134	$	2,476	$	3,366	$	869,730

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table represents the credit risk profile based on payment activity as of September 30, 2019, by class of loans:



	Nonperforming		Performing		Total
	(In thousands)
Real Estate:
One-to-four family	$	586	$	301,751	$	302,337
Multi-family	—		62,173		62,173
Commercial real estate	116		253,942		254,058
Construction and land	29		64,925		64,954

Consumer:
Home equity	116		36,782		36,898
Auto and other consumer	475		110,837		111,312

Commercial business	—		14,325		14,325

Total loans	$	1,322	$	844,735	$	846,057

The following table represents the credit risk profile based on payment activity as of December 31, 2018, by class of loans:



	Nonperforming		Performing		Total
	(In thousands)
Real Estate:
One-to-four family	$	759	$	335,419	$	336,178
Multi-family	—		82,331		82,331
Commercial real estate	133		253,102		253,235
Construction and land	44		54,058		54,102

Consumer:
Home equity	369		37,260		37,629
Auto and other consumer	245		87,112		87,357

Commercial business	173		18,725		18,898

Total loans	$	1,723	$	868,007	$	869,730

Troubled debt restructuring. A TDR is a loan to a borrower who is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that First Federal is granting the borrower a concession of some kind. First Federal has granted a variety of concessions to borrowers in the form of loan modifications. The modifications are generally related to the loan's interest rate, term and payment amount or a combination thereof.

The following table is a summary of information pertaining to TDR loans included in impaired loans at the dates indicated:



	September 30, 2019		December 31, 2018
	(In thousands)
Total TDR loans	$	3,576	$	3,745
Allowance for loan losses related to TDR loans	45		43
Total nonaccrual TDR loans	133		84

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

There were no newly restructured and renewals or modifications of existing TDR loans that occurred during the three months ended September 30, 2019.

The following table presents newly restructured and renewals or modifications of existing TDR loans by class that occurred during the nine months ended September 30, 2019, by type of concession granted.



	Number of Contracts	Rate Modification		Term Modification		Combination Modification		Total Modifications
		(Dollars in thousands)
Pre-modification outstanding recorded investment
One- to four-family	1	$	—	$	50	$	—	$	50

Post-modification outstanding recorded investment
One- to four-family	1	$	—	$	51	$	—	$	51

The following is a summary of TDR loans which incurred a payment default within 12 months of the restructure date during the nine months ended September 30, 2019.



	Number of Contracts	Rate Modification		Term Modification		Combination Modification		Total Modifications
		(Dollars in thousands)
TDR loans that subsequently defaulted
One- to four-family	1	$	—	$	—	$	48	$	48

The following table presents newly restructured and renewals or modifications of existing TDR loans by class that occurred during the three months ended September 30, 2018, by type of concession granted.



	Number of Contracts	Rate Modification		Term Modification		Combination Modification		Total Modifications
		(Dollars in thousands)
Pre-modification outstanding recorded investment
One- to four-family	1	$	—	$	—	$	49	$	49

Post-modification outstanding recorded investment
One- to four-family	1	$	—	$	—	$	47	$	47

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents newly restructured and renewals or modifications of existing TDR loans by class that occurred during the nine months ended September 30, 2018, by type of concession granted.



	Number of Contracts	Rate Modification		Term Modification		Combination Modification		Total Modifications
		(Dollars in thousands)
Pre-modification outstanding recorded investment
One- to four-family	3	$	—	$	—	$	229	$	229

Post-modification outstanding recorded investment
One- to four-family	3	$	—	$	—	$	260	$	260

There were no TDR loans which incurred a payment default within 12 months of the restructure date during the three and nine months ended September 30, 2018.

No additional funds were committed to be advanced in connection with impaired loans at September 30, 2019.

The following table presents TDR loans by class at the dates indicated by accrual and nonaccrual status.



	September 30, 2019						December 31, 2018
	Accrual		Nonaccrual		Total		Accrual		Nonaccrual		Total
	(In thousands)
One-to-four family	$	2,255	$	133	$	2,388	$	2,358	$	84	$	2,442
Multi-family	108		—		108		110		—		110
Commercial real estate	650		—		650		663		—		663
Home equity	164		—		164		258		—		258
Commercial business	266		—		266		272		—		272

Total TDR loans	$	3,443	$	133	$	3,576	$	3,661	$	84	$	3,745

Note 4 - Deposits

The aggregate amount of time deposits in excess of the Federal Deposit Insurance Corporation ("FDIC") insured limit, currently $250,000, at September 30, 2019 and December 31, 2018, was $85.6 million and $107.0 million, respectively. Deposits and weighted-average interest rates at the dates indicated are as follows:



	September 30, 2019			December 31, 2018
	Amount		Weighted-Average Interest Rate	Amount		Weighted-Average Interest Rate
	(Dollars in thousands)
Savings	$	173,786	0.96%	$	143,412	0.74%
Transaction accounts	274,660		0.03%	262,152		0.05%
Money market accounts	243,189		0.44%	273,344		0.43%
Certificates of deposit	279,065		2.02%	261,352		1.86%

	$	970,700	0.87%	$	940,260	0.77%

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Maturities of certificates at the dates indicated are as follows:



	September 30, 2019		December 31, 2018
	(In thousands)
Within one year or less	$	214,390	$	148,119
After one year through two years	40,622		78,966
After two years through three years	11,053		20,934
After three years through four years	5,232		6,759
After four years through five years	7,768		6,574
After five years	—		—

	$	279,065	$	261,352

Brokered certificates of deposits of $37.2 million are included in the September 30, 2019, certificate of deposits total.

Deposits at September 30, 2019 and December 31, 2018, included $54.8 million and $80.0 million, respectively, in public fund deposits. Investment securities with a carrying value of $42.2 million and $47.6 million were pledged as collateral for these deposits at September 30, 2019 and December 31, 2018, respectively. This exceeds the minimum collateral requirements established by the Washington Public Deposit Protection Commission.

Interest on deposits by type for the periods shown was as follows:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
	(In thousands)
Savings	$	397	$	104	$	1,085	$	148
Transaction accounts	26		25		98		38
Insured money market accounts	312		317		945		814
Certificates of deposit	1,406		1,052		4,005		2,608

	$	2,141	$	1,498	$	6,133	$	3,608

Note 5 - Federal Taxes on Income

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

Under current Federal income tax regulations, charitable contribution deductions are limited to 10% of taxable income. Due to this limitation, the Company currently has a valuation allowance of $1.2 million for financial statement reporting purposes related to its contribution to the Foundation. The contribution carryforward and related valuation allowance will expire in 2020. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company evaluates whether its deferred tax assets will be realized and adjusts the amount of its valuation allowance, if necessary.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Effective January 1, 2018, the corporate U.S. statutory federal income tax rate was reduced from 35% to 21% under the Tax Cuts and Jobs Act. The Company completed its accounting under ASC 740 in December 2017 for all material deferred tax assets and liabilities with provisional amounts recorded for immaterial items.

The effective tax rates were 18.9% and 18.6% for the nine months ended September 30, 2019 and 2018, respectively. The effective tax rates differ from the statutory maximum federal tax rate for 2019 and 2018 of 21%, largely due to the nontaxable earnings on bank owned life insurance and tax-exempt interest income earned on certain investment securities and loans.

Note 6 - Earnings per Share

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. In addition, nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are considered participating securities and are included in the computation of earnings per share.

The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the three and nine months ended September 30, 2019 and 2018.



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
	(In thousands, except share data)
Numerator:
Net income	$	2,510	$	1,926	$	6,796	$	4,975

Denominator:
Basic weighted average common shares outstanding	9,854,973		10,324,048		9,930,069		10,447,231
Dilutive restricted stock grants	48,368		73,556		76,738		48,884
Diluted weighted average common shares outstanding	9,903,341		10,397,604		10,006,807		10,496,115

Basic earnings per share	$	0.25	$	0.19	$	0.68	$	0.48

Diluted earnings per share	$	0.25	$	0.19	$	0.68	$	0.47

Unallocated ESOP shares are not included as outstanding for either basic or diluted earnings per share calculations. As of September 30, 2019 and 2018, there were 807,299 and 860,224 shares in the ESOP that remain unallocated, respectively.

Potential dilutive shares are excluded from the computation of EPS if their effect is anti-dilutive. There were 5,248 and 916 restricted stock award anti-dilutive weighted-average shares for the three months ended September 30, 2019 and 2018, respectively. There were 17,344 and 0 restricted stock award anti-dilutive weighted-average shares for the nine months ended September 30, 2019 and 2018, respectively.

