Annual Report 2018
unique. innovative. solutions.
Dear Fellow Shareholders,
In 2018, First Financial Northwest, Inc. (the “Company”)
continued to deliver on our long-term business strategy to
operate and grow First Financial Northwest Bank (the
“Bank”) as a well-capitalized and profitable community
bank, offering one-to-four family residential, commercial
real estate, multifamily, construction, land development,
consumer and business loans along with a diversified
array of deposit and other products and services to
individuals and businesses in our market areas. We
capitalized on our deep knowledge of our local
communities to serve the convenience and needs of
customers, delivering consistent, high-quality professional
service; offering competitive deposit
rates and
developing customer relationships to diversify our deposit
mix, growing lower cost deposits, attracting new
customers, and expanding our geographical footprint.
Financial highlights:
Net income increased 75.7% to $14.9 million,
or $1.43 per diluted share;
Net loans receivable increased $34.2 million to
$1.02 billion;
Total deposits increased by $99.5 million to
$939.0 million;
Nonperforming assets
remained
low at
$1.2 million, or 0.10% of total assets;
Book value per share increased to $14.35 from
$13.27 in 2017; and
Tier 1 leverage ratio and total capital ratio of
10.4% and 14.7%, respectively.
In April 2018, we opened our tenth branch at The
Junction in Bothell. The innovative and cost-efficient
branch model we developed to implement our growth
strategy has proven successful in attracting new
customers as we continue our strategy of leveraging our
established name and franchise, capital strength, and
loan production capability. Our eleventh branch was
opened at Kent Station in January 2019. We recently
signed a lease to open a branch in Kirkland, continuing
our expansion along the I-405 corridor east of Seattle.
In addition to deposits, we continued to utilize wholesale
funding sources, including FHLB advances and acquiring
deposits in the national brokered certificate of deposit
market, to assist with funding needs and interest rate risk
management efforts. We are managing our loan
portfolio to minimize concentration risk and diversify the
types of loans within the portfolio; managing credit risk
to minimize the risk of loss and interest rate risk to
optimize our net interest margin; and improving
profitability through disciplined pricing, expense control
and balance sheet management.
In 2018, the Company continued to deploy a portion of
its capital by paying $3.2 million in cash dividends to
shareholders and repurchasing 203,900 shares of its
common stock at an average price of $15.43 per share
under a 550,000 share stock repurchase plan
approved by our Board of Directors which commenced
in early November 2018. We continued to buy back
our shares in the first quarter of 2019. The plan expires
on May 3, 2019.
At the end of the year, we added Randy Riffle, a
commercial credit executive with extensive experience,
to our leadership team to further enhance our credit
culture and to expand and diversify our business loan
portfolio. In April 2019, Patricia Remch was appointed
to our Board of Directors. Her expansive background
with the Federal Home Loan Bank of San Francisco, her
training as an economist, knowledge of capital markets,
and her sales and marketing experience will be a
tremendous asset to the Company and the Bank.
Ultimately, it is our talented and dedicated employees,
delivering unique and innovative solutions to our
customers and building long-term banking relationships
in our communities, who drive the success of our
Company. We continue to provide financial literacy
education in our communities with our employees each
donating an average of nearly eight hours to Community
Reinvestment Act qualified projects in 2018.
We are committed to our strategy and remain focused
on executing on our Bank’s mission to provide
unique. innovative. solutions.
for our customers. We will continue to build on our
successes in our efforts to meet our ongoing commitment
to deliver value to our customers, communities and
shareholders.
Thank you for your investment and continued support.
Sincerely,
Roger H. Molvar
Chairman
Joseph W. Kiley III
President and
Chief Executive Officer
April 26, 2019
2018 Form 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2018
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-33652
FIRST FINANCIAL NORTHWEST, INC.
(Exact name of registrant as specified in its charter)
Washington
(State or other jurisdiction of incorporation or organization)
26-0610707
(I.R.S. Employer Identification Number)
201 Wells Avenue South, Renton, Washington
(Address of principal executive offices)
Registrant’s telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
98057
(Zip Code)
(425) 255-4400
Common Stock, $0.01 par value per share
(Title of Each Class)
The Nasdaq Stock Market LLC
(Name of Each Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES NO X
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES NO X
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days. YES X NO
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will
not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 _____
Smaller reporting company _____
Accelerated filer X
Emerging growth company _____
Non-accelerated filer _____
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new
or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. _____
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). YES NO X
The aggregate market value of the Common Stock outstanding held by nonaffiliates of the Registrant based on the closing sales price of the Registrant’s
Common Stock as quoted on The Nasdaq Stock Market LLC on June 30, 2018, was $184,306,825 (9,441,948 shares at $19.52 per share). For purposes of this
calculation, common stock held only by executive officers, the employee stock ownership plan and directors of the Registrant is considered to be held by affiliates.
As of March 11, 2019, the Registrant had 10,509,425 shares of common stock outstanding.
1. Portions of Registrant’s Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders (Part III).
DOCUMENTS INCORPORATED BY REFERENCE
(This page has been left blank intentionally)
FIRST FINANCIAL NORTHWEST, INC.
2018 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Forward-Looking Statements
Internet Website
PART I.
Item 1.
Business
General
Market Area
Lending Activities
Asset Quality
Investment Activities
Deposit Activities and Other Sources of Funds
Subsidiaries and Other Activities
Competition
Employees
How We Are Regulated
Taxation
Executive Officers of First Financial Northwest, Inc.
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4. Mine Safety Disclosures
PART II.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Business Strategy
Critical Accounting Policies
Comparison of Financial Condition at December 31, 2018, and December 31, 2017
Comparison of Operating Results for the Years Ended December 31, 2018, and 2017
Comparison of Financial Condition at December 31, 2017, and December 31, 2016
Comparison of Operating Results for the Years Ended December 31, 2017, and 2016
Average Balances, Interest and Average Yields/Costs
Yields Earned and Rates Paid
Rate/Volume Analysis
Asset and Liability Management and Market Risk
Liquidity
Capital
Commitments and Off-Balance Sheet Arrangements
Impact of Inflation
Recent Accounting Pronouncements
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
i
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PART III.
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions and Director Independence
Item 14. Principal Accounting Fees and Services
PART IV.
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10-K Summary
Signatures
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ii
Forward-Looking Statements
Certain matters discussed in this Annual Report on Form 10-K constitute forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations,
plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on
certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,”
“intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs
such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs,
plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business
environment in which we operate, projections of future performance or financial items, perceived opportunities in the market,
potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based
upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or
achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a
wide variety or range of factors including, but not limited to: the credit risks of lending activities, including changes in the level
and trend of loan delinquencies and write-offs, that may be affected by deterioration in the housing and commercial real estate
markets, and may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for
loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic
conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences
between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the
demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;
results of examinations of us by the Federal Reserve Bank of San Francisco (“FRB”) and our bank subsidiary by the Federal
Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institutions, Division of Banks (“DFI”)
or other regulatory authorities, including the possibility that any such regulatory authority may initiate an enforcement action
against the Company or the Bank which could require us to increase our reserve for loan losses, write-down assets, change our
regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements
or restrictions on us, any of which could adversely affect our liquidity and earnings; our ability to pay dividends on our common
stock; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs
and expenses; the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect
and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing
fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential
associated charges; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information
technology systems or on the third-party vendors who perform several of our critical processing functions; our ability to retain
key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to
implement a branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and
management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue
synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan
delinquency rates; costs and effects of litigation, including settlements and judgments; increased competitive pressures among
financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that
adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory
capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (the “Dodd-Frank Act”) and the implementing regulations; the availability of resources to address changes in laws,
rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party
providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial
institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on
accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist
activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing,
products and services; and other risks detailed in this Form 10-K and our other reports filed with the U.S. Securities and Exchange
Commission (“SEC”). Any of the forward-looking statements that we make in this Form 10-K and in the other public reports and
statements we make may turn out to be wrong because of the inaccurate assumptions we might make, because of the factors
illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future
results may be materially different from those expressed in any forward looking statements made by or on our behalf. Therefore,
these factors should be considered in evaluating the forward looking statements, and undue reliance should not be placed on such
statements. We undertake no responsibility to update or revise any forward-looking statements.
As used throughout this report, the terms “Company”, “we”, “our”, or “us” refer to First Financial Northwest, Inc. and
its consolidated subsidiaries, including First Financial Northwest Bank and First Financial Diversified Corporation.
iii
Internet Website
The information contained on our website, www.ffnwb.com, is not included as a part of, or incorporated by reference
into, this Annual Report on Form 10-K. Other than an investor’s own Internet access charges, we make available free of charge
through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to these reports, proxy statements and other SEC filings on our investor relations page. All of our reports, proxy statements, and
other SEC filings are posted as soon as reasonably practicable after they are electronically filed with the SEC and are also available
free of charge at the SEC’s website at www.sec.gov.
iv
Item 1. Business
General
PART I
First Financial Northwest, Inc. (“First Financial Northwest” or the “Company”), a Washington corporation, was formed
on June 1, 2007, for the purpose of becoming the holding company for First Financial Northwest Bank (“the Bank”) in connection
with the Bank’s conversion from a mutual holding company structure to a stock holding company structure which was completed
on October 9, 2007. At December 31, 2018, the Company had total assets of $1.3 billion, net loans of $1.0 billion, deposits of
$939.0 million and stockholders’ equity of $153.7 million. First Financial Northwest’s business activities generally are limited to
passive investment activities and oversight of its investment in First Financial Northwest Bank. Accordingly, the information set
forth in this report, including consolidated financial statements and related data, relates primarily to First Financial Northwest
Bank.
The Bank was organized in 1923 as a Washington state-chartered savings and loan association, converted to a federal
mutual savings and loan association in 1935 and to a Washington state-chartered mutual savings bank in 1992. In 2002, First
Savings Bank reorganized into a two-tier mutual holding company structure, became a stock savings bank, and the wholly-owned
subsidiary of First Financial of Renton, Inc. In connection with the 2002 conversion, First Savings Bank changed its name to First
Savings Bank Northwest. Subsequently, in August 2015, the Bank changed its name to First Financial Northwest Bank to better
reflect the commercial banking services it provides beyond those typically provided by a traditional savings bank. In February
2016, the Bank officially changed its charter from a Washington chartered stock savings bank to a Washington chartered commercial
bank.
First Financial Northwest became a bank holding company, after converting from a savings and loan holding company
on March 31, 2015, and is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve
Board” or “Federal Reserve”) through the FRB. The change was consistent with First Financial Northwest Bank’s shift in focus
from a traditional savings and loan association towards a full service, commercial bank. Additionally, First Financial Northwest
Bank is examined and regulated by the DFI and by the FDIC. First Financial Northwest Bank is required to maintain reserves at
a level set by the Federal Reserve Board. The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Des Moines, which
is one of the 11 regional banks in the Federal Home Loan Bank System (“FHLB System”). For additional information, see “How
We are Regulated - Regulation and Supervision of First Financial Northwest Bank - Federal Home Loan Bank System.”
In February 2016, First Financial Northwest Bank converted its charter from a community-based savings bank to a
commercial bank as a way of better serving its customer needs. The Bank’s largest concentration of customers is in King County,
with additional concentrations in Snohomish, Pierce, and Kitsap counties, Washington. The Bank is headquartered in Renton, in
King County, where it has a full-service branch as well as a smaller branch located in a commercial development known as “The
Landing”. The Bank has additional smaller branches in King County located in Bellevue, Woodinville, and Bothell, and opened
a new branch in Kent in the first quarter of 2019. In Snohomish County, Washington, the Bank has five additional branches located
in Mill Creek, Edmonds, Clearview, Smokey Point, and Lake Stevens. These smaller branches are focused on efficiency through
the extensive use of the latest banking technology. First Financial Northwest Bank’s business consists of attracting deposits from
the public and utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/
land, business and consumer loans.
The principal executive office of First Financial Northwest is located at 201 Wells Avenue South, Renton, Washington,
98057; our telephone number is (425) 255-4400.
Market Area
We consider our primary market area to be the Puget Sound Region that consists primarily of King, Snohomish and, to
a lesser extent, Pierce and Kitsap counties. During 2018, the Puget Sound Region experienced strong appreciation in residential
real estate prices throughout much of the year similar to trends in recent periods. However, price appreciation in more expensive
areas of King County such as Seattle and Bellevue have slowed recently due to affordability issues and higher mortgage rates.
List prices in Snohomish, Pierce and Kitsap counties are lower than King County and properties have continued to experience
price appreciation higher than the national average.
King County has the largest population of any county in the state of Washington and covers approximately 2,100 square
miles. It has a population of approximately 2.19 million residents and a median household income of approximately $83,600,
according to U.S. Census estimates. King County has a diversified economic base with many nationally recognized firms including
1
Boeing, Microsoft, Amazon, Starbucks, Nordstrom, Costco and Paccar. According to the Washington State Employment Security
Department, the unemployment rate for King County was 3.3% at December 31, 2018, compared to 3.6% at December 31, 2017,
and the national average of 3.9% at December 31, 2018. The median sales price of a residential home in King County for
December 2018 was $597,000, an increase of 2.1% from 2017, according to the Northwest Multiple Listing Service ("MLS").
Residential sales volumes decreased 11.5% in 2018 compared to 2017 and inventory levels as of December 31, 2018 were at 1.7
months according to the MLS. The number of listings in King County have increased substantially from last year but remain below
historical levels.
Pierce County, covering approximately 1,700 square miles, has the second largest population of any county in the state
of Washington. It has approximately 877,000 residents and a median household income of approximately $63,900, according to
U.S. Census estimates. The Pierce County economy is diversified with the presence of military-related government employment
(Joint Base Lewis-McChord), transportation and shipping employment (Port of Tacoma), and aerospace-related employment
(Boeing). According to the Washington State Employment Security Department, the unemployment rate for Pierce County was
5.3% in December 2018, compared to 5.4% in December 2017. The median sales price of a residential home in Pierce County
was $339,800 for December 2018, a 7.9% increase compared to 2017, according to the MLS. Residential sales volumes declined
by 5.2% in 2018 compared to 2017 and inventory levels as of December 31, 2018 were at 1.5 months according to the MLS.
Snohomish County has the third largest population of any county in the state of Washington and covers approximately
2,090 square miles. It has approximately 802,000 residents and a median household income of approximately $78,000, according
to U.S. Census estimates. The economy of Snohomish County is diversified with the presence of military-related government
employment (Naval Station Everett), aerospace-related employment (Boeing), and retail trade. According to the Washington State
Employment Security Department, the unemployment rate for Snohomish County was 3.6% in December 2018 compared to 4.0%
in December 2017. The median sales price of a residential home in Snohomish County was $454,900 for December 2018, a 7.0%
increase compared to December of 2017, according to the MLS. Residential sales volumes dropped by 9.9% in 2018 compared
to 2017 and inventory levels as of December 31, 2018 were at 1.5 months according to the MLS.
Kitsap County has the seventh largest population of any county in the state of Washington and covers approximately
395 square miles. It has approximately 266,000 residents and a median household income of approximately $68,300, according
to U.S. Census estimates. The Kitsap County economy is diversified with the presence of military-related government employment
(Naval Base Kitsap, Puget Sound Naval Shipyard), health care, retail trade and education. According to the Washington State
Employment Security Department, the unemployment rate for Kitsap County was 4.9% in December 2018, compared to 5.0%
in December 2017. The median sales price of a residential home was $343,000 for December 2018, an increase of 8.9% compared
to December 2017, according to the MLS. Residential sales volumes declined by 7.2% in 2018 compared to 2017 and inventory
levels as of December 31, 2018 were at 1.5 months according to the MLS.
For a discussion regarding competition in our primary market area, see “- Competition” later in Item 1 of this report.
Lending Activities
General. We focus our lending activities primarily on loans secured by commercial real estate, construction/land, first
mortgages on one-to-four family residences, multifamily, and business lending. We offer a variety of secured consumer loans,
including savings account loans and home equity loans that include lines of credit and second mortgage term loans. As of
December 31, 2018, our net loan portfolio totaled $1.0 billion and represented 81.7% of our total assets.
Our current loan policy generally limits the maximum amount of loans we can make to one borrower to 15% of the Bank’s
total risk-based capital, or $21.0 million at December 31, 2018. Exceptions to this policy are allowed only with the prior approval
of the Board of Directors and if the borrower exhibits financial strength or sufficient, measurable compensating factors exist after
consideration of the loan-to-value ratio, borrower’s financial condition, net worth, credit history, earnings capacity, installment
obligations, and current payment history. The regulatory limit of loans we can make to one borrower is 20% of total risk-based
capital, or $28.0 million, at December 31, 2018. At this date, our single largest lending relationship, totaling $21.9 million, exceeded
our internal lending guideline and was approved by the Board of Directors in accordance with our loan policy.
During 2018, the concentration of loans to our five largest lending relationships decreased. At December 31, 2018, loans
to our five largest lending relationships totaled $79.9 million compared to $88.5 million at December 31, 2017, a decrease of
$8.6 million, or 9.8%. Not only did the total of these relationships decrease during 2018, their percentage of total loans, net of
loans in process (“LIP”) also decreased to 7.7% at December 31, 2018 from 8.8% at December 31, 2017. The total number of
loans comprising these relationships increased slightly to 19 at December 31, 2018 from 18 at December 31, 2017. The following
table details the types of loans to our five largest lending relationships at December 31, 2018.
2
Borrower (1)
Number
of Loans
One-to-Four
Family
Residential(2) Multifamily
Commercial
Real
Estate(2)
(Dollars in thousands)
Construction/
Land
Aggregate
Balance of
Loans (3)
Business
Real estate investor
Real estate investor
Real estate investor
Real estate investor
Real estate investor
Total
5
3
5
3
3
$
— $
8,616
$
13,255
$
— $
— $
428
444
—
—
—
—
5,079
—
15,021
14,758
—
—
—
—
8,836
3,629
—
—
—
9,818
19
$
872
$
13,695
$
43,034
$
12,465
$
9,818
$
21,871
15,449
15,202
13,915
13,447
79,884
________
(1) The composition of borrowers represented in the table may change between periods.
(2) The one-to-four family residential loans for these borrowers are all owner occupied. The commercial real estate loans are for
non-owner occupied, income producing properties.
(3) Net of LIP.
The composition of loans to our five largest borrowers has changed at December 31, 2018, as compared to
December 31, 2017, with increases in multifamily loans and commercial real estate loans of $3.0 million and $3.9 million,
respectively. Partially offsetting these increases, total construction/land development loans and business loans decreased by
$14.9 million and $503,000, respectively. At December 31, 2018, all of the borrowers listed in the table above were in compliance
with the original repayment terms of their respective loans.
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6
One-to-Four Family Residential Lending. As of December 31, 2018, $342.0 million, or 30.5% of our total loan portfolio
consisted of loans secured by one-to-four family residences.
First Financial Northwest Bank is a traditional portfolio lender when it comes to financing residential home loans. In
2018, we originated $119.9 million and purchased $1.2 million in one-to-four family residential loans. At December 31, 2018,
$194.2 million, or 56.8% of our one-to-four family residential portfolio consisted of owner occupied loans with the remaining
$147.8 million, or 43.2% consisting of non-owner occupied loans. In addition, at December 31, 2018, $185.8 million, or 54.3%
of our one-to-four family residential loan portfolio consisted of fixed-rate loans. Substantially all of our one-to-four family
residential loans require monthly principal and interest payments.
Our fixed-rate, one-to-four family residential loans are generally originated with 15 to 30 year terms, although such loans
typically remain outstanding for substantially shorter periods, particularly in the current low interest rate environment. We also
originate hybrid loans with initial fixed-rate terms of five to ten years that convert to variable-rate which adjusts annually thereafter.
In addition, substantially all of our one-to-four family residential loans contain due-on-sale clauses that allow us to declare the
unpaid amount due and payable upon the sale of the property securing the loan. Typically, we enforce these due on sale clauses
to the extent permitted by law and as a standard course of business. The average period of time a loan is outstanding is a function
of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates, and the interest
rates payable on outstanding loans.
Our lending policy generally limits the maximum loan-to-value ratio on mortgage loans secured by one-to-four family
residential properties to 85% of the lesser of the appraised value or the purchase price. Properties securing our one-to-four family
residential loans are appraised by independent appraisers approved by us. We require the borrowers to obtain title insurance and
if necessary, flood insurance. We generally do not require earthquake insurance due to competitive market factors.
Loans secured by rental properties represent potentially higher risk and, as a result, we adhere to more stringent
underwriting guidelines. Of primary concern in non-owner occupied real estate lending is the consistency of rental income of the
property. Payments on loans secured by rental properties depend primarily on the tenants’ continuing ability to pay rent to the
property owner, the character of the borrower or, if the property owner is unable to find a tenant, the property owner’s ability to
repay the loan without the benefit of a rental income stream. In addition, successful operation and management of non-owner
occupied properties, including property maintenance standards, may affect repayment. As a result, repayment of such loans may
be subject to adverse conditions in the real estate market or the economy. We request that borrowers and loan guarantors, if any,
provide annual financial statements, a budget factoring in a rental income cash flow analysis of the borrower as well as the net
operating income of the property, information concerning the borrower’s expertise, credit history and profitability, and the value
of the underlying property. These loans are generally secured by a first mortgage on the underlying collateral property along with
an assignment of rents and leases. If the borrower has multiple rental property loans with us, the loans are typically not
cross collateralized. At December 31, 2018, $382,000 of one-to-four family residential loans were in nonaccrual status, although
$110,000 of these loans were performing in accordance with their repayment terms at that date.
Multifamily and Commercial Real Estate Lending. As of December 31, 2018, $169.4 million, or 15.1% of our total
loan portfolio was secured by multifamily and $373.8 million, or 33.3% of our loan portfolio was secured by commercial real
estate properties. Our commercial real estate loans are typically secured by office and medical buildings, retail shopping centers,
mini-storage facilities, industrial use buildings and warehouses. Commercial real estate and multifamily loans are subject to similar
underwriting standards and processes. These loans are viewed primarily as cash flow loans and secondarily as loans secured by
real estate.
Typically, multifamily and commercial real estate loans have higher balances, are more complex to evaluate and monitor,
and involve a greater degree of risk than one-to-four-family residential loans. In an attempt to compensate for and mitigate this
risk, these loans are generally priced at higher interest rates than one-to-four family residential loans and generally have a maximum
loan-to-value ratio of 80% of the lesser of the appraised value or purchase price. We generally require loan guarantees by any
parties with a property ownership interest of 20% or more. If the borrower is a corporation or partnership, we generally require
personal guarantees from the principals based upon a review of their personal financial statements and individual credit reports.
7
The following table presents a breakdown of our multifamily and commercial real estate loan portfolio at December 31,
2018, and 2017:
December 31, 2018
December 31, 2017
Amount
% of Total in
Portfolio
Amount
% of Total in
Portfolio
(Dollars in thousands)
$
$
$
155,279
14,076
169,355
100,495
131,222
32,462
28,035
25,398
16,315
16,003
23,889
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100.0% $
$
26.9
35.1
8.7
7.5
6.8
4.4
4.3
6.3
177,882
7,020
184,902
112,327
129,875
32,201
10,684
22,701
16,591
19,970
17,493
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100.0%
31.0%
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8.9
3.0
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4.6
5.5
4.8
$
373,819
100.0% $
361,842
100.0%
Multifamily real estate:
Multifamily, general
Micro-unit apartments
Total multifamily
Commercial real estate:
Office
Retail
Storage
Motel
Warehouse
Nursing home (1)
Mobile home park
Other non-residential
Total non-residential
_______________
(1) LIP for nursing home loans at December 31, 2018 and 2017 was $21,000 and $544,000, respectively.
The average loan size in our multifamily and commercial real estate loan portfolios was $1.0 million and $2.0 million,
respectively, as of December 31, 2018. At this date, $58.8 million, or 34.7%, of our multifamily loans and $122.4 million, or
32.7%, of our commercial real estate loans were located outside of our primary market area. We currently target individual
multifamily, and commercial real estate loans between $1.0 million and $5.0 million. The largest multifamily loan as of
December 31, 2018, was a 105-unit apartment complex with a net outstanding principal balance of $8.7 million located in King
County, Washington. As of December 31, 2018, the largest commercial real estate loan had a net outstanding balance of $13.3 million
and was secured by an office building located in King County, Washington. Both of these loans were performing according to
their respective loan repayment terms as of December 31, 2018.
The credit risk related to multifamily and commercial real estate loans is considered to be greater than the risk related to
one-to-four family residential loans because the repayment of multifamily and commercial real estate loans typically is dependent
on the income stream from the real estate securing the loan as collateral and the successful operation of the borrower’s business,
that can be significantly affected by adverse conditions in the real estate markets or in the economy. For example, if the cash flow
from the borrower’s project is reduced due to leases not being obtained or renewed, the borrower’s ability to repay the loan may
be impaired. In addition, many of our multifamily and commercial real estate loans are not fully amortizing and contain large
balloon payments upon maturity. These balloon payments generally require the borrower to either refinance or occasionally sell
the underlying property in order to make the balloon payment.
If we foreclose on a multifamily or commercial real estate loan, our holding period for the collateral typically is longer
than for one-to-four family residential mortgage loan foreclosures because there are fewer potential purchasers of the collateral.
Our multifamily and commercial real estate loans generally have relatively large balances to single borrowers or related groups
of borrowers. Accordingly, if we make any errors in judgment in the collectability of our multifamily or commercial real estate
loans, any resulting charge-offs may be larger on a per loan basis than those incurred in our one-to-four family residential or
consumer loan portfolios. At December 31, 2018, there were no multifamily loans past due 90 days or more, or in nonaccrual
status. There was one commercial real estate loan with an outstanding balance of $326,000 that was in nonaccrual status and in
the process of foreclosure at December 31, 2018. However, this loan was subsequently paid in full in January 2019. There were
no multifamily or commercial real estate loans charged-off during the years ended December 31, 2018, 2017 and 2016.
8
Construction/Land Loans. We originate construction/land loans primarily to residential builders for the construction
of single-family residences, condominiums, townhouses, multifamily properties and residential developments located in our market
area. Land loans include land non-development loans for the purchase or refinance of unimproved land held for future residential
development, improved residential lots held for speculative investment purposes or lines of credit secured by land, and land
development loans. Construction/land loans to builders generally require the borrower to have an existing relationship with the
Bank and a proven record of successful projects. At December 31, 2018, our total construction/land loans were $195.3 million, or
17.4% of our total loan portfolio. The balance of our construction/land loans decreased from $237.6 million, or 21.7% of our total
loans, at December 31, 2017 as loan payoffs exceeded loan originations. The Company’s strategic plan projects an increase in
construction loan origination activity in 2019 as we renew our focus on these loans. The Bank’s lending policy sets forth the
guideline that the balance of our acquisition, development, and construction loans, net of LIP and deferred fees and costs, not
exceed 100% of the Bank’s risk-based capital. Management intends to maintain levels near this guideline, however the uncertainty
of the timing associated with construction loan draws occasionally results in the actual concentration exceeding the guideline. At
December 31, 2018, the Bank’s net acquisition, development, and construction loans totaled $114.9 million, for a concentration
of 81.9%. There were no construction/land loans classified as nonaccrual at either December 31, 2018 or 2017. There were no
construction/land loan charge-offs during the years ended December 31, 2018, 2017 and 2016, respectively.
Following is the composition of our total construction/land loan portfolio at the dates indicated. All of the loans represented
were performing:
Construction speculative:
One-to-four family residential
Multifamily
Total construction speculative
Construction permanent: (1)
One-to-four family residential
Multifamily
Commercial real estate
Total construction permanent
Land:
Land development
Land non-development
Total land
Total construction/land loans (2)
December 31,
2018
2017
(In thousands)
$
84,916
$
17,017
101,933
1,688
66,625
18,300
86,613
500
6,240
6,740
$
195,286
$
84,834
9,985
94,819
2,570
98,454
5,325
106,349
528
35,877
36,405
237,573
_____________
(1) Includes loans where the builder does not intend to sell the property after the construction phase is completed.
(2) LIP for construction/land loans at December 31, 2018, and 2017, was $86.4 million and $92.0 million, respectively.
The following table includes construction/land loans by county, net of LIP, at December 31, 2018:
County
Loan Balance
Percent of Construction/
Land Loan Balance
(Dollars in thousands)
King
Snohomish
Pierce
Kitsap
All other
Total
94,331
1,933
9,145
2,623
822
108,854
86.6%
1.8
8.4
2.4
0.8
100.0%
$
$
9
Loans to finance the construction of single-family homes, subdivisions and land loans are generally offered to builders
in our primary market areas. Loans that are termed “speculative” are those where the builder does not have, at the time of loan
origination, a signed contract with a buyer for the home or lot who has a commitment for permanent financing with either us or
another lender. The buyer may be identified either during or after the construction period, with the risk that the builder may have
to fund the debt service on the speculative loan along with real estate taxes and other carrying costs for the project for a significant
period of time after completion of the project until a buyer is identified. The maximum loan-to-value ratio applicable to these
loans is generally 100% of the actual cost of construction, provided that the loan-to-completed value does not exceed 80%, with
approval required from the Chief Credit Officer (“CCO”) for loan-to-value ratios over 80%. In addition, a minimum of 20%
verified equity is generally also required. Verified equity refers to cash equity invested in the project. Development plans are
required from builders prior to committing to the loan. We require that builders maintain adequate title insurance and other
appropriate insurance coverage, and, if applicable, appropriate environmental data report(s) that the land is free of hazardous or
toxic waste. While maturity dates for residential construction loans are largely a function of the estimated construction period of
the project and typically do not exceed one year, land loans generally are for 12 to 18 months. Substantially all of our residential
construction loans have adjustable-rates of interest based on The Wall Street Journal prime rate. During the term of construction,
the accumulated interest on the loan is either added to the principal of the loan through an interest reserve or billed monthly. At
December 31, 2018, the LIP balance on construction/land loans was $86.4 million, including $6.2 million set aside for interest
reserves. When these loans exhaust their original reserves set up at origination, no additional reserves are permitted unless the
loan is re-analyzed and it is determined that the additional reserves are appropriate, based on the updated analysis. Construction
loan proceeds are disbursed periodically as construction progresses and as inspections by our approved inspectors warrant. At
December 31, 2018, our three largest construction/land loans, net of LIP, consisted of an $8.9 million commercial real estate
construction loan, a $6.7 million multifamily construction loan, and a $5.7 million multifamily construction loan. All three loans
will rollover to a permanent loan at the completion of the construction period and all three properties are located in King County.
Our residential construction loans to borrowers for one-to-four family, non-owner occupied residences typically are
structured to be converted to fixed-rate permanent loans at the end of the construction phase with one closing for both the construction
loan and the permanent financing. Prior to making a commitment to fund a construction loan, we require an appraisal of the
post construction value of the project by an independent appraiser. During the construction phase, which typically lasts 12 to 18
months, an approved inspector or designated Bank employee makes periodic inspections of the construction site to certify
construction has reached the stated percentage of completion. Typically, disbursements are made in monthly draws and interest-
only payments are required. These loans are converted to fixed-rate permanent loans at the end of the construction phase. At
December 31, 2018, there was one non-owner occupied construction loan of $1.7 million that will rollover to a permanent non-
owner occupied one to four family residential loan in 2020.
We also make construction loans for commercial development projects. The projects include multifamily, retail, office/
warehouse and office buildings. These loans typically have an interest-only payment phase during construction and generally
convert to permanent financing when construction is complete. Disbursement of funds is at our sole discretion and is based on
the progress of construction. The Bank uses an independent third party or Bank employee to conduct monthly inspections to certify
that construction has reached the stated percentage of completion and that previous disbursements are reflected in the degree of
work performed to date. Generally, the maximum loan-to-value ratio applicable to these loans is 90% of the actual cost of
construction or 80% of the prospective value at completion. At December 31, 2018, $84.9 million of multifamily and commercial
real estate construction loans will rollover to permanent loans with the Bank at the end of their construction period.
Land development loans are generally made to builders for preparation of a building site and do not include the construction
of buildings on the property. The maximum loan-to-value ratio for these loans is 75%. Land non-development loans are generally
for raw land where we do not finance the cost of preparing the site for building and are subject to a maximum loan to value ratio
of 65%.
Our construction/land loans are based upon estimates of costs in relation to values associated with the completed project.
Construction/land lending involves additional risks when compared with permanent residential lending because funds are advanced
upon the collateral for the project based on an estimate of costs that will produce a future value at completion. Because of the
uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of
governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a
project and the completed project loan-to-value ratio. Changes in the demand, such as for new housing and higher than anticipated
building costs may cause actual results to vary significantly from those estimated. For these reasons, this type of lending also
typically involves higher loan principal amounts and is often concentrated with a small number of builders. These loans often
involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability
of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or
guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have
inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because
10
construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these
loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on
construction loans by rapidly increasing the end-purchasers’ borrowing costs, thereby reducing the overall demand for the project.
Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also
complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract
with another builder to complete construction. Furthermore, in the case of speculative construction loans, there is the added risk
associated with identifying an end-purchaser for the finished project. Land loans also pose additional risk because of the lack of
income being produced by the property and the potential illiquid nature of the collateral. These risks can also be significantly
influenced by supply and demand conditions.
Business Lending. Business loans totaled $30.5 million, or 2.7% of the loan portfolio at December 31, 2018. Business
loans are generally secured by business equipment, accounts receivable, inventory or other property. Loan terms typically vary
from one to five years. The interest rates on such loans are either fixed-rate or adjustable-rate. The interest rates for the adjustable rate
loans are indexed to the prime rate published in The Wall Street Journal plus a margin. Our business lending policy includes credit
file documentation and requires analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s
capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present
and future cash flows is also an important aspect of our credit analysis. We generally obtain personal guarantees on our business
loans. The largest business loan had an outstanding balance of $9.8 million at December 31, 2018 and was performing according
to its repayment terms. At December 31, 2018, we did not have any business loans delinquent in excess of 90 days or in nonaccrual
status.
At December 31, 2018, the Bank’s aircraft loan portfolio had an outstanding balance of $11.1 million, or 36.3% of total
business loans. We intend to grow this portfolio over the coming years. These loans are collateralized by new or used, single engine
piston aircraft to light jets for business or personal use. We anticipate that our aircraft loans will range in size from $250,000 to
$3.0 million with the primary focus of our underwriting guidelines on the asset value of the collateral rather than the ability of the
borrower to repay the loan. The average loan size in our aircraft loan portfolio was $582,000 as of December 31, 2018.
Repayments of business loans are often dependent on the cash flows of the borrower, which may be unpredictable, and
the collateral securing these loans may fluctuate in value. Our business loans are originated primarily based on the identified cash
flow of the borrower and secondarily on the underlying collateral provided by the borrower. Credit support provided by the borrower
for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of
a personal guarantee, if any. As a result, in the case of loans secured by accounts receivable, the availability of funds for the
repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
The collateral securing business loans may depreciate over time, may be difficult to appraise, or may fluctuate in value based on
the success of the business.
Consumer Lending. We offer a limited variety of consumer loans to our customers, consisting primarily of home equity
loans and savings account loans. Generally, consumer loans have shorter terms to maturity and higher interest rates than one to four
family residential loans. Consumer loans are offered with both fixed and adjustable interest rates and with varying terms. At
December 31, 2018, consumer loans were $13.0 million, or 1.0% of the total loan portfolio.
At December 31, 2018, the largest component of the consumer loan portfolio consisted of home equity loans, primarily
home equity lines of credit that totaled $11.2 million, or 86.1% of the total consumer loan portfolio. The home equity lines of
credit include $4.7 million of equity lines of credit in first lien position and $6.5 million of second liens on residential properties.
At December 31, 2018, unfunded commitments on our home equity lines of credit totaled $17.1 million. Home equity loans are
made for purposes such as the improvement of residential properties, debt consolidation and education expenses. At origination,
the loan-to-value ratio is generally 90% or less, when taking into account both the balance of the home equity loans and the first
mortgage loan. Home equity loans are originated on a fixed-rate or adjustable-rate basis. The interest rate for the adjustable-rate
second lien loans is indexed to the prime rate published in The Wall Street Journal and may include a margin. Home equity loans
generally have a 10 to 30 year term, with a 10 year draw period, and either convert to principal and interest payments with no
further draws or require a balloon payment due at maturity.
Consumer loans entail greater risk than one-to-four family residential mortgage loans, particularly in the case of consumer
loans that are unsecured or secured by rapidly depreciating assets. In these cases, any repossessed collateral for a defaulted consumer
loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of
damage, loss or depreciation. The remaining deficiency often does not warrant further collection efforts against the borrower
beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower’s continuing
financial stability and are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore,
the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount
11
that can be recovered on these loans. Home equity lines of credit have greater credit risk than one-to-four family residential
mortgage loans because they are generally secured by mortgages subordinated to the existing first mortgage on the property that
we may or may not hold in our portfolio. We do not have private mortgage insurance coverage on these loans. Adjustable-rate
loans may experience a higher rate of default in a rising interest rate environment due to the increase in payment amounts when
interest rates reset higher. If current economic conditions deteriorate for our borrowers and their home prices fall, we may also
experience higher credit losses from this loan portfolio. For our home equity loans that are in a second lien position, it is unlikely
that we will be successful in recovering our entire loan principal outstanding in the event of a default. At December 31, 2018, one
consumer loan totaling $44,000 was in nonaccrual status, however, no consumer loans were delinquent more than 30 days. During
the years ended December 31, 2018, and 2017, there were no consumer loans charged-off. In comparison, for the year ended
December 31, 2016, consumer loans totaling $83,000 were charged off.
Loan Maturity and Repricing. The following table sets forth certain information at December 31, 2018, regarding the
amount of total loans in our portfolio based on their contractual terms to maturity, not including prepayments.
Within One
Year
After One
Year
Through
Three Years
After Three
Years
Through
Five Years
After Five
Years
Through
Ten Years
Beyond
Ten Years
Total
(In thousands)
Real estate:
One-to-four family residential
$
17,207
$
15,231
$
3,690
$
10,753
$
295,085
$
341,966
Multifamily
Commercial
Construction/land
Total real estate
Business
Consumer
Total
22,299
35,611
88,257
7,873
51,350
35,399
163,374
109,853
376
2,249
16,126
1,097
18,994
30,680
30,732
84,096
9,578
290
67,638
212,793
23,560
314,744
4,406
—
52,551
43,385
17,338
169,355
373,819
195,286
408,359
1,080,426
—
9,334
30,486
12,970
$
165,999
$
127,076
$
93,964
$
319,150
$
417,693
$ 1,123,882
The following table sets forth the amount of total loans due after December 31, 2019, with fixed or adjustable interest
rates.
Real estate:
One-to-four family residential
Multifamily
Commercial
Construction/land
Total real estate
Business
Consumer
Total
Fixed-Rate
Adjustable-Rate
Total
(In thousands)
$
180,076
$
144,683
$
48,845
167,807
44,823
441,551
13,640
1,010
98,211
170,401
62,206
475,501
16,470
9,711
324,759
147,056
338,208
107,029
917,052
30,110
10,721
$
456,201
$
501,682
$
957,883
Loan Solicitation and Processing. The majority of our consumer and residential mortgage loan originations are generated
through the Bank and from time to time through outside brokers and correspondent relationships we have established with select
mortgage companies or other financial institutions. We originate multifamily, commercial real estate, construction/land and business
loans primarily using the Bank’s loan officers, with referrals coming from builders, brokers and existing customers.
Upon receipt of a loan application from a prospective borrower, we obtain a credit report and other data to verify specific
information relating to the loan applicant’s employment, income, and credit standing. All real estate loans requiring an appraisal
are done by an independent third-party appraiser. All appraisers are approved by us, and their credentials are reviewed annually,
as is the quality of their appraisals.
12
We use a multi-level approval matrix which establishes lending targets and tolerance levels depending on the loan type
being approved. The matrix also sets minimum credit standards and approval limits for each of the loan types.
Lending Authority. The Directors’ Loan Committee consists of at least three members of the Board of Directors. The
Directors’ Loan Committee recommends for approval by the Board of Directors exceptions to the aggregate loan limit to one
borrower of 15% of total risk-based capital, or $21.0 million at December 31, 2018. The Board of Directors approves exceptions
to such aggregate loan limit to one borrower up to 20% of total risk-based capital, or $28.0 million at December 31, 2018.
Officer Lending Authority. Individual signing authority has been delegated to two lending officers. Our Senior Credit
Approval Officer (“SCAO”) has authority from the Board of Directors to approve loans and aggregate relationships up to and
including $3.0 million. The Board of Directors has given our Chief Credit Officer (“CCO”) authority to approve credit to one
borrower not to exceed our aggregate loan limit of 15% of total risk-based capital.
Loan Originations, Servicing, Purchases, Sales and Repayments. For the years ended December 31, 2018, 2017 and
2016, our total loan originations and purchases were $370.8 million, $430.7 million and $420.8 million, respectively.
One-to-four family residential loans are generally originated in accordance with the guidelines established by Freddie
Mac and Fannie Mae, with the exception of our special community development loans originated to satisfy compliance with the
Community Reinvestment Act. Our loans are underwritten by designated real estate loan underwriters internally in accordance
with standards as provided by our Board-approved loan policy. We require title insurance on all loans and fire and casualty insurance
on all secured loans and home equity loans where real estate serves as collateral. Flood insurance is also required on all secured
loans when the real estate is located in a flood zone.
The following table shows total loans originated, purchased, repaid and other changes during the periods indicated.
Year Ended December 31,
2018
2017
2016
(In thousands)
Loan originations:
Real estate:
One-to-four family residential
$
119,946
$
89,622
$
Multifamily
Commercial
Construction/land
Total real estate
Business
Consumer
Total loans originated
Loan purchases and participations:
One-to-four family residential
Multifamily
Commercial
Construction/land
Business
Total loan purchases and participations (1)
Principal repayments
Charge-offs
Loans transferred to other real estate owned (“OREO”)
Change in LIP, net deferred fees, and ALLL
8,363
47,332
118,237
293,878
21,361
14,524
329,763
1,230
3,705
21,546
4,582
10,000
41,063
(342,136)
—
—
5,552
Net increase in loans
$
34,242
$
20,612
49,524
138,591
298,349
23,438
9,379
331,166
3,087
45,340
46,802
1,100
3,177
59,222
22,914
92,495
165,363
339,994
13,998
5,674
359,666
7,352
11,761
41,990
—
—
99,506
(235,667)
—
—
(21,386)
173,619
$
61,103
(271,768)
(83)
—
(18,947)
129,971
_______________
(1) Includes $19.9 million, $76.2 million and $61.1 million in loan purchases during 2018, 2017 and 2016 respectively.
13
Loan Origination and Other Fees. In some instances, we receive loan origination fees on real estate-related products.
Loan fees generally represent a percentage of the principal amount of the loan and are paid by the borrower. The amount of fees
charged to the borrower on one-to-four family residential loans and multifamily and commercial real estate loans can range from
0% to 2%. United States generally accepted accounting principles require that certain fees received, net of certain origination
costs, be deferred and amortized over the contractual life of the loan. Net deferred fees or costs associated with loans that are
prepaid or sold are recognized in income at the time of prepayment or sale. We had $1.2 million of net deferred loan fees at both
December 31, 2018, and 2017.
Loan purchases generally include a premium, which is deferred and amortized into interest income with net deferred fees
over the contractual life of the loan. During 2018, total premiums of $630,000, or 3.2% of the purchased principal, were paid on
purchased loans. In comparison, premiums of $1.8 million, or 2.3% of the purchased principal were paid on purchased loans during
2017.
One-to-four family residential and consumer loans are generally originated without a prepayment penalty. The majority
of our multifamily and commercial real estate loans, however, have prepayment penalties associated with the loans. Most of the
multifamily and commercial real estate loan originations with interest rates fixed for the first five years will adjust thereafter and
have a prepayment penalty of 2% - 3% of the principal balance in year one, with decreasing penalties in subsequent years. Longer
initial fixed rate terms generally have correspondingly longer prepayment penalty periods.
Asset Quality
As of December 31, 2018, we had two owner occupied one-to-four family residential loans totaling $495,000 and one
commercial real estate loan of $326,000 past due 30 days or more. These loans represented 0.08% of total loans, net of LIP.
Subsequent to December 31, 2018, the $326,000 nonperforming commercial real estate loan was paid in full. We generally assess
late fees or penalty charges on delinquent loans of up to 5.0% of the monthly payment. The borrower is given up to a 15 day grace
period from the due date to make the loan payment.
We handle collection procedures internally or with the assistance of outside legal counsel. Late charges are incurred when
the loan exceeds 10 to 15 days past due depending upon the loan product. When a delinquent loan is identified, corrective action
takes place immediately. The first course of action is to determine the cause of the delinquency and seek cooperation from the
borrower in resolving the issue. Additional corrective action, if required, will vary depending on the borrower, the collateral, if
any, and whether the loan requires specific handling procedures as required by the Washington State Deed of Trust Act.
If the borrower is chronically delinquent and all reasonable means of obtaining payments have been exhausted, we will
seek to foreclose on the collateral securing the loan according to the terms of the security instrument and applicable law. The
following table shows our delinquent loans by the type of loan, net of LIP, and the number of days delinquent at December 31, 2018:
Loans Delinquent
Total
30-59 Days
60-89 Days
90 Days and Greater
Delinquent Loans
Number
of Loans
Principal
Balance
Number
of Loans
Principal
Balance
Number
of Loans
Principal
Balance
Number
of Loans
Principal
Balance
(Dollars in thousands)
Real estate:
One-to-four family residential:
Owner occupied
Commercial
Total
1
—
1
$
$
223
—
223
1
1
2
$
$
272
326
598
— $
—
— $
—
—
—
2
1
3
$
$
495
326
821
Construction/land, commercial real estate, and multifamily loans generally have larger individual loan amounts that have
a greater single impact on asset quality in the event of delinquency or default. We continue to monitor our loan portfolio and
believe additions to nonperforming loans, charge-offs, provisions for loan losses, and/or OREO are possible in the future,
particularly if the housing market and other economic conditions do not continue to improve.
14
The following table sets forth information with respect to our nonperforming assets and troubled debt restructured loans
(“TDRs”) for the periods indicated. All loan balances and ratios are calculated using loan balances that are net of LIP.
2018
2017
December 31,
2016
(Dollars in thousands)
2015
2014
Loans accounted for on a nonaccrual basis:
Real estate:
One-to-four family residential
Commercial
Consumer
Total loans accounted for on a nonaccrual basis
Total nonperforming loans
OREO
Total nonperforming assets
TDRs:
Nonaccrual (1)
Performing
Total TDRs
Nonperforming loans as a percent of total loans, net
of LIP
Nonperforming loans as a percent of total assets
Nonperforming assets as a percent of total assets
$
$
$
$
$
128
$
798
$
996
$
382
326
44
752
752
483
1,235
$
—
51
179
179
483
662
—
60
858
858
2,331
$
3,189
— $
— $
174
9,399
9,399
17,805
30,083
$
17,805
$ 30,257
—
89
830
434
75
1,085
1,339
1,085
3,663
4,748
1,339
9,283
$
10,622
131
42,128
42,259
$
$
—
54,241
54,241
$
$
$
0.07%
0.06
0.10
0.02%
0.10%
0.01
0.05
0.08
0.31
0.16%
0.11
0.48
0.20%
0.14
1.13
Total loans, net of LIP
$ 1,037,429
$1,002,694
$ 828,161
$ 697,416
$ 677,033
Foregone interest on nonaccrual loans
18
26
51
103
126
_______
(1) These loans are also included in the appropriate loan category above under the caption: “Loans accounted for on a nonaccrual
basis.”
Nonperforming Loans. When a loan becomes 90 days past due, we generally place the loan on nonaccrual status unless
the credit is well secured and in the process of collection. Loans may be placed on nonaccrual status prior to being 90 days past
due if there is an identified problem such as an impending foreclosure or bankruptcy or if the borrower is unable to meet their
scheduled payment obligations. Our nonperforming loans increased by $573,000, or 320.1%, at December 31, 2018, as compared
to December 31, 2017, with the addition of two nonperforming loans during 2018. Subsequent to December 31, 2018, a $326,000
nonperforming commercial loan was paid in full. During 2018, there were no charge offs to nonperforming loans.
Other Real Estate Owned. Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is
classified as OREO until it is sold. When the property is acquired, it is recorded at the lower of its cost or fair market value of the
property, less selling costs. We had $483,000 of OREO at both December 31, 2018 and 2017 comprised of undeveloped lots. Our
special assets department’s primary focus is the prompt and effective management of our troubled, nonperforming assets, and
expediting their disposition to minimize any potential losses. During 2018 and 2017, we did not foreclose or accept deeds-in-lieu
of foreclosure on any loans. In the future, we may experience foreclosure, deed-in-lieu of foreclosure, and short sale activity while
we work with our nonperforming loan customers to minimize our loss exposure.
Because of our structure, we believe we are able to make decisions regarding offers on OREO and the real estate underlying
our nonperforming loans very quickly compared to larger institutions where decisions could take six to twelve months. This
distinction has historically worked to our benefit in reducing our nonperforming assets and disposing of OREO.
Troubled Debt Restructured Loans. We account for certain loan modifications or restructurings as TDRs. In general,
the modification or restructuring of a debt is considered a TDR if, for economic or legal reasons related to the borrower’s financial
difficulties, we grant a concession to the borrower that we would not otherwise consider. These loans are all considered to be
impaired loans. At December 31, 2018, we had $9.4 million in TDRs as compared to $17.8 million at December 31, 2017.
15
Prior to 2012, we utilized a strategy for a limited number of our lending relationships of establishing an “A” and “B”
note structure. We created an “A” note representing a reduced principal balance expected to be fully collected and at a debt service
level and loan-to-value ratio acceptable to us. The “A” note was classified as a performing TDR as long as the borrower continued
to perform in accordance with the note terms. The “B” note represented the amount of the principal reduction portion of the original
note and was immediately charged-off. The “B” note is held by the Bank and when the “A” note is paid off, the Bank may proceed
with collection efforts on the “B” note. During 2017, due to the improved financial condition of the borrowers holding “A” and
“B” notes, and the increased market value of the underlying properties, the Bank issued revised notes that allowed for recovery
of the “B” note principal, and in some cases, recognition of interest income as payments were made. In 2018, the remaining
“B” notes on these agreements were paid off, resulting in recoveries of $4.3 million of previously charged off balances. At
December 31, 2018, the balance of TDRs included $560,000 in remaining “A” notes.
The largest TDR relationship at December 31, 2018 totaled $1.4 million and was comprised of one to four family
residential loans secured by rental properties located in Pierce County. At December 31, 2018, there was no LIP in connection
with our TDRs. For additional information regarding our TDRs, see Note 4 of the Notes to Consolidated Financial Statements
contained in Item 8 of this report.
The following table summarizes our total TDRs:
Performing TDRs:
One-to-four family residential
Multifamily
Commercial real estate
Consumer
Total performing TDRs
Total TDRs
December 31,
2018
2017
(In thousands)
$
6,941
$
13,434
—
2,415
43
9,399
$
9,399
$
1,134
3,194
43
17,805
17,805
Classified Assets. Federal regulations provide for the classification of lower quality loans and other assets as substandard,
doubtful or loss. An asset is considered substandard if it is inadequately protected by the current net worth and payment capacity
of the borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that we 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 we classify problem assets as either substandard or doubtful, we may establish a specific allowance in an amount
we deem prudent. General allowances represent loss allowances that have been established to recognize the inherent risk associated
with lending activities, but 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 those assets in the period in which they are deemed
uncollectible. Our determinations as to the classification of our assets and the amount of our valuation allowances are subject to
review by the FDIC and the DFI that can order the establishment of additional loss allowances or the charge-off of specific loans
against established loss reserves. Assets that do not currently expose us to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are designated as special mention. At December 31, 2018, special mention
loans totaled $2.5 million.
In connection with the filing of periodic reports with the FDIC and in accordance with our loan policy, we regularly
review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable
regulations. The decrease in our classified loans during the year ended December 31, 2018 was a result of loan repayments as
well as our efforts to work with our borrowers to bring their loans current when possible or restructure the loan when appropriate.
During 2018, we continued our aggressive approach to reduce nonperforming assets and improve asset quality.
16
Classified loans, net of LIP, consisting solely of substandard loans, were as follows at the dates indicated:
One-to-four family residential
Commercial real estate
Consumer
Total classified loans
December 31,
2018
2017
(In thousands)
$
$
$
919
326
44
673
555
52
1,289
$
1,280
With the exception of these classified loans, of which $752,000 were accounted for as nonaccrual loans at
December 31, 2018, management is not aware of any loans as of December 31, 2018, where the known credit problems of the
borrower would cause us to have serious doubts as to the ability of such borrowers to comply with their present loan repayment
terms and which may result in the future inclusion of such loans in the nonperforming loan categories.
Allowance for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL
must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan
portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general
allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off
history, the prevailing economy, the borrower’s ability to repay, the regulatory environment, competition, geographic and loan
type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, managements’ experience level,
our loan review and grading systems, the value of underlying collateral, and the level of problem loans in assessing the ALLL.
The specific allowance component is created when management believes that the collectability of a specific loan has been impaired
and a loss is probable. The specific reserves are computed using current appraisals, listed sales prices and other available information,
less costs to complete, if any, and costs to sell the property. This evaluation is inherently subjective as it requires estimates that
are susceptible to significant revision as more information becomes available or as future events differ from predictions. In addition,
specific reserves may be created upon a loan’s restructuring, based on a discounted cash flow analysis comparing the present value
of the anticipated repayments under the restructured terms to the outstanding principal balance of the loan.
Quarterly, our Board of Directors’ Internal Asset Review Committee reviews and recommends approval of the allowance
for loan losses and any provision or recapture of provision for loan losses, and the full Board of Directors approves the provision
or recapture after considering the Committee’s recommendation. The allowance is increased by the provision for loan losses which
is charged against current period earnings. If the analysis of our loan portfolio indicates the risk of loss is less than the balance of
the ALLL, a recapture of provision of loan loss is added to current period earnings.
For the year ended December 31, 2018, we recorded a $4.0 million recapture of provision for loan losses to our ALLL,
as compared to a $400,000 recapture of provision for loan losses for the year ended December 31, 2017, and a provision for loan
losses of $1.3 million for the year ended December 31, 2016. The recapture of provision for loan losses in 2018 was primarily a
result of the $4.5 million in net recoveries received on previously charged-off loans partially offset by the provision necessary to
support the increase in total loans, net LIP, of $34.7 million. The quality of our loan portfolio was stable, with a significant decrease
in TDRs and a small increase in delinquent and nonperforming loans, due primarily to our efforts working with our borrowers to
bring their loan payments current whenever possible. The ALLL was $13.3 million, or 1.29% of total loans, net of LIP, at
December 31, 2018, as compared to $12.9 million, or 1.28% at December 31, 2017. The level of the ALLL is based on estimates
and the ultimate losses may vary from the estimates. Management reviews the adequacy of the ALLL on a quarterly basis.
A loan is considered impaired when, based on current information and events, it is probable we will be unable to collect
the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors
considered by management in determining impairment include payment status, collateral value, market conditions, rent rolls, and
the borrower’s and guarantor’s, if any, financial strength. Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a
case by case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of
the delay, the reasons for the delay, the borrower’s prior payment record and the amounts of the shortfall in relation to the principal
and interest owed. Loans are evaluated for impairment on a loan-by-loan basis. As of December 31, 2018 and 2017, impaired loans
were $10.1 million and $18.0 million, respectively. At December 31, 2018, there was no LIP in connection with our impaired
loans.
17
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18
We believe that the ALLL as of December 31, 2018 was adequate to absorb the probable and inherent losses in the loan
portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the ALLL are
reasonable, there can be no assurance that such estimates and assumptions will be proven correct in the future, or that the actual
amount of future provisions will not exceed the amount of past provisions, or that any increased provisions that may be required
will not adversely impact our financial condition and results of operations. Future additions to the ALLL may become necessary
based upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan
balances or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of the ALLL
is subject to review by bank regulators as part of the routine examination process that may result in the establishment of additional
loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available
to them at the time of their examination.
The following table sets forth an analysis of our ALLL at the dates and for the periods indicated.
ALLL at beginning of period
(Recapture of provision) provision for loan losses
$ 12,882
(4,000)
$ 10,951
(400)
$
9,463
1,300
$ 10,491
(2,200)
$ 12,994
(2,100)
At or For the Year Ended December 31,
2018
2017
2016
2015
2014
(Dollars in thousands)
Charge-offs:
One-to-four family residential
Multifamily
Commercial real estate
Construction/land
Consumer
Total charge-offs
Total recoveries
Net recoveries (charge-offs)
ALLL at end of period
—
—
—
—
—
—
—
—
—
—
—
—
4,465
4,465
2,331
2,331
—
—
—
—
(83)
(83)
271
188
(27)
(281)
—
—
(54)
(362)
1,534
1,172
$ 13,347
$ 12,882
$ 10,951
$ 9,463
(78)
—
(311)
(223)
(30)
(642)
239
(403)
$ 10,491
ALLL as a percent of total loans, net of LIP
Net (recoveries) charge-offs to average loans receivable, net of
LIP
ALLL as a percent of nonperforming loans, net of LIP
1.29%
1.28%
1.32%
1.36%
1.55%
(0.45)
(0.27)
(0.02)
(0.18)
0.06
1,774.87% 7,196.65% 1,276.34% 872.17% 783.50%
Investment Activities
General. Under Washington State law, commercial banks are permitted to invest in various types of liquid assets, including
U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings
institutions, banker’s acceptances, repurchase agreements, federal funds, commercial paper, investment grade corporate debt
securities, and obligations of states and their political sub-divisions.
The Investment, Asset/Liability Committee (“ALCO”), consisting of the Chief Executive Officer, Chief Financial Officer,
and Controller of First Financial Northwest Bank, other members of management and the Board of Directors, has the authority
and responsibility to administer our investment policy, monitor portfolio strategies, and recommend appropriate changes to policy
and strategies to the Board of Directors. On a monthly basis, management reports to the Board a summary of investment holdings
with respective market values and all purchases and sales of investment securities. The Chief Financial Officer has the primary
responsibility for the management of the investment portfolio and considers various factors when making decisions, including the
marketability, maturity, liquidity, and tax consequences of proposed investments. The maturity structure of investments will be
affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the
trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The general objectives of the investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining
earnings when loan demand is low, and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment
risk, liquidity risk and interest rate risk.
19
At December 31, 2018, our investment portfolio consisted principally of mortgage-backed securities, municipal bonds,
U.S. government agency obligations, and corporate bonds. From time to time, investment levels may increase or decrease depending
upon yields available on investment opportunities and management’s projected demand for funds for loan originations, net deposit
flows, and other activities. At December 31, 2018, we did not hold securities of any single issuer (other than government-sponsored
entities) that exceeded 10% of our shareholders’ equity. We currently do not have any investments held to maturity or for trading.
Other than our utilization of interest rate swaps, we do not currently participate in other hedging programs, stand-alone
contracts for interest rate caps or floors or other activities involving the use of off-balance sheet derivative financial instruments,
and have no present intention to do so. As of December 31, 2018, we had one interest rate swap with an aggregate notional amount
of $50.0 million and a fair value of $1.7 million. For additional information, see Item 1A. Risk Factors -“If interest rate swaps we
entered into prove ineffective, it could result in volatility in our operating results, including potential loses, which could have a
material adverse effect on our results of operations and cash flows, Item 7. “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Asset and Liability Management”, and Note 11 of the Notes to Consolidated Financial
Statements contained in Item 8 of this report.
Mortgage-Backed Securities. The mortgage-backed securities in our portfolio were primarily comprised of Fannie Mae,
Freddie Mac, and Ginnie Mae issued mortgage-backed securities. These issuers guarantee the timely payment of principal and
interest in the event of default. In addition, at December 31, 2018, our mortgage-backed securities included $9.0 million of other
“private label” mortgage-backed securities. The mortgage-backed securities portfolio had a weighted-average yield of 3.20% at
December 31, 2018.
U.S. Government Agency Obligations. The agency securities in our portfolio were comprised of Fannie Mae, Freddie
Mac, Ginnie Mae, U.S. Small Business Administration (“SBA”) and FHLB agency securities. These issuers guarantee the timely
payment of principal and interest in the event of default. At December 31, 2018, the portfolio of government agency securities
had a weighted-average yield of 3.92%.
The guarantees of the SBA, as a U.S. government agency and Ginnie Mae, as part of a U.S. government agency are
backed by the full faith and credit of the United States. Fannie Mae, Freddie Mac, and the Federal Home Loan Banks are U.S.
government-sponsored entities. Although their guarantees are not backed by the full faith and credit of the United States, they
may borrow from the U.S. Treasury, which has taken other steps to ensure these U.S. government-sponsored entities can fulfill
their financial obligations.
Corporate Bonds. The corporate bond portfolio was primarily comprised of variable rate securities issued by various
financial institutions. At December 31, 2018, the corporate bond portfolio had a weighted-average yield of 6.42%.
Municipal Bonds. The municipal bond portfolio is comprised of tax-exempt municipal bonds. The pre-tax weighted-
average yield on the municipal bond portfolio was 2.82% at December 31, 2018.
Federal Home Loan Bank Stock. As a member of the FHLB Des Moines, we are required to own capital stock. The
required amount of capital stock is based on a percentage of our previous year-end assets and our outstanding FHLB advances.
The redemption of any excess stock we hold is at the discretion of the FHLB Des Moines. During 2018, our FHLB stock holdings
decreased by $2.6 million, primarily as a result of the $69.5 million decrease in our FHLB advances during 2018. The carrying
value of our FHLB stock totaled $7.3 million at December 31, 2018. During the years ended December 31, 2018 and 2017, we
received FHLB cash dividends of $458,000 and $296,000, respectively.
20
The following table sets forth the composition of our investment portfolio at the dates indicated.
2018
December 31,
2017
2016
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
(In thousands)
$
24,276
$
23,643
$
26,961
$
26,564
$
42,060
$
6,351
23,311
8,983
10,615
—
48,190
23,490
6,287
22,061
8,979
10,544
—
47,438
23,218
5,510
22,288
—
13,126
—
43,088
22,502
5,472
21,576
—
13,395
—
42,633
22,602
18,013
19,133
—
13,083
120
15,937
22,506
41,332
18,009
18,634
—
12,987
120
15,857
22,321
Available-for-sale:
Mortgage-backed securities:
Fannie Mae
Freddie Mac
Ginnie Mae
Other
Tax-exempt municipal bonds
Taxable municipal bonds
U.S. government agencies
Corporate bonds
Total available-for-sale
$
145,216
$
142,170
$
133,475
$
132,242
$
130,852
$
129,260
At December 31, 2018, 2017, and 2016 there were no investments held to maturity.
During the year ended December 31, 2018, gross proceeds from the call, maturity and sale of investments was
$17.2 million, with net realized losses of $20,000.
Management reviews investment securities on an ongoing basis for the presence of other than temporary impairment
(“OTTI”) or permanent impairment, taking into consideration current market conditions, fair value in relationship to cost, extent
and nature of the change in fair value, issuer rating changes and trends, whether management intends to sell a security or if it is
likely that we will be required to sell the security before recovery of the amortized cost basis of the investment, which may be
maturity, and other factors. For debt securities, if management intends to sell the security or it is likely that we will be required to
sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If
management does not intend to sell the security and it is not likely that we will be required to sell the security, but management
does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing
credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized
cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or
current effective interest rate, depending on the nature of the security being measured for potential OTTI. The remaining impairment
related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is
recognized as a charge to other comprehensive income (loss). Impairment losses related to all other factors are presented as separate
categories within other comprehensive income (loss). There were no losses related to OTTI at December 31, 2018 and 2017. For
additional information regarding our investments, see Note 3 of the Notes to Consolidated Financial Statements contained in Item
8 of this report.
21
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22
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of our funds for lending and other investment purposes.
Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are
influenced significantly by general interest rates and market conditions. Borrowings from the FHLB are used to supplement the
availability of funds from other sources and also as a source of term funds to assist in the management of interest rate risk.
Our deposit composition reflects a mixture of various deposit products. We rely on marketing activities, customer service,
and the availability of a broad range of products and services to attract and retain customer deposits.
Deposits. We offer a competitive range of deposit products within our market area, including noninterest bearing accounts,
interest-bearing demand accounts, money market deposit accounts, statement savings accounts, and certificates of deposit. Deposit
account terms vary according to the minimum balance required, the time periods the funds must remain on deposit, and the interest
rate, among other factors. In determining the terms of our deposit accounts, we consider the development of long-term profitable
customer relationships, current market interest rates, current maturity structures, deposit mix, our customer preferences, and the
profitability of acquiring customer deposits compared to alternative funding sources. As part of our strategy to shift our deposit
mix to lower cost funds, we continued to better align our pricing with competitors in our local market to meet our goals. To
supplement local deposits, funds are also generated through national brokered certificates of deposit. At December 31, 2018,
$97.8 million, or 10.4% of total deposits were brokered certificates of deposit, with remaining maturities ranging from one month
to five years. These funds cannot be withdrawn early except in the case of the death or adjudication of incompetence of the
depositor. However, the Bank has a quarterly call option six months after issuance on $69.3 million of these brokered deposits
that allows the Bank to close the certificate of deposit and return the deposit to the customer if the Bank determines it is in its best
interest to do so. The long term nature of these brokered deposits, along with the enhanced features of these deposits as compared
to retail certificates of deposit, assists us in our interest rate risk management efforts.
The following table sets forth our total deposit activity for the periods indicated.
Total deposits, beginning balance
Increase in retail deposits
Increase in brokered funds
Net increase in deposits
Total deposits, ending balance
$
$
2018
Year Ended December 31,
2017
(In thousands)
839,502
$
717,476
$
2016
77,193
22,337
99,530
122,026
—
122,026
939,032
$
839,502
$
675,407
32,732
9,337
42,069
717,476
At December 31, 2018, deposits totaled $939.0 million. We had $313.5 million of jumbo (greater than or equal to $100,000)
certificates of deposit, which were 33.4% of total deposits at December 31, 2018. Of these jumbo deposits, $129.3 million were
greater than or equal to $250,000. At that date, included in the jumbo certificates of deposit, were public funds totaling $28.5 million,
or 3.0% of total deposits, of which $26.9 million was in excess of the $250,000 standard FDIC insurance coverage. Under
Washington State law, in order to participate in the public funds program, we are required to pledge eligible securities of a minimum
of 50% of the public deposits in excess of $250,000.
23
The following table sets forth information regarding our certificates of deposit and other deposits at December 31, 2018.
Weighted-
Average
Interest
Rate
Term
Category
Amount
(Dollars in thousands)
—% N/A
Noninterest bearing demand deposits
$
0.16
0.13
1.31
1.05
1.94
1.86
2.13
2.10
N/A
N/A
N/A
Interest-bearing demand
Statement savings
Money market
Certificates of deposit, retail
Three months or less
Over three through six months
Over six through twelve months
Over twelve months
Retail certificates of deposit, fair value
adjustment
Total certificates of deposit, retail
46,108
40,079
24,799
339,047
706
5,260
36,584
348,682
(58)
391,174
2.18
Over twelve months
Total certificates of deposit, brokered
97,825
Percentage
of Total
Deposits
4.9%
4.3
2.6
36.1
0.1
0.6
3.9
37.1
—
41.7
10.4
Certificates of Deposit. The following table sets forth the amount and maturities of certificates of deposit at
Total deposits
$
939,032
100.0%
December 31, 2018.
0.00 - 1.00%
1.01 - 2.00%
2.01 - 3.00%
3.01 - 4.00%
Retail certificates
of deposit, fair
value adjustment
Within
One Year
After One Year
Through
Two Years
After Two
Years Through
Three Years
After Three
Years Through
Four Years
Thereafter
Total
(In thousands)
$
13,547
$
1,438
$
793
$
130
$
3
$
161,783
53,978
1,060
41,420
42,826
7,050
25,892
55,749
8,519
4,255
11,533
16,953
1,165
13,077
27,886
15,911
234,515
177,163
61,468
(30)
(16)
(9)
90,944
$
(3)
32,868
$
—
42,131
$
(58)
488,999
Total
$
230,338
$
92,718
$
24
The following table sets forth the amount of our jumbo certificates of deposit by remaining maturity as of
December 31, 2018.
Maturity Period
Three months or less
Over three months through six months
Over six months through twelve months
Over twelve months
Total
Certificates of Deposit
(In thousands)
$
$
38,732
27,459
79,409
167,879
313,479
Deposit Flow. The following table sets forth the deposit balances by the types of accounts we offered at the dates indicated.
2018
December 31,
2017
2016
Amount
Percent of
Total
Amount
Percent of
Total
Amount
Percent of
Total
(Dollars in thousands)
Noninterest bearing
$
Interest-bearing demand
Statement savings
Money market
Certificates of deposit, retail:
0.00 - 1.00%
1.01 - 2.00%
2.01 - 3.00%
3.01 - 4.00%
5.01 - 6.00%
Retail certificates of deposit,
fair value adjustment
Total certificates of deposit,
retail
Certificates of deposit,
brokered
0.00 - 1.00%
1.01 - 2.00%
2.01 - 3.00%
3.01 - 4.00%
Total certificates of deposit,
brokered
Total deposits
46,108
40,079
24,799
339,047
15,790
191,294
131,328
52,820
—
(58)
391,174
121
43,221
45,835
8,648
4.9% $
4.3
2.6
36.1
1.7
20.4
14.0
5.6
—
—
41.7
—
4.6
4.9
0.9
45,434
38,224
28,456
318,636
79,323
247,517
6,531
—
—
(107)
5.4% $
4.5
3.4
38.0
9.4
29.5
0.8
—
—
—
33,422
18,532
28,383
204,998
124,710
228,458
3,349
—
136
—
4.7%
2.5
4.0
28.6
17.4
31.8
0.5
—
—
—
333,264
39.7
356,653
49.7
1,038
68,965
5,485
—
0.1
8.2
0.7
—
9.0
1,038
74,014
436
—
75,488
0.1
10.3
0.1
—
10.5
97,825
10.4
75,488
$
939,032
100.0% $
839,502
100.0% $
717,476
100.0%
Borrowings. Customer deposits are the primary source of funds for our lending and investment activities. We use advances
from the FHLB and to a lesser extent federal funds (“Fed Funds”) purchased to supplement our supply of lendable funds, to meet
short-term deposit withdrawal requirements and to provide longer term funding to better match the duration of selected loan and
investment maturities. In addition, at December 31, 2018 we had supplemental funding sources of $91.2 million available at the
FRB and $35.0 million available between two other financial institutions.
25
As a member of the FHLB, we are required to own capital stock in the FHLB and are authorized to apply for advances
on the security of that stock and certain of our mortgage loans, provided that certain creditworthiness standards have been met.
Advances are individually made under various terms pursuant to several different credit programs, each with its own interest rate
and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition
of the member institution and the adequacy of collateral pledged to secure the credit. We maintain a credit facility with the FHLB
that provides for immediately available advances, subject to acceptable collateral. At December 31, 2018, our remaining FHLB
credit capacity was $408.3 million and outstanding advances from the FHLB totaled $146.5 million.
The following table sets forth information regarding FHLB advances at the end of and during the periods indicated. The
table includes both long- and short-term borrowings.
Maximum amount of borrowings outstanding at any month end
$
224,000
$
231,500
$
251,500
At or for the Year Ended December 31,
2018
2017
2016
(Dollars in thousands)
Average borrowings outstanding
Average rate paid during the year
Balance outstanding at end of the year
Weighted-average rate paid at end of the year
Subsidiaries and Other Activities
183,667
192,227
163,893
1.92%
1.30%
0.87%
$
146,500
$
216,000
$
171,500
2.62%
1.60%
0.87%
First Financial Northwest, Inc. First Financial Northwest has two wholly-owned subsidiaries, First Financial Northwest
Bank and First Financial Diversified Corporation. First Financial Diversified Corporation currently holds a loan portfolio of
one to-four family residential, commercial real estate, and consumer loans. At December 31, 2018, First Financial Diversified’s
net loans receivable of $1.8 million represented less than one percent of the Company’s loan portfolio.
First Financial Northwest Bank. First Financial Northwest Bank is a community-based commercial bank. The Bank
primarily serves the greater Puget Sound region of King and to a lesser extent, Pierce, Snohomish and Kitsap Counties, Washington
through our full-service banking office in Renton, Washington and nine additional branches in King and Snohomish Counties,
Washington. We are in the business of attracting deposits from the public and utilizing those deposits to originate loans.
Competition
The Bank operates in the highly competitive Puget Sound region of Western Washington. We face competition in
originating loans and attracting deposits within our geographic market area. The competitive environment is impacted by changes
in the regulatory environment, technology and product delivery systems as well as consolidation in the industry creating larger,
more diversified competitors. We compete by striving to consistently deliver high-quality personal service to our customers seeking
to achieve a high level of customer satisfaction.
The Bank attracts deposits primarily through its branch office system. The competition is primarily from commercial
banks, savings institutions and credit unions in the same geographic area. Based on the most current FDIC market share data dated
June 30, 2018, the top five banks in the Seattle-Tacoma-Bellevue metropolitan statistical area (comprised of Bank of America,
Wells Fargo, JP Morgan Chase, US Bancorp and KeyBank) controlled 71% of the deposit market. In addition to the FDIC insured
competitors, credit unions, insurance companies, brokerage firms, and more recently, financial technology (or “FinTech”)
companies also compete for consumer deposit relationships. According to FDIC statistical market data, the Bank’s share of
aggregate deposits in the market area is less than 1%. Our competition for loans comes principally from commercial banks,
mortgage brokers, thrift institutions, credit unions, finance companies and FinTech companies. Several other financial institutions
compete with us for banking business in our market area. Many of our competitors have substantially more resources than the
Bank, some of which are able to offer a broader range of services, such as trust departments and enhanced retail services. Among
the advantages of some of these competitors are their ability to make larger loans, initiate extensive advertising campaigns, access
lower cost funding sources, and allocate their investable assets in regions of highest yield and demand. The challenges posed by
such large competitors may impact our ability to originate loans, secure low cost deposits, and establish product pricing levels
that support our net interest margin goals that may limit our future growth and earnings potential.
26
Employees
At December 31, 2018, we had 156 full-time employees. Our employees are not represented by any collective bargaining
group. We consider our employee relations to be good.
How We Are Regulated
The following is a brief description of certain laws and regulations that are applicable to First Financial Northwest and
First Financial Northwest Bank. On March 31, 2015, First Financial Northwest converted from a registered savings and loan
holding company to a bank holding company. As a bank holding company, First Financial Northwest is subject to examination
and supervision by, and is required to file certain reports with, the FRB. First Financial Northwest also is subject to the rules and
regulations of the SEC under the federal securities laws. First Financial Northwest Bank, which changed its charter from a
Washington-chartered savings bank to a Washington-chartered commercial bank effective on February 11, 2016, is subject to
regulation and oversight by the DFI, the applicable provisions of Washington law and by the regulations of the DFI adopted
thereunder. First Financial Northwest Bank also is subject to regulation and examination by the FDIC, which insures its deposits
to the maximum extent permitted by law.
The laws and regulations affecting depository institutions and their holding companies have changed significantly,
particularly in connection with the enactment of the Dodd-Frank Act. Among other changes, the Dodd-Frank Act established the
Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve. The CFPB assumed
responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has
authority to impose new requirements.
In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”), was enacted
to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank
Act. While the ECRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects
of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets
of more than $50 billion.
The EGRRCPA, among other matters, expands the definition of qualified mortgages which may be held by a financial
institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated
assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio”
of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “community bank
leverage ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and
any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt
corrective action rules.