Note 7 - Employee Benefits

Employee Stock Ownership Plan

In connection with the Conversion, the Company established an ESOP for eligible employees of the Company and the Bank. Employees of the Company and the Bank who have been credited with at least 1,000 hours of service during a 12-month period are eligible to participate in the ESOP.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Pursuant to the Plan, the ESOP purchased shares in the open market with funds borrowed from First Northwest. The Bank will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable to First Northwest over a period of 20 years, bearing estimated interest at 2.46%. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Bank's discretionary contributions to the ESOP and earnings on the ESOP assets. An annual principal and interest payment of $835,000 was made by the ESOP during the nine months ended September 30, 2019.

As shares are committed to be released from collateral, the Company reports compensation expense equal to the average daily market prices of the shares and the shares become outstanding for EPS computations. The compensation expense is accrued monthly throughout the year. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest.

Compensation expense related to the ESOP for the three months ended September 30, 2019 and 2018, was $185,000 and $214,000, respectively. For the nine months ended September 30, 2019 and 2018 compensation expense related to the ESOP was $512,000 and $651,000, respectively.

Shares issued to the ESOP as of the dates indicated are as follows:



	September 30, 2019		December 31, 2018
	(Dollars in thousands)
Allocated shares	227,473		174,584
Committed to be released shares	13,257		26,442
Unallocated shares	807,299		847,003

Total ESOP shares issued	1,048,029		1,048,029

Fair value of unallocated shares	$	13,982	$	12,561

Note 8 - Stock-based Compensation

On November 16, 2015, the Company's shareholders approved the First Northwest Bancorp 2015 Equity Incentive Plan (the "2015 EIP"), which provides for the grant of incentive stock options, non-qualified stock options, restricted stock and restricted stock units to eligible participants. The cost of awards under the 2015 EIP generally is based on the fair value of the awards on their grant date. The maximum number of shares that may be utilized for awards under the 2015 EIP is 1,834,050. The 2015 EIP provides for the use of authorized but unissued shares or shares that have been reacquired by First Northwest to fund share-based awards. At September 30, 2019, there were 1,293,150 total shares available for grant under the 2015 EIP, including 52,614 shares available to be granted as restricted stock.

During the three and nine months ended September 30, 2019, 23,400 shares of restricted stock were awarded and no stock options were granted. There were 20,000 shares of restricted stock awarded during the three and nine months ended September 30, 2018. Awarded shares of restricted stock vest ratably over five years from the date of grant as long as the eligible participant remains in service to the Company. The Company recognizes compensation expense for the restricted stock awards based on the fair value of the shares at the grant date amortized over five years.

For the three months ended September 30, 2019 and 2018, total compensation expense for the 2015 EIP was $251,000 and $256,000, respectively. For the nine months ended September 30, 2019 and 2018, total compensation expense for the 2015 EIP was $804,000 and $788,000, respectively.

Included in the above compensation expense for the three months ended September 30, 2019 and 2018, was directors' compensation of $86,000 and $86,000, respectively. For the nine months ended September 30, 2019 and 2018, directors' compensation was $256,000 and $256,000, respectively.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables provide a summary of changes in non-vested restricted stock awards for the periods shown:



	For the Three Months Ended
	September 30, 2019
	Shares		Weighted-Average Grant Date Fair Value
Non-vested at July 1, 2019	286,600		$	13.69
Granted	23,400		16.27
Vested	(58,951	)	13.24
Canceled (1)	(16,249	)	13.24

Non-vested at September 30, 2019	234,800		14.08

(1) A surrender of vested stock awards by a participant surrendering the number of shares valued at the current stock price at the vesting date to cover the total cost of the vested shares. The surrendered shares are canceled and are unavailable for reissue.



	For the Nine Months Ended
	September 30, 2019
	Shares		Weighted-Average Grant Date Fair Value
Non-vested at January 1, 2019	290,600		$	13.72
Granted	23,400		16.27
Vested	(58,951	)	13.24
Canceled (1)	(16,249	)	13.24
Forfeited	(4,000	)	16.07

Non-vested at September 30, 2019	234,800		14.08

(1) A surrender of vested stock awards by a participant surrendering the number of shares valued at the current stock price at the vesting date to cover the total cost of the vested shares. The surrendered shares are canceled and are unavailable for reissue.

As of September 30, 2019, there was $2.9 million of total unrecognized compensation cost related to non-vested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of approximately 2.89 years.

Note 9 - Fair Value Accounting and Measurement

Fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants in the Company’s principal market. The Company has established and documented its process for determining the fair values of its assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, management determines the fair value of the Company’s assets and liabilities using valuation models or third-party pricing services, both of which rely on market-based parameters when available, such as interest rate yield curves, option volatilities and credit spreads, or unobservable inputs. Unobservable inputs may be based on management’s judgment, assumptions, and estimates related to credit quality, liquidity, interest rates, and other relevant inputs.

Any changes to valuation methodologies are reviewed by management to ensure they are relevant and justified. Valuation methodologies are refined as more market-based data becomes available.

A three-level valuation hierarchy is used in determining fair value that is based on the transparency of the inputs used in the valuation process. The inputs used in determining fair value in each of the three levels of the hierarchy are as follows:

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 - Either: (i) quoted prices for similar assets or liabilities; (ii) observable inputs, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data.

Level 3 - Unobservable inputs.

The hierarchy gives the highest ranking to Level 1 inputs and the lowest ranking to Level 3 inputs. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the overall fair value measurement.

Qualitative disclosures of valuation techniques - Securities available for sale: where quoted prices are available in an active market, securities are classified as Level 1. Level 1 instruments include highly liquid government bonds, securities issued by the U.S. Treasury, and exchange-traded equity securities.

If quoted prices are not available, management determines fair value using pricing models, quoted prices of similar securities, which are considered Level 2, or discounted cash flows. In certain cases, where there is limited activity in the market for a particular instrument, assumptions must be made to determine their fair value. Such instruments are classified as Level 3.

Assets and liabilities measured at fair value on a recurring basis - Assets and liabilities are considered to be valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly, or quarterly). The following tables show the Company’s assets measured at fair value on a recurring basis at the dates indicated:



	September 30, 2019
	Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
	(In thousands)
Securities available-for-sale
Municipal bonds	$	—	$	10,406	$	—	$	10,406
ABS agency	—		25,266		—		25,266
ABS corporate	—		37,096		—		37,096
Corporate debt	—		9,636		—		9,636
SBA	—		29,815		—		29,815
MBS agency	—		129,726		—		129,726
MBS corporate	—		9,251		—		9,251
	$	—	$	251,196	$	—	$	251,196

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



	December 31, 2018
	Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
	(In thousands)
Securities available-for-sale
Municipal bonds	$	—	$	869	$	—	$	869
ABS agency	—		25,752		—		25,752
ABS corporate	—		36,723		—		36,723
Corporate debt	—		9,888		—		9,888
SBA	—		35,670		—		35,670
MBS agency	—		143,455		—		143,455
MBS corporate	—		10,610		—		10,610
	$	—	$	262,967	$	—	$	262,967

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

The following tables present the Company’s assets measured at fair value on a nonrecurring basis at the dates indicated:



	September 30, 2019
	Level 1		Level 2		Level 3		Total
	(In thousands)
Impaired loans	$	—	$	—	$	5,905	$	5,905


	December 31, 2018
	Level 1		Level 2		Level 3		Total
	(In thousands)
Impaired loans	$	—	$	—	$	6,558	$	6,558

At September 30, 2019 and December 31, 2018, there were no impaired loans with discounts to appraisal disposition value or other unobservable inputs.