The EGRRCPA also expands the category of holding companies that may rely on the Federal Reserve’s “Small Bank
Holding Company and Savings and Loan Holding Company Policy Statement” by raising the maximum amount of assets a
qualifying holding company may have from $1 billion to $3 billion. A major result of this change is to exclude most such holding
companies from the minimum capital requirements of the Dodd-Frank Act. The Federal Reserve made this change effective
August 30, 2018. In addition, the Act includes regulatory relief for community banks regarding regulatory examination cycles,
call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the EGRRCPA will ultimately be applied to
us or what specific impact that Act and the forthcoming implementing rules and regulations will have.
In addition, the laws and regulations governing us may be amended from time to time by the relevant legislative bodies
and regulators. Any such legislative action or regulatory changes in the future could adversely affect us. We cannot predict whether
any such changes may occur.
Regulation and Supervision of First Financial Northwest Bank
General. As a state-chartered commercial bank, First Financial Northwest Bank is subject to applicable provisions of
Washington state law and regulations of the DFI in addition to federal law and regulations of the FDIC applicable to state banks
that are not members of the Federal Reserve System. State law and regulations govern First Financial Northwest Bank’s ability
to take deposits and pay interest, to make loans on or invest in residential and other real estate, to make consumer loans, to invest
in securities, to offer various banking services to its customers and to establish branch offices. Under state law, commercial banks
27
in Washington also generally have all of the powers that federal commercial banks have under federal laws and regulations. First
Financial Northwest Bank is subject to periodic examination by and reporting requirements of the DFI.
Insurance of Accounts and Regulation by the FDIC. First Financial Northwest Bank’s deposits are insured up to
$250,000 per separately insured deposit ownership right or category by the Deposit Insurance Fund of the FDIC. As insurer, the
FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require reporting by, FDIC-
insured institutions. The FDIC also may prohibit any insured institution from engaging in any activity the FDIC determines by
regulation or order to pose a serious risk to the deposit insurance fund. The FDIC also has the authority to initiate enforcement
actions against commercial institutions and may terminate the deposit insurance if it determines that the institution has engaged
in unsafe or unsound practices or is in an unsafe or unsound condition.
Under the FDIC’s rules, the assessment base for a bank is equal to its total average consolidated assets less average
tangible equity capital. Currently, the FDIC’s base assessment rates are 3 to 30 basis points and are subject to certain adjustments.
For institutions with less than $10 billion in assets, rates are determined based on supervisory ratings and certain financial ratios.
No institution may pay a dividend if it is in default on its federal deposit insurance assessment.
In addition, federally insured institutions are required to pay a Financing Corporation (“FICO”) assessment in order to
fund the interest on bonds issued to resolve thrift failures in the 1980s. For the quarter ended December 31, 2018, the FICO
assessment rate was 0.32 basis points (annualized) of the assessment base, computed on assets. These assessments will continue
until the remaining bonds have matured in September 2019. For 2018, the Bank incurred approximately $502,000 in FDIC and
FICO assessment expense.
The FDIC may terminate the deposit insurance of any insured depository institution, including First Financial Northwest
Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe
or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or any condition imposed
by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent
termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution
at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years,
as determined by the FDIC. We are not aware of any practice, condition or violation that might lead to termination of First Financial
Northwest Bank’s deposit insurance.
A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results
of operations of the Bank. There can be no prediction as to what changes in insurance assessment rates may be made in the future.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation, guidelines
for all insured depository institutions relating to: internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings and compensation, fees and
benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address
problems at insured depository institutions before capital becomes impaired. Each insured depository institution must implement
a comprehensive written information security program that includes administrative, technical and physical safeguards appropriate
to the institution’s size and complexity and the nature and scope of its activities. The information security program also must be
designed to ensure the security and confidentiality of customer information, protect against any unanticipated threats or hazards
to the security or integrity of such information, protect against unauthorized access to or use of such information that could result
in substantial harm or inconvenience to any customer and ensure the proper disposal of customer and consumer information. Each
insured depository institution must also develop and implement a risk-based response program to address incidents of unauthorized
access to customer information in customer information systems. If the FDIC determines that an institution fails to meet any of
these guidelines, it may require an institution to submit to the FDIC an acceptable plan to achieve compliance. We are not aware
of any conditions relating to these safety and soundness standards that would require submission of a plan of compliance by First
Financial Northwest Bank.
Capital Requirements. Federally insured financial institutions, such as First Financial Northwest Bank, and their holding
companies, are required to maintain a minimum level of regulatory capital.
The Federal Reserve and the FDIC adopted new capital changes effective January 1, 2015, (with some changes phased
in over several years), First Financial Northwest Bank became subject to new capital regulations adopted by the Federal Reserve
and the FDIC, which establish minimum required ratios for common equity Tier 1 capital (“CET1”), Tier 1 capital and total capital,
and the leverage ratio; set out risk-weights for assets and certain off-balance sheet items for purposes of the risk-based capital
ratios, require an additional capital conservation buffer over the minimum risk-based ratios’ and define what qualifies as capital
for purposes of meeting the capital requirements. These regulations implement the regulatory capital reforms required by the
28
Dodd-Frank Act and the “Basel III” requirements. First Financial Northwest was also subject to these regulations until
August 30, 2018, pursuant to the EGRRCPA as discussed above.
Under the capital regulations, the minimum capital ratios are: (1) a CET1 capital ratio of 4.5% of risk-weighted assets;
(2) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3) a total risk-based capital ratio of 8.0% of risk-weighted assets; and
(4) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%. CET1 generally consists of common stock,
retained earnings, accumulated other comprehensive income (“AOCI”) unless an institution has elected to exclude AOCI from
regulatory capital, and certain minority interests, all subject to applicable regulatory adjustments and deductions. Tier 1 capital
generally consists of CET1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock
and subordinated debt meeting certain conditions plus an amount of the allowance for loan and lease losses up to 1.25% of assets.
Total capital is the sum of Tier 1 and Tier 2 capital.
There are a number of changes in what constitutes regulatory capital compared to the rules in effect prior to January 1, 2015,
some of which are subject to transition periods. These changes include the phasing-out of certain instruments as qualifying capital
and eliminate or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital.
Mortgage servicing assets and deferred tax assets over designated percentages of CET1 are deducted from capital. In addition,
Tier 1 capital includes AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities. However,
because of our asset size, we were eligible for the one-time option of permanently opting out of the inclusion of unrealized gains
and losses on available for sale debt and equity securities in our capital calculations. We elected this option in the first quarter of
2015.
For purposes of determining risk-based capital, assets and certain off-balance sheet items are risk-weighted from 0% to
1,250%, depending on the risk characteristics of the asset or item. The new regulations make certain changes in the risk-weighting
of assets to better reflect credit risk and other risk exposure compared to the earlier capital rules. These include a 150% risk weight
(up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for
non residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; and a 20% (up from 0%) credit
conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally
cancellable (currently set at 0%). Mortgage servicing and deferred tax assets that are not deducted from capital were proposed to
increase to 250% in 2018, however they remained at 100%.
In addition to the minimum CET1, Tier 1, and total capital ratios, the capital regulations require a capital conservation
buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order
to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. The phase-in of the
capital conservation buffer requirement began on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was
required, which increased each year where the buffer requirement is fully implemented as of January 1, 2019.
To be considered “well capitalized,” a depository institution must have a Tier 1 risk-based capital ratio of at least 8%, a
total risk-based capital ratio of at least 10%, a CET1 capital ratio of at least 6.5% and a leverage ratio of at least 5%, and not be
subject to an individualized order, directive or agreement under which its primary federal banking regulator requires it to maintain
a specific capital level. As of December 31, 2018, First Financial Northwest Bank met the requirements to be “well capitalized”
and met the fully phased-in capital conservation buffer requirement.
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The table below sets forth First Financial Northwest Bank’s capital position at December 31, 2018 and 2017, based on
FDIC thresholds to be well-capitalized.
Bank equity capital under U.S. Generally Accepted Accounting Principles
(“GAAP”)
$128,008
$123,023
December 31,
2018
2017
Amount
Ratio
Amount
Ratio
(Dollars in thousands)
Tier 1 leverage capital
Tier 1 leverage capital requirement
Excess
Common equity tier 1
Common equity tier 1 capital requirement
Excess
Tier 1 risk-based capital
Tier 1 risk-based capital requirement
Excess
Total risk-based capital
Total risk-based capital requirement
Excess
$128,257
10.37% $122,090
10.20%
61,863
5.00
59,843
5.00
$ 66,394
5.37% $ 62,247
5.20%
$128,257
13.43% $122,090
12.52%
62,089
6.50
63,379
6.50
$ 66,168
6.93% $ 58,711
6.02%
$128,257
13.43% $122,090
12.52%
76,417
8.00
78,006
8.00
$ 51,840
5.43% $ 44,084
4.52%
$140,220
14.68% $134,292
13.77%
95,521
10.00
97,507
10.00
$ 44,699
4.68% $ 36,785
3.77%
The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon a
determination that an institution’s capital level is or may become inadequate in light of particular risks or circumstances.
Management of First Financial Northwest Bank believes that, under the current regulations, First Financial Northwest Bank will
continue to meet its minimum capital requirements in the foreseeable future.
For a complete description of First Financial Northwest Bank’s required and actual capital levels on December 31, 2018,
see Note 14 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
The Financial Accounting Standards Board has adopted a new accounting standard for US Generally Accepted Accounting
Principles that will be effective for us for our first fiscal year beginning after December 15, 2019. This standard, referred to as
Current Expected Credit Loss, or CECL, requires FDIC-insured institutions and their holding companies (banking organizations)
to recognize credit losses expected over the life of certain financial assets. CECL covers a broader range of assets than the current
method of recognizing credit losses and generally results in earlier recognition of credit losses. Upon adoption of CECL, a banking
organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption
equal to the difference, if any, between the amount of credit loss allowances under the current methodology and the amount required
under CECL. For a banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect
other items, in a manner that reduces its regulatory capital.
The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC) have
adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of
CECL on its regulatory capital.
Prompt Corrective Action. Federal statutes establish a supervisory framework for FDIC-insured institutions based on
five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically
undercapitalized. An institution’s category depends upon where its capital levels are in relation to relevant capital measures. The
well-capitalized category is described above. An institution that is not well capitalized is subject to certain restrictions on brokered
deposits, including restrictions on the rates it can offer on its deposits, generally. To be considered adequately capitalized, an
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institution must have the minimum capital ratios described above. Any institution which is neither well capitalized nor adequately
capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and
restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by First Financial
Northwest Bank to comply with applicable capital requirements would, if unremedied, result in progressively more severe
restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to
ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking
regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital
requirements. Additionally, approval of any regulatory application filed for their review may be dependent on compliance with
capital requirements.
At December 31, 2018, First Financial Northwest Bank was categorized as “well capitalized” under the prompt corrective
action regulations of the FDIC. For additional information, see Note 14 of the Notes to Consolidated Financial Statements contained
in Item 8 of this report.
Federal Home Loan Bank System. First Financial Northwest Bank is a member of the FHLB of Des Moines, one of
11 regional FHLBs that administer the home financing credit function of savings institutions. The FHLBs are subject to the
oversight of the Federal Housing Finance Agency (“FHFA”) and each FHLB serves as a reserve or central bank for its members
within its assigned region. The FHLBs are funded primarily from proceeds derived from the sale of consolidated obligations of
the FHLB System and make loans or advances to members in accordance with policies and procedures established by the Board
of Directors of the FHLB, which are subject to the oversight of the FHFA. All advances from the FHLB are required to be fully
secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for
residential home financing. See “Business – Deposit Activities and Other Sources of Funds – Borrowings.”
At December 31, 2018, the Bank held $7.3 million in FHLB of Des Moines stock that was in compliance with the holding
requirements. The Bank purchased 2,079 shares of additional stock in March 2018 as a result of the increase in assets as of
December 31, 2017. In addition, activity stock was purchased and sold throughout 2018 in response to increases or payoffs to our
outstanding advances. At December 31, 2018, the Bank had a net decrease in activity stock held of 27,800 shares for the year. The
FHLB pays dividends quarterly, and First Financial Northwest Bank received $458,000 in dividends during the year ended
December 31, 2018.
The FHLBs continue to contribute to low- and moderately-priced housing programs through direct loans or interest
subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions
have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions could
also have an adverse effect on the value of FHLB of Des Moines stock in the future. A reduction in value of First Financial
Northwest Bank’s FHLB of Des Moines stock may result in a decrease in net income and possibly capital.
Commercial Real Estate Lending Concentrations. The federal banking agencies have issued guidance on sound risk
management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial
real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to
conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or
as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real estate lending but to guide banks
in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The
guidance directs the FDIC and other federal bank regulatory agencies to focus their supervisory resources on institutions that may
have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate
lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following
supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
• Total reported loans for construction, land development and other land represent 100% or more of the bank’s total regulatory
capital; or
• Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank’s total regulatory
capital and the outstanding balance of the bank’s commercial real estate loan portfolio has increased 50% or more during
the prior 36 months.
The guidance provides that the strength of an institution’s lending and risk management practices with respect to such
concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy. As of December 31, 2018,
First Financial Northwest Bank’s aggregate recorded loan balances for construction, land development and land loans were 81.9%
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of regulatory capital. In addition, at December 31, 2018, First Financial Northwest Bank’s loans on commercial real estate, as
defined by the FDIC, were 451.8% of regulatory capital.
Activities and Investments of Insured State-Chartered Financial Institutions. Federal law generally limits the
activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. An insured
state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing
as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or
new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the
bank’s total assets, (3) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors’, trustees’
and officers’ liability insurance coverage or bankers’ blanket bond group insurance coverage for insured depository institutions
and (4) acquiring or retaining the voting shares of a depository institution owned by another FDIC-insured institution if certain
requirements are met.
Washington State has enacted a law regarding financial institution parity. Primarily, the law affords Washington
state chartered commercial banks the same powers as Washington state-chartered savings banks and provides that Washington
chartered commercial banks may exercise any of the powers that the Federal Reserve has determined to be closely related to the
business of banking and the powers of national banks, subject to the approval of the Director of the DFI in certain situations.
Finally, the law provides additional flexibility for Washington state-chartered commercial and savings banks with respect to interest
rates on loans and other extensions of credit. Specifically, they may charge the maximum interest rate allowable for loans and
other extensions of credit by federally-chartered financial institutions to Washington residents.
Environmental Issues Associated With Real Estate Lending. The Comprehensive Environmental Response,
Compensation and Liability Act (“CERCLA”) is a federal statute that generally imposes strict liability on all prior and present
“owners and operators” of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing
that the term “owner and operator” excludes a person whose ownership is limited to protecting its security interest in the site.
Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial interpretations that have
left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a
loan. To the extent that legal uncertainty exists in this area, all creditors, including First Financial Northwest Bank, that have made
loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to
liability for cleanup costs that often are substantial and can exceed the value of the collateral property.
Federal Reserve System. The Federal Reserve requires that all depository institutions maintain reserves on transaction
accounts and non-personal time deposits. These reserves may be in the form of cash or deposits with the regional Federal Reserve
Bank. Interest-bearing demand accounts and other types of accounts that permit payments or transfers to third parties fall within
the definition of transaction accounts and are subject to reserve requirements, as are any non-personal time deposits at a savings
bank. As of December 31, 2018, First Financial Northwest Bank’s deposits with the FRB exceeded such reserve requirements.
Affiliate Transactions. First Financial Northwest and First Financial Northwest Bank are separate and distinct legal
entities. First Financial Northwest (and any non-bank subsidiary of First Financial Northwest) is an affiliate of First Financial
Northwest Bank. Federal laws strictly limit the ability of banks to engage in certain transactions with their affiliates. Transactions
deemed to be a “covered transaction” under Section 23A of the Federal Reserve Act and between a bank and an affiliate are limited
to 10% of the bank’s capital and surplus and, with respect to all affiliates, to an aggregate of 20% of the bank’s capital and surplus.
Further, covered transactions that are loans and extensions of credit generally are required to be secured by eligible collateral in
specified amounts. Federal law also requires that covered transactions and certain other transactions listed in Section 23B of the
Federal Reserve Act between a bank and its affiliates be on terms as favorable to the bank as transactions with nonaffiliates. For
additional information, see “– Regulation and Supervision of First Financial Northwest – Limitations on Transactions with
Affiliates” below.
In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans to executive officers, directors
and principal shareholders. Under Section 22(h), loans to a director, executive officer or greater than 10% shareholder of a bank
and certain affiliated interests, may not exceed, together with all other outstanding loans to such person and affiliated interests,
the bank’s loans to one borrower limit (generally equal to 15% of the institution’s unimpaired capital and surplus). Section 22(h)
also requires that loans to directors, executive officers and principal shareholders be made on terms substantially the same as
offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that
(1) is widely available to employees of the institution and (2) does not give preference to any director, executive officer or principal
shareholder, or certain affiliated interests, over other employees of the bank. Section 22(h) also requires prior board approval for
certain loans. In addition, the aggregate amount of extensions of credit by a bank to all insiders cannot exceed the bank’s unimpaired
capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At December 31, 2018,
First Financial Northwest Bank was in compliance with these restrictions.
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Community Reinvestment Act. First Financial Northwest Bank is subject to the provisions of the Community
Reinvestment Act of 1977 (“CRA”), which require the appropriate federal bank regulatory agency to assess a bank’s performance
under the CRA in meeting the credit needs of the community serviced by the bank, including low and moderate income
neighborhoods. The regulatory agency’s assessment of the bank’s record is made available to the public. Further, a bank’s CRA
performance must be considered in connection with a bank’s application, to among other things, establish a new branch office
that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of,
a federally regulated financial institution. First Financial Northwest Bank received a “satisfactory” rating during its most recent
CRA examination.
Dividends. The amount of dividends payable by First Financial Northwest Bank to First Financial Northwest depends
upon First Financial Northwest Bank’s earnings and capital position, and is limited by federal and state laws, regulations and
policies. According to Washington law, First Financial Northwest Bank may not declare or pay a cash dividend on its capital stock
if it would cause its net worth to be reduced below (1) the amount required for liquidation accounts or (2) the net worth requirements,
if any, imposed by the Director of the DFI. In addition, dividends may not be declared or paid if First Financial Northwest Bank
is in default in payment of any assessments due to the FDIC. Dividends on First Financial Northwest Bank’s capital stock may
not be paid in an aggregate amount greater than the aggregate retained earnings of First Financial Northwest Bank, without the
approval of the Director of the DFI.
The amount of dividends actually paid during any one period is affected by First Financial Northwest Bank’s policy of
maintaining a strong capital position. Federal law further restricts dividends payable by an institution that does not meet the capital
conservation buffer requirement and provides that no insured depository institution may pay a cash dividend if it would cause the
institution to be “undercapitalized,” as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory
agencies also have the general authority to limit the dividends paid by insured banks if such payments are deemed to constitute
an unsafe and unsound practice.
Privacy Standards. First Financial Northwest Bank is subject to FDIC regulations implementing the privacy protection
provisions of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999. These regulations require First Financial
Northwest Bank to disclose its privacy policy, including informing consumers of its information sharing practices and informing
consumers of their rights to opt out of certain practices.
Anti-Money Laundering and Customer Identification. The Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law on
October 26, 2001. The USA PATRIOT Act and the Bank Secrecy Act requires financial institutions to develop programs to prevent
financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial
institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement
Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers
seeking to open new financial accounts, and, effective in 2018, the beneficial owners of accounts. Bank regulators are directed
to consider a holding company’s effectiveness in combating money laundering when ruling on Bank Holding Company Act and
Bank Merger Act applications.
Other Consumer Protection Laws and Regulations. The Dodd-Frank Act established the CFPB and empowered it to
exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial
protection laws. First Financial Northwest Bank is subject to consumer protection regulations issued by the CFPB, but as a financial
institution with assets of less than $10 billion, First Financial Northwest Bank is generally subject to supervision and enforcement
by the FDIC with respect to its compliance with federal consumer financial protection laws and CFPB regulations.
First Financial Northwest Bank is subject to a broad array of federal and state consumer protection laws and regulations
that govern almost every aspect of its business relationships with consumers. While not exhaustive, these laws and regulations
include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability
Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage
Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Home
Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit Billing Act, the Homeowners Protection Act,
the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection
with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices and various regulations that
implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the
manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing
other services. Failure to comply with these laws and regulations can subject First Financial Northwest Bank to various penalties,
33
including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages and the
loss of certain contractual rights.
Regulation and Supervision of First Financial Northwest
General. First Financial Northwest, as sole shareholder of First Financial Northwest Bank, is a bank holding company
registered with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve
under the Bank Holding Company Act of 1956, as amended (“BHCA”), and the regulations of the FRB. Accordingly, First Financial
Northwest is required to file quarterly reports with the Federal Reserve and provide additional information as the Federal Reserve
may require. The Federal Reserve may examine First Financial Northwest, and any of its subsidiaries, and charge First Financial
Northwest for the cost of the examination. The Federal Reserve also has extensive enforcement authority over bank holding
companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders
and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may
be initiated for violations of law and regulations and unsafe or unsound practices. First Financial Northwest is also required to
file certain reports with, and otherwise comply with the rules and regulations of the SEC.
The Bank Holding Company Act. Under the BHCA, First Financial Northwest is supervised by the Federal Reserve. The
Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to
its subsidiary bank and may not conduct its operations in an unsafe or unsound manner. In addition, the Dodd-Frank Act and earlier
Federal Reserve policy provide that a bank holding company should serve as a source of strength to its subsidiary bank by having
the ability to provide financial assistance to its subsidiary bank during periods of financial distress to the bank. A bank holding
company’s failure to meet its obligation to serve as a source of strength to its subsidiary bank will generally be considered by the
Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both. No
regulations have yet been proposed by the Federal Reserve to implement the source of strength provisions required by the Dodd-
Frank Act. First Financial Northwest and any subsidiaries that it may control are considered “affiliates” within the meaning of the
Federal Reserve Act, and transactions between First Financial Northwest Bank and affiliates are subject to numerous
restrictions. With some exceptions, First Financial Northwest and its subsidiaries are prohibited from tying the provision of various
services, such as extensions of credit, to other services offered by First Financial Northwest or by its affiliates.
Acquisitions. The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or
control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging in
activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Under the BHCA,
the Federal Reserve may approve the ownership of shares by a bank holding company in any company, the activities of which the
Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a
proper incident thereto. These activities include: operating a savings institution, mortgage company, finance company, credit card
company or factoring company; performing certain data processing operations; providing certain investment and financial advice;
underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-
operating basis; selling money orders, travelers’ checks and U.S. Savings Bonds; real estate and personal property appraising;
providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for
customers. The Federal Reserve must approve the acquisition (or acquisition of control) of a bank or other FDIC-insured depository
institution by a bank holding company, and the appropriate federal banking regulator must approve a bank’s acquisition (or
acquisition of control) of another bank or other FDIC-insured institution.
Acquisition of Control of a Bank Holding Company. Under federal law, a notice or application must be submitted to
the Federal Reserve if any person (including a company), or group acting in concert, seeks to acquire “control” of a bank holding
company. An acquisition of control can occur upon the acquisition of 10% or more of the voting stock of a bank holding company
or as otherwise defined by the Federal Reserve. In considering such a notice or application, the Federal Reserve takes into
consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the
acquisition. Any company that acquires control becomes subject to regulation as a bank holding company.
Regulatory Capital Requirements. As discussed above, pursuant to EGRRCPA, effective August 30, 2018, bank holding
companies with less than $3 billion in consolidated assets were generally no longer subject to the Federal Reserve’s capital
regulations, which are generally the same as the capital regulations applicable to First Financial Northwest Bank. At the time of
this change, First Financial Northwest was considered “well capitalized” (as defined for a bank holding company), with a total
risk-based capital ratio of 10.0% or more and a Tier 1 risk-based capital ratio of 8.0% or more, and was not subject to an individualized
order, directive or agreement under which the Federal Reserve requires it to maintain a specific capital level.
34
Restrictions on Dividends. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank
holding companies which expresses its view that a bank holding company must maintain an adequate capital position and generally
should not pay cash dividends unless the company’s net income for the past year is sufficient to fully fund the cash dividends and
that the prospective rate of earnings appears consistent with the company’s capital needs, asset quality, and overall financial
condition. The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious
financial problems to borrow funds to pay dividends. For additional information, see Item 1.A. “Risk Factors – Certain regulatory
restrictions are imposed on us and lack of compliance could result in monetary penalties and/or additional regulatory actions.” in
this report.
Stock Repurchases. A bank holding company, except for certain “well-capitalized” and highly rated bank holding
companies, is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such
purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal
Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound
practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement with, the
Federal Reserve. During the year ended December 31, 2018, First Financial Northwest repurchased 203,900 shares of its common
stock.
Federal Securities Laws. First Financial Northwest’s common stock is registered with the SEC under Section 12(b) of
the Securities Exchange Act of 1934, as amended (“Exchange Act”). We are subject to information, proxy solicitation, insider
trading restrictions and other requirements under the Exchange Act.
The Dodd-Frank Act. Among other requirements, the Dodd-Frank Act requires public companies, like First Financial
Northwest, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid
to executive officers and (b) at least once every six years on whether they should have a “say on pay” vote every one, two or three
years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a
shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments;
(iii) provide disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the
financial performance of the issuer; and (iv) require companies to disclose the ratio of the Chief Executive Officer’s annual total
compensation to the median annual total compensation of all other employees. For certain of these changes, the implementing
regulations have not been promulgated, so the full impact of the Dodd-Frank Act on public companies cannot be determined at
this time.
The federal banking agencies have issued final rules to implement the provisions of the Dodd-Frank Act commonly referred
to as the Volcker Rule. The regulations contain prohibitions and restrictions on the ability of financial institutions holding companies
and their affiliates to engage in proprietary trading and to hold certain interests in, or to have certain relationships with, various
types of investment funds, including hedge funds and private equity funds. Management believes First Financial Northwest’s
investment portfolio and investment strategies are in compliance with the various provisions of the Volcker Rule regulations.
Sarbanes-Oxley Act of 2002. As a public company that files periodic reports with the SEC under the Exchange Act,
First Financial Northwest, is subject to the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), which addresses, among other
issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate
information. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory
systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board
of directors and management and between a board of directors and its committees. Our policies and procedures have been updated
to comply with the requirements of the Sarbanes-Oxley Act.
Taxation
Federal Taxation
General. First Financial Northwest and First Financial Northwest Bank are subject to federal income taxation in the same
general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is
intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules
applicable to First Financial Northwest or First Financial Northwest Bank. The tax years still open for review by the Internal
Revenue Service are 2015 through 2018.
35
First Financial Northwest files a consolidated federal income tax return with First Financial Northwest Bank. Accordingly,
any cash distributions made by First Financial Northwest to its shareholders are considered to be taxable dividends and not as a
non-taxable return of capital to shareholders for federal and state tax purposes.
Method of Accounting. For federal income tax purposes, First Financial Northwest currently reports its income and
expenses on the accrual method of accounting and uses a fiscal year ending on December 31 for filing its federal income tax return.
Minimum Tax. The Tax Cuts and Jobs Act (the “Tax Act”) effective January 1, 2018, repealed the corporate alternative
minimum tax (AMT), allowing corporations to fully apply any unused AMT credit. At December 31, 2017, the Company had no
AMT credit carryforward to apply against the 2018 tax liability.
Net Operating Loss Carryovers. Under the Tax Act, a financial institution may carryforward net operating losses
indefinitely. The Company had no net operating loss carryforwards at December 31, 2018.
Corporate Dividends-Received Deduction. First Financial Northwest may eliminate from its income dividends received
from First Financial Northwest Bank as a wholly-owned subsidiary of First Financial Northwest that files a consolidated return
with First Financial Northwest Bank. The corporate dividends-received deduction is 100%, or 80%, in the case of dividends
received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock
ownership of the payer of the dividend. Corporations that own less than 20% of the stock of a corporation distributing a dividend
may deduct 70% of dividends received or accrued on their behalf.
For additional information regarding our federal income taxes, see Note 13 of the Notes to Consolidated Financial
Statements contained in Item 8 of this report.
State Taxation
First Financial Northwest and its subsidiaries are subject to a business and occupation tax imposed under Washington
state law at the rate of 1.50% of gross receipts. In addition, various municipalities also assess business and occupation taxes at
differing rates. Interest received on loans secured by first lien mortgages or deeds of trust on residential properties, rental income
from properties, and certain investment securities are exempt from this tax. An audit by the Washington State Department of
Revenue was completed for the years 2010 through 2013, resulting in no material tax revisions.
The Bank has purchased and originated loans in California. The Company no longer had employees or real estate located
in California in 2018, so therefore, will file its final California state tax return for 2018.
Executive Officers of First Financial Northwest, Inc.
The business experience for at least the past five years for the executive officers of First Financial Northwest and its
primary subsidiary First Financial Northwest Bank is set forth below.
Joseph W. Kiley III, age 63, has served as President and Chief Executive Officer of First Financial and First Financial
Diversified since September 2013; as director of First Financial and First Financial Diversified since December 2012; and as
President, Chief Executive Officer and director of First Financial Northwest Bank since September 2012. He previously served
as President, Chief Executive Officer, and director of Frontier Bank, F.S.B., Palm Desert, California, and its holding company,
Western Community Bancshares, Inc. Mr. Kiley has over 25 years of executive experience at banks, thrifts and their holding
companies that includes, but is not limited to, serving as president, chief executive officer, chief financial officer, and director.
Mr. Kiley holds a Bachelor of Science degree in Business Administration (Accounting) from the California State University, Chico,
and is a former California certified public accountant. Mr. Kiley is a member of the Renton Rotary Club, City of Renton Mayor’s
Business Executive Forum, City of Renton Mayor’s Blue Ribbon Panel, and past Chair of the Board of Directors of the Renton
Chamber of Commerce. He currently serves on the Board of the Washington Bankers’ Association (WBA), WBA Treasurer, WBA
Government Relations Liaison, and American Bankers Association Government Relations Council - Administrative Committee.
Richard P. Jacobson, age 55, has served as Chief Operating Officer of First Financial Northwest Bank since July 2013,
and as Chief Financial Officer of First Financial Northwest, First Financial Diversified, and the Bank since August 2013. He was
appointed as a director of First Financial, First Financial Diversified and the Bank effective September 2013. Mr. Jacobson served
as a consultant to First Financial from April 2010 to April 2012. Subsequently, he worked as a mortgage loan originator in Palm
Desert, California from July 2012 to July 2013. Previously, he had been employed by Horizon Financial Corp. and its wholly-
owned subsidiary, Horizon Bank, Bellingham, Washington, for 23 years, and had served as President, Chief Executive Officer
and a director of Horizon Financial Corp. and Horizon Bank from January 2008 to January 2010. Mr. Jacobson also served as
36
Chief Financial Officer of Horizon Financial Corp. and Horizon Bank from March 2000 until October 2008. Between 1985 and
2008, Mr. Jacobson served in several other positions at Horizon Financial Corp. and Horizon Bank, and spent two years as a
Washington state licensed real estate appraiser from 1992 to 1994. Mr. Jacobson received his Bachelor’s degree in Business
Administration (Finance) from the University of Washington. In addition, Mr. Jacobson graduated with honors from the American
Bankers Association’s National School of Banking. Mr. Jacobson is a past president of the Whatcom County North Rotary Club
and has served on the boards of his church, the United Way, Boys and Girls Club, and Junior Achievement.
Randy T. Riffle, age 43, was appointed Chief Credit Officer and Executive Vice President of First Financial Northwest
Bank in December 2018. Previously, Mr. Riffle was a member of KeyBank’s Pacific Region executive leadership team and led
its West Credit Campus as Senior Vice President, Commercial Credit Executive from 2015 to 2018. Prior to that, Mr. Riffle served
as Senior Vice President, Business Banking Sales Leader and Market Executive from 2011 to 2015. Between 2002 and 2011, he
held multiple roles with increasing responsibility with KeyBank. Mr. Riffle received his Bachelor’s degree in Business Management
from the University of Northern Iowa and a Graduate degree in banking from the Pacific Coast Banking School (“PCBS”), where
he continues to serve as Vice Chair of the board overseeing PCBS. Mr. Riffle’s community service has included terms serving the
Washington Bankers Association (Director), the United Way of King County (fundraising), and Olive Crest (Trustee), a not-for-
profit organization serving at-risk children. He has additionally attained certification from the Lean Six Sigma Institute.
Simon Soh, age 54, is Senior Vice President and Chief Lending Officer, a position he held since October 2012. From
August 2017 until December 2018, Mr. Soh also served as Chief Credit Officer. Previously, from August 2010 until October 2012,
Mr. Soh served as Vice President and Loan Production Manager of First Financial Northwest Bank. Prior to that, he was First Vice
President and Commercial Lending Manager at East West Bank. In 1998, Mr. Soh was a founding member of Pacifica Bank in
Bellevue, Washington that merged with United Commercial Bank in 2005, later becoming East West Bank in 2009. Mr. Soh has
over 30 years of experience in commercial banking.
Ronnie J. Clariza, age 38, was appointed Chief Risk Officer and Senior Vice President of First Financial Northwest
Bank in November 2013. Mr. Clariza previously served as Vice President and Risk Management Officer since May 2008, and
prior to that, as Assistant Vice President and Compliance Officer, as well as serving in various other compliance and internal audit
roles since he began with the Bank in 2003. Mr. Clariza is a graduate of the University of Washington where he received his
Bachelor of Arts degree in Business Administration, Finance, and is a certified regulatory Compliance Officer. Mr. Clariza is an
active member of the Washington Bankers’ Association Education Committee. He is also a past member of the Washington Bankers’
Association Enterprise Risk Management Committee, and served as a Volunteer Compliance Manager for the Seattle Children’s
Hospital Guild Association.
Dalen D. Harrison, age 59, was appointed Chief Deposit Officer of First Financial Northwest Bank in March 2014 and
Senior Vice President in July 2014. Ms. Harrison served as Senior Vice President and Director of Retail Banking at Peoples Bank
in Bellingham, Washington from 2010 until 2014. Prior to that, she served as Vice President of Rainier Pacific Bank, Tacoma,
Washington, from 1994 until 2010. Ms. Harrison received a Bachelor of Arts degree in Business Administration from St Mary’s
College in Moraga, California. Ms. Harrison has served on the boards of Rainier Pacific Foundation, First Place for Children, Gig
Harbor Rotary Foundation and Renton Downtown Partnership, and currently serves on the board of the Renton Area Youth and
Family Services.
Christine A. Huestis, age 53, is Vice President and Controller of First Financial Northwest and First Financial Northwest
Bank. Prior to joining First Financial Northwest in October 2013, she was employed by Realty in Motion, LLC, a holding company
for several mortgage default service companies in Bellevue, Washington. From 1999 until joining First Financial Northwest, Ms.
Huestis held key accounting positions at affiliated companies within Realty in Motion, with her most recent position being that
of Controller. Ms. Huestis received a Bachelor of Science degree in Accounting from Central Washington University. She is a
certified public accountant and is a member of the American Institute of Certified Public Accountants.
Item 1A. Risk Factors.
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision,
you should carefully consider the risks and uncertainties described below together with all of the other information included in
this report and our other filings with the SEC. In addition to the risks and uncertainties described below, other risks and uncertainties
not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business,
financial condition, capital levels, cash flows, liquidity, results of operations and prospects. The risks discussed below also include
forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking
statements. The market price of our common stock could decline significantly due to any of these identified or other risks and you
could lose some or all of your investment. This report is qualified in its entirety by these risk factors.
37
Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.
Our loans are primarily to businesses and individuals in the state of Washington with 87.6% of loans, net of LIP to
borrowers or secured by properties located in Washington and 12.4% of loans, net of LIP to borrowers or secured by properties
in other states. Of our out of state loans at December 31, 2018, 3.8% of loans, net of LIP, were secured by properties in California.
A decline in the national economy or the economies of the four counties which we consider to be our primary market area could
have a material adverse effect on our business, financial condition, results of operations, and prospects. Weakness in the global
economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is
not known how the recent changes in tariffs being imposed on international trade may also affect these businesses. Changes in
agreements or relationships between the United States and other countries may also affect these businesses.
While real estate values and unemployment rates have recently improved, a deterioration in economic conditions in the
market areas we serve, in particular the Puget Sound area of Washington State, could result in the following consequences, any
of which could have a materially adverse impact on our business, financial condition, results of operations:
loan delinquencies, problem assets and foreclosures may increase;
•
• we may increase our allowance for loan losses;
•
•
demand for our products and services may decline resulting in a decrease in our total loans or assets;
collateral for loans, especially real estate, may decline in value, exposing us to increased risk of loss on existing
loans, reducing customers’ borrowing power, and reducing the value of assets and collateral associated with
existing loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
and
the amount of our low-cost or noninterest-bearing deposits may decrease and the composition of our deposits
may be adversely affected.
•
•
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and
capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans in our portfolio
are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively
affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by
various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural
disasters such as earthquakes and tornadoes. If we are required to liquidate a significant amount of collateral during a period of
reduced real estate values, our financial condition and profitability could be adversely affected.
Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans
and generally have a negative effect on our financial condition and results of operations.
Our results of operations, liquidity and cash flows are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to
many factors that are beyond our control, including general economic conditions and policies of various governmental and
regulatory agencies, and, in particular, the Federal Reserve Board. The Federal Reserve has steadily increased the targeted federal
funds rate over the last three fiscal years to 2.50% at December 31, 2018. The Federal Reserve could make additional increases
in interest rates during 2019, subject to economic conditions. If the Federal Reserve increases the targeted federal funds rate,
overall interest rates will likely rise, which may negatively impact both the housing markets by reducing refinancing activity and
new home purchases and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering our operating
costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral
securing loans, which could negatively affect our financial performance.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and
investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to
originate and/or sell loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, which could negatively
impact shareholders’ equity, and our ability to realize gains from the sale of such assets, (iii) our ability to obtain and retain deposits
in competition with other available investment alternatives, (iv) the ability of our borrowers to repay adjustable or variable rate
loans, and (v) the average duration of our investment securities portfolio and other interest-earning assets. In a changing interest
rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our
business, financial condition and results of operations could be materially affected.
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Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers
to repay their current loan obligations or by reducing our margins and profitability. Our net interest margin is the difference
between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in
interest rates-up or down-could adversely affect our net interest margin and, as a result, our net interest income. Although the
yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one
can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in
duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise,
our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yields
on interest-earning assets catch up. Changes in the slope of the “yield curve”, or the spread between short-term and long-term
interest rates-could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates
are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens
or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can
earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as
borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk as we
may have to redeploy such repayment proceeds into lower yielding investments, which would likely hurt our income.
A sustained increase in market interest rates could adversely affect our earnings. As a result of the low interest rate
environment, an increasing percentage of our deposits have been comprised of deposits bearing no or a relatively low rate of
interest and having a shorter duration than our assets. We would incur a higher cost of funds to retain these deposits in a rising
interest rate environment. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates
received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected
In addition, a portion of our adjustable-rate loans have interest rate floors below which the loan’s contractual interest rate
may not adjust. At December 31, 2018, 54.5% of our net loans were comprised of adjustable-rate loans. At that date, $246.6 million,
or 43.6%, of these loans with an average interest rate of 4.26% were at their floor interest rate. The inability of our loans to adjust
downward can contribute to increased income in periods of declining interest rates, although this result is subject to the risks that
borrowers may refinance these loans during periods of declining interest rates. Also, when loans are at their respective floor, which
is above the fully-indexed rate, there is a further risk that our interest income may not increase as rapidly as our cost of funds
during periods of increasing interest rates and could have a material adverse effect on our results of operations.
Changes in interest rates also affect the value of our interest-earning assets, including our securities portfolio. Generally,
the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities
available for sale are reported as a separate component of equity, net of tax. Decreases in the fair value of securities available for
sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce the
potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market
interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk
modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our
balance sheet or projected operating results. For further discussion of how changes in interest rates could impact us, see Item 7A.
“Quantitative and Qualitative Disclosures About Market Risk” for additional information about our interest rate risk management.
Our construction/land loans are based upon estimates of costs and the value of the completed project.
We make construction/land loans to contractors and builders primarily to finance the construction of single and multifamily
homes, subdivisions, as well as commercial properties. We originate these loans whether or not the collateral property underlying
the loan is under contract for sale. At December 31, 2018, construction/land loans totaled $195.3 million, or 17.4% of our total
loan portfolio, a decrease of $42.3 million or 17.8% since December 31, 2017. At December 31, 2018, $86.6 million were one-
to-four family construction loans, $83.6 million were multifamily construction loans, and $18.3 million were commercial
construction loans. Land loans, which are loans made with land as security, totaled $6.7 million, or less than one percent of our
total loan portfolio at December 31, 2018. Land loans include land non-development loans for the purchase or refinance of
unimproved land held for future residential development, improved residential lots held for speculative investment purposes and
lines of credit secured by land, and land development loans.
Construction/land lending involves additional risks when compared with permanent residential lending because funds
are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion.
Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and
the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to
complete a project and the completed project loan-to-value ratio. Changes in the demand, such as for new housing and higher than
39
anticipated building costs, may cause actual results to vary significantly from those estimated. For these reasons, this type of
lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. A downturn
in housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the
value of our collateral and our ability to sell the collateral upon foreclosure. Some of our builders have more than one loan
outstanding with us and also have residential mortgage loans for rental properties with us. Consequently, an adverse development
with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
In addition, during the term of most of our construction loans, no payment from the borrower is required since the
accumulated interest is added to the principal of the loan through an interest reserve. As a result, these loans often involve the
disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower
to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay
principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security
for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans
require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult
and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly
increasing the end-purchasers’ borrowing costs, thereby reducing the overall demand for the project. Properties under construction
are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of
working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to
complete construction. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying
an end-purchaser for the finished project. Land loans also pose additional risk because of the lack of income being produced by
the property and the potential illiquid nature of the collateral. These risks can also be significantly impacted by supply and demand
conditions.
At December 31, 2018, $101.9 million of our construction/land loans were for speculative construction loans. All of our
permanent construction loans also have a take-out commitment for a permanent loan with us. At December 31, 2018, all of our
construction/land loans were classified as performing.
Our level of commercial and multifamily real estate loans may expose us to increased lending risks.
While commercial and multifamily real estate lending may potentially be more profitable than single-family residential
lending, it is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict.
Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan
underwriting and on an ongoing basis. At December 31, 2018, we had $373.8 million of commercial real estate loans, representing
33.3% of our total loan portfolio and $169.4 million of multifamily loans, representing 15.1% of our total loan portfolio. These
loans typically involve higher principal amounts than other types of loans and some of our commercial borrowers have more than
one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose
us to a significantly greater risk of loss compared to an adverse development with respect to a one to four family residential loan.
Repayment on these loans is dependent upon income generated, or expected to be generated, by the property securing the loan in
amounts sufficient to cover operating expenses and debt service that may be adversely affected by changes in the economy or
local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained
or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multifamily loans also expose a lender to
greater credit risk than loans secured by one-to-four family residential real estate because the collateral securing these loans
typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multifamily real estate loans
are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to
either sell or refinance the underlying property in order to make the payment that may increase the risk of default or non-payment.
A secondary market for most types of commercial and multifamily real estate loans is not readily available, so we have
less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we
foreclose on a commercial or multifamily real estate loan, our holding period for the collateral typically is longer than for one to four
family residential loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial
real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve Board and the Office of the Comptroller of the Currency have promulgated joint guidance
on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this
guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment
to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other
factors (i) total reported loans for construction, land development, and other land represent 100% or more of total capital, or
40
(ii) total reported loans secured by multifamily and non-farm residential properties, loans for construction, land development and
other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate
related entities, represent 300% or more of total capital. Based on the FDIC criteria, the Bank has a concentration in commercial
real estate lending as total loans for multifamily, non-farm/non-residential, construction, land development and other land
represented 451.8% of total risk-based capital at December 31, 2018. The particular focus of the guidance is on exposure to
commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at
greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of
repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices
and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management
should employ heightened risk management practices including board and management oversight and strategic planning,
development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. While we
believe we have implemented policies and procedures with respect to our commercial real estate lending consistent with this
guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of
the guidance that may result in additional costs to us.
Expansion of our business loans may expose the Company to greater risk of loss.
The Company’s strategic plan includes growth in originations of business loans that are collateralized by non-real estate
assets. Our business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral
provided by the borrower. The borrowers’ cash flow may prove to be unpredictable, and collateral securing these loans may
fluctuate in value. Most often, this collateral is accounts receivable, inventory, or equipment. In the case of loans secured by
accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the
borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to
appraise, may be illiquid and may fluctuate in value based on the success of the business. Further, the borrowers’ ability to repay
these loans may be impacted more from general economic conditions as compared to real estate secured loans.
Our non-owner occupied real estate loans may expose us to increased credit risk.
At December 31, 2018, $147.8 million, or 43.2% of our one-to-four family residential loan portfolio and 13.2% of our
total loan portfolio, consisted of loans secured by non-owner occupied residential properties. At December 31, 2018, all of our
non-owner occupied one-to-four family residential loans were performing in accordance with their repayment terms. Loans secured
by non-owner occupied properties generally expose a lender to greater risk of non-payment and loss than loans secured by owner
occupied properties because repayment of such loans depend primarily on the tenant’s continuing ability to pay rent to the property
owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan
without the benefit of a rental income stream. In addition, the physical condition of non-owner occupied properties is often below
that of owner occupied properties due to lenient property maintenance standards that negatively impact the value of the collateral
properties. Furthermore, some of our non-owner occupied residential loan borrowers have more than one loan outstanding with
us. At December 31, 2018, we had 88 non-owner occupied residential loan relationships with an outstanding balance over $500,000
and an aggregate balance of $118.5 million. Consequently, an adverse development with respect to one credit relationship may
expose us to a greater risk of loss compared to an adverse development with respect to an owner occupied residential mortgage
loan.
Our business may be adversely affected by credit risk associated with residential property.
At December 31, 2018, $342.0 million, or 30.5% of our total loan portfolio, was secured by first liens on one to four
family residential loans. In addition, at December 31, 2018, our home equity lines of credit totaled $11.2 million. A significant
portion of our one to four family residential real estate loan portfolio consists of jumbo loans that do not conform to secondary
market mortgage requirements, and therefore are not immediately salable to Fannie Mae or Freddie Mac because such loans exceed
the maximum balance allowable for sale (generally $453,000 to $667,000 for single family homes in our primary market areas
in 2018). Jumbo one to four family residential loans may expose us to increased risk because of their larger balances, and because
they cannot be immediately sold to government sponsored enterprises.
In addition, one-to-four family residential loans are generally sensitive to regional and local economic conditions that
significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A
decline in residential real estate values resulting from a downturn in the housing market may reduce the value of the real estate
collateral securing these types of loans and increase our risk of loss if borrowers default on their loans. Recessionary conditions
or declines in the volume of real estate sales and/or the sales prices coupled with elevated unemployment rates may result in higher
than expected loan delinquencies or problem assets, and a decline in demand for our products and services. These potential negative
41
events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business
operations.
We may be adversely affected by recent changes in U.S. tax laws.
Changes in tax laws contained in the Tax Act, which was enacted in December 2017, include a number of provisions that
will have an impact on the banking industry, borrowers and the market for single-family residential real estate. Changes include
(i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) limitations on interest
deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense and (iv) a limitation on the
deductibility of property taxes and state and local income taxes. The recent changes in the tax laws may have an adverse effect
on the market for, and valuation of, residential properties, and on the demand for such loans in the future and could make it harder
for borrowers to make their loan payments. If home ownership becomes less attractive, demand for mortgage loans could decrease
which could adversely affect our business and loan growth. The value of the properties securing loans in our loan portfolio may
also be adversely impacted as a result of the changing economics of home ownership, which could require an increase in our
provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial
condition and results of operations.
To meet our growth objectives we may originate or purchase loans outside of our market area which could affect the level
of our net interest margin and nonperforming loans.
In order to achieve our desired loan portfolio growth, we have and may continue to opportunistically originate or purchase
loans outside of our market area either individually, through participations, or in bulk or “pools”. We perform certain due diligence
procedures and may re-underwrite these loans to our underwriting standards prior to purchase, and anticipate acquiring loans
subject to customary limited indemnities, however, we may be exposed to a greater risk of loss as we acquire loans of a type or
in geographic areas where management may not have substantial prior experience and which may be more difficult for us to
monitor. Further, when determining the purchase price we are willing to pay to acquire loans, management will make certain
assumptions about, among other things, how borrowers will prepay their loans, the real estate market and our ability to collect
loans successfully and, if necessary, to dispose of any real estate that may be acquired through foreclosure. To the extent that our
underlying assumptions prove to be inaccurate or the basis for those assumptions change (such as an unanticipated decline in the
real estate market), the purchase price paid may prove to have been excessive, resulting in a lower yield or a loss of some or all
of the loan principal. For example, if we purchase “pools” of loans at a premium and some of the loans are prepaid before we
anticipate, we will earn less interest income on the acquired loans than expected. Our success in increasing our loan portfolio
through loan purchases will depend on our ability to price the loans properly and on general economic conditions in the geographic
areas where the underlying properties or collateral for the loans acquired are located. Inaccurate estimates or declines in economic
conditions or real estate values in the markets where we purchase loans could significantly adversely affect the level of our
nonperforming loans and our results of operations. At December 31, 2018, our loan portfolio included $81.7 million, or 7.9% of
total loans, net of LIP, located in counties within Washington State that are outside of our primary market area. In addition, our
portfolio included $128.3 million, or 12.4% of total loans, net of LIP, in loans located outside of Washington State.
We engage in aircraft financing transactions, in which high-value collateral is susceptible to potential catastrophic loss.
Consequently, if any of these transactions becomes nonperforming, we could suffer a loss on some or all of our value in
the assets.
Because our primary focus for aircraft loans is on the asset value of the collateral, the collectability of an aircraft loan
ultimately may be dependent on the value of the aircraft. Aircraft values have from time to time experienced sharp decreases due
to a number of factors including, but not limited to, the availability of used aircraft, decreases in passenger and air cargo demand,
increases in fuel costs, government regulation and the comparative value of newly manufactured similar aircraft. Aircraft as
collateral also presents unique risks because it is high-value and susceptible to rapid movement across different locations and
potential catastrophic loss. Although the loan documentation for these transactions will include insurance covenants and other
provisions to protect us against risk of loss, there can be no assurance that the insurance proceeds would be sufficient to ensure
our full recovery of the aircraft loan. Moreover, a relatively small number of nonperforming aircraft loans could have a significant
negative impact on the value of our loan portfolio. If we are required to liquidate a significant amount of aircraft collateral during
a period of reduced values, our financial condition and profitability could be adversely affected. At December 31, 2018, or loan
portfolio included $11.1 million in aircraft loans.
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If interest rate swaps we entered into prove ineffective, it could result in volatility in our operating results, including
potential losses, which could have a material adverse effect on our results of operations and cash flows.
We are exposed to the effects of interest rate changes as a result of the borrowings we use to maintain liquidity and fund
our expansion and operations. To limit the impact of interest rate changes on earnings, prepayment penalties and cash flows and
to lower overall borrowing costs while taking into account variable interest rate risk, we may borrow at fixed rates or variable
rates depending upon prevailing market conditions. We may also enter into derivative financial instruments such as interest rate
swaps in order to mitigate our interest rate risk on a related financial instrument.
Our interest rate contracts expose us to:
•
•
•
•
basis or spread risk, which is the risk of loss associated with variations in the spread between the interest rate contract
and the hedged item;
credit or counter-party risk which is the risk of the insolvency or other inability of another party to the transaction to
perform its obligations;
interest rate risk;
volatility risk which is the risk that the expected uncertainty relating to the price of the underlying asset differs from what
is anticipated; and
•
liquidity risk.
If we suffer losses on our interest rate contracts, our business, financial condition and prospects may be negatively affected,
and our net income will decline.
We record the swaps at fair value, and designate them as an effective cash flow hedge under ASC 815, Derivatives and
Hedging. Each quarter, we measure hedge effectiveness using the “hypothetical derivative method” and record in earnings any
gains or losses resulting from hedge ineffectiveness. The hedge provided by our swaps could prove to be ineffective for a number
of reasons, including early retirement of the debt, as is allowed under the debt, or in the event the counterparty to the interest rate
swaps were determined to not be creditworthy. Any determination that the hedge created by the swaps was ineffective could have
a material adverse effect on our results of operations and cash flows and result in volatility in our operating results. In addition,
any changes in relevant accounting standards relating to the swaps, especially ASC 815, Derivatives and Hedging, could materially
increase earnings volatility.
As of December 31, 2018, we had interest rate swaps outstanding with an aggregate notional amount of $50.0 million. At
December 31, 2018, the fair value of our interest rate swaps was $1.7 million. For additional information, see “Management’s
Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management”.
Uncertainty relating to the London Interbank Offered Rate ("LIBOR") calculation process and potential phasing out of
LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR,
announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator
of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be
guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions
to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere.
At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to
predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, subordinated debentures,
or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. Uncertainty as to
the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates
and the value of LIBOR-based loans, and to a lesser extent, securities in our portfolio, and may impact the availability and cost
of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute
indices for the calculation of interest rates under our loan agreements with our borrowers or our existing borrowings, we may
incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over
the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of
operations.
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Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
While conditions in the housing and real estate markets and economic conditions in our market areas have remained
strong, if slow economic conditions return or real estate values and sales deteriorate, we may experience higher delinquencies and
credit losses. As a result, we could be required to increase our provision for loan losses and to charge-off additional loans in the
future. If charge-offs in future periods exceed the ALLL, we may need additional provisions to replenish the ALLL.
The determination of the appropriate level of the ALLL inherently involves a high degree of subjectivity and requires us
to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our
borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining
the amount of the ALLL, we review our loans and the loss and delinquency experience and evaluate economic conditions and
make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates
are incorrect, the ALLL may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for increases in
our provision for loan losses which is charged against income. Deterioration in economic conditions, new information regarding
existing loans, identification of additional problem loans or relationships, and other factors, both within and outside of our control,
may increase our loan charge offs and/or may otherwise require an increase in the ALLL. Management also recognizes that
significant new growth in loan portfolios, new loan products and the refinancing of existing loans can result in portfolios comprised
of unseasoned loans that may not perform in a historical or projected manner and will increase the risk that our allowance may
be insufficient to absorb losses without significant additional provisions. In addition, bank regulatory agencies periodically review
our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further
loan charge offs based on their judgment about information available to them at the time of their examination. Any increases in
the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition,
results of operations, and capital.
In addition, the Financial Accounting Standards Board has adopted a new accounting standard referred to as Current
Expected Credit Loss, or CECL, which will require financial institutions to determine periodic estimates of lifetime expected
credit losses on loans, and recognize the expected credit losses as allowances for credit losses. This will change the current method
of providing allowances for credit losses only when they have been incurred and are probable, which may require us to increase
our allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine the
appropriate level of the allowance for credit losses. This accounting pronouncement is expected to be applicable to us for our first
fiscal year after December 15, 2019. We are evaluating the impact the CECL accounting model will have on our accounting, but
expect to recognize a onetime cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting
period in which the new standard is effective. We cannot yet determine the magnitude of any such one-time cumulative adjustment
or of the overall impact of the new standard on our financial condition or results of operations. The federal banking regulators,
including the Federal Reserve and the FDIC, have adopted a rule that gives a banking organization the option to phase in over a
three-year period the day-one adverse effects of CECL on its regulatory capital. For more on this new accounting standard, see
Note 1 of the Notes to Consolidated Financial Statements contained in Item 8 of this report.
We may incur losses on our securities portfolio as a result of changes in interest rates.
Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential
adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect
of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying securities, and changes
in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-
than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income,
which could have a material effect on our business, financial condition and results of operations. The process for determining
whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial
performance and liquidity of the issuer and any collateral underlying the security to assess the probability of receiving all contractual
principal and interest payments on the security. There can be no assurance that the declines in market value will not result in other-
than-temporary impairments of these assets, and would lead to accounting charges that could have a material adverse effect on
our net income and capital levels. For the year ended December 31, 2018, we did not incur any other-than-temporary impairments
on our securities portfolio.
Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.
Liquidity is essential to our business, therefore, the inability to obtain adequate funding may negatively affect growth
and, consequently, our earnings capability and capital levels. We rely on a number of different sources in order to meet our potential
liquidity demands. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals,
payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other
44
unpredictable circumstances, including events causing industry or general financial market stress. An inability to raise funds
through deposits, borrowings, the sale of loans or investment securities, or other sources could have a substantial negative effect
on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us
could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could
detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn
in the Washington markets in which our loans are concentrated, negative operating results, or adverse regulatory action against
us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets
or negative views and expectations about the prospects for the financial services industry and the continued uncertainty in credit
markets. In particular, our liquidity position could be significantly constrained if we are unable to access funds from the FHLB
Des Moines, the FRB or other wholesale funding sources, or if adequate financing is not available at acceptable interest rates. Finally,
if we are required to rely more heavily on more expensive funding sources, our revenues may not increase proportionately to cover
our costs. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our
expenses, or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in
turn, have a material adverse effect on our business, financial condition and results of operations. Additionally, collateralized
public funds are bank deposits of state and local municipalities. These deposits are required to be secured by certain investment
grade securities to ensure repayment that, on the one hand, tends to reduce our contingent liquidity risk by making these funds
somewhat less credit sensitive, but on the other hand, reduces standby liquidity by restricting the potential liquidity of the pledged
collateral. Although these funds historically have been a relatively stable source of funds for us, availability depends on the
individual municipality’s fiscal policies and cash flow needs. At December 31, 2018 we held $28.5 million in public funds.
If limitations arise in our ability to utilize the national brokered deposit market or to replace short-term deposits, our
ability to replace maturing deposits on acceptable terms could be adversely impacted.
First Financial Northwest Bank utilizes the national brokered deposit market for a portion of our funding needs. At
December 31, 2018, the balance of brokered certificates of deposit was $97.8 million, with remaining maturities of 1 to 57 months.
Under FDIC regulations, in the event we are deemed to be less than well-capitalized, we would be subject to restrictions on our
use of brokered deposits and the interest rate we can offer on our deposits. If this happens, our use of brokered deposits and the
rates we would be allowed to pay on deposits may significantly limit our ability to use deposits as a funding source. If we are
unable to participate in this market for any reason in the future, our ability to replace these deposits at maturity could be adversely
impacted.
Further, there may be competitive pressures to pay higher interest rates on deposits, which would increase our funding
costs. If deposit clients move money out of the Bank deposits and into other investments (or into similar products at other institutions
that may provide a higher rate of return), we could lose a relatively low cost source of funds, increasing our funding costs and
reducing our net interest income and net income. Additionally, any such loss of funds could result in reduced loan originations,
which could materially negatively impact our growth strategy and results of operations.
Our limited branch locations limit our ability to attract deposits and as a result, a large portion of our deposits are certificates
of deposit, including “jumbo” certificates that may not be as stable as other types of deposits.
With ten branch locations in operation during 2018, our ability to compete with larger institutions for noninterest bearing
deposits is limited as these institutions have a larger branch network providing greater convenience to customers. As a result, we
are dependent on more interest rate sensitive deposits. At December 31, 2018, $391.2 million, or 41.7%, of our total deposits were
retail certificates of deposit and, of that amount, $313.5 million were “jumbo” certificates greater than or equal to $100,000, with
$129.3 million of these certificates greater than or equal to $250,000. In addition, deposit inflows are significantly influenced by
general interest rates. Our money market accounts and jumbo certificates of deposit and the retention of these deposits are
particularly sensitive to general interest rates, making these deposits traditionally a more volatile source of funding than other
deposit accounts. In order to retain our money market accounts and jumbo certificates of deposit, we may have to pay a higher
rate, resulting in an increase in our cost of funds. In a rising rate environment, we may be unwilling or unable to pay a competitive
rate because of the resulting compression in our interest rate spread. To the extent that such deposits do not remain with us, they
may need to be replaced with borrowings or other deposits that could increase our cost of funds and negatively impact our interest
rate spread and financial condition.
Our branching strategy may cause our expenses to increase faster than revenues.
During 2018, we opened a new branch office in Bothell, Washington. In addition, the Bank secured a lease and received
regulatory approval to open our eleventh branch in Kent, Washington. Our current business strategy includes continued similar
branch expansion in areas to enhance our market presence. These offices are much smaller than traditional bank branch offices,
utilizing the improved technology available with our core data processor. This allows us to maintain management’s focus on
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efficiency, while working to expand the Bank’s presence into new markets. The success of our expansion strategy into new markets,
however, is contingent upon numerous factors, such as our ability to select suitable locations, assess each market’s competitive
environment, secure managerial resources, hire and retain qualified personnel and implement effective marketing strategies. The
opening of new offices may not increase the volume of our loans and deposits as quickly or to the degree that we hope, and opening
new offices will increase our operating expenses. On average, de novo branches do not become profitable until three to four years
after opening. We currently expect to lease rather than own the additional branch properties. Further, the projected time line and
the estimated dollar amounts involved in opening de novo branches could differ significantly from actual results. The success of
our acquired branches is dependent on retention of existing customers’ deposits as well as expanding our market presence in these
locations. We may not successfully manage the costs and implementation risks associated with our branching strategy. Accordingly,
any new branch may negatively impact our earnings for some period of time until the branch reaches certain economies of scale.
Finally, there is a risk that our new branches will not be successful even after they have been established or acquired.
We may be required to raise additional capital in the future, but that capital may not be available when it is needed, or
it may only be available on unacceptable terms, which could adversely affect our financial condition and results of
operations.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.
We may at some point, however, need to raise additional capital to support continued growth or be required by our regulators to
increase our capital resources. Any capital we obtain may result in the dilution of the interests of existing holders of our common
stock. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are
outside of our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed,
on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations and
pursue our growth strategy could be materially impaired and our financial condition and liquidity could be materially and adversely
affected. In addition, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse
regulatory action.
Development of new products and services may impose additional costs on us and may expose us to increased operational
risk.
Our financial performance depends, in part, on our ability to develop and market new and innovative services and to
adopt or develop new technologies that differentiate our products or provide cost efficiencies, while avoiding increased related
expenses. This dependency is exacerbated in the current “FinTech” environment, where financial institutions are investing
significantly in evaluating new technologies, such as “Blockchain,” and developing potentially industry-changing new products,
services and industry standards. The introduction of new products and services can entail significant time and resources, including
regulatory approvals. Substantial risks and uncertainties are associated with the introduction of new products and services, including
technical and control requirements that may need to be developed and implemented, rapid technological change in the industry,
our ability to access technical and other information from our clients, the significant and ongoing investments required to bring
new products and services to market in a timely manner at competitive prices and the preparation of marketing, sales and other
materials that fully and accurately describe the product or service and its underlying risks. Our failure to manage these risks and
uncertainties also exposes us to enhanced risk of operational lapses which may result in the recognition of financial statement
liabilities. Regulatory and internal control requirements, capital requirements, competitive alternatives, vendor relationships and
shifting market preferences may also determine if such initiatives can be brought to market in a manner that is timely and attractive
to our clients. Failure to successfully manage these risks in the development and implementation of new products or services could
have a material adverse effect on our business and reputation, as well as on our consolidated results of operations and financial
condition.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or
sanctions.
The USA PATRIOT Act and Bank Secrecy Acts and related regulations require financial institutions to develop programs
to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected,
financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement
Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers
seeking to open new financial accounts and beneficial owners of accounts. Failure to comply with these regulations could result
in fines or sanctions. During the last few years, several banking institutions have received large fines for non-compliance with
these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws
and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these
laws and regulations. If our policies and procedures are deemed deficient, we would be subject to liability, including fines and
46
regulatory actions, which may include restrictions on our ability to pay dividends and the denial of regulatory approvals to proceed
with certain aspects of our business plan, including acquisitions.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also
have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial
condition, results of operations and growth prospects.
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives,
results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to
protect the deposit insurance funds and consumers, not to benefit our shareholders. These regulations may sometimes impose
significant limitations on operations. Regulatory authorities have extensive discretion in connection with their supervisory and
enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the
institution and the adequacy of an institution's allowance for loan losses. These bank regulators also have the ability to impose
conditions in the approval of merger and acquisition transactions.
The significant federal and state banking regulations that affect us are described in this report under the heading “Item
1. Business- How We are Regulated”. These regulations, along with the currently existing tax, accounting, securities, insurance,
and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions
conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws,
regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Any
new regulations or legislation, change in existing regulations or oversight, whether a change in regulatory policy or a change in
a regulator’s interpretation of a law or regulation, could have a material impact on our operations, increase our costs of regulatory
compliance and of doing business and or otherwise adversely affect us and our profitability. Additionally, actions by regulatory
agencies or significant litigation against us may lead to penalties that materially affect us. Further, changes in accounting standards
can be both difficult to predict and involve judgment and discretion in their interpretation by us and our independent registered
public accounting firm. These changes could materially impact, potentially even retroactively, how we report our financial condition
and results of our operations as could our interpretation of those changes. We cannot predict what restrictions may be imposed
upon us with future legislation.
Our operations rely on numerous external vendors.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day
operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted
arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted
arrangements under service level agreements because of changes in the vendor's organizational structure, financial condition,
support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which
in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely
affected to the extent such an agreement is not renewed by the third party vendor or is renewed on terms less favorable to us.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack. Communications and information
systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general
ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of
confidential and other information in our computer systems and networks. Although we take protective measures and endeavor
to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to
breaches, fraudulent or unauthorized access, denial or degradation of service attacks, misuse, computer viruses, malware or other
malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our
or our customers’ confidential and other information processed and stored in, and transmitted through, our computer systems and
networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties.
We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate
vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or
not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation.
Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third
party technologies (including browsers and operating systems), or other developments could result in a compromise or breach of
47
the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and
underlying transactions. Any compromise of our security also could deter customers from using our internet banking services that
involve the transmission of confidential information. We rely on standard internet security systems to provide the security and
authentication necessary to effect secure transmission of data. Although we have developed and continue to invest in systems and
processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these
precautions may not protect our systems from compromises or breaches of our security measures, and could result in losses to us
or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption
to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our
exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business,
financial condition and results of operations.
.
Our security measures may not protect us from system failures or interruptions. While we have established policies and
procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not
occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and
other operational functions to certain third-party providers. While we select third-party vendors carefully, we do not control their
actions. If our third-party providers encounter difficulties, including those resulting from breakdowns or other disruptions in
communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks
and security breaches, or if we otherwise have difficulty in communicating with them, our ability to adequately process and account
for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business
operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense.
Threats to information security also exist in the processing of customer information through various other vendors and their
personnel.
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be
adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses as a result of
third party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other
disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is
any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we
cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as
found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems
failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional
regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our
financial condition and results of operations.
The board of directors oversees the risk management process including the risk of cybersecurity, and engages with
management on cybersecurity issues.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer unexpected
losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return, which is
critical to optimizing stockholder value. We have established processes and procedures intended to identify, measure, monitor,
report, analyze and control the types of risk to which we are subject. These risks include liquidity risk, credit risk, market risk,
interest rate risk, operational risk, legal and compliance risk, and reputational risk, among others. We also maintain a compliance
program to identify measure, assess, and report on our adherence to applicable laws, policies and procedures. While we assess
and improve these programs on an ongoing basis, there can be no assurance that our risk management or compliance programs,
along with other related controls, will effectively mitigate all risk and limit losses in our business. However, as with any risk
management framework, there are inherent limitations to our risk management strategies as there may exist, or develop in the
future, risks that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we
could suffer unexpected losses and our business, financial condition and results of operations could be materially adversely affected.
We are subject to certain risks in connection with our data management or aggregation.
We are reliant on our ability to manage data and our ability to aggregate data in an accurate and timely manner to ensure
effective risk reporting and management. Our ability to manage data and aggregate data may be limited by the effectiveness of
our policies, programs, processes and practices that govern how data is acquired, validated, stored, protected and processed. While
we continuously update our policies, programs, processes and practices, many of our data management and aggregation processes
48
are manual and subject to human error or system failure. Failure to manage data effectively and to aggregate data in an accurate
and timely manner may limit our ability to manage current and emerging risks, as well as to manage changing business needs.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to
the risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have
increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures
designed to prevent such losses, there can be no assurance that such losses will not occur.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect
our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of
qualified persons with knowledge of, and experience in, the community banking industry where First Financial Northwest Bank
conducts its business. The process of recruiting personnel with the combination of skills and attributes required to carry out our
strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management,
loan origination, finance, administrative, marketing, and technical personnel and upon the continued contributions of our
management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key
executives, including our President, and certain other employees. In addition, our success has been and continues to be highly
dependent upon the services of our directors, many of whom are at or nearing retirement age, and we may not be able to identify
and attract suitable candidates to replace such directors.
We participate in a multiple employer defined benefit pension plan for the benefit of our employees. If we were to withdraw
from this plan, or if Pentegra, the multiple employer defined benefit pension plan sponsor, requires us to make additional
contributions, we could incur a substantial expense in connection with the withdrawal or the request for additional
contributions.
We participate in the Pentegra Defined Benefit Plan for Financial Institutions, a multiple employer pension plan for the
benefit of our employees. Effective March 31, 2013, we did not allow additional employees to participate in this plan. On
March 31, 2013, we froze the future accrual of benefits under this plan with respect to those participating employees. In connection
with our decision to freeze our benefit accruals under the plan, and since then, we considered withdrawing from the plan.
The actual expense that would be incurred in connection with a withdrawal from the plan is primarily dependent upon
the timing of the withdrawal, the total value of the plan’s assets at the time of withdrawal, general market interest rates at that
time, expenses imposed on withdrawal, and other conditions imposed by Pentegra as set forth in the plan. If we choose to withdraw
from the plan in the future, we could incur a substantial expense in connection with the withdrawal.
Even if we do not withdraw from the plan Pentegra, as sponsor of the plan, may request that we make an additional
contribution to the plan, in addition to contributions that we are regularly required to make, or obtain a letter of credit in favor of
the plan, if our financial condition worsens to the point that it triggers certain criteria set out in the plan. If we fail to make the
contribution or obtain the requested letter of credit, then we may be forced to withdraw from the plan and establish a separate,
single employer defined benefit plan that we anticipate would be underfunded to a similar extent as under the multiple employer
plan.
We rely on dividends from the Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our principal subsidiary, First Financial Northwest Bank, and derive
substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. Accordingly, we are,
and will be, dependent upon dividends from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other
cash needs and to pay dividends on our common stock. First Financial Northwest Bank’s ability to pay dividends is subject to its
ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to us, we
may not be able to pay dividends on our common stock or continue our stock repurchases. Also, our right to participate in a
distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.
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Item 1B. Unresolved Staff Comments
First Financial Northwest has not received any written comments from the SEC regarding its periodic or current reports
under the Securities Exchange Act of 1934, as amended, that are unresolved.
Item 2. Properties
The corporate office for First Financial Northwest and First Financial Northwest Bank is located at 201 Wells Avenue
South, Renton, Washington and is owned by us. The Bank’s full service retail operation is also at this location. At
December 31, 2018, the Bank had eight leased locations in Washington currently in operation: Mill Creek, Edmonds, “The Landing”
in Renton, Bellevue, Bothell, Woodinville, Smokey Point, and Lake Stevens. In addition, the Bank entered into a lease for a future
branch location in Kent, Washington, that is scheduled to open in the first quarter of 2019. The lending division operations of First
Financial Northwest Bank are at our owned location at 207 Wells Avenue South, Renton, Washington. This location is also the
site for the operations of First Financial Northwest’s wholly-owned subsidiary, First Financial Diversified. The lease terms for
our properties are for an initial term of three to five years with the option to extend for additional three to five year periods. In the
opinion of management, all properties are adequately covered by insurance, are in a good state of repair and are appropriately
designed for their present and future use.
Item 3. Legal Proceedings
From time to time, we are involved as plaintiff or defendant in various legal actions arising in the normal course of
business. As of December 31, 2018, we were not involved in any significant litigation and do not anticipate incurring any material
liability as a result of any such litigation.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on The Nasdaq Stock Market LLC’s Global Select Market (“NASDAQ”), under the symbol
“FFNW.” As of December 31, 2018, there were 10.7 million shares of common stock issued and outstanding and we had
536 shareholders of record, excluding persons or entities that hold stock in nominee or “street name” accounts with brokers.
Stock Repurchases
The Company’s Board of Directors authorized a stock repurchase plan that began on November 5, 2018 and expires on
May 3, 2019. The plan authorizes the repurchase of up to 550,000 shares of the Company’s stock in accordance with a plan
established under the guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934 as administered through an
independent broker. At December 31, 2018, the Company had repurchased under this stock repurchase plan 203,900 shares at an
average price of $15.43 per share.
The following table represents the share repurchased during the fourth quarter ended December 31, 2018.
Period
October 1 - October 31, 2018
November 1 - November 30, 2018
December 1 - December 31, 2018
Total
Total Number of
Shares
Purchased
Average
Price Paid
per Share
Total Number of
Shares
Purchased as
Part of Plan
— $
83,700
120,200
203,900
—
15.63
15.28
15.43
—
83,700
120,200
203,900
Maximum
Number of
Shares that May
be Repurchased
Under the Plan
—
466,300
346,100
346,100
50
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d) in Part III, Item 12 of this report is
incorporated herein by reference.
Performance Graph
The following graph compares the cumulative total shareholder return on First Financial Northwest’s Common Stock
with the cumulative total return on the Russell 2000 Index, the SNL Micro CAP U.S. Bank Index, and the SNL Thrift Index, a
peer group index.
The graph assumes that total return includes the reinvestment of all dividends and that the value of the investment in
First Financial Northwest’s common stock and each index was $100 on December 31, 2013, and is the base amount used in the
graph. The closing price of First Financial Northwest’s common stock on December 31, 2018 was $15.47.
Index
12/31/2013
12/31/2014
12/31/2015
12/31/2016
12/31/2017
12/31/2018
First Financial Northwest, Inc.
Russell 2000 Index
SNL Thrift Index
SNL Micro Cap U.S. Bank Index
100.00
100.00
100.00
100.00
118.25
104.89
107.55
113.41
139.80
100.26
120.94
126.11
201.06
121.63
148.14
155.04
160.50
139.44
147.06
189.67
162.99
124.09
123.87
179.97
Period Ended
51
Item 6. Selected Financial Data
The following table sets forth certain information concerning our consolidated financial position and results of operations
at and for the dates indicated and has been derived from our audited consolidated financial statements. The information below is
qualified in its entirety by the detailed information included elsewhere herein and should be read along with Item 7. “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary
Data” included in this Form 10-K.
FINANCIAL CONDITION DATA:
(In thousands, except share data)
At or For the Year Ended December 31,
2018
2017
2016
2015
2014
Total assets
Investments available-for-sale
Loans receivable, net (1)
Deposits
Advances from the FHLB
Stockholders’ equity
OPERATING DATA:
Interest income
Interest expense
Net interest income
(Recapture of provision) provision for loan losses
Net interest income after (recapture of provision)
provision for loan losses
Noninterest income
Noninterest expense
Income before provision for federal income taxes
Provision for federal income taxes
Net income
Basic earnings per share
Diluted earnings per share
___________________
$ 1,252,424
$ 1,210,229
$ 1,037,584
$ 979,913
$ 936,997
142,170
1,022,904
939,032
146,500
153,738
132,242
988,662
839,502
216,000
142,634
129,260
815,043
717,476
171,500
138,125
129,565
685,072
675,407
125,500
170,673
120,374
663,938
614,127
135,500
181,412
$
55,913
$
47,644
$
41,709
$
37,197
$
38,689
14,738
41,175
(4,000)
45,175
2,878
29,461
18,592
3,693
14,899
1.44
1.43
$
$
$
10,022
37,622
(400)
38,022
2,208
26,809
13,421
4,942
8,479
0.82
0.81
$
$
$
7,507
34,202
1,300
32,902
2,651
22,949
12,604
3,712
8,892
0.75
0.74
$
$
$
6,751
30,446
(2,200)
32,646
1,279
19,878
14,047
4,887
9,160
0.67
0.67
$
$
$
6,241
32,448
(2,100)
34,548
498
18,503
16,543
5,856
10,687
0.72
0.71
$
$
$
(1) Net of ALLL, LIP and deferred loan fees and costs.