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables present the carrying value and estimated fair value of financial instruments at the dates indicated:



	September 30, 2019
	Carrying Amount		Estimated Fair Value		Fair Value Measurements Using:
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial assets
Cash and cash equivalents	$	56,481	$	56,481	$	56,481	$	—	$	—
Investment securities available for sale	251,196		251,196		—		251,196		—
Investment securities held to maturity	37,649		39,035		—		39,035		—
Loans held for sale	2,055		2,055		—		2,055		—
Loans receivable, net	841,146		818,269		—		—		818,269
FHLB stock	4,931		4,931		—		4,931		—
Accrued interest receivable	3,726		3,726		—		3,726		—
Mortgage servicing rights, net	926		1,771		—		—		1,771

Financial liabilities
Demand deposits	$	691,635	$	691,635	$	691,635	$	—	$	—
Time deposits	279,065		279,762		—		279,762		—
Borrowings	85,324		85,623		—		85,623		—
Accrued interest payable	262		262		—		262		—



	December 31, 2018
	Carrying Amount		Estimated Fair Value		Fair Value Measurements Using:
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial assets
Cash and cash equivalents	$	26,323	$	26,323	$	26,323	$	—	$	—
Investment securities available for sale	262,967		262,967		—		262,967		—
Investment securities held to maturity	43,503		42,990		—		42,990		—
Loans receivable, net	863,852		840,861		—		—		840,861
FHLB stock	6,927		6,927		—		6,927		—
Accrued interest receivable	4,048		4,048		—		4,048		—
Mortgage servicing rights, net	1,044		1,479		—		—		1,479

Financial liabilities
Demand deposits	$	678,908	$	678,908	$	678,908	$	—	$	—
Time deposits	261,352		259,549		—		259,549		—
Borrowings	136,552		137,153		—		137,153		—
Accrued interest payable	521		521		—		521		—

Financial assets and liabilities other than investment securities are not traded in active markets. Estimated fair values require subjective judgments and are approximate. The estimates of fair value in the previous table are not necessarily representative of amounts that could be realized in actual market transactions, or of the underlying value of the Company. The methods and assumptions used by the Company in estimating fair values of financial instruments as set forth below in accordance with ASC Topic 825, Financial Instruments, as amended by ASU 2016-01 requiring public entities to use the exit price notion effective January 1, 2018, are as follows:

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Securities - Fair values for investment securities are primarily measured using information from a third-party pricing service. The pricing service uses pricing models based on market data. In the event that limited or less transparent information is provided by the third-party pricing service, fair value is estimated using secondary pricing services or non-binding third-party broker quotes.

Loans receivable, net - At September 30, 2019, the fair value of loans is estimated by discounting the future cash flows using the current rate at which similar loans and leases would be made to borrowers with similar credit and for the same remaining maturities. Additionally, to be consistent with the requirements under FASB ASC Topic 820 for Fair Value Measurements and Disclosures, the loans were valued at a price that represents the Company’s exit price or the price at which these instruments would be sold or transferred.

Mortgage servicing rights, net - The estimated fair value of mortgage servicing rights is based on market prices for comparable mortgage servicing contracts when available. If no comparable contract is available, the estimated fair value is based on a valuation model that calculates the present value of estimated future net servicing income.

Note 10 - Noninterest Income

On January 1, 2018, the Company adopted the amendments of ASU 2014-09 Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The Company has included the following table regarding the Company’s noninterest income for the periods presented.



	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2019		2018			2019		2018
	(In thousands)
Noninterest income:
Loan fees (1)	$	248	$	223		$	969	$	480
Deposit fees	454		433			1,364		1,194
Debit interchange income	41		33			90		102
Credit card interchange income	466		456			1,325		1,309
Investment securities gain (loss), net (1)	—		(58		)	57		77
Gain on loan sales, net (1)	655		139			830		456
Increase in cash surrender value of BOLI (1)	147		150			435		448
Other income:
Investment services revenue	47		20			155		177
Gain or loss on subsidiary (1)	18		18			50		50
Remaining other income	5		6			20		14
Total other income	70		44			225		241

Total noninterest income	$	2,081	$	1,420		$	5,295	$	4,307

(1) Not within scope of Topic 606

The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of the new revenue guidance.

Deposit fees - The Company earns fees from its deposit customers for account maintenance, transaction-based activity and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposit accounts are charged to deposit customers for specific services

FIRST NORTHWEST BANCORP AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

Debit interchange income - Debit and Automated Teller Machine ("ATM") interchange income represent fees earned when a debit card issued by the Company is used. The Company earns interchange fees from debit cardholder transactions through card networks. In addition, the Company earns interchange fees for use of its ATM by customers of other banking institutions. Interchange fees are based on purchase volumes and other factors and are recognized as transactions occur. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholder's debit card. Certain expenses directly associated with the credit and debit card are netted against interchange income.

Credit card interchange income- Credit card interchange income represents fees earned when a credit card issued by the Bank through a third-party vendor is used. Similar to the debit card interchange, the Bank earns an interchange fee for each transaction made with a Bank-branded credit card. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholder's credit card. Certain expenses directly related to the credit card interchange contract are netted against interchange income.

Investment services revenue - Commissions received on the sale of investment related products is determined by a percentage of underlying instruments sold and is recognized when the sale is finalized.

Sale of other real estate owned (OREO) - Gains/losses on the sale of OREO are included in non-interest expense and are generally recognized when the performance obligation is complete. This is typically at delivery of control over the property to the buyer at time of each real estate closing.

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. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by the use of words such as “believes,” “expects,” “anticipates,” “estimates” or similar expressions. Forward‑looking statements include, but are not limited to:


•	statements of our goals, intentions and expectations;


•	statements regarding our business plans, prospects, growth and operating strategies;


•	statements regarding the quality of our loan and investment portfolios; and


•	estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:


•	changes in general economic conditions, either nationally or in our market area, that are worse than expected;


•	the credit risks of our lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;


•	fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;


•	a decrease in the secondary market demand for loans that we originate for sale;


•	management’s assumptions in determining the adequacy of the allowance for loan losses;


•	our ability to control operating costs and expenses;


•	whether our management team can implement our operational strategy, including but not limited to our loan growth;


•	our ability to successfully execute on merger and/or acquisition strategies and integrate any newly acquired assets, liabilities, customers, systems, and management personnel into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;


•	staffing needs and associated expenses in response to product demand or the implementation of corporate strategies, including our growth strategies related to the home lending center and new branches;


•	the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;


•	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;


•	increased competitive pressures among financial services companies;


•	our ability to attract and retain deposits;


•	our ability to retain key members of our senior management team;


•	changes in consumer spending, borrowing and savings habits;


•	our ability to successfully manage our growth in compliance with regulatory requirements;


•	results of examinations of us by the Washington State Department of Financial Institutions, Department of Banks, the Federal Deposit Insurance Corporation, the Federal Reserve Bank of San Francisco, or other regulatory authorities, which could result in restrictions that may adversely affect our liquidity and earnings;


•	changes in accounting policies and practices, as may be adopted by the financial institutions regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;


•	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;


•	inability of key third-party vendors to perform their obligations to us; and


•	other economic, competitive, governmental, regulatory and technical factors affecting our operations, pricing, products and services and other risks described elsewhere in our filings with the Securities and Exchange Commission, including this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2018.

These developments could have an adverse impact on our financial position and our results of operations.

Any of the forward looking statements that we make in this report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.

General

First Northwest Bancorp (the "Company") is a bank holding company which primarily engages in the business activity of its subsidiary, First Federal Savings and Loan Association of Port Angeles ("First Federal" or the "Bank"). First Federal is a community-oriented financial institution serving Western Washington. Our thirteen locations include ten full-service banking offices, two locations primarily serving our customers through the use of Interactive Teller Machines ("ITM"), and a Lending Center which has been focused on the origination of loans secured by one- to four-family residential properties and that we intend to expand to include a commercial lending team. Our business and operating strategy is focused on diversifying our loan portfolio through geographic expansion and loan product mix, expanding our deposit product offerings by upgrading existing services and use of technology, and enhancing our infrastructure to support our changing lending and deposit capabilities in order to meet the changing needs and expectations of our customers.

We offer a wide range of products and services focused on the lending and depository needs of the communities we serve. While we have a large concentration of first lien one- to four-family mortgage loans, we have increased our origination of commercial real estate, multi-family real estate, and construction loans, as well as engaging in indirect auto lending and auto loan purchase programs, in order to diversify our portfolio and increase interest income. We continue to originate one- to four-family residential mortgage loans and may sell loans into the secondary market to increase noninterest income and manage our interest rate risk, or we may retain loans in our portfolio to enhance interest income. We offer traditional consumer and business deposit products, including transaction accounts, savings and money market accounts and certificates of deposit for individuals, businesses and nonprofit organizations. Deposits are our primary source of funds for our lending and investing activities.

First Federal is impacted by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions. Deposit flows are influenced by a number of factors, including interest rates paid on competing deposits, available alternative investments, account maturities, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles.

Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest earned on our loans and investments and interest expense paid on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. A secondary source of income is noninterest income, which includes revenue we receive from providing products and services, including service charges on deposit accounts, mortgage banking income, earnings from bank-owned life insurance, and gains and losses from sales of securities.

An offset to net interest income is the provision for loan losses, which represents the periodic charge to operations which is required to adequately provide for probable losses inherent in our loan portfolio. As a loan's risk rating improves, property values increase, or recoveries of amounts previously charged off are received, a recapture of previously recognized provision for loan losses may be added to net interest income.

The noninterest expenses we incur in operating our business consist of salaries and employee benefits and expenses, occupancy and equipment expenses, federal deposit insurance premiums and regulatory assessments, data processing expenses, expenses related to real estate and personal property owned and other miscellaneous expenses.

Critical Accounting Policies

There are no material changes to the critical accounting policies as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2018.

Comparison of Financial Condition at September 30, 2019 and December 31, 2018

Assets. Total assets declined to $1.25 billion at September 30, 2019 from $1.26 billion at December 31, 2018.

Total loans, excluding loans held for sale, decreased $23.7 million to $846.1 million at September 30, 2019, from $869.7 million at December 31, 2018. During the nine months ended September 30, 2019, one- to four family residential loans declined $33.8 million, due to the sale of a $28.5 million pool of loan sales combined with repayment and other sale activity exceeding new originations held in portfolio. Multi-family loans decreased $20.2 million, mainly due to prepayment activity outpacing new loan originations, while the balance of commercial real estate loans stayed relatively stable. Auto and other consumer and construction and land loans increased $24.0 million and $10.9 million, respectively, as we continued to grow our specialty auto loan portfolio and construction lending business. Strong competition for quality commercial credits remains, and an increase in refinance activity of one- to-four family residential loans was observed during the period.

Construction and land loans increased 20.1% to $65.0 million at September 30, 2019, from $54.1 million at December 31, 2018. The majority of our construction loans are geographically dispersed throughout the Puget Sound region and, as a result, these loans are susceptible to risks that may be different depending on the location of the project. We manage our construction lending by utilizing a licensed third-party vendor to assist us in monitoring our construction projects and intend to begin utilizing internal staffing to monitor certain projects, which we expect will enhance fee income related to these loans.

We monitor real estate values and general economic conditions in our market areas, in addition to assessing the strength of our borrowers, in order to prudently underwrite construction loans. We have seen a slowing of construction lending, which has resulted in a decline in construction commitments. While we continue to focus on construction loan origination activity, we may see a decline in outstanding construction loan balances over time if we are unable to source quality construction loans to replace completed projects. We continually assess our lending strategies across all product lines and markets within which we do business in order to improve our earnings potential over time while also prudently managing credit risk. We also intend to evaluate opportunities to grow loans through wholesale channels in order to supplement our organic originations and improve net interest income.

The following tables show our construction commitments by type and geographic concentrations at the dates indicated:



September 30, 2019		North Olympic Peninsula ⁽¹⁾		Puget Sound Region ⁽²⁾		Other Washington		Total
		(In thousands)
Construction Commitment
	One- to four-family residential	$	12,411	$	21,691	$	406	$	34,508
	Multi-family residential	—		42,769		—		42,769
	Commercial real estate	6,127		10,536		—		16,663
	Total commitment	$	18,538	$	74,996	$	406	$	93,940

Construction Funds Disbursed
	One- to four-family residential	$	5,282	$	9,071	$	101	$	14,454
	Multi-family residential	—		29,898		—		29,898
	Commercial real estate	1,619		9,302		—		10,921
	Total disbursed	$	6,901	$	48,271	$	101	$	55,273

Undisbursed Commitment
	One- to four-family residential	$	7,129	$	12,620	$	305	$	20,054
	Multi-family residential	—		12,871		—		12,871
	Commercial real estate	4,508		1,234		—		5,742
	Total undisbursed	$	11,637	$	26,725	$	305	$	38,667

Land Funds Disbursed
	One- to four-family residential	$	5,478	$	2,801	$	—	$	8,279
	Commercial real estate	1,122		280		—		1,402
	Total disbursed for land	$	6,600	$	3,081	$	—	$	9,681

(1) Includes Clallam and Jefferson counties.
(2) Includes Kitsap, Mason, Thurston, Pierce, King, Snohomish, Skagit, Whatcom, and Island counties.



December 31, 2018		North Olympic Peninsula		Puget Sound Region		Other Washington		Total
		(In thousands)
Construction Commitment
	One- to four-family residential	$	16,814	$	18,550	$	—	$	35,364
	Multi-family residential	—		45,313		—		45,313
	Commercial real estate	1,868		20,147		—		22,015
	Total Commitment	$	18,682	$	84,010	$	—	$	102,692

Construction Funds Disbursed
	One- to four-family residential	$	8,321	$	8,998	$	—	$	17,319
	Multi-family residential	—		17,348		—		17,348
	Commercial real estate	1,584		9,424		—		11,008
	Total disbursed	$	9,905	$	35,770	$	—	$	45,675

Undisbursed Commitment
	One- to four-family residential	$	8,493	$	9,552	$	—	$	18,045
	Multi-family residential	—		27,965		—		27,965
	Commercial real estate	284		10,723		—		11,007
	Total undisbursed	$	8,777	$	48,240	$	—	$	57,017

Land Funds Disbursed
	One- to four-family residential	$	6,124	$	2,023	$	—	$	8,147
	Commercial real estate	—		280		—		280
	Total disbursed for land	$	6,124	$	2,303	$	—	$	8,427

During the nine months ended September 30, 2019, the Company originated $113.2 million of loans, of which $50.6 million, or 44.7%, were originated in the Puget Sound region of Washington, $58.8 million, or 51.9%, in the North Olympic Peninsula, and $3.9 million, or 3.4%, in other areas in Washington. The Company purchased an additional $48.4 million in loans, mainly specialty auto loans of $37.1 million, during the nine months ended September 30, 2019.

Our allowance for loan losses decreased $90,000, or 0.9%, to $9.4 million at September 30, 2019, from $9.5 million at December 31, 2018, mainly as a result of a decline in loan balances. The allowance for loan losses as a percentage of total loans remained at 1.1% at both September 30, 2019 and December 31, 2018.

Nonperforming loans decreased $401,000, or 23.3%, to $1.3 million at September 30, 2019, from $1.7 million at December 31, 2018, mainly attributable to decreases in nonperforming home equity loans of $253,000 and commercial business loans and one- to four-family loans of $173,000 each, partially offset by an increase in auto and other consumer nonperforming loans of $230,000. Nonperforming loans to total loans remained the same at 0.2% at both September 30, 2019 and December 31, 2018. The allowance for loan losses as a percentage of nonperforming loans increased to 714.3% at September 30, 2019, from 553.3% at December 31, 2018, and classified loans increased $1.3 million to $4.6 million at September 30, 2019, from $3.4 million at December 31, 2018.

At September 30, 2019, there were $3.6 million in restructured loans, of which $3.4 million were performing in accordance with their modified payment terms and returned to accrual status.

Asset quality remains strong with net loan charge-offs concentrated mainly in our auto loan portfolio. We have adjusted our indirect auto loan product offerings in an effort to improve credit quality and reduce future charge-off activity. We continue to monitor and make changes to the indirect auto loan program in order to prudently balance risk and return within the auto loan portfolio. We believe that our allowance for loan losses was adequate to absorb the known and inherent risks of loss in the loan portfolio as of September 30, 2019.

Loans receivable, excluding loans held for sale, consisted of the following at the dates indicated:



	September 30, 2019			December 31, 2018
	(In thousands)
Real Estate:
One-to-four family	$	302,337		$	336,178
Multi-family	62,173			82,331
Commercial real estate	254,058			253,235
Construction and land	64,954			54,102
Total real estate loans	683,522			725,846

Consumer:
Home equity	36,898			37,629
Auto and other consumer	111,312			87,357
Total consumer loans	148,210			124,986

Commercial business loans	14,325			18,898

Total loans	846,057			869,730
Less:
Net deferred loan fees	117			292
Premium on purchased loans, net	(4,649		)	(3,947		)
Allowance for loan losses	9,443			9,533
Loans receivable, net	$	841,146		$	863,852

The following table represents nonperforming assets at the dates indicated.



	September 30, 2019			December 31, 2018
	(In thousands)
Nonperforming loans:
Real estate loans:
One- to four-family	$	586		$	759
Commercial real estate	116			133
Construction and land	29			44

Total real estate loans	731			936

Consumer loans:
Home equity	116			369
Other	475			245

Total consumer loans	591			614

Commercial business	—			173

Total nonperforming loans	1,322			1,723

Real estate owned:
Land	69			72

Total real estate owned	69			72

Repossessed assets	59			52

Total nonperforming assets	$	1,450		$	1,847

Nonaccrual and 90 days or more past due loans as a percentage of total loans	0.2		%	0.2		%

Total investment securities decreased $17.6 million, or 5.7%, to $288.8 million at September 30, 2019, from $306.5 million at December 31, 2018, due to sales, calls, and normal repayment activity. Mortgage-backed securities represent the largest portion of our investment securities portfolio and totaled $169.4 million at September 30, 2019, or 58.7% of the investment securities portfolio, a decrease during the year of $15.9 million, or 8.6%, from $185.3 million at December 31, 2018. Other investment securities, including municipal bonds and other asset-backed securities, were $119.4 million at September 30, 2019, or 41.3% of the investment securities portfolio, a decrease of $1.7 million from $121.1 million at December 31, 2018. The investment portfolio, including mortgage-backed securities, had an estimated projected average life of 4.5 years as of September 30, 2019, and 5.0 years as of December 31, 2018, and had an estimated average repricing term of 3.2 years as of September 30, 2019, and 3.7 years as of December 31, 2018, based on the interest rate environment at those times.