52
KEY FINANCIAL RATIOS:
2018
2017
2016
2015
2014
At or For the Year Ended December 31,
Performance Ratios:
Return on average assets
Return on average equity
Dividend payout ratio
Equity-to-assets ratio
Interest rate spread
Net interest margin
Average interest-earning assets to average interest-bearing
liabilities
Efficiency ratio
Noninterest expense as a percent of average total assets
Book value per common share
Capital Ratios: (1)
Tier 1 leverage
Common equity tier 1
Tier 1 capital ratio
Total capital ratio
Asset Quality Ratios: (2)
Nonperforming loans as a percent of total loans
Nonperforming assets as a percent of total assets
ALLL as a percent of total loans, net of LIP
1.21%
0.76%
0.88%
0.96%
1.17%
9.86
21.53
12.28
3.37
3.56
5.94
32.93
11.79
3.47
3.60
5.55
32.02
13.31
3.47
3.60
5.15
35.57
17.42
3.23
3.38
5.85
27.73
19.36
3.62
3.77
114.28
114.07
117.11
120.45
121.15
66.88
2.40
67.31
2.42
62.27
2.27
62.66
2.07
56.37
2.03
$
14.35
$
13.27
$
12.63
$ 12.40
$ 11.96
10.37%
10.20%
11.17%
11.61%
11.79%
13.43
13.43
14.68
0.07
0.10
1.29
12.52
12.52
13.77
0.02
0.05
1.28
14.36
14.36
15.61
0.10
0.31
1.32
16.36
16.36
17.62
0.16
0.48
1.36
n/a
18.30
19.56
0.20
1.13
1.55
ALLL as a percent of nonperforming loans, net of LIP
Net (recoveries) charge-offs to average loans receivable, net
1,774.87
(0.45)
7,196.65
(0.27)
1,276.34
(0.02)
872.17
(0.18)
783.50
0.06
_______________
(1) Capital ratios are for First Financial Northwest Bank only.
(2) Loans are reported net of LIP.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is
intended to enhance your understanding of our financial condition and results of operations. The information in this section has
been derived from the Consolidated Financial Statements and footnotes thereto that appear in Item 8 of this Form 10-K. The
information contained in this section should be read in conjunction with these Consolidated Financial Statements and footnotes
and the business and financial information provided in this Form 10-K. Unless otherwise indicated, the financial information
presented in this section reflects the consolidated financial condition and results of operations of First Financial Northwest and
its subsidiaries.
Overview
First Financial Northwest Bank is a wholly-owned subsidiary of First Financial Northwest and, as such, comprises
substantially all of the activity for First Financial Northwest. First Financial Northwest Bank was a community-based savings
bank until February 4, 2016, when the Bank converted to a Washington state chartered commercial bank reflecting the commercial
banking services it now provides to its customers. The Bank primarily serves King, Snohomish, Pierce and Kitsap counties,
Washington through its full-service banking office and headquarters in Renton, Washington, as well as four retail branches in King
County, Washington and five retail branches in Snohomish County, Washington at December 31, 2018. The Bank purchased four
of these branches in 2017 and acquired $74.7 million in deposits (the “Branch Acquisition”). The Branch Acquisition expanded
our retail footprint and provided an opportunity to extend our unique brand of community banking into those communities. In
addition, the Bank received regulatory approval to open a new branch office in Kent, Washington which opened in the first quarter
of 2019.
53
The Bank’s business consists predominantly of attracting deposits from the general public, combined with borrowing
from the Federal Home Loan Bank of Des Moines (“FHLB”) and raising funds in the wholesale market, then utilizing these funds
to originate one-to-four family residential, multifamily, commercial real estate, construction/land, business, and consumer loans.
Our current business strategy emphasizes commercial real estate, construction, one-to-four family residential, and
multifamily lending. With the current low interest rate environment, we are not aggressively pursuing longer term assets, but rather
are focused on financing shorter term loans, in particular construction/land loans. During 2018, originations of new loans and
refinances modestly outpaced repayments, resulting in net loans receivable of $1.02 billion at December 31, 2018, as compared
to $988.7 million at December 31, 2017. Originations of construction/land loans decreased to $118.2 million in 2018 from
$138.6 million in 2017, contributing to the decrease in this loan portfolio to $195.3 million at December 31, 2018 as compared
to $237.6 million at December 31, 2017. However, we anticipate that construction/land lending will increase in 2019 and continue
to be a strong element of our total loan portfolio in future periods. We will continue to take a disciplined approach in our construction/
land lending by concentrating our efforts on residential loans to builders known to us, including multifamily loans to developers
with proven success in this type of construction. These loans typically mature in six to eighteen months and funding is usually not
fully disbursed at origination, therefore the impact to net loans receivable is generally minimal in the short term. At
December 31, 2018, construction/land loans net of LIP was $108.9 million, a 25.2% decrease from $145.6 million at
December 31, 2017.
We have also geographically expanded our loan portfolio through loan purchases or loan participations of commercial
and multifamily real estate loans that are outside of our primary market area. Through our efforts to geographically diversify our
loan portfolio with direct loan originations, loan participations, or loan purchases, our portfolio includes $128.3 million of loans
to borrowers or secured by properties located in 23 other states, including concentrations in California, Utah, Arizona and Oregon
of $39.5 million, $16.2 million, $14.6 million and $11.9 million, respectively at December 31, 2018.
Net income for the year ended December 31, 2018, was $14.9 million, or $1.43 per diluted share, compared to $8.5 million,
or $0.81 per diluted share, for the year ended December 31, 2017. The significant contributor to this increase was the $4.0 million
recapture of provision for loan losses reflecting net recoveries of $4.5 million on previously charged-off loans. Net interest income
also increased by $3.6 million, which included $1.0 million in interest income on the previously charged off loans. Noninterest
expenses increased by $2.7 million, reflecting continued growth in our operations. Also contributing to the increase in net income,
our federal tax provision decreased by $1.2 million primarily as a result of the reduction in our statutory federal income tax rate
to 21% as of January 1, 2018 due the enactment of the Tax Cuts and Jobs Act (the “Tax Act”). Following the passing of the Tax
Act, our net income in 2017 was reduced as we opted to sell certain fixed rate investment securities that were carried in an unrealized
loss position to receive the optimal tax benefit of the losses and to reinvest the proceeds to purchase primarily higher yielding
long-term adjustable rate securities, incurring a loss on sale of $670,000. Also relating to passage of the Tax Act, we recorded a
charge of $807,000 in 2017 through the federal income tax provision relating to changes to our net deferred tax asset (“DTA”)
valuation as a result of the new lower corporate income tax rates.
Our primary source of revenue is interest income, which is the income that we earn on our loans and investments. Interest
expense is the interest that we pay on our deposits and borrowings. Net interest income is the difference between interest income
and interest expense. Changes in levels of interest rates affect interest income and interest expense differently and, thus, impacts
our net interest income. First Financial Northwest Bank is generally liability-sensitive, meaning our interest-bearing liabilities
reprice at a faster rate than our interest-earning assets. Primarily as a result of increasing interest rates during 2018, our net interest
rate spread and net interest margin decreased to 3.37% and 3.56%, respectively, for the year ended December 31, 2018, as compared
to 3.47% and 3.60%, respectively, for the year ended December 31, 2017.
An offset to net interest income is the provision for loan losses, or the recapture of the provision for loan losses, that is
required to establish the ALLL at a level that adequately provides for probable losses inherent in our loan portfolio. As our loan
portfolio increases, or due to an increase for probable losses inherent in our loan portfolio, our ALLL may increase, resulting in
a decrease to net interest income. Improvements in loan risk ratings, increases in property values, or receipt of recoveries of
amounts previously charged off may partially or fully offset any increase to ALLL due to loan growth or an increase in probable
loan losses. During 2018, we had a recapture of provision of $4.0 million as compared to a recapture of $400,000 for the year
ended December 31, 2017. The recapture of provision for loan losses in 2018 was primarily the result of $4.5 million of loan
recoveries received on previously charged off loans, partially offset by the provision necessary for the $34.2 million increase in
net loan receivable. The recapture of provision for loan losses in 2017 was primarily a result of $2.3 million in net recoveries
received on previously charged-off loans partially offset by the provision necessary to support the $173.6 million growth in net
loans receivable. Our total adversely classified loans remained stable at $1.3 million at both December 31, 2018, and 2017. We
will continue to monitor our loan portfolio and make adjustments to our ALLL as we deem necessary.
54
Noninterest income is generated from various loan or deposit fees, increases in the cash surrender value of bank owned
life insurance (“BOLI”), and revenue earned on our wealth management brokerage services. This income is increased or partially
offset by any net gain or loss on sales of investment securities. Our noninterest income increased $670,000 during the year ended
December 31, 2018 as compared to 2017. The increase was primarily attributable to a $547,000 reduction in the loss on sale of
investments, a $191,000 increase in the noninterest income from our BOLI policies, and a $235,000 increase in deposit related
fees, partially offset by a $308,000 decrease in wealth management revenue.
Our noninterest expenses consist primarily of salaries and employee benefits, professional fees, regulatory assessments,
occupancy and equipment, and other general and administrative expenses. Salaries and employee benefits consist primarily of the
salaries and wages paid to our employees, payroll taxes, expenses for retirement, and other employee benefits. OREO-related
expenses consist primarily of maintenance and costs of utilities for the OREO inventory, market valuation adjustments, build-out
expenses, gains and losses from OREO sales, legal fees, real estate taxes, and insurance related to the properties included in the
OREO inventory. Professional fees include legal services, auditing and accounting services, computer support services, and other
professional services in support of strategic plans. Occupancy and equipment expenses, which are the fixed and variable costs of
buildings and equipment, consist primarily of lease expenses, real estate taxes, depreciation expenses, maintenance, and costs of
utilities. Also included in noninterest expense are changes to the Company’s unfunded commitment reserve which are reflected
in general and administrative expenses. This unfunded commitment reserve expense can vary significantly each quarter, based on
the amount believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities, and
reflects changes in the amounts that the Company has committed to fund but has not yet disbursed. Our noninterest expenses
increased $2.7 million during the year ended December 31, 2018 as compared to 2017. The increase was primarily attributable to
a $1.5 million increase in salary and employee benefits expenses, a $777,000 increase in occupancy and equipment expenses, and
a $479,000 increase in other general and administrative expenses, partially offset by a $271,000 decrease in professional fees.
Business Strategy
Our long-term business strategy is to operate and grow First Financial Northwest Bank as a well-capitalized and profitable
community bank, offering one-to-four family residential, commercial and multifamily, construction/land, consumer and business
loans along with a diversified array of deposit and other products and services to individuals and businesses in our market areas.
We intend to accomplish this strategy by leveraging our established name and franchise, capital strength, and loan production
capability by:
• Capitalizing on our intimate knowledge of our local communities to serve the convenience and needs of customers, and
delivering a consistent, high-quality level of professional service;
• Offering competitive deposit rates and developing customer relationships to diversify our deposit mix, growing lower
cost deposits, attracting new customers, and expanding our footprint in the geographical area we serve;
• Utilizing wholesale funding sources, including but not limited to FHLB advances and acquiring deposits in the national
brokered certificate of deposit market, to assist with funding needs and interest rate risk management efforts, as needed;
• Managing our loan portfolio to minimize concentration risk and diversify the types of loans within the portfolio;
• Managing credit risk to minimize the risk of loss and interest rate risk to optimize our net interest margin; and
•
Improving profitability through disciplined pricing, expense control and balance sheet management, while continuing to
provide excellent customer service.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assumptions by management and that have,
or could have, a material impact on our income or the carrying value of our assets. The following are our critical accounting
policies.
Allowance for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL
must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan
portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific allowances. The general
allowance is determined by applying factors to our various groups of loans. Management considers factors such as charge-off
history, the current and expected economic conditions, borrower’s ability to repay, the regulatory environment, competition,
geographic and loan type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, management’s
experience level, our loan review and grading systems, the value of underlying collateral, and the level of problem loans in assessing
the ALLL. Specific allowances result when management performs an impairment analysis on a loan when it determines it is
probable that all contractual amounts of principal and interest will not be paid as scheduled. The analysis usually occurs when a
55
loan has been classified as substandard or placed on nonaccrual status. If the market value less costs to sell (“market value”) of
the impaired loan is less than the recorded investment in the loan, impairment is recognized by establishing a specific reserve in
the ALLL for the loan or by adjusting an existing reserve amount. The amount of the specific reserve is computed using current
appraisals, listed sales prices, and other available information less costs to complete, if any, and costs to sell the property. This
evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes
available or as future events differ from predictions. In addition, specific reserves may be created upon a loan’s restructuring,
based on a discounted cash flow analysis, comparing the present value of the anticipated repayments under the restructured terms
to the outstanding principal balance of the loan.
Our Board of Directors’ Internal Asset Review Committee reviews and recommends for approval the allowance for loan
losses on a quarterly basis, and any related provision or recapture of provision for loan losses, and the full Board of Directors
approves the provision or recapture after considering the Committee’s recommendations. The allowance is increased by the
provision for loan losses which is charged against current period earnings. When analysis of the loan portfolio warrants, the
allowance is decreased and a recapture of provision of loan losses is included in current period earnings.
We believe that the ALLL is a critical accounting estimate because it is highly susceptible to change from period to period
requiring management to make assumptions about probable losses inherent in the loan portfolio. The impact of an unexpected
large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, thereby reducing
earnings. For additional information see Item 1A. “Risk Factors – Our allowance for loan losses may prove to be insufficient to
absorb losses in our loan portfolio,” in this Form 10-K.
Valuation of OREO. Real estate properties acquired through foreclosure or by deed-in-lieu of foreclosure are recorded
at the lower of cost or fair value less estimated costs to sell. Fair value is generally determined by management based on a number
of factors, including third-party appraisals of fair value in an orderly sale. Accordingly, the valuation of OREO is subject to
significant external and internal judgment. If the carrying value of the loan at the date a property is transferred into OREO exceeds
the fair value less estimated costs to sell, the excess is charged to the ALLL. Management periodically reviews OREO values to
determine whether the property continues to be carried at the lower of its recorded book value or fair value, net of estimated costs
to sell. Any further decreases in the value of OREO are considered valuation adjustments and are charged to noninterest expense
in the Consolidated Income Statements. Expenses and income from the maintenance and operations and any gains or losses from
the sales of OREO are included in noninterest expense.
Deferred Taxes. Deferred tax assets arise from a variety of sources, the most significant being expenses recognized in
our financial statements but disallowed in the tax return until the associated cash flow occurs, and write-downs in the value of
assets for financial statement purposes that are not deductible for tax purposes until the asset is sold or deemed worthless.
When warranted, we record a valuation allowance to reduce our deferred tax assets to the amount that can be recognized
in line with the relevant accounting standards. The level of deferred tax asset recognition is influenced by management’s assessment
of our historic and future profitability profile. At each balance sheet date, existing assessments are reviewed and, if necessary,
revised to reflect changed circumstances. In a situation where income is less than projected or recent losses have been incurred,
the relevant accounting standards require convincing evidence that there will be sufficient future tax capacity. For additional
information regarding our deferred taxes, see Note 13 of the Notes to Consolidated Financial Statements contained in Item 8.
Other-Than-Temporary Impairments On the Market Value of Investments. Declines in the fair value of
available for sale or held-to-maturity investments below their cost that is deemed to be other-than-temporary results in a reduction
in the carrying amount of such investments to their fair value. A charge to earnings and an establishment of a new cost basis for
the investment is made. Unrealized investment losses are evaluated at least quarterly to determine whether such declines should
be considered other-than-temporary and therefore be subject to immediate loss recognition. Although these evaluations involve
significant judgment, an unrealized loss in the fair value of a debt security is generally deemed to be temporary when the fair value
of the investment security is below the carrying value primarily due to changes in interest rates and there has not been significant
deterioration in the financial condition of the issuer. Other factors that may be considered in determining whether a decline in the
value of a debt security is other-than-temporary include ratings by recognized rating agencies; the extent and duration of an
unrealized loss position; actions of commercial banks or other lenders relative to the continued extension of credit facilities to the
issuer of the security; the financial condition, capital strength and near-term prospects of the issuer and recommendations of
investment advisers or market analysts. Therefore, deterioration of market conditions could result in impairment losses recognized
within the investment portfolio.
Fair Value. FASB ASC 820, Fair Value Measurements and Disclosures, establishes a hierarchical disclosure framework
associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment
utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial
56
instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally
will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely,
financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of
judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial
instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the
transaction. See Note 7 of the Notes to Consolidated Financial Statements contained in Item 8 for additional information about
the level of pricing transparency associated with financial instruments carried at fair value.
Derivatives and Hedge Accounting. The Bank recognizes its interest rate swap as a cash flow hedge derivative instrument,
and as such, reports the fair value as an asset or liability. Fair value is based on dealer quotes, pricing models, discounted cash
flow methodologies or similar techniques for which the determination of fair value may require significant management judgment
or estimation. The derivative is marked to its fair value through other comprehensive income. The gain or loss on the derivative
is reclassified into earnings in the same income statement line item that is used to present the earnings effect of the hedged item.
Intangible Assets. The Company incurred goodwill and a core deposit intangible asset through the Branch Acquisition
during 2017. These assets were booked at fair value at the time of the acquisition. Goodwill is evaluated annually for impairment,
with any impairment recognized as noninterest expense. The core deposit intangible is amortized into noninterest expense.
Comparison of Financial Condition at December 31, 2018 and December 31, 2017
Assets. The following table details the changes in the composition of our assets at December 31, 2018 from
December 31, 2017.
Balance at
December 31, 2018
Change from
December 31, 2017
Percentage
Change
(Dollars in thousands)
(1,067)
1,946
$
8,122
8,888
Cash on hand and in banks
$
Interest-earning deposits
Investments available-for-sale, at fair value
Loans receivable, net
Premises and equipment, net
FHLB stock, at cost
Accrued interest receivable
Deferred tax assets, net
OREO
BOLI
Prepaid expenses and other assets
Goodwill
Core deposit intangible
142,170
1,022,904
21,331
7,310
4,068
1,844
483
29,841
3,458
889
1,116
Total assets
$
1,252,424
$
9,928
34,242
717
(2,572)
(16)
633
—
814
(2,280)
—
(150)
42,195
(11.6)%
28.0
7.5
3.5
3.5
(26.0)
(0.4)
52.3
—
2.8
(39.7)
—
(11.8)
3.5 %
The $42.2 million increase in total assets during 2018 was primarily a result of utilizing growth in deposits, partially
offset by a decrease in FHLB advances, to grow our loan portfolio by $34.2 million and our investments available-for-sale by
$9.9 million.
Interest-earning deposits with banks. Our interest-earning deposits with banks, consisting primarily of funds held at
the Federal Reserve Bank of San Francisco, remained relatively steady during 2018, increasing by $1.9 million at
December 31, 2018 from December 31, 2017. These funds fluctuate based on our funding needs.
Investments available-for-sale. Our investments available-for-sale increased by $9.9 million, or 7.5%, during 2018.
The growth in our deposits outpaced the growth in loans, therefore available funds were invested in higher interest-earning securities
to enhance our interest income. During the year, we purchased $37.0 million of securities with an expected yield of 3.67%, partially
offset by sales of $5.5 million of securities. The restructure of our available-for-sale investments in December 2017 and additional
sales and purchases throughout 2018 resulted in an increase the average yield on these assets to 2.92% for 2018 from 2.61% in
2017. Securities purchased in 2018 included $21.7 million in fixed rate and $15.3 million in variable rate securities, comprised
57
of $11.9 million in U.S. government agency bonds, $17.0 million in mortgage-backed securities, $6.0 million in corporate bonds
and $2.1 million in municipal bonds. The sales of investments available-for-sale generated a net loss of $20,000 for the year ended
December 31, 2018. We also received calls or partial calls and proceeds at maturity during 2018 of $11.7 million. In addition to
the purchase and call activity, we received principal repayments of $7.1 million on our investments available-for-sale during 2018.
The effective duration of our securities portfolio increased to 3.00% at December 31, 2018 as compared to 2.90% at
December 31, 2017 partially due to longer-term securities purchased during the year as part of our restructuring of this portfolio.
Effective duration is a measure that attempts to quantify the anticipated percentage change in the value of an investment (or
portfolio) in the event of a 100 basis point change in market yields. Since the Bank’s portfolio includes securities with embedded
options (including call options on bonds and prepayment options on mortgage-backed securities), management believes that
effective duration is an appropriate metric to use as a tool when analyzing the Bank’s investment securities portfolio, as effective
duration incorporates assumptions relating to such embedded options, including changes in cash flow assumptions as interest rates
change.
Loans receivable. Net loans receivable increased by $34.2 million during 2018 to $1.02 billion. The most significant
increase occurred in one-to-four family residential loans, with a $63.3 million, or 22.7% increase. In addition, commercial real
estate loans increased by $12.0 million, or 3.3%. Commercial real estate and one to four family residential loans continue to be
the largest concentrations in our loan portfolio at 33.3% and 30.5%, respectively, of total loans. Business and consumer loans also
grew during 2018 with increases of $7.4 million and $3.8 million, respectively. Partially offsetting these increases, construction/
land loans decreased by $42.3 million and multifamily loans decreased by $15.5 million as payoffs outpaced originations in these
categories. During 2018, we supplemented our loan originations by purchasing $19.9 million in performing one-to-four family
and commercial real estate loans from other financial institutions. The loans were purchased at an average premium of 3.2% and
included $14.9 million of loans secured by commercial real estate properties located in New York, Utah, Pennsylvania and
California, reflecting our efforts to geographically diversify our loan portfolio with loans meeting our investment and credit quality
objectives.
The quality of our loan portfolio remained stable during 2018, although our nonperforming loans increased to $752,000
at December 31, 2018 from $179,000 at December 31, 2017 primarily as a result of a $326,000 nonperforming commercial real
estate loan that was subsequently paid in full. Nonperforming loans as a percent of our total loans remained low at 0.07% and
0.02% at both December 31, 2018 and 2017, respectively. Adversely classified loans, defined as substandard or below, remained
at $1.3 million at both December 31, 2018 and 2017. The following table presents a breakdown of our nonperforming assets:
December 31,
2018
2017
Amount of
Change
Percent of
Change
(Dollars in thousands)
Nonperforming loans:
One-to-four family residential
Commercial real estate
Consumer
Total nonperforming loans
OREO
Total nonperforming assets
$
382
326
44
752
483
$
1,235
$
$
128
$
—
51
179
483
662
$
254
326
(7)
573
—
573
198.4%
100.0%
(13.7)
320.1
—
86.6%
We continued to focus on reducing our nonperforming assets through loan work outs or pursuing foreclosure. Foregone
interest during the year ended December 31, 2018 relating to nonperforming loans totaled $18,000. There was no LIP related to
nonperforming loans at December 31, 2018 or 2017. OREO remained at $483,000 at both December 31, 2018 and 2017. We did
not foreclose on any properties during either 2018 or 2017. The stability in our nonperforming assets reflects the quality of our
loan portfolio and our commitment to identify any problem loans and take prompt actions to turn nonperforming assets into
performing assets.
Allowance for loan and lease losses. We believe that we use the best information available to establish the ALLL, and
that the ALLL as of December 31, 2018 was adequate to absorb the probable and inherent losses in the loan portfolio at that
date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable,
there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount
of future provisions will not exceed the amount of past provisions, or that any increased provisions that may be required will not
adversely impact our financial condition and results of operations. Future additions to the allowance may become necessary based
58
upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan balances,
or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of our ALLL is subject
to review by bank regulators as part of the routine examination process that which may result in the establishment of additional
loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available
to them at the time of their examination.
The ALLL was $13.3 million or 1.29% of total loans receivable, net of LIP at December 31, 2018 as compared to $12.9
million or 1.28% of total loans receivable, net of LIP at December 31, 2017. The ALLL represented 1,774.9% of nonperforming
loans at December 31, 2018 compared to 7,196.7% at December 31, 2017. The following table details activity and information
related to the ALLL for the years ended December 31, 2018 and 2017. All loan balances and ratios are calculated using loan
balances that are net of LIP.
ALLL balance at beginning of year
Recapture of provision for loan losses
Recoveries
ALLL balance at end of year
ALLL as a percent of total loans, net of LIP
ALLL as a percent of nonperforming loans
Total nonperforming loans
Nonperforming loans as a percent of total loans
Total loans receivable, net LIP
Total loans originated
At or For the Years Ended
December 31,
2018
2017
(Dollars in thousands)
$
12,882
(4,000)
4,465
13,347
$
1.29%
1,774.87
752
0.07%
1,037,429
329,763
$
$
10,951
(400)
2,331
12,882
1.28%
7,196.65
179
0.02%
1,002,694
331,166
$
$
$
$
Intangible assets. As a result of our Branch Acquisition in 2017, the Bank recognized goodwill of $889,000 and a core
deposit intangible (“CDI”) of $1.3 million. Goodwill was calculated as the excess purchase price of the branches over the fair
value of the assets acquired and liabilities assumed at August 25, 2017.
The CDI was provided by a third party valuation service and represents the fair value of the customer relationships that
provide a low-cost source of funding. The analysis was performed on the acquired noninterest-bearing checking, interest-bearing
checking, savings, and money market accounts. The initial ratio of CDI to the acquired balances of core deposits was 2.23%. This
amount will amortize into noninterest expense on an accelerated basis over ten years and had a balance of $1.1 million at
December 31, 2018.
Deposits. During the year ended December 31, 2018, deposits increased $99.5 million from December 31, 2017. Details
of deposit balances and their concentrations are as follows:
December 31,
2018
2017
(dollars in thousands)
Noninterest-bearing demand
deposits
Interest-bearing demand
Statement savings
Money market
Certificates of deposit, retail (1)
Certificates of deposit, brokered
Total deposits
$
$
46,108
40,079
24,799
339,047
391,174
97,825
939,032
4.9% $
4.3
2.6
36.1
41.7
10.4
100.0% $
45,434
38,224
28,456
318,636
333,264
75,488
839,502
5.4%
4.6
3.4
38.0
39.6
9.0
100.0%
____________________
(1) Retail certificates of deposit are shown net of a $58,000 and $107,000 fair value adjustment at December 31, 2018, and 2017,
respectively, from acquired deposits.
59
The $77.2 million growth in retail deposits during 2018 was primarily the result of continued growth in our four acquired
branches and two de novo branches opened in 2018 and 2017. In addition, in the third quarter of 2018, we elected to aggressively
pursue deposit growth as we competitively priced our products to increase our deposit portfolio in advance of anticipated rate
increases. The result of this strategy was an increase in retail certificates of deposit of $57.9 million and money market accounts
by $20.4 million. The growth in retail deposits allowed us to reduce our borrowings and enhance our liquidity.
To assist in our funding needs, our portfolio of brokered certificates of deposit increased $22.3 million to $97.8 million
at December 31, 2018. While brokered certificates of deposit may carry a higher cost than our retail certificates, their remaining
maturity periods of one month to 4.8 years, along with the enhanced call features of a majority of these deposits, assist us in our
efforts to manage interest rate risk.
At December 31, 2018 and December 31, 2017, we held $28.5 million and $21.5 million in public funds, respectively,
nearly all of which were retail certificates of deposit. These funds were secured at December 31, 2018 with the Washington State
Public Deposit Protection Commission by $15.6 million in pledged investment securities.
Advances. We use advances from the FHLB as an alternative funding source to manage interest rate risk and to leverage
our balance sheet. Total FHLB advances at December 31, 2018 were $146.5 million as compared to $216.0 million at December
31, 2017. During 2018, as part of our ongoing liquidity management efforts, we paid off a portion of our existing $120.0 million
member option variable-rate advance and $11.5 million in maturing FHLB advances and restructured our FHLB advances to
include $55 million of three-year member option variable-rate advances that reprice quarterly and allow for prepayment without
penalties on the repricing date. In addition, at December 31, 2018, we had $31.5 million in FHLB overnight advances. The
repayment option on our member option variable-rate advances and short term nature of overnight FHLB advances provides us
flexibility to adjust the level of our borrowings as our customer deposit balances grow consistent with our asset/liability objectives.
Our average borrowings during 2018 were $183.7 million. At December 31, 2018, $91.5 million of our FHLB advances, including
overnight advances, were due to mature in 2019, with the remaining $55.0 million due to mature in one to three years. Our FHLB
advances also include a $50.0 million fixed rate three-month advance that renews quarterly at the fixed interest rate in effect at
that time designated as a cash flow hedge, as described below.
Cash Flow Hedge. To assist in managing interest rate risk, the Bank entered into a five-year, $50 million notional, pay
fixed, receive floating cash flow hedge or interest rate swap with a qualified institution on October 25, 2016. Under the terms of
the Cash Flow Hedge agreement, the Bank pays a fixed interest rate of 1.34% for five years and in return receives an interest
payment based on the three-month LIBOR index, which resets quarterly. Concurrently, the Bank borrowed a $50 million fixed
rate three-month FHLB advance that will be renewed quarterly at the fixed interest rate at that time. Effectiveness of the swap is
evaluated quarterly with any ineffectiveness recognized as a gain or a loss on the income statement in noninterest income. A change
in the fair value of the cash flow hedge is recognized as an other asset or other liability on the balance sheet with the tax-effected
portion of the change included in other comprehensive income. At December 31, 2018, we recognized a $1.7 million fair value
asset as a result of the increase in market value of the hedge agreement.
Stockholders’ Equity. Total stockholders’ equity increased $11.1 million, or 7.8% to $153.7 million at December 31, 2018
from $142.6 million at December 31, 2017. The increase in stockholders’ equity was primarily a result of $14.9 million in net
income partially offset by $3.2 million in shareholder cash dividends and the repurchase of 203,900 shares of stock at an aggregate
cost of $3.2 million. In addition, net stock-based compensation totaled $2.6 million and other comprehensive loss, net of tax,
increased $1.3 million during the year ended December 31, 2018. Additional shares of common stock were issued from authorized
shares due to the exercise of stock options and restricted stock awards in 2018 totaling 166,119 shares, resulting in an increase to
stockholders’ equity of $1.3 million.
Comparison of Operating Results for the Years Ended December 31, 2018 and December 31, 2017
Net Interest Income. Net interest income in 2018 was $41.2 million, a $3.6 million or 9.4% increase from $37.6 million in
2017, due primarily to an $8.3 million increase in interest income partially offset by a $4.7 million increase in interest expense.
Interest income increased during the year ended December 31, 2018 primarily as a result of the $117.4 million growth in the
average balance of net loans receivable and in particular, one-to-four family and commercial real estate loans. In addition, the
average yield of interest-earning assets increased to 4.83% for the year ended December 31, 2018 from 4.57% for the year ended
December 31, 2017. The increase in average assets was funded by a $97.7 million increase in average interest-bearing liabilities.
The average cost of these funds increased to 1.46% for the year ended December 31, 2018 from 1.10% for the year ended December
31, 2017, primarily as a result of the overall increase in the target federal funds rate during 2018 and higher deposit balances. Our
interest-bearing liabilities reprice faster than our interest earning assets in response to changes in market interest rates, resulting
in a 10 basis point reduction in our interest rate spread to 3.37% for the year ended December 31, 2018. In addition, our net interest
60
margin decreased to 3.56% for the year ended December 31, 2018, from 3.60% for the year ended December 31, 2017. For more
information on this, see “Asset and Liability Management and Market Risk.”
The following table compares average interest-earning asset balances, associated yields, and resulting changes in interest
and dividend income for the years ended December 31, 2018 and 2017:
Year Ended December 31,
2018
2017
Average
Balance
Yield
Average
Balance
Yield
Change in
Interest and
Dividend Income
Loans receivable, net
995,810
$
Investments available-for-sale
141,100
Interest-earning deposits 11,628
FHLB stock
8,748
Total interest-earning assets
1,157,286
$
(Dollars in thousands)
5.13% $
2.92
1.74
5.24
878,449
134,105
22,194
8,914
4.96% $
7,520
2.61
1.07
3.32
622
(35)
162
4.83% $
1,043,662
4.57% $
8,269
During the year ended December 31, 2018, the $7.5 million increase in loan interest income was primarily the result of
a $117.4 million increase in the average balance of net loans receivable and to a lesser extent, an increase in the average loan yield
of 17 basis points. Repayments of previously charged off notes as part of an A/B note restructure contributed $1.0 million to loan
interest income.
Interest income from investments available-for-sale increased $622,000 during 2018 as a combined result of a $7.0 million
increase in the average balance of our investments and a 31 basis point increase in the average yield to 2.92% from 2.61% during
2017. The increase in the average yield was a result of the restructuring of our investments portfolio through the sales of lower
yielding investment securities and utilizing the proceeds received to purchase higher yielding, long-term investment securities.
Interest income on interest-earning deposits decreased $35,000 during the year ended December 31, 2018, primarily as
a result of a $10.6 million decrease in the average balance of these deposits as excess funds were converted into higher yielding
assets. Partially offsetting this decrease, the average yield of these deposits increased to 1.74% for the year ended December 31, 2018
from 1.07% for the year ended December 31, 2017. The rate increase was the result of increases in the Federal Reserve’s targeted
federal funds rate during 2018.
The following table details average balances, cost of funds and the resulting increase in interest expense for the years
ended December 31, 2018 and 2017:
Year Ended December 31,
2018
2017
Average
Balance
Cost
Average
Balance
Cost
(Dollars in thousands)
Change in
Interest
Expense
Interest-bearing demand accounts
$
40,360
0.20% $
25,724
Statement savings accounts
Money market accounts
326,075
Certificates of deposit, retail 350,603
Certificates of deposit, brokered
86,203
Advances from the FHLB 183,667
0.13
1.09
1.66
2.01
1.92
25,267
28,160
247,770
345,981
75,488
192,227
0.29% $
0.15
0.72
1.26
1.67
1.30
Total interest-bearing liabilities
$ 1,012,632
1.46% $
914,893
1.10% $
6
(8)
1,771
1,463
469
1,015
4,716
Interest expense increased $4.7 million to $14.7 million for the year ended December 31, 2018 from $10.0 million for
the year ended December 31, 2017. The increase in interest expense during 2018 was primarily a result of the increase in the
average cost of interest-bearing deposits of 31 basis points and the increase in the average cost of our FHLB borrowings of 62 basis
points reflecting higher market interest rates. In support of our asset growth, the average balances of interest-bearing deposits
61
increased by $106.3 million. The growth in our deposits more than met our funding needs, allowing the Bank to pay down certain
FHLB advances, resulting in a decrease for 2018 in average FHLB advances of $8.6 million.
The average cost of our retail deposits increased as a result of the increase in market interest rates that occurred during
2018. Money market interest expense increased by $1.8 million as a result of a $78.3 million increase in the average balance
primarily due to the Branch Acquisition combined with a 37 basis point increase in the average cost of these funds. The cost of
retail and brokered certificates of deposit increased by 40 and 34 basis points, respectively, as the growth in the rates needed to
compete for these deposits in the marketplace have increased in response to increases in the targeted federal funds rate. In addition,
we replaced $17.7 million of maturing brokered certificates of deposit with new brokered certificates of deposit at higher market
interest rates.
Provision for Loan Losses. Our recapture of provision for loan losses was $4.0 million for the year ended
December 31, 2018 as compared to $400,000 for the year ended December 31, 2017. The recapture of provision in 2018 was
primarily the result of $4.5 million in net recoveries of previously charged off loans, partially reduced by the provision for loan
losses required as a result of the $34.2 million increase in net loans receivable. In comparison, the recapture in 2017 was primarily
the result of a $2.3 million in net recoveries partially offset by the provision required for the $173.6 million increase in net loans
receivable. The quality of our loan portfolio remained stable as indicated by our credit metrics and by the $7.8 million decrease
in loans with specific reserves. The related specific reserves declined to $62,000 at December 31, 2018 from $135,000 at
December 31, 2017.
The large recoveries in both 2018 and 2017 were the result of repayments on the remaining balances on the charged off
portion of ”A” and “B” note restructures occurring prior to 2012. These payoffs exhausted the off-balance sheet note “B” balances
and therefore we do not anticipate recoveries of this magnitude in future periods. At December 31, 2018, the remaining balance
on these “A” notes was $560,000, which are being repaid in accordance with their restructured payment terms. For more information
on these “A” and “B” note restructures, see “Business-Asset Quality-Troubled Debt Restructured Loans” contained in Item 1 of
this report.
Noninterest Income. Noninterest income increased $670,000 to $2.9 million for the year ended December 31, 2018
from $2.2 million for the year ended December 31, 2017. The following table provides a detailed analysis of the changes in the
components of noninterest income:
Year Ended
December 31, 2018
Change from
December 31, 2017
Percentage
Change
(Dollars in thousands)
Deposit related fees
Loan related fees
Loss on sale of investments, net
BOLI change in cash surrender value
Wealth management revenue
Other
Total noninterest income
$
$
681
$
768
(20)
814
611
24
2,878
$
235
(8)
547
191
(308)
13
670
52.7%
(1.0)
(96.5)
30.7
(33.5)
118.2
30.3%
The largest change to our noninterest income was the $20,000 loss on sale of investments for the year ended
December 31, 2018 as compared to a $567,000 loss on sale of investments for the year ended December 31, 2017. For the year
ended December 31, 2017, as a result of the Tax Act, we opted to sell certain investment securities that were carried in an unrealized
loss position to receive the optimal tax benefit of the losses and to reinvest the proceeds to purchase primarily higher yielding
adjustable rate securities. In comparison, in 2018, a relatively small number of securities that were in a loss position were sold
and replaced with securities that assist in managing our interest rate risk.