The investment portfolio was comprised of 88.6% in amortizing securities at September 30, 2019 and 91.5% at December 31, 2018. As a result, the projected average life of our securities may vary due to prepayment activity, which, particularly in the mortgage-backed securities portfolio, is generally affected by changing interest rates. Management continues to focus on improving the mix of earning assets by originating loans and decreasing securities as a percentage of earning assets; however, we may purchase investment securities as a source of additional interest income and also in lieu of carrying higher cash balances at nominal interest rates. For additional information, see Note 2 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.

Liabilities. Total liabilities decreased $13.5 million to $1.07 billion at September 30, 2019, from $1.09 billion at December 31, 2018, primarily due to a decrease in borrowings of $51.3 million, partially offset by an increase in deposit accounts.

Deposit balances increased $30.4 million, or 3.2%, to $970.7 million at September 30, 2019, from $940.3 million at December 31, 2018. There was a shift in the mix of deposits with a $30.2 million decrease in money market accounts offset by a $30.4 million increase in savings accounts, which we attribute to our promotional savings product which carries a twelve-month rate guarantee that is more favorable than our money market offerings. We anticipate that robust competition for deposits with other financial institutions and financial intermediaries will continue in our markets and that we will continue to offer competitive products and pricing to defend and grow customer deposits. In addition to customer deposits, we utilized brokered certificates of deposit ("brokered CDs") as an additional funding source in order to manage our cost of funds more effectively, reduce our reliance on public funds deposits, and become more selective when competing on rate. At September 30, 2019, we had $37.2 million in brokered CDs included in our balance of certificates of deposit.

Equity. Total shareholders' equity increased $5.0 million during the year to $177.3 million at September 30, 2019, primarily the result of net income of $6.8 million and an increase in the value of our available-for-sale securities portfolio, resulting in a $4.1 million decrease in our accumulated other comprehensive loss, net of tax. These increases were partially offset by $6.0 million in repurchases of shares of common stock during the quarter.

Comparison of Results of Operations for the Three Months Ended September 30, 2019 and 2018

General. Net income increased $584,000, or 30.3%, to $2.5 million for the three months ended September 30, 2019, compared to net income of $1.9 million for the three months ended September 30, 2018.

Net Interest Income. Net interest income remained at $9.3 million for both the three months ended September 30, 2019 and 2018. The yield on average interest-earning assets increased nine basis points to 4.14% for the three months ended September 30, 2019, compared to 4.05% for the same period in the prior year. We continued to increase our concentration of loans receivable, as a percentage of interest-earning assets, which earned higher yields than investment and cash alternatives and contributed to improved overall yields on interest-earning assets.

The average cost of interest-bearing liabilities increased 22 basis points to 1.27% for the three months ended September 30, 2019, compared to 1.05% for the same period last year, due primarily to increases in the average balance and cost of deposits.

Due to the average cost of interest-bearing liabilities increasing at a faster pace than our interest-earning assets, the net interest margin decreased eight basis points to 3.17% for the three months ended September 30, 2019, from 3.25% for the same period in 2018. For additional information, see Rate/Volume Analysis contained in Item 2 of this Form 10-Q

Interest Income. Total interest income increased $540,000, or 4.7%, to $12.1 million for the three months ended September 30, 2019, from $11.6 million for the comparable period in 2018, primarily due to an increase in the average balance of, and yields earned on, loans receivable. Interest and fees on loans receivable increased $673,000, to $9.9 million for the three months ended September 30, 2019, from $9.3 million for the three months ended September 30, 2018, due primarily to an increase in the average balance of net loans receivable of $35.7 million. Average loan yields increased 12 basis points to 4.60% for the three months ended September 30, 2019 compared to the three months ended September 30, 2018, as we continued to increase our balance of higher yielding loans, including auto and consumer lending through our indirect and purchased auto loan programs.

Interest income on investment securities decreased $31,000 to $921,000 for the three months ended September 30, 2019, compared to $952,000 for the three months ended September 30, 2018, due to an $8.9 million decrease in average balance partially offset by a 14 basis point increase in average yield. The change in average yield on investment securities does not include the benefit of nontaxable income from municipal bonds. Interest income on mortgage-backed and related securities for the three months ended September 30, 2019 decreased $109,000, or 9.1%, compared to the three months ended September 30, 2018, the result of a decrease of $4.4 million in average balance and an 18 basis point decrease in average yield.

The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the periods shown:



	Three Months Ended September 30,
	2019				2018				Increase (Decrease) in Interest Income
	Average Balance Outstanding		Yield		Average Balance Outstanding		Yield		Increase (Decrease) in Interest Income
	(Dollars in thousands)
Loans receivable, net	$	862,587	4.60	%	$	826,880	4.48	%	$	673
Investment securities	111,695		3.30		120,575		3.16		(31		)
Mortgage-backed securities	172,639		2.52		176,997		2.70		(109		)
FHLB stock	5,019		7.33		5,776		6.93		(8		)
Interest-bearing deposits in banks	15,413		1.69		9,765		2.05		15
Total interest-earning assets	$	1,167,353	4.14		$	1,139,993	4.05		$	540

Interest Expense. Total interest expense increased $542,000, or 23.7%, to $2.8 million for the three months ended September 30, 2019, compared to $2.3 million for the three months ended September 30, 2018, mainly due to a 42.9% increase in deposit costs, partially offset by a 12.8% decrease in borrowing costs. Deposit costs increased for the three months ended September 30, 2019, due to increased interest rates paid and customers transferring deposits into higher-yielding accounts. The average balance of interest-bearing deposits increased $41.6 million, or 5.4%, to $806.7 million for the three months ended September 30, 2019, from $765.2 million for the three months ended September 30, 2018, as we continued to target growth in deposits in new and existing market areas. During the three months ended September 30, 2019, the average balance and related cost of savings accounts increased $52.5 million and 58 basis points, respectively, compared to the same period in 2018, the result of an above market rate savings promotion targeting growth in newer markets. During the same period, compared to 2018, the average balance of certificates of deposit balances grew $23.8 million with an increase in the average rate paid of 37 basis points, mainly as a result of the utilization of brokered CDs. During the three months ended September 30, 2019, the average balance of money market accounts decreased $39.6 million compared to the same period in the prior year, as customers moved money into accounts at other financial institutions or into higher-yielding certificates of deposit and savings accounts at First Federal. The average cost of all deposit products increased to 1.06% for the three months ended September 30, 2019, from 0.78% for the three months ended September 30, 2018. Borrowing costs increased due primarily to an increase in the average rate paid of 22 basis points during the most recent quarter compared to the same period in 2018. We prepaid $15.0 million in FHLB advances during the most recent quarter that had an average rate of 3.81%, which better positions us to align our funding costs more closely with earning asset yields going forward.

The following table details average balances, cost of funds and the change in interest expense for the periods shown:



	Three Months Ended September 30,
	2019				2018				Increase (Decrease) in Interest Expense
	Average Balance Outstanding		Rate		Average Balance Outstanding		Rate		Increase (Decrease) in Interest Expense
	(Dollars in thousands)
Savings accounts	$	168,495	0.94	%	$	115,973	0.36	%	$	293
Transaction accounts	116,328		0.09		111,506		0.09		1
Money market accounts	245,640		0.51		285,214		0.44		(5		)
Certificates of deposit	276,247		2.04		252,462		1.67		354
Borrowings	87,492		3.16		107,681		2.94		(101		)
Total interest-bearing liabilities	$	894,202	1.27		$	872,836	1.05		$	542

Provision for Loan Losses. There was a recapture of provision for loan losses of $170,000 during the three months ended September 30, 2019, which was mainly the result of the sale of a pool of one- to four-family residential loans, compared to a $197,000 provision for loan losses for the three months ended September 30, 2018.

The following table details activity and information related to the allowance for loan losses for the periods shown:



	Three Months Ended September 30,
	2019			2018
	(Dollars in thousands)
Provision for loan losses	$	(170	)	$	197
Net charge-offs	(118		)	(144		)
Allowance for loan losses	9,443			9,335
Allowance for losses as a percentage of total gross loans receivable at the end of this period	1.1		%	1.1		%
Total nonaccruing loans	1,322			2,473
Allowance for loan losses as a percentage of nonaccrual loans at end of period	714.3		%	377.5		%
Nonaccrual and 90 days or more past due loans as a percentage of total loans	0.2		%	0.3		%
Total loans	$	846,057		$	845,797

Noninterest Income. Noninterest income increased $661,000, or 46.5%, to $2.1 million for the three months ended September 30, 2019, from $1.4 million for the three months ended September 30, 2018, primarily due to an increase in loan and deposit service fees, as noted above.

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



	Three Months Ended September 30,					Increase (Decrease)
	2019		2018			Amount			Percent
	(Dollars in thousands)
Loan and deposit service fees	$	1,165	$	1,122		$	43		3.8	%
Mortgage servicing fees, net of amortization	44		23			21			91.3
Net gain on sale of loans	655		139			516			371.2
Net gain (loss) on sale of investment securities	—		(58		)	58			100.0
Increase in cash surrender value of bank-owned life insurance	147		150			(3		)	(2.0	)
Other income	70		44			26			59.1
Total noninterest income	$	2,081	$	1,420		$	661		46.5	%

Noninterest Expense. Noninterest expense decreased slightly during the three months ended September 30, 2019, compared to the three months ended September 30, 2018, as we continued to strive for better efficiencies and cost management in the absence of new branching initiatives.

The following table provides an analysis of the changes in the components of noninterest expense for the periods shown:



	Three Months Ended September 30,					Increase (Decrease)
	2019			2018		Amount			Percent
	(Dollars in thousands)
Compensation and benefits	$	4,771		$	4,740	$	31		0.7	%
Data processing	680			676		4			0.6
Occupancy and equipment	1,161			1,119		42			3.8
Supplies, postage, and telephone	208			211		(3		)	(1.4	)
Regulatory assessments and state taxes	209			172		37			21.5
Advertising	197			185		12			6.5
Professional fees	278			319		(41		)	(12.9	)
FDIC insurance premium	(72		)	76		(148		)	(194.7	)
FHLB prepayment penalty	344			—		344			100.0
Other	648			621		27			4.3
Total	$	8,424		$	8,119	$	305		3.8	%

Provision for Income Tax. An income tax expense of $580,000 was recorded for the three months ended September 30, 2019, compared to $443,000 for the three months ended September 30, 2018, generally due to an increase in income before taxes of $721,000. For additional information, see Note 5 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.

Comparison of Results of Operations for the Nine Months Ended September 30, 2019 and 2018

General. Net income increased $1.8 million, or 36.6%, to $6.8 million for the nine months ended September 30, 2019, compared to net income of $5.0 million for the nine months ended September 30, 2018.

Net Interest Income. Net interest income increased $603,000 to $28.0 million for the nine months ended September 30, 2019, from $27.4 million for the nine months ended September 30, 2018. This increase was mainly the result of a change in the mix of earning assets, with a decrease in the investment portfolio and an increase in loans receivable. The yield on average interest-earning assets increased 20 basis points to 4.14% for the nine months ended September 30, 2019, compared to 3.94% for the same period in the prior year.

The net interest margin decreased six basis points to 3.15% for the nine months ended September 30, 2019, from 3.21% for the same period in 2018. While we experienced a 20 basis point increase in asset yields, our cost of interest-bearing liabilities increased 33 basis points, reducing our net interest rate spread and net interest margin.

Of the $603,000 increase in net interest income during the nine months ended September 30, 2019, compared to the nine months ended September 30, 2018, $1.8 million was the result of an increase in volume, partially offset by $1.2 million due to changes in rates. The increase in loans receivable was the main contributor to the increase in net interest income with $2.1 million due to an increase in average volumes and $1.0 million due to increases in rates for a total of $3.2 million.

The average cost of interest-bearing liabilities increased to 1.28% for the nine months ended September 30, 2019, compared to 0.95% for the same period last year, due primarily to promotional rates on, and increases in the average balance of, savings accounts and certificates of deposit used to attract and retain deposits.

Interest Income. Total interest income increased $3.2 million, or 9.4%, to $36.8 million for the nine months ended September 30, 2019, from $33.7 million for the comparable period in 2018, primarily due to both an increase in the average balance of, and yields earned on, loans receivable. Interest and fees on loans receivable increased to $30.0 million for the nine months ended September 30, 2019, from $26.8 million for the nine months ended September 30, 2018. The average balance of net loans receivable increased $63.8 million and the average yield on loans receivable increased 16 basis points to 4.58% compared to 4.42% the prior year.

Interest income on investment securities increased $113,000, or 4.1% to $2.9 million for the nine months ended September 30, 2019, compared to $2.8 million for the nine months ended September 30, 2018, due to an increase in average yield of 38 basis points, partially offset by a decrease in the average balance of $10.0 million compared to the same period in 2018. The change in average yields on investment securities does not include the benefit of nontaxable income from municipal bonds. Interest income on mortgage-backed and related securities for the nine months ended September 30, 2019 decreased $194,000 compared to the nine months ended September 30, 2018, primarily due to a $9.0 million decrease in the average balance.

The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the periods shown:



	Nine Months Ended September 30,
	2019			2018			Increase (Decrease) in Interest Income
	Average Balance Outstanding		Yield	Average Balance Outstanding		Yield	Increase (Decrease) in Interest Income
	(Dollars in thousands)
Loans receivable, net	$	872,259	4.58%	$	808,485	4.42%	$	3,163
Investment securities	116,180		3.33	126,167		2.95	113
Mortgage-backed securities	178,411		2.64	187,429		2.65	(194		)
FHLB stock	6,310		5.66	6,871		4.60	31
Interest-bearing deposits in banks	13,468		1.88	10,004		1.81	54
Total interest-earning assets	$	1,186,628	4.14	$	1,138,956	3.94	$	3,167

Interest Expense. Total interest expense increased $2.6 million, or 40.8%, to $8.9 million for the nine months ended September 30, 2019, compared to $6.3 million for the nine months ended September 30, 2018, due to an increase in deposit costs of $2.5 million, or 70.0%. Deposit costs increased for the nine months ended September 30, 2019, due to a combination of promotional products and higher rates needed to compete to attract new and retain existing deposit customers. We also experienced disintermediation as existing customers transferred all or a portion of existing, lower-rate deposit accounts into higher-yielding accounts. The average balance of interest-bearing deposits increased $55.9 million, or 7.5%, to $799.1 million for the nine months ended September 30, 2019, from $743.2 million for the nine months ended September 30, 2018, as we continued to target growth in deposits in new and existing market areas.

During the nine months ended September 30, 2019, the cost of savings accounts increased as a result of an increase in average balance of $52.0 million and an increase in the average rate paid of 71 basis points, due to a promotional savings account offered at a higher rate compared to the same period in 2018. In addition, the cost of certificates of deposit increased due to an increase in average balance of $21.3 million and an increase in the average

rate paid of 59 basis points, compared to the nine months ended September 30, 2018, due to an increase in promotional account activity as well as utilization of brokered CDs in 2019. During the same period, the average balance of money market accounts declined $20.0 million while the average balance of transaction accounts remained relatively stable with a modest $2.6 million increase. The average cost of all deposit products increased to 1.02% for the nine months ended September 30, 2019, from 0.65% for the nine months ended September 30, 2018. Borrowing costs increased primarily due to a 40 basis point increase in average rates paid, partially offset by a decrease in the average balance of $16.5 million.

The following table details average balances, cost of funds and the change in interest expense for the periods shown:



	Nine Months Ended September 30,
	2019			2018			Increase (Decrease) in Interest Expense
	Average Balance Outstanding		Rate	Average Balance Outstanding		Rate	Increase (Decrease) in Interest Expense
	(Dollars in thousands)
Savings accounts	$	161,764	0.89%	$	109,731	0.18%	$	937
Transaction accounts	115,681		0.11	113,124		0.04	60
Money market accounts	257,045		0.49	277,065		0.39	131
Certificates of deposit	264,573		2.02	243,279		1.43	1,397
Borrowings	120,194		3.01	136,722		2.61	39
Total interest-bearing liabilities	$	919,257	1.28	$	879,921	0.95	$	2,564

Provision for Loan Losses. The provision for loan losses was $420,000 during the nine months ended September 30, 2019, primarily due to charge-off activity related to our indirect auto loan portfolio, partially offset by a provision recapture for the sale of a one- to four family loan pool, and was $902,000 for the nine months ended September 30, 2018, also due to charge-off activity and growth in our auto portfolio.