Deposit related fees of $681,000 were recorded for the year ended December 31, 2018, a $235,000 increase over the
prior year. As a result of our deposit growth and corresponding increase in customer transactions, our transactional based fee
revenue also increased.
Our BOLI noninterest income increased by $191,000 during 2018 due to the timing in recognizing policy expenses and
dividends on $4.2 million of new policies purchased in 2017. Policy expenses were deducted from earnings over the first year
subsequent to the purchase date of certain policies, partially reducing the noninterest income on our BOLI policies we otherwise
62
would recognize. For the year ended December 31, 2018, we recognized the net $814,000 increase in cash surrender value of these
policies as noninterest income, which assists in offsetting expenses for employee benefits.
Partially offsetting these increases, wealth management revenue decreased by $308,000 during 2018. This decrease is a
combined result of a reduction in sales staff and normal fluctuations in the timing and mix of commissions received on serviced
accounts due to the nature and timing of the underlying investments. This line of business assists the Bank with providing options
to our customers to better meet their financial needs. Total assets managed by our wealth management division increased to
$64.8 million at December 31, 2018, from $44.6 million at December 31, 2017.
Noninterest Expense. Noninterest expense increased $2.7 million to $29.5 million for the year ended December 31, 2018
from $26.8 million for the year ended December 31, 2017. The following table provides a detailed analysis of the changes in the
components of noninterest expense:
Year Ended
December 31, 2018
Change from
December 31, 2017
Percentage
Change
(Dollars in thousands)
Salaries and employee benefits
$
19,302
$
Occupancy and equipment
Professional fees
Data processing
OREO related expenses, net
Regulatory assessments
Insurance and bond premiums
Marketing
Other general and administrative
Total noninterest expense
$
3,283
1,538
1,392
7
502
443
344
2,650
29,461
$
1,529
777
(271)
(65)
74
11
44
74
479
2,652
8.6%
31.0
(15.0)
(4.5)
(110.4)
2.2
11.0
27.4
22.1
9.9%
The primary contributor to the increase in noninterest expense was our branch expansion over the past year. For the year
ended December 31, 2018, salaries and employee benefits increased by $1.5 million as compared to the previous year to $19.3
million as a result of normal wage increases and, as a result of our growth in the number of branches and the development of new
product lines.
Occupancy and equipment expense increased $777,000 to $3.3 million during 2018 as a result of the addition of one
new branch location in 2018 and incurring a full year of expenses for the five new branches opened during 2017. Lease expense
increased by $241,000 and depreciation expense increased by $316,000 primarily as a result of additional leasehold improvements
and fixed assets related to opening the new branches.
Other general and administrative expenses increased by $479,000 during the year ended December 31, 2018, primarily
as a result of a $225,000 wire related fraud incurred in the fourth quarter. In January 2019, the Bank received a $125,000 insurance
settlement to partially offset this loss. Additional increases in other general and administrative expenses were due to increases in
customer transactions and employee related expenses reflecting the growth in our operations. CDI amortization increased by
$97,000 in 2018 as we recognized a full year of amortization as compared to four months of amortization in 2017.
Partially offsetting the increases in noninterest expense, professional fees decreased by $271,000 and data processing
decreased by $65,000 for 2018, as compared to 2017 as we incurred additional expenses in 2017 for these services in support of
our Branch Acquisition. For additional information regarding our Branch Acquisition, see Note 2 of the Notes to Consolidated
Financial Statements contained in Item 8 of this report.
Federal Income Tax Expense. We recorded a $3.7 million federal income tax provision for 2018, compared to $4.9 million
for 2017. Although pretax net income increased by $5.2 million in 2018 as compared to 2017, the lower statutory federal corporate
income tax rate of 21% for 2018 rather than the 35% rate previously used more than offset the increase in pretax net income. The
Company’s federal income tax provision in 2018 also benefited from stock option exercises that occurred at prices higher than
originally estimated, resulting in higher allowable expense recognition for tax purposes. In addition, for the year ended December
31, 2017, the revaluation of our deferred tax asset (“DTA”) balance at the new federal corporate income tax rate of 21% resulted
in a one-time $807,000 increase in federal income tax expense for the year ended December 31, 2017.
63
Comparison of Financial Condition at December 31, 2017 and December 31, 2016
Assets. The following table details the changes in the composition of our assets at December 31, 2017 from
December 31, 2016.
Balance at
December 31, 2017
Cash on hand and in banks
Interest-earning deposits
Investments available for sale, at fair value
Loans receivable, net
Premises and equipment, net
FHLB stock, at cost
Accrued interest receivable
Deferred tax assets, net
OREO
BOLI
Prepaid expenses and other assets
Goodwill
Core deposit intangible
Total assets
$
$
9,189
6,942
132,242
988,662
20,614
9,882
4,084
1,211
483
29,027
5,738
889
1,266
1,210,229
Change from
December 31, 2016
(Dollars in thousands)
3,410
$
(18,631)
2,982
173,619
2,153
1,851
937
(1,931)
(1,848)
4,874
3,074
889
1,266
172,645
$
Percentage
Change
59.0%
(72.9)
2.3
21.3
11.7
23.0
29.8
(61.5)
(79.3)
20.2
115.4
n/a
n/a
16.6%
The $172.6 million increase in total assets during 2017 was primarily a result of utilizing growth in deposits, additional
advances from the FHLB, and excess cash held at the Federal Reserve Bank of San Francisco to grow our loan portfolio by $173.6
million.
Interest-earning deposits with banks. Our interest-earning deposits with banks, consisting primarily of funds held at
the Federal Reserve Bank of San Francisco, decreased by $18.6 million from December 31, 2016 to December 31, 2017 primarily
to fund new loan originations during 2017.
Investments available-for-sale. Our investments available-for-sale increased by $3.0 million, or 2.3%, during 2017 as
we continued to restructure our available for sale investment portfolio to transition our investment portfolio to securities with
higher yields in order to enhance our interest income. Following the passing of the Tax Act, we elected to restructure a portion of
our investment portfolio through the sale of certain fixed rate securities that were carried in an unrealized loss position and the
purchase of primarily adjustable rate securities. During the year, we purchased $58.8 million of securities with an expected yield
of 2.24%, partially funded by sales of $40.0 million of securities with an average yield of 1.78%. The restructure discussed above
resulted in an increase in the average yield of our available-for-sale investments to 2.61% in 2017 from 2.31% in 2016. Securities
purchased included $15.1 million in fixed rate and $43.7 million in variable rate securities, comprised of $36.0 million in U.S.
government agency bonds, $18.2 million in mortgage-backed securities, $3.0 million in corporate bonds and $1.6 million in
municipal bonds. The sales of investments available-for-sale generated a net loss of $567,000 for the year ended December 31,
2017. We also received calls or partial calls and proceeds at maturity during 2017 of $731,000 of U.S. Government agency and
municipal securities. In addition to the purchase and call activity, we received principal repayments of $10.7 million on our
investments available-for-sale during 2017.
The effective duration of our portfolio decreased to 2.90% at December 31, 2017 as compared to 4.00% at
December 31, 2016. Effective duration is a measure that attempts to quantify the anticipated percentage change in the value of an
investment (or portfolio) in the event of a 100 basis point change in market yields. Since the Bank’s portfolio includes securities
with embedded options (including call options on bonds and prepayment options on mortgage-backed securities), management
believes that effective duration is an appropriate metric to use as a tool when analyzing the Bank’s investment securities portfolio,
as effective duration incorporates assumptions relating to such embedded options, including changes in cash flow assumptions as
interest rates change.
Loans receivable. Net loans receivable increased by $173.6 million during 2017 to $988.7 million as a result of growth
in all loan categories. The most significant increases occurred in multifamily loans, with a $61.7 million, or 50.0% increase and
64
commercial real estate loans, with a $58.1 million or 19.1% increase. Commercial real estate and one-to-four family residential
loans continue to be the largest concentrations in our loan portfolio at 33.0% and 25.5%, respectively, of total loans. The growth
in construction/land loans was less than other loan types, with a decrease in concentration to 21.7% of our total loan portfolio in
2017 from 23.2% in 2016. During 2017, we supplemented our loan originations by purchasing $76.2 million in performing one-
to-four family, multifamily, commercial, and aircraft loans from other financial institutions. The loans were purchased at an average
premium of 2.3% and are intended to be held to maturity. The majority of these purchased loans are secured by properties located
in states across the country, reflecting our efforts to geographically diversify our loan portfolio with loans meeting our investment
and credit quality objectives.
The quality of our loan portfolio continued to improve during 2017 as our nonperforming loans decreased to $179,000
at December 31, 2017 from $858,000 at December 31, 2016. Nonperforming loans as a percent of our total loans remained low
at 0.02% and 0.10% at December 31, 2017 and 2016, respectively. Adversely classified loans, defined as substandard or below,
decreased to $1.3 million at December 31, 2017, from $1.9 million at December 31, 2016. The following table presents a breakdown
of our nonperforming assets:
Nonperforming loans:
One-to-four family residential
Consumer
Total nonperforming loans
OREO
Total nonperforming assets
December 31,
2017
2016
Amount of
Change
Percent of
Change
(Dollars in thousands)
$
$
128
$
798
$
51
179
483
662
60
858
2,331
$
3,189
$
(670)
(9)
(679)
(1,848)
(2,527)
(84.0)%
(15.0)
(79.1)
(79.3)
(79.2)%
We continued to focus on reducing our nonperforming assets through loan work outs or pursuing foreclosure. Foregone
interest during the year ended December 31, 2017 relating to nonperforming loans totaled $26,000. There was no LIP related to
nonperforming loans at December 31, 2017 or 2016. OREO decreased to $483,000 at December 31, 2017 as we continued to sell
our inventory of foreclosed real estate. During 2017, we sold three properties for $1.9 million as compared to sales of two properties
for $988,000 during 2016. We did not foreclose on any properties during either 2017 or 2016. The continued decline in our
nonperforming assets reflects improvements in the quality of our loan portfolio and our commitment to identify any problem loans
and take prompt actions to turn nonperforming assets into performing assets.
Allowance for loan and lease losses. The ALLL was $12.9 million or 1.28% of total loans outstanding at December 31,
2017 as compared to $11.0 million or 1.32% of total loans outstanding at December 31, 2016. The ALLL represented 7,196.7%
of nonperforming loans at December 31, 2017 compared to 1276.3% at December 31, 2016. The following table details activity
and information related to the ALLL for the years ended December 31, 2017 and 2016. All loan balances and ratios are calculated
using loan balances that
are net of LIP.
65
ALLL balance at beginning of year
(Recapture of provision) provision for loan losses
Charge-offs
Recoveries
ALLL balance at end of year
ALLL as a percent of total loans, net of LIP
ALLL as a percent of nonperforming loans
Total nonperforming loans
Nonperforming loans as a percent of total loans
Total loans receivable, net LIP
Total loans originated
At or For the Years Ended
December 31,
2017
2016
(Dollars in thousands)
$
10,951
(400)
—
2,331
9,463
1,300
(83)
271
12,882
$
10,951
1.28%
1.32%
7,196.65
1,276.34
179
0.02%
1,002,694
331,166
$
$
858
0.10%
828,161
359,666
$
$
$
$
Intangible assets. As a result of our Branch Acquisition, the Bank recognized goodwill of $889,000 and CDI of $1.3
million. Goodwill was calculated as the excess purchase price of the branches over the fair value of the assets acquired and liabilities
assumed at August 25, 2017.
The CDI was provided by a third party valuation service and represents the fair value of the customer relationships that
provide a low-cost source of funding. The analysis was performed on the acquired noninterest-bearing checking, interest-bearing
checking, savings, and money market accounts. The initial ratio of CDI to the acquired balances of core deposits was 2.23%. This
amount will amortize into noninterest expense on an accelerated basis over ten years.
Deposits. During the year ended December 31, 2017, deposits increased $122.0 million from December 31, 2016.
Details of deposit balances and their concentrations are as follows:
December 31,
2017
2016
(dollars in thousands)
Noninterest-bearing demand
deposits
Interest-bearing demand
Statement savings
Money market
Certificates of deposit, retail (1)
Certificates of deposit, brokered
Total deposits
$
$
45,434
38,224
28,456
318,636
333,264
75,488
839,502
5.4% $
4.6
3.4
38.0
39.6
9.0
100.0% $
33,422
18,532
28,383
204,998
356,653
75,488
717,476
4.7%
2.5
4.0
28.6
49.7
10.5
100.0%
____________________
(1) Retail certificates of deposit are shown net of $107,000 fair value adjustment at December 31, 2017 from acquired deposits.
There is no fair value adjustment at December 31, 2016.
The growth in retail deposits during 2017 was primarily the result of our expansion from four branch locations to nine,
with the addition of one de novo branch and acquisition of four other branches. The Branch Acquisition was executed to further
shift our deposit mix by increasing core deposits and strengthen our liquidity position while providing access to contiguous markets.
At the acquisition date, deposits were $74.7 million, consisting primarily of $32.7 million in money market accounts and $15.6
million in retail certificates of deposit. At December 31, 2017, we had retained 98% of the acquired deposits.
During 2017, we continued the work on shifting the mix of our deposit portfolio to be less reliant on certificates of deposit,
as the Bank continued to focus its efforts on growing accounts with a lower cost of funds. Our efforts resulted in money market
accounts increasing $113.6 million and checking accounts increasing $31.7 million while retail certificates of deposit decreased
$23.4 million during 2017. In addition, continued growth in our wealth management services provided our customers with other
66
long-term investment choices, resulting in a decrease in deposits (primarily maturing certificates of deposit) which converted to
investment accounts.
Our portfolio of brokered certificates of deposit remained at $75.5 million at December 31, 2017, unchanged from
December 31, 2016. We may add to our portfolio of these brokered deposits as a source of additional funding in future periods.
While brokered certificates of deposit may carry a higher cost than our retail certificates, their remaining maturity periods of six
months to 36 months, along with the enhanced call features of a majority of these deposits, assist us in our efforts to manage
interest rate risk.
At December 31, 2017 and December 31, 2016, we held $21.5 million and $23.7 million in public funds, respectively,
nearly all of which were retail certificates of deposit. These funds were secured at December 31, 2017 with the Washington State
Public Deposit Protection Commission by $14.2 million in pledged investment securities.
Advances. We use advances from the FHLB as an alternative funding source to manage interest rate risk and to leverage
our balance sheet. Throughout the year, we utilized FHLB federal funds to balance our funding needs with our total funding
sources. Total FHLB advances at December 31, 2017 were $216.0 million as compared to $171.5 million at December 31, 2016.
During 2017, as part of our ongoing liquidity management efforts, we replaced a $20.0 million matured advance, and refinanced
our existing $80.0 million member option variable-rate advance and $20.0 million of FHLB Fed Funds into a new $120.0 million
three-year member option variable-rate advance that reprices quarterly and allows for prepayment without penalties on the repricing
date. At December 31, 2017, we had $24.5 million in FHLB Fed Funds. Our average borrowings during 2017 were $192.2 million.
At December 31, 2017, $86.0 million of our FHLB advances, including Fed Funds, were due to mature in 2018, with the remaining
$130.0 million due to mature in one to three years.
Cash Flow Hedge. As part of its interest rate risk management efforts, the Bank entered into a five-year, $50 million
notional, pay fixed, receive floating cash flow hedge or interest rate swap with a qualified institution on October 25, 2016. Under
the terms of the agreement, the Bank pays a fixed interest rate of 1.34% for five years and in return receives an interest payment
based on the three-month LIBOR index, which resets quarterly. Concurrently, the Bank borrowed a $50 million fixed rate three
month FHLB advance that will be renewed quarterly at the fixed interest rate at that time. Effectiveness of the swap is evaluated
quarterly with any ineffectiveness recognized as a gain or a loss on the income statement in noninterest income. A change in the
fair value of the cash flow hedge is recognized as an other asset or other liability on the balance sheet with the tax-effected portion
of the change included in other comprehensive income. At December 31, 2017, we recognized a $1.5 million fair value asset as
a result of the increase in market value of the hedge agreement.
Stockholders’ Equity. Total stockholders’ equity increased $4.5 million, or 3.3% to $142.6 million at December 31, 2017
from $138.1 million at December 31, 2016. The increase in stockholders’ equity was primarily a result of $8.5 million in net
income partially offset by $2.8 million in shareholder dividends and the repurchase of 326,800 shares of stock at an aggregate
cost of $5.3 million. In addition, the exercise of stock options and issuance of restricted stock resulted in 136,986 shares being
issued from authorized shares and an increase to stockholders’ equity of $1.2 million.
The Company elected to early adopt ASU 2018-02 and reclassified $41,000 of stranded other comprehensive income as
a result of the reduction in the tax rate in the corporate income rate from the enactment of the Tax Act from 35% to 21%. The
result was a decrease to accumulated other comprehensive income and an increase to retained earnings, with no net change in
stockholders’ equity.
Comparison of Operating Results for the Years Ended December 31, 2017 and December 31, 2016
Net Interest Income. Net interest income in 2017 was $37.6 million, a $3.4 million or 10.0% increase from
$34.2 million in 2016 due primarily to a $5.9 million increase in interest income partially offset by a $2.5 million increase in
interest expense. Interest income increased during the year ended December 31, 2017 primarily as a result of the growth in average
loans receivable and in particular, multifamily and commercial real estate loans. In addition, the average yield of interest-earning
assets increased to 4.57% for the year ended December 31, 2017 from 4.39% for the year ended December 31, 2016. The increase
in average assets was funded by a $102.7 million increase in average interest-bearing liabilities. The average cost of these funds
increased to 1.10% for the year ended December 31, 2017 from 0.92% for the year ended December 31, 2016, primarily as a result
of the overall increase in federal funds rate during 2017. Although the total yield on assets and total cost of funds increased during
2017, our net interest rate spread and net interest margin remained constant at 3.47% and 3.60% year over year. Continued growth
in higher yielding loans helped contribute to maintaining these ratios.
67
The following table compares average interest-earning asset balances, associated yields, and resulting changes in interest
and dividend income for the years ended December 31, 2017 and 2016:
Year Ended December 31,
2017
2016
Average
Balance
Yield
Average
Balance
Yield
Change in
Interest and
Dividend Income
Loans receivable, net
878,449
$
Investments available-for-sale
134,105
Interest-earning deposits 22,194
FHLB stock
8,914
Total interest-earning assets
1,043,662
$
(Dollars in thousands)
4.96% $
2.61
1.07
3.32
765,948
132,372
45,125
7,714
4.99% $
2.31
0.52
2.62
5,389
450
2
94
4.57% $
951,159
4.39% $
5,935
During the year ended December 31, 2017, the $5.4 million increase in loan interest income was primarily the result of
a $112.5 million increase in the average balance of net loans receivable. Also contributing to the increase in loan interest income,
repayments of previously charged off notes as part of an A/B note restructure contributed $495,000 in additional loan interest
income.
Interest income from investments available-for-sale increased $450,000 during 2017 as a combined result of a $1.7 million
increase in the average balance of our investments and a 30 basis point increase in the average yield to 2.61% from 2.31% during
2016. The increase in the average yield was a result of the restructuring of our investments portfolio through the sales of lower
yielding investment securities and utilizing the proceeds received to purchase higher yielding, long-term investment securities.
Interest income on interest-earning deposits remained stable with a modest $2,000 increase during the year ended
December 31, 2017. Although the average balance of these funds decreased by $22.9 million as they were converted into higher-
yielding assets, the increase in average yield to 1.07% for the year ended December 31, 2017 from 0.52% for the year ended
December 31, 2016 more than offset the decline in the average balance. The rate increase was the result of increases in the Federal
Reserve’s targeted federal funds rate during 2017.
The following table details average balances, cost of funds and the resulting increase in interest expense for the years
ended December 31, 2017 and 2016:
Year Ended December 31,
2017
2016
Average
Balance
Cost
Average
Balance
(Dollars in thousands)
Cost
Interest-bearing demand accounts
$
25,267
0.29% $
28,160
Statement savings accounts
Money market accounts
247,770
Certificates of deposit, retail 345,981
Certificates of deposit, brokered
75,488
Advances from the FHLB 192,227
0.15
0.72
1.26
1.67
1.30
17,545
29,221
196,670
335,496
69,392
163,893
0.17% $
0.16
0.44
1.17
1.76
0.86
Total interest-bearing liabilities
914,893
$
1.10% $
812,217
0.92% $
Change in
Interest
Expense
43
(5)
909
428
41
1,099
2,515
Interest expense increased $2.5 million to $10.0 million for the year ended December 31, 2017 from $7.5 million for the
year ended December 31, 2016. The increase in interest expense during 2017 was primarily a result of the increase in the average
cost of interest-bearing deposits of 10 basis points and the increase in the average cost of our FHLB borrowings of 44 basis points.
Also contributing to a lesser extent to the increase in interest expense, the average balances of interest-bearing deposits and
borrowings increased by $74.3 million and $28.3 million, respectively, in support of our asset growth.
68
The average cost of our retail deposits increased as a result of the increase in market interest rates that occurred during
2017. The average cost of brokered certificates of deposit decreased by nine basis points during 2017 as a result of the redemption
of higher rate brokered certificates of deposit and subsequent replacement with lower rate brokered certificates of deposit during
2016.
Provision for Loan Losses. Our recapture of provision for loan losses was $400,000 for the year ended December 31, 2017
as compared to a provision for loan losses of $1.3 million for the year ended December 31, 2016. The recapture of provision in
2017 was primarily the result of $2.3 million in net recoveries of previously charged off loans partially reduced by the provision
for loan losses required as a result of the $173.6 million increase in net loans receivable. In comparison, the provision in 2016
was primarily the result of a $130.0 million increase in net loans receivable. The quality of our loan portfolio continued to improve
as indicated by our credit metrics and that the loans evaluated individually for specific reserves decreased by $13.0 million. The
related specific reserves declined to $135,000 at December 31, 2017 from $309,000 at December 31, 2016.
Noninterest Income. Noninterest income decreased $443,000 to $2.2 million for the year ended December 31, 2017
from $2.7 million for the year ended December 31, 2016. The following table provides a detailed analysis of the changes in the
components of noninterest income:
Deposit related fees
Loan related fees
Gain on sale of investments, net
BOLI change in cash surrender value
Wealth management revenue
Other
Total noninterest income
Year Ended
December 31, 2017
Change from
December 31, 2016
Percentage
Change
(Dollars in thousands)
$
$
446
$
776
(567)
623
919
11
2,208
$
185
105
(617)
(221)
106
(1)
(443)
70.9 %
15.6
(1,234.0)
(26.2)
13.0
(8.3)
(16.7)%
The largest change to our noninterest income was the $567,000 loss on sales of investments for the year ended
December 31, 2017 as compared to a $50,000 gain on sale of investments for the year ended December 31, 2016. As a result of
the Tax Act, we opted to sell a selection of our investment securities that were in a loss position to receive the optimal tax benefit
of the losses.
Our BOLI noninterest income decreased by $221,000 during 2017 due to the $4.2 million purchase in the second quarter
of new policies that offset the premium against the increase in cash surrender value for the first year. For the year ended
December 31, 2017, we recognized the net $623,000 increase in cash surrender value of these policies as noninterest income,
which assists in offsetting expenses for employee benefits.
Partially offsetting these losses, deposit related fees increased by $185,000, primarily as a result of the increase in debit
card transactions reflecting the increase in the number of our accounts as well as other deposit related services at our branch
locations. Loan related fees increased by $105,000 as a result of a $166,000 increase in prepayment penalties during the year
ended December 31, 2017, partially offset by a $40,000 reduction in loan servicing fees and a $21,000 reduction in fees from
interest rate swaps from commercial loan customers during the year. Interest rate swap fees are received on loans when certain
commercial loan customers participate in an interest rate swap with a third party broker institution and the Bank receives a fee
that is recognized as other noninterest income at the time the loan is originated. In addition, wealth management revenue increased
$106,000 during 2017.
Noninterest Expense. Noninterest expense increased $3.9 million to $26.8 million for the year ended December 31, 2017
from $22.9 million for the year ended December 31, 2016. The following table provides a detailed analysis of the changes in the
components of noninterest expense:
69
Year Ended
December 31, 2017
Change from
December 31, 2016
Percentage
Change
(Dollars in thousands)
Salaries and employee benefits
$
17,773
$
2,396
Occupancy and equipment
Professional fees
Data processing
OREO-related reimbursement of expenses, net
Regulatory assessments
Insurance and bond premiums
Marketing
Other general and administrative
2,506
1,809
1,457
(67)
491
399
270
2,171
Total noninterest expense
$
26,809
$
522
(170)
546
(361)
71
50
76
730
3,860
15.6%
26.3
(8.6)
59.9
(122.8)
16.9
14.3
39.2
50.7
16.8%
For the year ended December 31, 2017, salaries and employee benefits increased by $2.4 million as compared to the
previous year to $17.8 million as a result of normal wage increases and the hiring of 24 new full time positions in support of the
growth in our operations, including new branches and new product lines. In addition, in response to the Tax Act, the Bank paid a
special one-time bonus to all non-executive employees totaling $224,000 to share with our employees the expected future tax
benefits the legislation provides.
Occupancy and equipment expense increased $522,000 to $2.5 million during 2017 as a result of the addition of five
branch locations, expenses related to our automated teller machine (“ATM”) conversion and the upgrade of our main Renton
branch. Lease expense increased by $165,000 and depreciation expense increased by $186,000 as we added one building, leasehold
improvements and computer equipment to support the new branch operations. In support of our ATM conversion and Branch
Acquisition, our data processing expense increased by $546,000 for 2017 as compared to 2016. The rate of the increase in data
processing expense is expected to decline in future periods as we complete system conversion costs, although our core processor
service fees will increase reflecting the expected increase in deposit accounts activity from the growth in customer accounts.
OREO related reimbursement of expense was $67,000, a $361,000 improvement over the previous year. Valuation expense
to adjust our carrying value to market value decreased by $207,000 for the year ended December 31, 2017 as compared to the
year ended December 31, 2016. In addition, sales of OREO properties resulted in a net gain of $110,000 in 2017 as compared to
a net loss of $87,000 in 2016.
Other general and administrative expenses increased by $730,000 during the year ended December 31, 2017, primarily
as a result of a $254,000 increase in the reserve for unfunded commitments due to a $20.5 million increase in our unfunded loans
in process and $9.3 million increase in unfunded lines of credit. This reserve is held to absorb estimated probable losses of our
unfunded lines of credit and construction loans and varies as a result of the timing of funding these loans. Other general and
administrative expense increases included $103,000 for additional debit card operating expenses and $88,000 in additional deposit
related expenses, both the result of increased customer volumes at our branch locations. With the addition of California loan
activity and overall increase in loan income, the Bank incurred an $83,000 increase in state taxes. As a result of our Branch
Acquisition, the Bank recognized CDI amortization expense of $53,000 during 2017.
Federal Income Tax Expense. We recorded a $4.9 million federal income tax provision for 2017, compared to $3.7 million
for 2016. The Tax Act resulted in a revaluation of our DTA balance at the new corporate income tax rate of 21% rather than the
35% rate previously used, effective January 1, 2018. The reduction in our DTA balance resulted in a one-time $807,000 increase
in federal income tax expense for the year ended December 31, 2017. In addition, our federal income tax expense increased due
to pretax net income increasing by $817,000 for the year ended December 31, 2017 as compared to the year ended
December 31, 2016.
70
Average Balances, Interest and Average Yields/Cost
The following table presents information regarding average balances of assets and liabilities as well as interest income
from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate
spreads, net interest margins and the ratio of average interest-earning assets to average interest-bearing liabilities. Average balances
have been calculated using the average daily balances during the period. Interest and dividends are not reported on a tax equivalent
basis.
Year Ended December 31,
2018
Interest
and
Dividends
Average
Balance (1)
Yield/
Cost
Average
Balance (1)
2017
Interest
and
Dividends
Yield/
Cost
Average
Balance (1)
2016
Interest
and
Dividends
Yield/
Cost
(Dollars in thousands)
Interest-earnings assets:
$ 995,810
Loans receivable, net
$ 51,127
5.13% $ 878,449
$ 43,607
4.96% $ 765,948
$ 38,218
4.99%
2.31
0.52
2.62
4.39
0.17%
0.16
0.44
1.17
1.76
0.94
0.86
0.92
3.47%
3.60%
Investments available-for-sale
141,100
4,126
Interest-earning deposits
FHLB stock
11,628
8,748
202
458
Total interest-earning assets
1,157,286
55,913
2.92
1.74
5.24
4.83
134,105
3,504
22,194
8,914
237
296
1,043,662
47,644
2.61
1.07
3.32
4.57
Noninterest earning assets
Total average assets
Interest-bearing liabilities:
70,110
$1,227,396
Interest-bearing demand accounts $
40,360
$
Statement savings accounts
Money market accounts
Certificates of deposit, retail
Certificates of deposit, brokered
Total deposits
Advances from the FHLB and
other borrowings
25,724
326,075
350,603
86,203
828,965
183,667
Total interest-bearing liabilities
1,012,632
Noninterest bearing liabilities
Average equity
63,619
151,145
79
34
3,550
5,825
1,730
11,218
3,520
14,738
64,994
$1,108,656
0.20% $
25,267
$
0.13
1.09
1.66
2.01
1.35
1.92
1.46
28,160
247,770
345,981
75,488
722,666
192,227
914,893
51,116
142,647
73
42
1,779
4,362
1,261
7,517
2,505
10,022
132,372
3,054
45,125
7,714
951,159
59,084
$1,010,243
235
202
41,709
30
47
870
3,934
1,220
6,101
1,406
7,507
0.29% $
17,545
$
0.15
0.72
1.26
1.67
1.04
1.30
1.10
29,221
196,670
335,496
69,392
648,324
163,893
812,217
37,834
160,192
Total average liabilities and equity
$1,227,396
$1,108,656
$1,010,243
Net interest income
$ 41,175
$ 37,622
$ 34,202
Interest rate spread
Net interest margin
Ratio of average interest-
earning assets to average
3.37%
3.56%
3.47%
3.60%
interest-bearing liabilities
114.28%
114.07%
117.11%
________________
(1) The average loans receivable, net balances include nonaccruing loans.
71
Yields Earned and Rates Paid
The following table presents the weighted-average yields earned on our assets and the weighted-average interest rates
paid on our liabilities, together with the net yield on interest-earning assets and liabilities, for the dates indicated.
Yield on interest-earning assets:
Loans receivable, net
4.97%
5.13%
4.96%
4.99%
Weighted Average
Yield at
December 31, 2018
Net Yield
Year Ended December 31,
2018
2017
2016
Investment securities available-for-sale
3.21
Interest-earning deposits
FHLB stock
Total interest-earning assets
Rate paid on interest-bearing liabilities:
Interest-bearing demand accounts
Statement savings accounts
Money market accounts
Certificates of deposit, retail
Certificates of deposit, brokered
Total interest-bearing deposits
2.29
—
4.70
0.16
0.13
1.31
2.10
2.18
1.67
Advances from the FHLB and other borrowings 2.25
1.75
Total interest-bearing liabilities
Interest rate spread
Net interest margin
2.96
N/A
2.92
1.74
5.24
4.83
0.20
0.13
1.09
1.66
2.01
1.35
1.92
1.46
3.37
3.56
Rate/Volume Analysis
2.61
1.07
3.32
4.57
0.29
0.15
0.72
1.26
1.67
1.04
1.30
1.10
3.47
3.60
2.31
0.52
2.62
4.39
0.17
0.16
0.44
1.17
1.76
0.94
0.86
0.92
3.47
3.60
The following table presents the effects of changing rates and volumes on our net interest income. Information is provided
with respect to: (1) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and
(2) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes in rate/volume
are allocated proportionately to the changes in rate and volume.
72
Year Ended December 31, 2018
Compared to December 31, 2017
Change in Interest
Year Ended December 31, 2017
Compared to December 31, 2016
Change in Interest
Rate
2018
Volume
Total
Rate
(In thousands)
2017
Volume
Total
Interest-earning assets:
Loans receivable, net
Investments available-for-sale
Interest-earning deposits
FHLB stock
$
1,694
$
5,826
$
7,520
$
439
78
168
183
$
(113) $
(6) $
622
(35)
162
Net change in interest income
2,379
5,890
8,269
Interest-bearing liabilities:
Interest-bearing demand accounts
$
(38) $
Statement savings accounts
Money market accounts
Certificates of deposit, retail
Certificates of deposit, brokered
Advances from the FHLB
Net change in interest expense
(4)
1,209
1,405
290
1,127
3,989
44
$
(4) $
$
562
58
$
179
$
(112) $
727
$
6
(8)
1,771
1,463
469
1,015
4,716
Net change in net interest income
$
(1,610) $
5,163
$
3,553
$
(224) $
410
121
63
370
30
(3)
683
305
(66)
856
$
1,805
(1,435) $
5,613
$
40
$
(119) $
$
31
5,389
450
2
94
5,565
5,935
13
$
(2) $
$
226
123
107
243
710
4,855
$
$
$
$
43
(5)
909
428
41
1,099
2,515
3,420
Asset and Liability Management and Market Risk
General. Our Board of Directors has approved an asset/liability management policy to guide management in maximizing
interest rate spread by managing the differences in terms between interest-earning assets and interest-bearing liabilities while
maintaining acceptable levels of liquidity, capital adequacy, interest rate risk, credit risk, and profitability. The policy established
an Investment, Asset/Liability Committee (“ALCO”) comprised of certain members of senior management and the Board of
Directors. The Committee’s purpose is to communicate, coordinate and manage our asset/liability position consistent with our
business plan and Board-approved policies. The ALCO meets quarterly to review various areas including:
•
•
•
•
•
•
•
•
economic conditions;
interest rate outlook;
asset/liability mix;
interest rate risk sensitivity;
current market opportunities to promote specific products;
historical financial results;
projected financial results; and
capital position.
The Committee also reviews current and projected liquidity needs. As part of its procedures, the Committee regularly
reviews interest rate risk by forecasting the impact that changes in interest rates may have on net interest income and the market
value of portfolio equity, which is defined as the net present value of an institution’s existing assets, liabilities and off-balance
sheet instruments and evaluating such impacts against the maximum potential change in the market value of portfolio equity that
is authorized by the Board of Directors.
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are
established contractually for a period of time. Market interest rates change over time. Our loans generally have longer maturities
than our deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in
73
interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our
ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
We have utilized the following strategies in our efforts to manage interest rate risk:
• we are originating shorter term, higher yielding loans, whenever possible;
• we have attempted, where possible, to extend the maturities of our deposits which typically fund our long-term assets;
• we have invested in securities with relatively short average lives, generally less than eight years;
• we have added adjustable-rate loans to our loan portfolio;
• we have added brokered certificates of deposit with a call option as a funding source; and
• we have utilized an interest rate swap to effectively fix the rate on $50.0 million of FHLB advances.
How We Measure the Risk of Interest Rate Changes. We monitor our interest rate sensitivity on a quarterly basis by
measuring the impact of changes to net interest income in multiple rate environments. Management retains the services of a third
party consultant with over 30 years of experience in asset-liability management to assist in its interest rate risk and asset-liability
management. Management uses various assumptions to evaluate the sensitivity of our operations to changes in interest rates.
Although management believes these assumptions are reasonable, the interest rate sensitivity of our assets and liabilities on net
interest income and the market value of portfolio equity could vary substantially if different assumptions were used or actual
results differ from these assumptions. Although certain assets and liabilities may have similar maturities or periods of repricing,
they may react differently to changes in market interest rates. The interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities lag behind
changes in market interest rates. Non-uniform changes and fluctuations in market interest rates across various maturities will also
affect the results presented. In addition, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes
in interest rates on a short-term basis and over the life of the asset. Further, a portion of our adjustable-rate loans have interest rate
floors below which the loan’s contractual interest rate may not adjust. Approximately 54.5% of our net loans were adjustable-rate
loans at December 31, 2018. At that date, $246.6 million, or 43.6%, of these loans with a weighted-average interest rate of 4.3%
were at their floor interest rate. The inability of our loans to adjust downward can contribute to increased income in periods of
declining interest rates. However, when loans are at their floors, there is a further risk that our interest income may not increase
as rapidly as our cost of funds during periods of increasing interest rates. Further, in the event of a significant change in interest
rates, prepayment and early withdrawal levels would likely deviate from those assumed. Finally, the ability of many borrowers to
service their debt may decrease in the event of an interest rate increase. We consider all these factors in monitoring our interest
rate exposure.
The assumptions we use are based upon a combination of proprietary and market data that reflect historical results and
current market conditions. These assumptions relate to interest rates, prepayments, deposit decay rates and the market value of
certain assets under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans,
investments and borrowings and use our own assumptions on deposit decay rates except for time deposits. Time deposits are
modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposits can be maintained with
rate adjustments not directly proportionate to the change in market interest rates, based upon our historical deposit decay rates,
which are substantially lower than market decay rates. We have observed in the past that our deposit accounts during changing
rate environments have relatively lower volatility and less than market rate changes. When interest rates rise, we do not have to
raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our
analysis of our customer base, competitive factors, and historical experience.
Our income simulation model examines changes in net interest income in scenarios where interest rates were assumed
to remain at their base level, instantaneously increase by 100, 200 and 300 basis points or decline immediately by 100 and 200
basis points. A decline by 300 basis points is not reported as the current targeted federal funds rate is between 2.25% and 2.50%.
The following table illustrates the estimated change in our net interest income over the next 12 months from
December 31, 2018, that would occur in the event of an immediate change in interest rates equally across all maturities, with no
effect given to any steps that we might take to counter the effect of that interest rate movement.