The following table details activity and information related to the allowance for loan losses for the periods shown:



	Nine Months Ended September 30,
	2019			2018
	(Dollars in thousands)
Provision for loan losses	$	420		$	902
Net charge-offs	(510		)	(327		)
Allowance for loan losses	9,443			9,335
Allowance for losses as a percentage of total gross loans receivable at the end of this period	1.1		%	1.1		%
Total nonaccruing loans	1,322			2,473
Allowance for loan losses as a percentage of nonaccrual loans at end of period	714.3		%	377.5		%
Nonaccrual and 90 days or more past due loans as a percentage of total loans	0.2		%	0.3		%
Total loans	$	846,057		$	845,797

Noninterest Income. Noninterest income increased $988,000, or 22.9%, to $5.3 million for the nine months ended September 30, 2019, from $4.3 million for the nine months ended September 30, 2018. The increase in noninterest income was mainly the result of an increase in loan and deposit service fees related to the early prepayment of commercial and multi-family real estate loans, as well as an increase in deposit fees related to changes in our deposit account offerings. We also saw an increase in net gain on sale of loans, mainly the result of the sale of a pool of one- to four-family residential loans.

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



	Nine Months Ended September 30,				Increase (Decrease)
	2019		2018		Amount			Percent
	(Dollars in thousands)
Loan and deposit service fees	$	3,605	$	2,930	$	675		23.0	%
Mortgage servicing fees, net of amortization	143		155		(12		)	(7.7	)
Net gain on sale of loans	830		456		374			82.0
Net gain on sale of investment securities	57		77		(20		)	(26.0	)
Increase in cash surrender value of bank-owned life insurance	435		448		(13		)	(2.9	)
Other income	225		241		(16		)	(6.6	)
Total noninterest income	$	5,295	$	4,307	$	988		22.9	%

Noninterest Expense. Noninterest expense decreased $196,000, or 0.8%, to $24.5 million for the nine months ended September 30, 2019, compared to $24.7 million for the nine months ended September 30, 2018, primarily as a result of a decrease in advertising costs, compensation and benefits, professional fees, and FDIC insurance premium, partially offset by an increase in FHLB prepayment penalties and regulatory assessments and state taxes. We received a $441,000 credit from our health insurance carrier as a result of a lower than anticipated claims experience level during the most recent plan year, $391,000 of which partially offset compensation and benefits expense during the nine months ended September 30, 2019, and $50,000 of which is being held for the benefit of our employees to help offset the burden of future insurance premium increases. Advertising expenses were lower as a result of a combination of advertising expenses incurred during the nine months ended September 30, 2018, related to the opening of our Bainbridge Island branch that were not incurred during the same period in 2019, as well as managing the determination and timing of advertising and promotional expenses for the current year. The Bank received an FDIC insurance Small Bank Assessment Credit of $268,000 during the quarter, which resulted in a recapture of FDIC insurance premiums recorded last quarter and no premium expense recorded in the current quarter. We expect the Small Bank Assessment Credit to offset FDIC insurance premiums in Q4 of 2019 and provide a partial credit for Q1 2020 premiums. With the gain on sale of the one- to four-family loan pool during the most recent quarter, we repaid $15.0 million of FHLB advances, incurring a prepayment penalty, in order to lower our future cost of borrowings and better position our net interest margin in future periods. We incurred costs related to our most recent examination of the Department of Financial Institutions of the State of Washington and have paid increased state taxes on higher gross revenues, resulting in an increase in regulatory assessments and state taxes for the nine months ended September 30, 2019, compared to the same period in 2018. We also had additional expenses related to our CEO search and transition which were included in professional fees.

The following table provides an analysis of the changes in the components of noninterest expense for the periods shown:



	Nine Months Ended September 30,				Increase (Decrease)
	2019		2018		Amount			Percent
	(Dollars in thousands)
Compensation and benefits	$	14,097	$	14,296	$	(199	)	(1.4	)%
Data processing	1,978		1,981		(3		)	(0.2	)
Occupancy and equipment	3,409		3,348		61			1.8
Supplies, postage, and telephone	678		685		(7		)	(1.0	)
Regulatory assessments and state taxes	573		453		120			26.5
Advertising	569		799		(230		)	(28.8	)
Professional fees	907		1,099		(192		)	(17.5	)
FDIC insurance premium	82		231		(149		)	(64.5	)
FHLB prepayment penalty	344		—		344			100.0
Other	1,859		1,800		59			3.3
Total	$	24,496	$	24,692	$	(196	)	(0.8	)%

Provision for Income Tax. An income tax expense of $1.6 million was recorded for the nine months ended September 30, 2019, compared to $1.1 million for the nine months ended September 30, 2018, generally due to an increase in income before taxes of $2.3 million. For additional information, see Note 5 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q.

Average Balances, Interest and Average Yields/Cost

The following table set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest‑earning assets and interest expense on average interest‑bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest‑earning assets), and the ratio of average interest‑earning assets to average interest-bearing liabilities. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread at September 30, 2019 and 2018. Income and all average balances are monthly average balances, which management deems to be not materially different than daily averages. Nonaccruing loans have been included in the table as loans carrying a zero yield.



	At September 30, 2019		Three Months Ended September 30,														Nine Months Ended September 30,
	At September 30, 2019		2019							2018							2019							2018
	Yield/ Rate		Average Balance Outstanding			Interest Earned/ Paid		Yield/ Rate		Average Balance Outstanding			Interest Earned/ Paid		Yield/ Rate		Average Balance Outstanding			Interest Earned/ Paid		Yield/ Rate		Average Balance Outstanding			Interest Earned/ Paid		Yield/ Rate

Interest-earning assets:	(Dollars in thousands)
Loans receivable, net ⁽¹⁾	4.68	%	$	862,587		$	9,930	4.60	%	$	826,880		$	9,257	4.48	%	$	872,259		$	29,955	4.58	%	$	808,485		$	26,792	4.42	%
Investment securities	4.09		111,695			921		3.30		120,575			952		3.16		116,180			2,900		3.33		126,167			2,787		2.95
Mortgage-backed securities	2.61		172,639			1,087		2.52		176,997			1,196		2.70		178,411			3,536		2.64		187,429			3,730		2.65
FHLB dividends	4.99		5,019			92		7.33		5,776			100		6.93		6,310			268		5.66		6,871			237		4.60
Interest-bearing deposits in banks	0.57		15,413			65		1.69		9,765			50		2.05		13,468			190		1.88		10,004			136		1.81
Total interest-earning assets ⁽²⁾	4.16		1,167,353			12,095		4.14		1,139,993			11,555		4.05		1,186,628			36,849		4.14		1,138,956			33,682		3.94

Interest-bearing liabilities:
Savings accounts	0.96		$	168,495		$	397	0.94		$	115,973		104		0.36		$	161,764		$	1,085	0.89		$	109,731		148		0.18
Transaction accounts	0.03		116,328			26		0.09		111,506			25		0.09		115,681			98		0.11		113,124			38		0.04
Money market accounts	0.44		245,640			312		0.51		285,214			317		0.44		257,045			945		0.49		277,065			814		0.39
Certificates of deposit	2.02		276,247			1,406		2.04		252,462			1,052		1.67		264,573			4,005		2.02		243,279			2,608		1.43
Total deposits	0.87		806,710			2,141		1.06		765,155			1,498		0.78		799,063			6,133		1.02		743,199			3,608		0.65
Borrowings	2.33		87,492			691		3.16		107,681			792		2.94		120,194			2,717		3.01		136,722			2,678		2.61
Total interest-bearing liabilities	0.99		894,202			2,832		1.27		872,836			2,290		1.05		919,257			8,850		1.28		879,921			6,286		0.95

Net interest income						$	9,263						$	9,265						$	27,999						$	27,396
Net interest rate spread	3.17							2.87							3.00							2.86							2.99
Net earning assets			$	273,151						$	267,157						$	267,371						$	259,035
Net interest margin ⁽³⁾								3.17							3.25							3.15							3.21
Average interest-earning assets to average interest-bearing liabilities			130.5		%					130.6		%					129.1		%					129.4		%

(1) The average loans receivable, net balances include nonaccruing loans. (2) Includes interest-bearing deposits (cash) at other financial institutions. (3) Net interest income divided by average interest-earning assets.

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.