74
Interest Rate Simulation Impact on Net Interest Income
for the year ended December 31, 2018
Basis Point Change in Rates
Net Interest
Income
% Change
(Dollars in thousands)
$
+300
+200
+100
Base
(100)
(200)
37,439
37,474
37,633
37,634
38,094
37,755
(0.52)%
(0.43)
—
—
1.22
0.32
The following table illustrates the change in our net portfolio value (“NPV”) at December 31, 2018 that would occur in
the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that we might
take to counter the effect of that interest rate movement.
Basis Point
Change in Rates (1)
Amount
Net Portfolio Value (2)
$ Change (3)
Net Portfolio as % of Portfolio Value of Assets
% Change
NPV Ratio (4)
% Change (5)
Market Value
of Assets (6)
(Dollars in thousands)
+300
+200
+100
Base
(100)
(200)
$
126,228
$
138,021
152,261
163,714
172,352
171,258
(37,486)
(25,693)
(11,453)
—
8,638
7,544
(22.90)%
(15.69)
(7.00)
—
5.28
4.61
10.96%
(3.02)% $
1,151,247
11.70
12.58
13.21
13.61
13.30
(2.07)
(0.92)
—
0.70
0.61
1,179,196
1,210,290
1,239,635
1,265,929
1,288,059
__________
(1) No rates in the model are allowed to go below zero. Given the relatively low level of market interest rates, a calculation for
a decrease of greater than 200 basis points has not been prepared.
(2) The net portfolio value is the difference between the present value of the discounted cash flows of assets and liabilities and
represents the market value of the Company’s equity for any given interest rate scenario. Net portfolio value is useful for
determining, on a market value basis, how equity changes in response to various interest rate scenarios. Large changes in net
portfolio value reflect increased interest rate sensitivity and generally more volatile earnings streams.
(3) The increase or decrease in the estimated net portfolio value at the indicated interest rates compared to the net portfolio value
assuming no change in interest rates.
(4) Net portfolio value divided by the market value of assets.
(5) The increase or decrease in the net portfolio value divided by the market value of assets.
(6) The market value of assets represents the value of assets under the various interest rate scenarios and reflects the sensitivity
of those assets to interest rate changes.
The net interest income and net portfolio value tables presented above are predicated upon a stable balance sheet with
no growth or change in asset or liability mix. In addition, the net portfolio value is based upon the present value of discounted
cash flows using our estimates of current replacement rates to discount the cash flows. The effects of changes in interest rates in
the net interest income table are based upon a cash flow simulation of our existing assets and liabilities and assuming that delinquency
rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case.
Delinquency rates may change when interest rates change as a result of changes in the loan portfolio mix, underwriting conditions,
loan terms or changes in economic conditions that have a delayed effect on the portfolio. Even if interest rates change in the
designated amounts, there can be no assurance that our assets and liabilities would perform as assumed. Also, a change in U.S.
Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause changes
to the net portfolio value and net interest income other than those indicated above.
Liquidity
We are required to have enough cash flow in order to maintain sufficient liquidity to ensure a safe and sound operation.
We maintain cash flows above the minimum level believed to be adequate to meet the requirements of normal operations, including
75
potential deposit outflows. On a daily basis, we review and update cash flow projections to ensure that adequate liquidity is
maintained.
Our primary sources of funds are customer deposits, scheduled loan and investment repayments, including interest
payments, maturing loans and investment securities, and advances from the FHLB. These funds, together with equity, are used to
fund loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled
amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the
level of interest rates, economic conditions and competition. We believe that our current liquidity position, and our forecasted
operating results are sufficient to fund all of our existing commitments.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally
invested in short-term investments such as overnight deposits or agency or mortgage-backed securities. On a longer term basis,
we maintain a strategy of investing in various lending products as described in greater detail under Item 1. “Business – Lending
Activities.” At December 31, 2018, the undisbursed portion of construction LIP totaled $86.5 million and unused lines of credit
were $39.4 million. In addition, we had commitments to originate loans of $553,000 that includes a $230,000 standby letter of
credit. We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and withdrawals
on other deposit accounts, to fund loan commitments, and to maintain our portfolio of investment securities. Certificates of deposit
scheduled to mature in one year or less at December 31, 2018 totaled $230.4 million. Management’s policy is to maintain deposit
rates at levels that are competitive with other local financial institutions. Based on historical experience, we believe that a significant
portion of maturing certificates of deposit will remain with First Financial Northwest Bank. As further funding sources, we had
the ability at December 31, 2018 to borrow an additional $408.3 million from the FHLB, $91.2 million from the FRB and
$35.0 million from unused lines of credit with other financial institutions to meet commitments and for liquidity purposes. See
the Consolidated Statements of Cash Flows in Item 8 of this report for further details on our cash flow activities.
We measure our liquidity based on our ability to fund our assets and to meet liability obligations when they come due.
Liquidity (and funding) risk occurs when funds cannot be raised at reasonable prices, or in a reasonable time frame, to meet our
normal or unanticipated obligations. We regularly monitor the mix between our assets and our liabilities to manage our liquidity
and funding requirements.
Our primary source of funds is our retail deposits. When retail deposits are not available to provide the funds for our
assets, we use alternative funding sources. These sources include, but are not limited to, advances from the FHLB, wholesale
funding, brokered deposits, federal funds purchased, and dealer repurchase agreements, as well as other short-term alternatives.
We may also liquidate assets to meet our funding needs.
On a monthly basis, we estimate our liquidity sources and needs for the next six months. Also, we determine funding
concentrations and our need for sources of funds other than deposits. This information is used by our Asset/Liability Management
Committee in forecasting funding needs and investing opportunities.
Capital
Our total stockholders’ equity was $153.7 million at December 31, 2018. Consistent with our goal to operate a sound
and profitable financial organization we will actively seek to maintain the Bank as a “well capitalized” institution in accordance
with regulatory standards. As of December 31, 2018, First Financial Northwest Bank exceeded all regulatory capital requirements.
Regulatory capital ratios for First Financial Northwest Bank were as follows as of December 31, 2018: Total capital to risk-
weighted assets was 14.68%; Tier 1 capital and Common equity tier 1 capital to risk-weighted assets was 13.43%; and Tier 1
capital to total assets was 10.37%. At December 31, 2018, First Financial Northwest Bank met the financial ratios to be considered
well-capitalized under the regulatory guidelines. See Item 1. “Business – How We Are Regulated – Regulation and Supervision
of First Financial Northwest Bank – Capital Requirements.”
Commitments and Off-Balance Sheet Arrangements
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing
needs of our customers. These financial instruments include commitments to extend credit and the unused portions of lines of
credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized
in the consolidated statements of financial condition. Commitments to extend credit and lines of credit are not recorded as an asset
or liability by us until the instrument is exercised. At December 31, 2018 and 2017, we had no commitments to originate loans
for sale.
76
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition
established in the loan agreement. Commitments generally have fixed expiration dates or other termination clauses and may require
payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts
do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the customer.
The amount and type of collateral required varies, but may include real estate and income-producing commercial properties.
The following table summarizes our outstanding commitments to advance additional amounts pursuant to outstanding
lines of credit, and to disburse funds related to our construction loans at December 31, 2018.
Amount of Commitment Expiration - Per Period
Total
Amounts
Committed
Through
One Year
After One
Through
Three Years
After Three
Through Five
Years
After
Five Years
(In thousands)
Commitments to originate loans
$
553
$
323
$
— $
230
$
Unused portion of lines of credit
39,401
7,041
Undisbursed portion of construction loans
86,453
45,429
13,850
41,024
2,046
—
—
16,464
—
Total commitments
$
126,407
$
52,793
$
54,874
$
2,276
$
16,464
First Financial Northwest and its subsidiaries from time to time are involved in various claims and legal actions arising
in the ordinary course of business. There are currently no matters that in the opinion of management would have a material adverse
effect on First Financial Northwest’s consolidated financial position, results of operation or liquidity.
We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current
commitments.
The following table presents a summary of significant contractual obligations as of December 31, 2018, maturing as
indicated:
Deposits (1)
Term debt
Other long-term liabilities (2)
Lease commitments
Total contractual obligations
Less Than
One Year
One to
Three Years
Three to
Five Years
More Than
Five Years
Total
(In thousands)
$ 680,400
$
183,687
$
75,002
$
— $ 939,089
91,500
55,000
192
510
276
832
—
309
481
—
858
161
146,500
1,635
1,984
$ 772,602
$
239,795
$
75,792
$
1,019
$1,089,208
___________
(1) Deposit accounts with indeterminate maturities, such as noninterest bearing, interest-bearing demand, savings and money
(2)
market accounts are reflected as obligations due in less than one year.
Includes maximum payments related to employee benefit plans, assuming all future vesting conditions are met. Additional
information about employee benefit plans is provided in Note 12 of the Notes to Consolidated Financial Statements included
in Item 8 of this report.
Impact of Inflation
The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance
with accounting principles generally accepted in the United States of America. These principles generally require the measurement
of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing
power of money over time due to inflation.
Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature.
The primary impact of inflation is reflected in the increased cost of our operations. As a result, interest rates generally have a more
significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move
77
in the same direction or to the same extent as the prices of goods and services. In a period of rapidly rising interest rates, the
liquidity and maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation on earnings, as distinct from levels of interest rates, is in the area of noninterest expense.
Expense items such as employee compensation, employee benefits, and occupancy and equipment costs may be subject to increases
as a result of inflation. An additional effect of inflation is the possible increase in dollar value of the collateral securing loans that
we have made. Our management is unable to determine the extent, if any, to which properties securing loans have appreciated in
dollar value due to inflation.
Recent Accounting Pronouncements
See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of
Operations – Asset and Liability Management and Market Risk” of this Form 10-K is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2018, and 2017
Consolidated Income Statements for the Years Ended December 31, 2018, 2017, and 2016
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017, and 2016
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2018, 2017, and 2016
Consolidated Statements of Cash Flows For the Years Ended December 31, 2018, 2017, and 2016
Notes to Consolidated Financial Statements
Page
79
81
82
83
84
85
87
78
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
First Financial Northwest, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of First Financial Northwest, Inc.
and Subsidiaries (the “Company”) as of December 31, 2018 and 2017, the related consolidated
statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the
three years in the period ended December 31, 2018, and the related notes (collectively referred to as
the “consolidated financial statements”). We also have audited the Company’s internal control over
financial reporting as of December 31, 2018, based on criteria established in Internal Control –
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of the Company as of December 31, 2018 and 2017, and
the consolidated results of its operations and its cash flows for each of the three years in the period
ended December 31, 2018, in conformity with accounting principles generally accepted in the United
States of America. Also in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2018, based on criteria established in
Internal Control – Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for
maintaining effective internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting, included in the accompanying Management
Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to
express an opinion on the Company’s consolidated financial statements and an opinion on the
Company’s internal control over financial reporting based on our audits. We are a public accounting
firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and
are required to be independent with respect to the Company in accordance with the U.S. federal
securities laws and the applicable rules and regulations of the Securities and Exchange Commission
and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement, whether due to error or fraud, and whether
effective internal control over financial reporting was maintained in all material respects.
79
Our audits of the consolidated financial statements included performing procedures to assess the
risks of material misstatement of the consolidated financial statements, whether due to error or fraud,
and performing procedures to respond to those risks. Such procedures included examining, on a test
basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our
audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements.
Our audit of internal control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Everett, Washington
March 13, 2019
We have served as the Company’s auditor since 2009.
80
2
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except share data)
Assets
Cash on hand and in banks
Interest-earning deposits with banks
Investments available-for-sale, at fair value
Loans receivable, net of allowance of $13,347 and $12,882
Federal Home Loan Bank (“FHLB”) stock, at cost
Accrued interest receivable
Deferred tax assets, net
Other real estate owned (“OREO”)
Premises and equipment, net
Bank owned life insurance (“BOLI”), net
Prepaid expenses and other assets
Goodwill
Core deposit intangible
Total assets
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing deposits
Interest-bearing deposits
Total deposits
Advances from the FHLB
Advance payments from borrowers for taxes and insurance
Accrued interest payable
Other liabilities
Total liabilities
Commitments and contingencies (Note 15)
Stockholders’ Equity
Preferred stock, $0.01 par value; authorized 10,000,000 shares, no shares issued or
outstanding
Common stock, $0.01 par value; authorized 90,000,000 shares; issued and outstanding
10,710,656 shares at December 31, 2018, and 10,748,437 shares at December 31, 2017
Additional paid-in capital
Retained earnings, substantially restricted
Accumulated other comprehensive loss, net of tax benefit
Unearned Employee Stock Ownership Plan (“ESOP”) shares
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements.
81
December 31,
2018
2017
$
8,122
$
8,888
142,170
1,022,904
7,310
4,068
1,844
483
21,331
29,841
3,458
889
1,116
9,189
6,942
132,242
988,662
9,882
4,084
1,211
483
20,614
29,027
5,738
889
1,266
$ 1,252,424
$ 1,210,229
$
$
$
$
46,108
892,924
939,032
146,500
2,933
478
9,743
45,434
794,068
839,502
216,000
2,515
326
9,252
$ 1,098,686
$ 1,067,595
—
107
93,773
66,343
(2,253)
(4,232)
153,738
$
$
—
107
94,173
54,642
(928)
(5,360)
142,634
$ 1,252,424
$ 1,210,229
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Income Statements
(Dollars in thousands, except share data)
Interest income
Loans, including fees
Investments available-for-sale
Interest-earning deposits with banks
Dividends on FHLB stock
Total interest income
Interest expense
Deposits
FHLB advances
Total interest expense
Net interest income
(Recapture of provision) provision for loan losses
Net interest income after (recapture of provision) provision for loan losses
Noninterest income
Net (loss) gain on sale of investments
BOLI income
Wealth management revenue
Deposit related fees
Loan related fees
Other
Total noninterest income
Noninterest expense
Salaries and employee benefits
Occupancy and equipment
Professional fees
Data processing
OREO related expenses (reimbursements), net
Regulatory assessments
Insurance and bond premiums
Marketing
Other general and administrative
Total noninterest expense
Income before provision for federal income taxes
Federal income tax provision
Net income
Basic earnings per common share
Diluted earnings per common share
Basic weighted average number of common shares outstanding
Year Ended December 31,
2018
2017
2016
$
51,127
$
43,607
$
4,126
202
458
3,504
237
296
38,218
3,054
235
202
$
55,913
$
47,644
$
41,709
11,218
3,520
7,517
2,505
14,738
$
10,022
$
41,175
(4,000)
45,175
$
37,622
(400)
38,022
$
$
$
(20)
814
611
681
768
24
(567)
623
919
446
776
11
6,101
1,406
7,507
34,202
1,300
32,902
50
844
813
261
671
12
$
2,878
$
2,208
$
2,651
19,302
3,283
1,538
1,392
7
502
443
344
2,650
17,773
2,506
1,809
1,457
(67)
491
399
270
2,171
$
$
$
$
29,461
$
26,809
$
18,592
3,693
14,899
1.44
1.43
10,306,835
$
$
$
13,421
4,942
8,479
0.82
0.81
10,289,049
$
$
$
15,377
1,984
1,979
911
294
420
349
194
1,441
22,949
12,604
3,712
8,892
0.75
0.74
11,868,278
Diluted weighted average number of common shares outstanding
10,424,187
10,437,449
12,028,428
See accompanying notes to consolidated financial statements.
82
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In thousands)
Net income
Other comprehensive (loss) income, net of tax:
Unrealized holding losses on available-for-sale securities
Tax benefit
Reclassification adjustment for net losses (gains) realized in income
Tax (benefit) provision
Gain on cash flow hedge
Tax provision
Year Ended December 31,
2018
2017
2016
(In thousands)
$
14,899
$
8,479
$
8,892
(1,834)
385
20
(4)
137
(29)
(207)
72
567
(198)
192
(67)
(1,669)
584
(50)
18
1,333
(467)
(251)
8,641
Other comprehensive (loss) income, net of tax
Total comprehensive income
$
$
(1,325) $
$
13,574
359
8,838
$
$
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S
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities
$
14,899
$
8,479
$
8,892
Year Ended December 31,
2017
2016
2018
(Recapture of provision) provision for loan losses
OREO market value adjustments
(Gain) loss on sale of OREO property, net
Net amortization of premiums and discounts on investments
Loss (gain) on sale of investments available-for-sale
Depreciation of premises and equipment
Loss on sale of premises and equipment
Deferred federal income taxes
Allocation of ESOP shares
Stock compensation expense
Increase in cash surrender value of BOLI
Changes in operating assets and liabilities:
Prepaid expenses and other assets
Advance payments from borrowers for taxes and insurance
Accrued interest receivable
Accrued interest payable
Other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Proceeds from sales and call of investments
Principal repayments on investments
Purchases of investments
Net increase in loans receivable
Proceeds from sales of OREO properties
Net proceeds from sale or disposal of fixed assets
Purchases of premises and equipment
Redemption (purchase) of FHLB stock
Purchase of BOLI
Net cash received from branch acquisition
Net cash used in investing activities
Cash flows from financing activities:
Net increase in deposits
Advances from the FHLB
Repayments of advances from the FHLB
Proceeds from stock options exercises
Net share settlement of stock awards
Repurchase and retirement of common stock
Dividends paid
Net cash provided by financing activities
(4,000)
—
—
1,022
20
1,630
—
(281)
1,906
650
(814)
2,567
418
16
152
491
(400)
50
(110)
721
567
1,262
65
1,738
1,941
574
(623)
(2,829)
256
(937)
95
1,259
1,300
257
87
908
(50)
1,076
3
1,548
1,605
621
(844)
(105)
465
(179)
96
1,589
$
18,676
$
12,108
$
17,269
17,159
7,078
(37,021)
(30,242)
—
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2,572
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26,437
10,722
(58,796)
(173,219)
1,908
7
(2,824)
(1,851)
(4,251)
71,658
15,852
(44,561)
(131,271)
988
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(1,894)
—
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$ (42,801) $ (112,482) $ (136,282)
99,530
187,500
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1,365
(40)
(3,153)
(3,198)
25,004
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$
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108,500
(64,000)
1,309
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(5,238)
(2,777)
85,153
42,069
525,000
(479,000)
298
(98)
(40,812)
(2,803)
44,654
$
continued
85
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
Year Ended December 31,
2017
2016
2018
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest
Federal income taxes
Assets acquired in acquisition of branches (Note 2)
Liabilities assumed in acquisition of branches (Note 2)
Noncash transactions:
Change in unrealized loss on investments available-for-sale
Change in unrealized gain on cash flow hedge
$
$
$
879
16,131
17,010
$ (15,221) $ (74,359)
105,711
31,352
31,352
16,131
$
$
$
14,586
3,890
—
—
$
9,927
3,350
72,329
74,657
7,411
2,730
—
—
(1,814)
137
360
192
(1,719)
1,333
See accompanying notes to consolidated financial statements.
86
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation
First Financial Northwest, Inc. (“First Financial Northwest”), a Washington corporation, was formed on June 1, 2007 for
the purpose of becoming the holding company for First Financial Northwest Bank (“the Bank”) in connection with the conversion
from a mutual holding company structure to a stock holding company structure completed on October 9, 2007. First Financial
Northwest’s business activities generally are limited to passive investment activities and oversight of its investment in First Financial
Northwest Bank. Accordingly, the information presented in the consolidated financial statements and related data, relates primarily
to First Financial Northwest Bank. First Financial Northwest converted from a savings and loan holding company to a bank holding
company in 2015 and is subject to regulation by the Board of Governors of the Federal Reserve Bank of San Francisco (“FRB”).
First Financial Northwest Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State
Department of Financial Institutions (“DFI”).
First Financial Northwest Bank was organized in 1923 as a Washington state-chartered savings and loan association,
converted to a federal mutual savings and loan association in 1935, and converted to a Washington state-chartered mutual savings
bank in 1992. In 2002, First Financial Northwest Bank reorganized into a two-tier mutual holding company structure, became a
stock savings bank and became the wholly-owned subsidiary of First Financial of Renton, Inc. In connection with the mutual to
stock conversion in 2007, the Bank changed its name to First Savings Bank Northwest. In August 2015, the Bank changed its
name to First Financial Northwest Bank to support the expansion of focus to being more than a traditional “savings” bank. In
February 2016, the Bank changed its charter from a Washington chartered stock savings bank to a Washington chartered commercial
bank.
First Financial Northwest Bank is a community-based commercial bank primarily serving King and Snohomish Counties,
and to a lesser extent, Pierce and Kitsap Counties, Washington. In King County, the headquarters and full-service banking office,
as well as one branch office, are located in Renton. Additional King County branch offices are located in Bellevue, Woodinville
and Bothell, with a fifth scheduled to open in Kent in the first quarter of 2019. In Snohomish County, five additional branch offices
serve Mill Creek, Edmonds, Clearview, Smokey Point, and Lake Stevens. First Financial Northwest Bank’s business consists of
attracting deposits from the public and utilizing these deposits to originate one-to-four family residential, multifamily, commercial
real estate, construction/land, business and consumer loans.
First Financial Diversified Corporation (“FFD”), a wholly-owned subsidiary of First Financial Northwest, continues to
hold a portfolio of one-to-four family, land and consumer loans that are serviced by the Bank. At December 31, 2018, FFD had
net loans receivable of $1.8 million that were all performing.
The accompanying consolidated financial statements include the accounts of First Financial Northwest and its
wholly owned subsidiaries First Financial Northwest Bank and First Financial Diversified Corporation (collectively, “the
Company”). All significant intercompany balances and transactions between First Financial Northwest and its subsidiaries have
been eliminated in consolidation.
Basis of Presentation and Use of Estimates
The accounting and reporting policies of First Financial Northwest and its subsidiaries conform to U.S. generally accepted
accounting principles (“GAAP”). In preparing the consolidated financial statements, management makes estimates and assumptions
based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the
disclosures provided. Actual results could differ from these estimates. Material estimates particularly subject to change include
the allowance for loan and lease losses (“ALLL”), other real estate owned (“OREO”), deferred tax assets and the fair values of
financial instruments.
Subsequent Events
The Company has evaluated events and transactions subsequent to December 31, 2018 for potential recognition or
disclosure and determined there are no such events or transactions requiring recognition or disclosure.
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Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and in banks, interest-bearing
deposits and federal funds sold all with maturities of three months or less.
The Bank is required to maintain an average reserve balance with the FRB or maintain such reserve balance in the form
of cash. At December 31, 2018, and 2017, cash balances were sufficient where no additional reserve was required.
Investments
Investments are classified into one of three categories: (1) held-to-maturity, (2) available-for-sale, or (3) trading. We had
no held-to-maturity or trading securities at December 31, 2018, or 2017. Investments are categorized as held-to-maturity when
we have the positive intent and ability to hold them to maturity.
Investments are classified as available-for-sale if the Company intends to hold the securities for an indefinite period of
time, but not necessarily to maturity. Investments available-for-sale are reported at fair value. Unrealized holding gains and losses
on investments available-for-sale are excluded from earnings and are reported in other comprehensive income (loss), net of
applicable taxes. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Amortization or accretion of purchase premiums and discounts are included in investment income using the level-yield method
over the remaining period to contractual maturity. Dividend or interest income is recognized when it is earned.
The estimated fair value of investments is based on quoted market prices for investments traded in active markets or
dealer quotes. Mortgage-backed investments represent participation interest in pools of first mortgage loans originated and serviced
by the issuers of the investments.
Management makes an assessment to determine whether there have been any events or economic circumstances to indicate
that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. Management considers many
factors including the severity and duration of the impairment, recent events specific to the issuer or industry, and for debt securities,
external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be an other-than-
temporary impairment (“OTTI”) are written down to fair value. For equity securities, the write-down is recorded as a realized loss
in noninterest income in the Consolidated Income Statements. For debt securities, if management intends to sell the security or it
is likely that management will be required to sell the security before recovering its cost basis, the entire impairment loss would
be recognized in earnings as an OTTI. If management does not intend to sell the security and it is not likely that management will
be required to sell the security but management does not expect to recover the entire amortized cost basis of the security, only the
portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured
as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash
flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for
potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows
expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses
related to all other factors are presented as separate categories within OCI.
Loans Receivable
Loans are recorded at their outstanding principal balance adjusted for charge-offs, the ALLL and net deferred fees or
costs. Interest on loans is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs,
are deferred and recognized in interest income using the level-yield method without anticipating prepayments.
The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well secured
and in the process of collection. Consumer and other loans are typically managed in the same manner. In all cases, loans are placed
on nonaccrual or charged-off at an earlier date if collection of principal or interest is doubtful.
All interest accrued but not collected on loans that are placed on nonaccrual is reversed against interest income. Loans
are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments
are reasonably assured. In order to return a nonaccrual loan to accrual status, each loan is evaluated on a case-by-case basis. We
evaluate the borrower’s financial condition to ensure that future loan payments are reasonably assured. We also take into
consideration the borrower’s willingness and ability to make the loan payments and historical repayment performance. We require
the borrower to make the loan payments consistently for a period of at least six months as agreed to under the terms of any modified
loan agreement before we will consider reclassifying the loan to accrual status.
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FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be
unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.
Factors considered by management in determining impairment include payment status, collateral value, market conditions, rent
rolls and the financial strength of the borrower(s) and guarantor(s), if any. Loans that experience insignificant payment delays and
payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrowers, including the length of the delay, the reasons for
the delay, the borrower’s prior payment history and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured by the fair value method on a loan-by-loan basis.
When a loan is identified as impaired, its impairment is measured using the present value of expected future cash flows,
discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation
or liquidation of the collateral. In these cases, the Company uses an observable market price or current fair value of the collateral,
less certain completion costs and closing costs when foreclosure is probable, instead of discounted cash flows. The Company
obtains annual updated appraisals for impaired collateral dependent loans that exceed $1.0 million and loans that have been
transferred to OREO. In addition, the Company may order appraisals on properties not included within these guidelines when
there are extenuating circumstances where the Company is not otherwise able to determine the fair value of the property. Appraised
values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation
and/or management’s expertise and knowledge of the borrower. If management determines that the value of the impaired loan is
less than the recorded investment in the loan, an impairment is recognized through an allowance estimate or a charge-off to the
ALLL.
Troubled Debt Restructurings
Certain loan modifications or restructurings are accounted for as troubled debt restructurings (“TDR”). In general, the
modification or restructuring of a debt is considered a TDR if, for economic or legal reasons related to the borrower’s financial
difficulties, a concession is granted to the borrower that the Company would not otherwise consider. Examples of these modifications
or restructurings include advancement of maturity date, accepting interest only payments for a period of time, or granting an
interest rate concession for a period of time. The impaired portion of the loan with an interest rate concession and/or interest-only
payments for a specific period of time are calculated based on the present value of expected future cash flows discounted at the
loan’s effective interest rate. The effective interest rate is the rate of return implicit on the original loan. This impaired amount
reduces the ALLL and a valuation allowance is established to reduce the loan balance. As loan payments are received in future
periods, the ALLL entry is reversed and the valuation allowance is reduced utilizing the level yield method over the modification
period. A loan that is determined to be classified as a TDR is generally reported as a TDR until the loan is paid in full or otherwise
settled, sold, or charged-off.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses (“ALLL”) is a valuation allowance for probable incurred credit losses. Losses
are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Any subsequent
recoveries are credited to the allowance.
The ALLL is evaluated on a regular basis by management and is based upon management’s periodic review of the
collectability of the loans and factors such as the nature and volume of the loan portfolio, historical loss considerations, adverse
situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic
conditions. The evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more
information becomes available.
While management uses available information to recognize losses on loans, future additions to the allowance may be
necessary based on changes in economic conditions or changes to the credit quality of the loan portfolio. In addition, various
regulatory agencies, as an integral part of their examination process, periodically review the Company’s ALLL. Such agencies
may require management to make adjustments to the allowance based on their judgments about information available to them at
the time of their examination.
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Premises and Equipment
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives used to compute
depreciation and amortization is 15 to 40 years for buildings and building improvements, and is three to seven years for furniture,
fixtures, and equipment. Leasehold improvements are amortized over the life of the lease. Management reviews buildings,
improvements and equipment for impairment on an annual basis or whenever events or changes in the circumstances indicate that
the undiscounted cash flows for the property are less than its carrying value. If identified, an impairment loss is recognized through
a charge to earnings based on the fair value of the property.
Federal Home Loan Bank Stock
As a member of the Federal Home Loan Bank System, the Bank is required to maintain a minimum level of investment
in the Federal Home Loan Bank of Des Moines (“FHLB”) stock, based on specified percentages of total assets and the Bank’s
outstanding FHLB advances. Ownership of FHLB stock is restricted to the FHLB and member institutions. The Bank’s investment
in FHLB stock is carried at par value ($100 per share), which reasonably approximates its fair value.
Transfer of Financial Assets
Transfers of an entire financial asset, a group of entire financial assets, or participating interest in an entire financial asset
are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that
constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain
effective control over the transferred assets through an agreement to repurchase them before their maturity.
Other Real Estate Owned
OREO consists principally of properties acquired through foreclosure and is stated at the lower of cost or estimated market
value less selling costs. Losses arising from the acquisition of property, in full or partial satisfaction of loans, are charged to the
ALLL.
Subsequent to the transfer of foreclosed assets held for sale, the assets continue to be recorded at the lower of cost or fair
value (less estimated costs to sell), based on periodic evaluations. Subsequent write-downs in value are charged to noninterest
expense. Generally, legal and professional fees associated with foreclosures are expensed as incurred. Costs incurred to improve
property prior to sale are capitalized; however, in no event are recorded costs allowed to exceed estimated fair value. Subsequent
gains, losses, or expenses recognized on the sale of these properties are included in noninterest expense. The amounts that will
ultimately be recovered from foreclosed assets may differ substantially from the carrying value of the assets because of future
market factors beyond management’s control.
Bank-Owned Life Insurance
The Company has purchased life insurance on certain key executives and officers. Bank-owned life insurance (“BOLI”)
is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender
value adjusted for other charges or other amounts due that are probable at settlement. Increases to the cash surrender value are
recorded as noninterest income and partially offset expenses for employee benefits. Certain BOLI contracts contain endorsement
split-dollar life agreements. In these circumstances, the Bank accrues a reserve liability and related compensation expense for the
expected future benefit payout.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as unused lines of credit and commercial letters
of credit issued to meet customer financing needs. The face amount of these items represents the exposure to loss before considering
customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Reserve for Unfunded Commitments
Management maintains a reserve for unfunded commitments to absorb probable losses associated with our off-balance
sheet commitments to lend funds such as unused lines of credit and the undisbursed portion of construction loans. Management
determines the adequacy of the reserve based on reviews of individual exposures, current economic conditions, and other relevant
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FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
factors. The reserve is based on estimates and ultimate losses may vary from the current estimates. The reserve is evaluated on a
regular basis and necessary adjustments are reported in earnings during the period in which they become known. The reserve for
unfunded commitments is included in the other liabilities section of the consolidated balance sheets.
Stock-Based Compensation
Compensation cost is recognized for stock options and restricted stock awards, based on the fair value of these awards
at the grant date. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the
Company’s common stock at the grant date is used for restricted stock awards. Compensation cost is recognized over the required
service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a
straight-line basis over the requisite service period for the entire award.
Federal Income Taxes
The Company files a consolidated Federal income tax return and records its provision for income taxes under the asset
and liability method. Deferred taxes result from temporary differences in the recognition of certain income and expense amounts
between the Company’s financial statements and its tax return. The principal items giving rise to these differences include net
operating losses, valuation adjustments on foreclosed properties, and allowance for credit losses. Deferred tax assets and liabilities
are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected
to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes. Valuation allowances are established to reduce the net carrying amount of deferred tax assets if it is
determined to be more likely than not that all or some portion of the potential deferred tax asset will not be realized. The Company’s
policy is to recognize interest and penalties associated with income tax matters in income tax expense.
Employee Stock Ownership Plan
The cost of shares issued to the Employee Stock Ownership Plan (“ESOP”), but not yet allocated to participants, is shown
as a reduction of stockholders’ equity. Compensation expense is based on the market price of shares as they are committed to be
released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP
shares reduce debt and accrued interest.
Earnings Per Share
Nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are
participating securities and are included in the computation of earnings per share (“EPS”) pursuant to the two-class method. The
two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security
according to dividends declared or accumulated and participation rights in undistributed earnings. Certain shares of the Company’s
nonvested restricted stock awards qualify as participating securities.
Net income is allocated between the common stock and participating securities pursuant to the two-class method, based
on their rights to receive dividends, participate in earnings or absorb losses. Basic earnings per common share is computed by
dividing net earnings available to common shareholders by the weighted average number of common shares outstanding during
the period, excluding participating nonvested restricted shares. As ESOP shares are committed to be released, they are included
in the outstanding shares used in the basic EPS calculation.
Diluted earnings per share is computed in a similar manner, except that first the denominator is increased to include the
number of additional shares that would have been outstanding if potentially dilutive shares, excluding the participating securities,
were issued using the treasury stock method. For all periods presented, stock options and certain restricted stock awards are
potentially dilutive non-participating instruments issued by the Company.
Undistributed losses are not allocated to the nonvested share-based payment awards (the participating securities) under
the two-class method as the holders are not contractually obligated to share in the losses of the Company.
Comprehensive Income
Comprehensive income consists of net income and unrealized gains and losses on investments available-for-sale and
derivatives, which are also recognized as separate components of equity, net of tax.
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FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Advertising Expenses
Advertising costs are generally expensed as incurred.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully
disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates,
credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions
or in market conditions could significantly affect the estimates.
Segment Information
The Company’s activities are considered to be a single industry segment for financial reporting purposes. The Company
is engaged in the business of attracting deposits from the general public and providing lending services. Substantially all income
is derived from a diverse base of investments and commercial, construction, mortgage, and consumer lending activities.
Reclassification
Certain amounts in the consolidated financial statements for prior years have been reclassified to conform to the current
consolidated financial statement presentation. The results of the reclassifications are not considered material and have no effect
on previously reported net income or stockholders’ equity.
Derivatives
The Company designates certain interest rate swap agreements as a cash flow hedge, and as such, reports the fair value
as an asset or liability. The hedge is utilized to mitigate the risk of variability in future interest payments. The fair value of the
cash flow hedge is based on dealer quotes, pricing models, discounted cash flow methodologies or similar techniques for which
the determination of fair value may require significant management judgment or estimation. The derivative is marked to its fair
value, with the change in fair value recorded as other comprehensive income or loss. The gain or loss on the derivative is reclassified
into earnings in the same income statement line item that is used to present the earnings effect of the hedged item.
Goodwill
Goodwill is recorded from a business combination as the difference in purchase price and fair value of the assets acquired
and liabilities assumed. Goodwill has an indefinite useful life, and as such, is not amortized. The Company performs a goodwill
impairment analysis on an annual basis as of December 31. Additionally, the Company performs an impairment analysis as needed
when circumstances indicate impairment potentially exists. Any impairment will be recorded as a noninterest expense and
corresponding reduction in intangible asset on the consolidated financial statements.
Core Deposit Intangible
A core deposit intangible (“CDI”) asset is recognized from the assumption of core deposit liabilities in connection with
the acquisition of four branches from Opus Bank, a California state-chartered commercial bank (the “Branch Acquisition”). The
asset was valued by a third party and is amortized into noninterest expense over ten years. The CDI is evaluated for impairment
annually with any additional decline recorded as a noninterest expense on the Consolidated Income Statement.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU")
No. 2014-09, Revenue from Contracts with Customers (Topic 606). In August 2015, FASB issued ASU No. 2015-14, Revenue
from Contracts with Customers (Topic 606) which postponed the effective date of 2014-09. Subsequently, in March 2016, the
FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations. This
amendment clarifies that an entity should determine if it is the principal or the agent for each specified good or service promised
in a contract with a customer. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic
606): Identifying Performance Obligations and Licensing. The core principle of Topic 606 is that an entity must recognize revenue
when it has satisfied a performance obligation of transferring promised goods or services to a customer. These standards were
effective for interim and annual periods beginning after December 15, 2017. The Company has analyzed its sources of noninterest
income to determine when the satisfaction of the performance obligation occurs and the appropriate recognition of revenue. The
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FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
adoption of these ASUs did not have a material impact on the Company’s consolidated financial statements. For more discussion
on this topic, see Note 19 - Revenue Recognition in this report.
In January 2016, FASB issued ASU No. 2016-01, Financial Instruments - Overall, Recognition and Measurement of
Financial Assets and Financial Liabilities. ASU 2016-01 requires equity investments (except those accounted for under the equity
method of accounting) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendments
in this ASU require an entity to disclose the fair value of its financial instruments using the exit price notion. Exit price is the price
that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date. The amendments in this ASU were effective for fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. The Company has updated the fair value disclosure in Note 7 in this report to reflect
adoption of this standard, to include using the exit price notion in the fair value disclosure of financial instruments. Prior period
information has not been updated to conform with the new guidance. The adoption of ASU 2016-01 did not have a material impact
on the Company’s consolidated financial statements.
In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires lessees to recognize
on the balance sheet the assets and liabilities arising from operating leases. In July 2018, FASB issued ASU No. 2018-11, Leases
(Topic 842) to address the comparative reporting requirements when this ASU is adopted. Under this ASU, a lessee should recognize
a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. A
lessee should include payments to be made in an optional period only if the lessee is reasonably certain to exercise an option to
extend the lease or not to exercise an option to terminate the lease. For a finance lease, interest payments should be recognized
separately from amortization of the right-of-use asset in the statement of comprehensive income. For operating leases, the lease
cost should be allocated over the lease term on a generally straight-line basis. The amendments in ASU 2016-02 are effective for
fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. According to ASU 2018-11,
the Company may recognize the cumulative-effect adjustment to the opening balance of retained earnings at the time ASU 2016-02
is adopted. Early application of the amendments in the ASU is permitted. The Company is adopting this ASU in January 2019. At
adoption, the $86,000 balance of the deferred lease liability at December 31, 2018 will be moved to retained earnings. In addition,
a right of use asset and a lease liability of $1.8 million will be recognized as the present value of remaining lease payments at
December 31, 2018, and represents less than 1% of the Company’s assets at that date.