	Three Months Ended									Nine Months Ended
	September 30, 2019 vs. 2018									September 30, 2019 vs. 2018
	Increase (Decrease) Due to						Total Increase (Decrease)			Increase (Decrease) Due to						Total Increase (Decrease)
	Volume			Rate			Total Increase (Decrease)			Volume			Rate			Total Increase (Decrease)
	(In thousands)
Interest earning assets:
Loans receivable, net	$	407		$	266		$	673		$	2,116		$	1,047		$	3,163
Investments	(99		)	(41		)	(140		)	(402		)	321			(81		)
FHLB stock	(13		)	5			(8		)	(19		)	50			31
Other⁽¹⁾	29			(14		)	15			47			7			54
Total interest-earning assets	$	324		$	216		$	540		$	1,742		$	1,425		$	3,167

Interest-bearing liabilities:
Savings accounts	$	47		$	246		$	293		$	70		$	867		$	937
Interest-bearing transaction accounts	1			—			1			1			59			60
Money market accounts	(46		)	41			(5		)	(59		)	190			131
Certificates of deposit	99			255			354			228			1,169			1,397
Borrowings	(149		)	48			(101		)	(324		)	363			39
Total interest-bearing liabilities	$	(48	)	$	590		$	542		$	(84	)	$	2,648		$	2,564

Net change in interest income	$	372		$	(374	)	$	(2	)	$	1,826		$	(1,223	)	$	603

(1) Includes interest-bearing deposits (cash) at other financial institutions.

Off-Balance Sheet Activities

In the normal course of operations, First Federal engages in a variety of financial transactions that are not recorded in the financial statements. These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks. These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For the nine months ended September 30, 2019 and the year ended December 31, 2018, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows.

Contractual Obligations

At September 30, 2019, our scheduled maturities of contractual obligations were as follows:



	Within 1 Year		After 1 Year Through 3 Years		After 3 Years Through 5 Years		Beyond 5 Years		Total Balance
	(In thousands)

Certificates of deposit	$	214,390	$	51,675	$	13,000	$	—	$	279,065
FHLB advances	65,324		10,000		10,000		—		85,324
Operating leases	316		521		441		1,758		3,036
Borrower taxes and insurance	1,876		—		—		—		1,876
Deferred compensation	471		—		53		464		988
Total contractual obligations	$	282,377	$	62,196	$	23,494	$	2,222	$	370,289

Commitments and Off-Balance Sheet Arrangements

The following table summarizes our commitments and contingent liabilities with off-balance sheet risks as of September 30, 2019:



	Amount of Commitment Expiration
	Within 1 Year		After 1 Year Through 3 Years		After 3 Years Through 5 Years		Beyond 5 Years		Total Amounts Committed
	(In thousands)
Commitments to originate loans:
Fixed-rate	$	658	$	—	$	—	$	—	$	658
Adjustable-rate	27		—		—		—		27
Unfunded commitments under lines of credit or existing loans	2,095		24,381		2,963		46,274		75,713
Standby letters of credit	—		214		—		—		214
Total commitments	$	2,780	$	24,595	$	2,963	$	46,274	$	76,612

Liquidity Management

Liquidity is the ability to meet current and future financial obligations of a short-term and long-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of securities, and borrowings from the FHLB. While maturities and scheduled amortization of loans and securities are usually predictable sources of funds, deposit flows, calls of investment securities and borrowed funds, and prepayments on loans and investment securities are greatly influenced by general interest rates, economic conditions and competition, which can cause those sources of funds to fluctuate.

Management regularly adjusts our investments in liquid assets based upon an assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our interest-rate risk and investment policies.

Our most liquid assets are cash and cash equivalents followed by available for sale securities. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At September 30, 2019, cash and cash equivalents totaled $56.5 million, and unpledged securities classified as available-for-sale with a market value of $251.2 million provided additional sources of liquidity. We pledged collateral to support borrowings from the FHLB of $85.3 million and have an established borrowing arrangement with the Federal Reserve Bank of San Francisco, for which no collateral has been pledged as of September 30, 2019.

At September 30, 2019, we had $685,000 in loan commitments outstanding and an additional $76.2 million in undisbursed loans and standby letters of credit, including $38.7 million in undisbursed construction loan commitments.

Certificates of deposit due within one year as of September 30, 2019 totaled $214.4 million, or 76.8% of certificates of deposit. We believe the large percentage of certificates of deposit that mature within one year reflects customers' hesitancy to invest their funds for longer periods as interest rates have begun to rise. In addition, shorter-term rates are more favorable to longer terms with the current flat to inverted yield curve. If these maturing deposits are not renewed, however, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. We have the ability to attract and retain deposits by adjusting the interest rates offered. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on certificates of deposit. In addition, we believe that our branch network, and the general cash flows from our existing lending and investment activities, will afford us sufficient foreseeable long-term liquidity. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q.

The Company is a separate legal entity from the Bank and provides for its own liquidity to pay its operating expenses and other financial obligations. At September 30, 2019, the Company (on an unconsolidated basis) had liquid assets of $19.2 million.

Capital Resources

At September 30, 2019, shareholders' equity totaled $177.3 million, or 14.2% of total assets. Our book value per share of common stock was $16.42 at September 30, 2019, compared to $15.42 at December 31, 2018. Consistent with our goals to operate a sound and profitable organization, our policy for First Federal is to maintain its “well-capitalized” status in accordance with regulatory standards.

At September 30, 2019, the Bank exceeded all regulatory capital requirements and was considered "well capitalized" under FDIC regulatory capital guidelines.

The following table provides the capital requirements and actual results for First Federal at September 30, 2019.



	Actual					Minimum Capital Requirements				Minimum Required to be Well-Capitalized
	Amount		Ratio			Amount		Ratio		Amount		Ratio
					(Dollars in thousands)
Tier I leverage capital (to average assets)	$	147,430	12.0	%		$	49,020	4.0	%	$	61,275	5.0	%
Common equity tier I (to risk-weighted assets)	147,430		18.0			36,944		4.5		53,363		6.5
Tier I risk-based capital (to risk-weighted assets)	147,430		18.0			49,258		6.0		65,678		8.0
Total risk-based capital (to risk-weighted assets)	157,054		19.1			65,678		8.0		82,097		10.0

In order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses, the Bank must maintain common equity tier 1 capital ("CET1") at an amount greater than the required minimum levels plus a capital conservation buffer of 2.5%.

Effect of Inflation and Changing Prices

The consolidated financial statements and related financial data presented in this report have been prepared according to generally accepted accounting principles in the United States, which require the measurement of financial and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs and the effect that general inflation may have on both short-term and long-term interest rates. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Although inflation expectations do affect interest rates, interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There has not been any material change in the market risk disclosures contained in First Northwest Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2018.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.

An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) was carried out under the supervision and with the participation of the Company's Chief Executive Officer (Principal Executive Officer), Chief Financial Officer (Principal Financial and Accounting Officer), and other members of the Company's management team as of the end of the period covered by this quarterly report. The Company's Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2019, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

(b) Changes in Internal Controls.

There have been no changes in the Company's internal control over financial reporting (as defined in 13a-15(f) of the Exchange Act) that occurred during the quarter ended September 30, 2019, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business. While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent every error or instance of fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. 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. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is 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; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There have been no material changes to the risk factors set forth in Part I. Item 1A of the Company's Form 10-K for the year ended December 31, 2018.

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


(a)	Not applicable.


(b)	Not applicable.



Period	Total Number of Shares Purchased (1)	Average Price Paid per Share		Total Number of Shares Repurchased as Part of Publicly Announced Plans (2)	Maximum Number of Shares that May Yet Be Repurchased Under the Plans

July 1, 2019 - July 31, 2019	16,249	$	16.41	—	262,209
August 1, 2019 - August 31, 2019	60,000	16.17		60,000	202,209
September 1, 2019 - September 30, 2019	71,400	16.52		71,400	130,809
Total	147,649	$	16.37	131,400

(1) Shares repurchased by the Company during the quarter include shares acquired from participants in connection with cancellation of restricted stock to pay withholding taxes totaling 16,249 shares, 0 shares, and 0 shares, respectively, for the periods indicated.

(2) On September 26, 2017, the Board of Directors authorized the repurchase of up to 1,166,659 shares, or approximately 10% of its shares of common stock issued and outstanding as of September 18, 2017. The repurchase program permits shares to be repurchased in the open market or private transactions, through block trades, and pursuant to any trading plan that may be adopted in accordance with the SEC's Rule 10b5-1. As of September 30, 2019, a total of 1,035,850 shares, or 88.8% percent of the shares authorized in the September 2017 stock repurchase plan, have been purchased at an average cost of $16.10 per share, leaving 130,809 shares available for future purchases.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits



Exhibit No.	Exhibit Description	Filed Herewith
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act	X
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act	X
32	Certification pursuant to Section 906 of the Sarbanes-Oxley Act	X
101	The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive Income ; (4) Consolidated Statements of Cash Flows; and (5) Selected Notes to Consolidated Financial Statements

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 NORTHWEST BANCORP

Date: November 8, 2019	/s/ Laurence J. Hueth

	Laurence J. Hueth
	President, Chief Executive Officer and Director
	(Principal Executive Officer)


Date: November 8, 2019	/s/ Regina M. Wood

	Regina M. Wood
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)