In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326). This ASU replaces the
existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new
methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial
asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would
then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses
that have taken place during the reporting period. The measurement of expected credit losses will be based on historical information,
current conditions, and reasonable and supportable forecasts that impact the collectability of the reported amount. Available-for-
sale securities will bifurcate the fair value mark and establish an allowance for credit losses through the income statement for the
credit portion of that mark. The interest portion will continue to be recognized through accumulated other comprehensive income
or loss. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained
earnings as of the beginning of the first reporting period in which the ASU is adopted. The amendments in this ASU are effective
for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted
for fiscal years beginning after December 15, 2018. The Company is evaluating its current expected loss methodology on the loan
and investment portfolios to identify the necessary modifications in accordance with this standard and expects a change in the
processes and procedures to calculate the ALLL, including changes in assumptions and estimates to consider expected credit losses
over the life of the loan versus the current accounting practice that utilizes the incurred loss model. A valuation adjustment to the
ALLL or investment portfolio that is identified in this process will be reflected as a one-time adjustment in equity rather than
earnings. The Company is in the process of compiling historical data that will be used to calculate expected credit losses on the
loan portfolio to ensure that it is fully compliant with the ASU at the adoption date and is evaluating the potential impact adoption
of this ASU will have on its consolidated financial statements. The Company intends to adopt ASU 2016-13 in the first quarter of
2020, and as a result, expects the allowance for loan losses to increase. Until the evaluation is complete, however, the magnitude
of the increase will not be known.
In January 2017, FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350). This ASU simplifies
the impairment calculation for subsequent measurement of goodwill by eliminating the step of comparing the implied fair value
of a reporting unit’s goodwill with the carrying amount of that goodwill. Under the amendments in this ASU, an entity will evaluate
the carrying amount of a reporting unit to its fair value, as if the reporting unit had been acquired in a business combination. An
impairment charge should be recognized for the amount that the carrying amount exceeds the fair value, not to exceed the amount
of goodwill. The income tax effect should be considered for any tax deductible goodwill when measuring the impairment loss.
The amendments in this ASU are effective for goodwill impairment tests in fiscal years beginning after December 15, 2019. Early
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FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
adoption is permitted for reporting periods after January 1, 2017. The Company recognized goodwill from its acquisition on
August 25, 2017 of four branches from Opus Bank, a California state-chartered commercial bank (the “Branch Acquisition”) and
adopted this ASU for the annual goodwill impairment test as of December 31, 2018. Adoption of ASU 2017-04 did not have a
material impact on the Company’s consolidated financial statements
In March 2017, FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20):
Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt
securities held at a premium. The ASU will take effect for SEC filers for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2018. The Company is currently evaluating its available-for-sale securities that fit the criteria of
this ASU but has not yet quantified the impact. The adoption of ASU No. 2017-08 is not expected to have a material impact on
the Company's consolidated financial statements.
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 its hedging strategies in its 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. The Company adopted this ASU during 2018 with no impact to its
current cash flow hedge, and consequently adoption did not have a material impact on the Company’s consolidated financial
statements.
In February 2018, FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220). This
ASU was issued to allow a reclassification from accumulated other comprehensive income to retained earnings from stranded tax
effects resulting from the revaluation of the net deferred tax asset (“DTA”) to the new corporate tax rate of 21% as a result of the
Tax Act. The ASU is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. The
Company adopted this ASU as of December 31, 2017, which resulted in reclassifying a net unrealized gain from the change in
tax rate with an increase to accumulated other comprehensive income and a decrease to retained earnings by $41,000, respectively.
In March 2018, FASB issued ASU No. 2018-05, Income Taxes (Topic 740). This ASU was issued to provide guidance
on the income tax accounting implications of the Tax Act and allows for entities to report provisional amounts for specific income
tax effects of the Act for which the accounting under Topic 740 was not yet complete but a reasonable estimate could be determined.
A measurement period of one-year is allowed to complete the accounting effects under Topic 740 and revise any previous estimates
reported. Any provisional amounts or subsequent adjustments included in an entity’s financial statements during the measurement
period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts
are determined. The Company adopted this ASU with the provisional adjustments as reported in the Consolidated Financial
Statements included in the Form 10-K that it filed for the year ended December 31, 2017. As of December 31, 2018, the Company
did not incur any adjustments to the provisional recognition.
In June 2018, FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718). This ASU was issued
to expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees.
Previously, these awards were recorded at the fair value of consideration received or the fair value of the equity instruments issued
and was measured as the earlier of the commitment date or date performance was completed. The amendments in this ASU require
the awards to be measured at the grant-date fair value of the equity instrument. This ASU is effective for fiscal years beginning
after December 15, 2018, and early adoption is permitted once the entity has adopted Topic 606. The Company has adopted this
ASU with the nonemployee share-based payment awards granted in June 2018, with no material impact on the Company’s
consolidated financial statements.
In August 2018, FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework - Changes
to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove certain disclosure requirements
regarding transfers between Level 1 and Level 2 of the fair value hierarchy and changes in unrealized gains and losses for recurring
Level 3 fair value measurements. In addition, the amendments modified and added certain disclosure requirements for Level 3
fair value measurements. This ASU is effective for fiscal years beginning after December 15, 2019, and early adoption is permitted.
Entities are permitted to early adopt any removed or modified disclosures and adopt the additional disclosures at the effective
date. Adoption of ASU 2018-13 is not expected to have a material impact on the Company’s consolidated financial statements.
In October 2018, 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.
Previously, FASB had defined four permissible U.S. benchmark rates for purposes of applying hedge accounting. This ASU was
94
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
issued in response to concerns about the sustainability of one of the approved benchmark rates, the London Interbank Offered
Rate (LIBOR), to allow the use of a preferred alternative reference rate referred to as the Secured Overnight Financing Rate
(SOFR). The Federal Reserve began publishing the daily SOFR on April 3, 2018. It is a volume-weighted median interest rate
that is calculated daily based on overnight transactions from the prior day’s trading activity in specified segments of the U.S.
Treasury repo market. The Overnight Index Swap (OIS) Rate based on SOFR will be a swap rate based on the underlying overnight
SOFR rate. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, or concurrent with
adoption of ASU 2017-12, whichever is sooner. The Company adopted both ASU 2017-12 and this ASU during 2018 with no
impact to its current cash flow hedge, and consequently adoption did not have a material impact on the Company’s consolidated
financial statements.
Note 2 - Acquisition
On August 25, 2017, First Financial Northwest Bank completed the Branch Acquisition, which included four retail
branches located in Woodinville, Clearview, Lake Stevens, and Smokey Point, Washington. The Bank acquired $74.7 million of
retail deposits, prior to the fair value adjustment, one owned bank branch, three leased branches, and certain fixed assets at these
branches. The purchase price of the Branch Acquisition paid by the Bank included a deposit premium of 3.125% of the average
daily balance of acquired deposits for 20 days prior to the closing date, or $2.5 million; 80% of the fair market value of the owned
branch building and land, or $488,000; the net book value of fixed assets, or $56,000; and $14,000 for other pro rations and
adjustments as of the closing date. In connection with the transaction, Opus Bank paid the Bank $71.6 million in cash for the
difference between these amounts and the total deposits assumed.
The Branch Acquisition was accounted for under the acquisition method of accounting, and accordingly, the assets received
and liabilities assumed were recorded at their fair market value as of August 25, 2017. Determining the fair value of assets and
liabilities is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated
fair values. Fair values are preliminary and subject to adjustment for up to one year after the closing date of the acquisition as
additional information regarding the fair values as of the acquisition date become available. The excess cost over fair value of net
assets acquired is recorded as goodwill.
The application of the acquisition method of accounting resulted in recognition of a CDI of $1.3 million and goodwill
of $889,000. The acquired CDI has been determined to have a useful life of approximately ten years and will be amortized on an
accelerated basis. Goodwill is not amortized but will be evaluated for impairment on an annual basis, or more often if circumstances
dictate, to determine if the carrying value remains appropriate.
For the years ended December 31, 2018, and 2017, the Company included on the Consolidated Income Statement $110,000
and $41,000 in revenue from the acquired branches, consisting of loan interest income and deposit related fees, and $1.5 million
and $545,000 in noninterest expense from the acquired branches.
95
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the estimated fair values of the assets received and liabilities assumed as of the acquisition
date:
At August 25, 2017
Acquired Book Value
Fair Value Adjustments
Amount Recorded
(In thousands)
Assets
Cash and cash equivalents
Premises and equipment, net
Goodwill
Core deposit intangible
Total assets acquired
Liabilities
Deposits
Noninterest-bearing deposits
Interest-bearing deposits
Total deposits
Total liabilities assumed
$
$
$
$
71,649
$
553
—
—
72,202
$
11,995
$
62,662
74,657
74,657
$
— $
119
889
1,319
2,327
$
— $
(128)
(128)
(128) $
71,649
672
889
1,319
74,529
11,995
62,534
74,529
74,529
Fair value estimates for the acquisition are set forth as follows:
(1) Premises and equipment: The fair value adjustment to fixed assets was the result of the markup of the building and
land to the appraised value and the immediate disposal of certain fixed assets that were included with the purchase price.
(2) Goodwill: The difference of the fair value of liabilities assumed and the fair value of assets acquired was recognized
as goodwill and was calculated as of August 25, 2017 as follows:
Purchase price
Recognized amounts of identifiable assets acquired and (liabilities assumed), at fair value
Cash and cash equivalents
Premises and equipment, net
Core deposit intangible
Deposits
Total fair value of identifiable net assets
Goodwill
At August 25, 2017
(In thousands)
$
3,008
74,657
672
1,319
(74,529)
2,119
889
(3) Core deposit intangible: The CDI represents the fair value of the acquired core deposits. The CDI will be amortized
over ten years into noninterest expense, with amortization expense of $150,000 recognized for the year ended
December 31, 2018 and $53,000 for the year ended December 31, 2017. Amortization expense of the CDI is expected
as of the acquisition date as follows:
96
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2018
(In thousands)
CDI Balance
$
Future amortization:
2019
2020
2021
2022
2023
Thereafter
Total future amortization
$
1,116
148
144
140
135
130
419
1,116
(4) Certificates of deposit: The fair value of acquired certificates of deposit was determined by a third-party valuation and
will be amortized into interest expense over 2.0 to 5.0 years, with amortization of $49,000 and $21,000 recognized for
the years ended December 31, 2018, and 2017, respectively. Amortization of the fair value adjustment is expected as
follows:
At December 31, 2018
(In thousands)
Certificates of deposit fair value
adjustment balance
$
Future amortization:
2019
2020
2021
2022
Total future amortization
$
58
30
16
9
3
58
The operating results of the Company include the operating results produced by the acquired liabilities and additional
branch locations. For illustrative purposes, the following table provides certain unaudited pro forma information for the years
ended December 31, 2018, and 2017, as if the four Opus branches had been acquired on January 1, 2017, the beginning of the
year prior to the date of acquisition. The pro forma information is an estimate of the additional interest expense, noninterest income,
and noninterest expense that might have been incurred during this period. The unaudited pro forma statement does not include
interest income earned on the investment of the acquired funds into either loans receivable or available-for-sale securities. Actual
results would have differed from the unaudited pro form information presented.
Unaudited Pro Forma
Year ended
December 31, 2018
Year ended
December 31, 2017
(In thousands except share data)
Total revenues (net interest income plus noninterest income)
$
44,053
$
39,255
Net income
Earnings per share - basic
Earnings per share - diluted
14,899
1.44
1.43
7,150
0.69
0.68
97
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 3 - Investments
The following tables summarize the amortized cost and fair value of investments available-for-sale at
December 31, 2018, and 2017, and the corresponding amounts of gross unrealized gains and losses.
Mortgage-backed investments:
Fannie Mae
Freddie Mac
Ginnie Mae
Other
Municipal bonds
U.S. Government agencies
Corporate bonds
Mortgage-backed investments:
Fannie Mae
Freddie Mac
Ginnie Mae
Municipal bonds
U.S. Government agencies
Corporate bonds
Amortized
Cost
December 31, 2018
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair Value
$
24,276
$
6,351
23,311
8,983
10,615
48,190
$
24
10
—
17
49
73
23,490
145,216
$
$
399
572
$
(657) $
(74)
(1,250)
(21)
(120)
(825)
(671)
(3,618) $
23,643
6,287
22,061
8,979
10,544
47,438
23,218
142,170
Amortized
Cost
December 31, 2017
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(In thousands)
Fair Value
$
26,961
$
5,510
22,288
13,126
43,088
22,502
$
133,475
$
69
18
14
290
81
527
999
$
$
(466) $
(56)
(726)
(21)
(536)
(427)
(2,232) $
26,564
5,472
21,576
13,395
42,633
22,602
132,242
There were no investments classified as held-to-maturity at December 31, 2018, or 2017.
The amortized cost and estimated fair value of investments available-for-sale at December 31, 2018, by expected maturity,
are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily
mortgage backed investments are shown separately.
Due within one year
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed investments
98
December 31, 2018
Amortized
Cost
Fair Value
(In thousands)
$
253
$
7,356
20,248
54,438
82,295
62,921
145,216
$
$
251
7,527
19,787
53,635
81,200
60,970
142,170
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under Washington State law, in order to participate in the public funds program the Company is required to pledge eligible
securities as collateral in an amount equal to 50% of the public deposits held. Investments with a carrying value of $15.6 million
and $14.2 million were pledged as collateral for public deposits at December 31, 2018, and 2017, respectively, both of which
exceeded the minimum collateral requirements established by the Washington Public Deposit Protection Commission. At
December 31, 2018, and 2017, there were no investments pledged as collateral for FHLB advances.
Sales and other redemptions of available-for-sale investments were as follows:
Proceeds
Gross gains
Gross losses
Year Ended December 31,
2018
2017
2016
(In thousands)
$
17,159
$
44,164
$
26,437
9
(29)
119
(686)
245
(195)
The following tables summarize the aggregate fair value and gross unrealized loss by length of time those investments
have been continuously in an unrealized loss position at December 31, 2018 and 2017.
Mortgage-backed investments:
Fannie Mae
Freddie Mac
Ginnie Mae
Other
Municipal bonds
U.S. Government agencies
Corporate bonds
Mortgage-backed investments:
Fannie Mae
Freddie Mac
Ginnie Mae
Municipal bonds
U.S. Government agencies
Corporate bonds
Less Than 12 Months
Fair Value
Unrealized
Loss
December 31, 2018
12 Months or Longer
Total
Fair Value
Unrealized
Loss
Fair Value
Unrealized
Loss
(In thousands)
$
$
5,480
1,994
2,867
6,008
4,161
5,985
—
26,495
$
$
(32) $
(23)
(8)
(21)
(46)
(13)
—
(143) $
16,721
3,185
19,194
—
934
30,779
6,828
77,641
$
$
(625) $
(51)
(1,242)
—
(74)
(812)
(671)
(3,475) $
22,201
5,179
22,061
6,008
5,095
36,764
6,828
104,136
$
$
(657)
(74)
(1,250)
(21)
(120)
(825)
(671)
(3,618)
Less Than 12 Months
December 31, 2017
12 Months or Longer
Total
Fair Value
Unrealized
Loss
Fair Value
Unrealized
Loss
Fair Value
Unrealized
Loss
(In thousands)
$
15,202
$
3,189
6,454
1,403
33,268
1,499
$
61,015
$
(91) $
(56)
(61)
(21)
(435)
(1)
(665) $
6,759
$
—
14,234
—
1,800
7,074
29,867
$
(375) $
—
(665)
—
(101)
(426)
(1,567) $
21,961
$
3,189
20,688
1,403
35,068
8,573
90,882
$
(466)
(56)
(726)
(21)
(536)
(427)
(2,232)
At December 31, 2018, and 2017, the Company had 51 and 36 securities, respectively, with a gross unrealized loss
position. Management reviewed the financial condition of the entities underlying the securities at both December 31, 2018, and
December 31, 2017, and determined that no OTTI was required. Management believes that, while actual fluctuation in unrealized
losses will occur over the life of an investment security, the temporary impairment on the investment securities that were in an
99
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
unrealized loss position at December 31, 2018 and 2017, will be incrementally relieved as the individual investment securities
approach their respective contractual maturity dates. The unrealized losses relate principally to the general change in interest rate
and illiquidity, and not credit quality. As management does not intend to sell the security, and it is likely that it will not be required
to sell the security before its anticipated recovery, no declines are deemed to be other-than-temporary.
Note 4 - Loans Receivable
Loans receivable at December 31, 2018, and 2017 are summarized as follows:
One-to-four family residential:
Permanent owner occupied
Permanent non-owner occupied
Multifamily:
Permanent
Commercial real estate:
Permanent
Construction/land: (1)
One-to-four family residential
Multifamily
Commercial
Land
Business
Consumer
Total loans
Less:
Loans in process (“LIP”)
Deferred loan fees, net
Allowance for loan and lease losses ("ALLL")
Loans receivable, net
December 31,
2018
2017
(In thousands)
$
194,141
$
147,825
341,966
169,355
169,355
373,819
373,819
86,604
83,642
18,300
6,740
195,286
30,486
12,970
1,123,882
86,453
1,178
13,347
$
1,022,904
$
148,304
130,351
278,655
184,902
184,902
361,842
361,842
87,404
108,439
5,325
36,405
237,573
23,087
9,133
1,095,192
92,498
1,150
12,882
988,662
____________
(1) Included in the construction/land category are “rollover” loans, which are loans that will convert upon completion of the
construction period to permanent loans. At that time, the loans will be classified according to the underlying collateral. In addition,
raw land or buildable lots, where the Company does not intend to finance the construction are included in the construction/land
category. At December 31, 2018, we classified $66.6 million of multifamily loans, $6.2 million of commercial land loans,
$1.7 million of one-to-four family residential and $18.3 million of commercial real estate loans as construction/land loans to
facilitate the review of the composition of our loan portfolio. At December 31, 2017, $71.4 million of multifamily loans,
$35.9 million of commercial land loans, $2.6 million one-to-four family residential and $5.3 million of commercial real estate
loans were reclassified to the construction/land category.
At December 31, 2018, and 2017, there were no loans classified as held for sale.
Concentrations of credit. Most of the Bank’s lending activity occurs within the state of Washington. The primary market
areas include King and to a lesser extent Pierce, Snohomish and Kitsap counties. At December 31, 2018, the Company’s loan
portfolio consists of one-to-four family residential loans which comprised 30.5%, commercial real estate and multifamily loans
100
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
were 33.3% and 15.1%, respectively, and construction/land loans were 17.4% of the total loan portfolio. Consumer and business
loans accounted for the remaining 3.7% of the loan portfolio. Included in the one-to-four family residential, multifamily, commercial
real estate, construction/land, and business loan portfolios at December 31, 2018 were $872,000, $13.7 million, $43.0 million,
$12.5 million and $9.8 million, respectively, to the Company’s five largest borrowing relationships.
The Company originates both adjustable and fixed interest rate loans. The composition of loans receivable at
December 31, 2018, and 2017, was as follows:
Fixed Rate
Adjustable Rate
December 31, 2018
Term to Maturity
Principal
Balance
(In thousands)
Term to Rate Adjustment
Principal
Balance
Due within one year
$
44,645 Due within one year
$
After one year through three years
After three years through five years
After five years through ten years
Thereafter
54,183 After one year through three years
77,883 After three years through five years
132,074 After five years through ten years
192,061 Thereafter
$
500,846
December 31, 2017
305,929
98,652
106,006
112,449
—
$
623,036
Fixed Rate
Adjustable Rate
Term to Maturity
Principal
Balance
(In thousands)
Term to Rate Adjustment
Principal
Balance
Due within one year
$
37,472 Due within one year
$
After one year through three years
After three years through five years
After five years through ten years
Thereafter
102,630 After one year through three years
80,811 After three years through five years
132,086 After five years through ten years
175,211 Thereafter
$
528,210
292,398
51,520
127,973
95,091
—
$
566,982
Our adjustable-rate loans are tied to various indexes, including LIBOR, the prime rate as published in The Wall Street
Journal, and the FHLB. Certain adjustable rate loans have interest rate adjustment limitations and are generally indexed to the
FHLB Long-Term Bullet advance rates published by the FHLB. Future market factors may affect the correlation of the interest
rate adjustment with the rates paid on short term deposits that have been primarily utilized to fund these loans.
Credit Quality Indicators. The Company assigns a risk rating to all credit exposures based on the risk rating system
designed to define the basic characteristics and identified risk elements of each credit extension. The Company utilizes a nine point
risk rating system. A description of the general characteristics of the risk grades is as follows:
• Grades 1 through 5: These grades are considered to be “pass” credits. These include assets where there is virtually no
credit risk, such as cash secured loans with funds on deposit with the Bank. Pass credits also include credits that are on
the Company’s watch list, where the borrower exhibits potential weaknesses, which may, if not checked or corrected,
negatively affect the borrower’s financial capacity and threaten their ability to fulfill debt obligations in the future.
• Grade 6: These credits, classified as ”special mention”, possess weaknesses that deserve management’s close attention.
Special mention assets do not expose the Company to sufficient risk to warrant adverse classification in the substandard,
doubtful or loss categories. If left uncorrected, these potential weaknesses may result in deterioration in the Company’s
credit position at a future date.
• Grade 7: These credits, classified as “substandard”, present a distinct possibility that the Company will sustain some loss
if the deficiencies are not corrected. These credits have well defined weaknesses which jeopardize the orderly liquidation
of the debt and are inadequately protected by the current net worth and payment capacity of the borrower or of any
collateral pledged.
101
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
• Grade 8: These credits are classified as “doubtful” have well defined weaknesses which make the full collection or
liquidation of the loan highly questionable and improbable. This classification is used where significant risk exposures
are perceived but the exact amount of the loss cannot yet be determined due to pending events.
• Grade 9: Assets classified as “loss” are considered uncollectible and cannot be justified as a viable asset for the Company.
There is little or no prospect of near term recovery and no realistic strengthening action of significance is pending.
As of December 31, 2018, and 2017, the Company had no loans rated as doubtful or loss. The following tables represent
a summary of loans at December 31, 2018, and 2017 by type and risk category:
One-to-
Four
Family
Residential Multifamily
December 31, 2018
Commercial
Real Estate
Construction/
Land
(In thousands)
Business
Consumer
Total (1)
Risk Rating:
Pass
Special mention
$
$
339,310
1,737
$
169,355
—
$
372,690
782
$
108,854
—
919
—
326
—
30,486
—
—
$
12,926
—
$1,033,621
2,519
44
1,289
$
341,966
$
169,355
$
373,798
$
108,854
$
30,486
$
12,970
$1,037,429
Substandard
Total
_____________
(1) Net of LIP.
One-to-
Four
Family
Residential Multifamily
December 31, 2017
Commercial
Real Estate
Construction /
Land
(In thousands)
Business
Consumer
Total (1)
Risk Rating:
Pass
Special mention
Substandard
$
275,653
$
184,902
$
358,285
$
145,618
$
23,087
$
8,893
$ 996,438
2,329
673
—
—
2,459
555
—
—
—
—
188
52
4,976
1,280
Total
$
278,655
$
184,902
$
361,299
$
145,618
$
23,087
$
9,133
$1,002,694
______________
(1) Net of LIP.
ALLL. When the Company classifies problem assets as either substandard or doubtful, pursuant to Federal regulations,
it may establish a specific reserve in an amount deemed prudent to address the risk specifically or may allow the loss to be addressed
in the general allowance. General allowances represent loss allowances which have been established to recognize the inherent risk
associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to the particular
problem assets. When an insured institution classifies problem assets as a loss, pursuant to Federal regulations, it is required to
charge-off such assets in the period in which they are deemed uncollectible. The determination as to the classification of the
Company’s assets and the amount of valuation allowances is subject to review by bank regulators, who can require the establishment
of additional loss allowances.
Loan grades are used by the Company to identify and track potential problem loans which do not rise to the levels described
for substandard, doubtful, or loss. The grades for watch and special mention are assigned to loans which have been criticized based
upon known characteristics such as periodic payment delinquency or stale financial information from the borrower and/or
guarantors. Loans identified as criticized (watch and special mention) or classified (substandard, doubtful or loss) are subject to
problem loan reporting every three months.
102
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables summarize changes in the ALLL and loan portfolio by type of loan and reserve method for the
periods indicated.
ALLL:
At or For the Year Ended December 31, 2018
One-to-
Four
Family
Residential Multifamily
Commercial
Real Estate
Construction/
Land
(In thousands)
Business Consumer
Total
Beginning balance
$
2,837
$
1,820
$
4,418
$
2,816
$
694
$
297
$
12,882
Charge-offs
Recoveries
(Recapture)
provision
Ending balance
General reserve
Specific reserve
Loans: (1)
Total Loans
General reserve (2)
Specific reserve (3)
—
4,279
(3,729)
3,387
3,328
59
$
$
$
$
—
—
(140)
1,680
1,680
—
$
$
—
14
345
4,777
4,774
3
$
$
—
171
(656)
2,331
2,331
—
$
$
—
—
242
936
936
—
$
$
—
1
(62)
236
236
—
$
$
—
4,465
(4,000)
13,347
13,285
62
$
341,966
$
169,355
$
373,798
$
108,854
$
30,486
$
12,970
$1,037,429
334,644
7,322
169,355
—
371,058
2,740
108,854
30,486
12,883
1,027,280
—
—
87
10,149
____________
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.
At or For the Year Ended December 31, 2017
One-to-
Four
Family
Residential Multifamily
Commercial
Real Estate
Construction/
Land
(In thousands)
Business Consumer
Total
$
$
$
$
$
$
$
$
2,551
—
2,195
(1,909)
2,837
2,721
116
278,655
265,093
13,562
$
$
$
$
1,199
—
—
621
1,820
1,820
—
184,902
183,768
1,134
$
$
$
$
3,893
—
78
447
4,418
4,399
19
361,299
358,105
3,194
$
$
$
$
2,792
—
—
24
2,816
2,816
—
145,618
145,618
—
$
$
$
$
237
—
—
457
694
694
—
23,087
23,087
—
$
$
$
279
—
58
(40)
297
297
—
10,951
—
2,331
(400)
12,882
12,747
135
9,133
9,039
94
$1,002,694
984,710
17,984
ALLL:
Beginning balance
Charge-offs
Recoveries
(Recapture)
provision
Ending balance
General reserve
Specific reserve
Loans: (1)
Total Loans
General reserve (2)
Specific reserve (3)
_____________
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.
103
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At or For the Year Ended December 31, 2016
One-to-
Four
Family
Residential Multifamily
Commercial
Real Estate
Construction/
Land
(In thousands)
Business Consumer
Total
$
$
$
$
$
$
$
$
3,028
—
165
(642)
2,551
2,349
202
249,435
224,363
25,072
$
$
$
$
1,193
—
1
5
1,199
1,199
—
123,250
121,686
1,564
$
$
$
$
3,395
—
104
394
3,893
3,867
26
303,694
299,987
3,707
$
$
$
$
1,193
—
—
1,599
2,792
2,711
81
136,922
136,427
495
$
$
$
$
229
—
—
8
237
237
—
7,938
7,938
—
425
(83)
1
(64)
279
$
9,463
(83)
271
1,300
$ 10,951
279
—
$ 10,642
309
6,922
6,819
103
$ 828,161
797,220
30,941
ALLL:
Beginning balance
Charge-offs
Recoveries
(Recapture) provision
Ending balance
General reserve
Specific reserve
Loans: (1)
Total Loans
General reserve (2)
Specific reserve (3)
______________
(1) Net of LIP.
(2) Loans collectively evaluated for impairment.
(3) Loans individually evaluated for impairment.
Past Due Loans. At December 31, 2018, total past due loans comprised 0.08% of total loans, net of LIP, as compared to
0.01% at December 31, 2017.
The following tables represent a summary at December 31, 2018, and 2017, of the aging of loans by type:
Loans Past Due as of December 31, 2018
30-59 Days
60-89 Days
90 Days
and
Greater
Total
Current
Total
Loans (1) (2)
(In thousands)
Real estate:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Construction/land
$
223
—
—
—
—
223
—
—
223
$
$
— $
—
—
—
—
—
—
—
— $
272
—
—
326
—
598
—
—
598
495
—
—
326
—
821
—
—
821
$
193,646
147,825
169,355
373,472
108,854
993,152
30,486
12,970
$ 1,036,608
$
194,141
147,825
169,355
373,798
108,854
993,973
30,486
12,970
$ 1,037,429
Total real estate
Business
Consumer
Total
_________________________
(1) There were no loans 90 days past due and still accruing interest at December 31, 2018.
(2) Net of LIP.
$
$
$
104
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans Past Due as of December 31, 2017
30-59 Days
60-89 Days
90 Days
and
Greater
Total
Current
Total
Loans (1) (2)
(In thousands)
Real estate:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Construction/land
$
$
101
—
—
—
—
101
—
—
101
— $
—
—
—
—
—
—
—
— $
— $
—
—
—
—
—
—
—
— $
101
—
—
—
—
101
—
—
101
$
148,203
130,351
184,902
361,299
145,618
970,373
23,087
9,133
$ 1,002,593
$
148,304
130,351
184,902
361,299
145,618
970,474
23,087
9,133
$ 1,002,694
Total real estate
Business
Consumer
Total
________________________
(1) There were no loans 90 days past due and still accruing interest at December 31, 2017.
(2) Net of LIP.
$
$
Nonaccrual Loans. The following table is a summary of nonaccrual loans at December 31, 2018, and 2017, by type of
loan:
One-to-four family residential
Commercial real estate
Consumer
Total nonaccrual loans
December 31,
2018
2017
(In thousands)
$
$
382
326
44
752
$
$
128
—
51
179
Nonperforming loans, net of LIP, were $752,000 and $179,000 at December 31, 2018, and 2017, respectively. Foregone
interest on nonaccrual loans for the years ended December 31, 2018, 2017, and 2016 were $18,000, $26,000 and $51,000,
respectively.
The following tables summarize the loan portfolio at December 31, 2018, and 2017, by type and payment activity:
December 31, 2018
One-to-Four
Family
Residential Multifamily
Commercial
Real Estate
Construction /
Land
Business
Consumer
Total (3)
Performing (1)
Nonperforming (2)
Total
$
$
341,584
382
341,966
$
$
169,355
—
169,355
$
$
373,472
326
373,798
$
108,854
—
108,854
$
$
30,486
—
30,486
$
$
12,926
44
12,970
$ 1,036,677
752
$ 1,037,429
(In thousands)
$
____________
(1) There were $193.8 million of owner-occupied one-to-four family residential loans and $147.8 million of non-owner occupied
one to-four family residential loans classified as performing.
(2) There were $382,000 of owner-occupied one-to-four family residential loans and no non-owner occupied one-to-four family
residential loans classified as nonperforming.
(3) Net of LIP.
105
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017
One-to-Four
Family
Residential Multifamily
Commercial
Real Estate
Construction/
Land
Business
Consumer
Total (3)
Performing (1)
Nonperforming (2)
Total
$
$
278,527
$
184,902
$
361,299
(In thousands)
$
145,618
$
23,087
$
9,082
128
—
—
—
—
51
278,655
$
184,902
$
361,299
$
145,618
$
23,087
$
9,133
$
$
1,002,515
179
1,002,694
_____________
(1) There were $148.2 million of owner-occupied one-to-four family residential loans and $130.3 million of non-owner occupied
one-to-four family residential loans classified as performing.
(2) There were $128,000 of owner-occupied one-to-four family residential loans and no non-owner occupied one-to-four family
residential loans classified as nonperforming.
(3) Net of LIP.
Impaired loans. The loan portfolio is constantly being monitored by management for delinquent loans and changes in the
financial condition of each borrower. When an issue is identified with a borrower and it is determined that the loan needs to be
classified as nonperforming and/or impaired, an evaluation of the collateral is performed prior to the end of the financial reporting
period and, if necessary, an appraisal is ordered in accordance with the Company’s appraisal policy guidelines. Based on this
evaluation, any additional provision for loan loss or charge-offs that may be needed is recorded prior to the end of the financial
reporting period.
There were no commitments to advance funds related to impaired loans at December 31, 2018, and 2017.
The following tables present a summary of loans individually evaluated for impairment at December 31, 2018, and 2017,
by the type of loan:
Recorded
Investment (1)
At December 31, 2018
Unpaid Principal
Balance (2)
(In thousands)
Related Allowance
Loans with no related allowance:
One-to-four family residential:
Owner occupied
Non-owner occupied
Commercial real estate
Consumer
Total
Loans with an allowance:
One-to-four family residential:
Owner occupied
Non-owner occupied
Commercial real estate
Total
Total impaired loans:
One-to-four family residential:
Owner occupied
Non-owner occupied
Commercial real estate
Consumer
Total
_________________
(1) Represents the loan balance less charge-offs.
(2) Contractual loan principal balance.
$
1,308
$
1,477
$
2,375
2,499
87
6,269
513
3,126
241
3,880
2,375
2,499
141
6,492
560
3,148
241
3,949
1,821
5,501
2,740
87
10,149
$
2,037
5,523
2,740
141
10,441
$
$
106
—
—
—
—
—
22
37
3
62
22
37
3
—
62
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recorded
Investment (1)
At December 31, 2017
Unpaid Principal
Balance (2)
(In thousands)
Related
Allowance
$
1,321
$
1,516
$
8,409
1,134
1,065
94
12,023
522
3,310
2,129
5,961
1,843
11,719
1,134
3,194
94
8,409
1,134
1,065
144
12,268
568
3,332
2,129
6,029
2,084
11,741
1,134
3,194
144
$
17,984
$
18,297
$
—
—
—
—
—
—
5
111
19
135
5
111
—
19
—
135
Loans with no related allowance:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Consumer
Total
Loans with an allowance:
One-to-four family residential:
Owner occupied
Non-owner occupied
Commercial real estate
Total
Total impaired loans:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Consumer
Total
_____________
(1) Represents the loan balance less charge-offs.
(2) Contractual loan principal balance.
107
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents a summary of recorded investment in impaired loans, and interest income recognized on
impaired loans for the years ended December 31, 2018, 2017 and 2016, by the type of loan:
2018
Year Ended December 31,
2017
2016
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
(In thousands)
$
1,207
$
82
$
1,773
$
93
$
2,566
$
5,583
900
1,885
91
9,666
518
3,211
—
1,046
—
—
4,775
1,725
8,794
900
2,931
—
91
146
—
172
8
408
35
162
—
27
—
—
224
117
308
—
199
—
8
12,438
1,227
2,467
98
18,003
1,301
3,680
—
1,025
99
—
6,105
3,074
16,118
1,227
3,492
99
98
553
74
80
8
808
32
170
—
139
—
—
341
125
723
74
219
—
8
20,653
1,344
2,295
117
26,975
2,026
5,520
236
2,192
396
30
10,400
4,592
26,173
1,580
4,487
396
147
156
1,061
106
253
12
1,588
104
236
—
42
17
—
399
260
1,297
106
295
17
12
$
14,441
$
632
$
24,108
$
1,149
$
37,375
$
1,987
Loans with no related allowance:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Consumer
Total
Loans with an allowance:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Construction/land
Consumer
Total
Total impaired loans:
One-to-four family residential:
Owner occupied
Non-owner occupied
Multifamily
Commercial real estate
Construction/land
Consumer
Total
108
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Troubled Debt Restructurings. The following is a summary of information pertaining to TDRs:
Performing TDRs
Nonaccrual TDRs
Total TDRs
December 31,
2018
2017
(In thousands)
$
$
9,399
$
—
9,399
$
17,805
—
17,805
The accrual status of a loan may change after it has been classified as a TDR. Management considers the following in
determining the accrual status of restructured loans: (1) if the loan was on accrual status prior to the restructuring, the borrower
has demonstrated performance under the previous terms, and a credit evaluation shows the borrower’s capacity to continue to
perform under the restructured terms (both principal and interest payments), the loan will remain on accrual at the time of the
restructuring; (2) if the loan was on nonaccrual status before the restructuring, and the Company’s credit evaluation shows the
borrower’s capacity to meet the restructured terms, the loan would remain as nonaccrual for a minimum of six months until the
borrower has demonstrated a reasonable period of sustained repayment performance (thereby providing reasonable assurance as
to the ultimate collection of principal and interest in full under the modified terms).
The following table presents for the periods indicated TDRs and their recorded investment prior to the modification and
after the modification:
Year Ended December 31,
2018
2017
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment
Number
of Loans
Number
of Loans
(Dollars in thousands)
TDRs that occurred during the period:
One-to-four family residential:
Principal and interest with interest rate
concession
Commercial real estate:
Advancement of maturity date
Total
1
$
563
$
—
—
1
$
563
$
563
—
563
8
$
2,492
$
2,492
1
9
891
$
3,383
$
891
3,383
At December 31, 2018 and 2017, the Company had no commitments to extend additional credit to borrowers whose loan
terms have been modified in a TDR. All TDRs are also classified as impaired loans and are included in the loans individually
evaluated for impairment in the calculation of the ALLL.
TDRs resulted in no charge-offs to the ALLL for the years ended December 31, 2018 and 2017. For the years ended
December 31, 2018 and 2017, there were no payment defaults on loans modified as TDRs within the previous 12 months.
109
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certain executive officers and directors have loans with the Bank. The aggregate dollar amount of these loans outstanding
to related parties is summarized as follows:
Balance at beginning of year
Additions
Change in director or executive status during year
Repayments
Balance at end of year
Note 5 - Other Real Estate Owned
Year Ended December 31,
2018
2017
2016
(In thousands)
$
$
$
9
—
—
(9)
— $
60
—
—
(51)
9
$
$
118
—
(40)
(18)
60
The following table is a summary of OREO activity for the periods indicated:
Balance at beginning of year
Gross proceeds from sale of OREO
Gain (loss) on sale of OREO
Market value adjustments
Balance at end of year
Year Ended December 31,
2018
2017
2016
(In thousands)
$
$
483
$
—
—
—
483
$
2,331
(1,908)
110
(50)
483
$
$
3,663
(988)
(87)
(257)
2,331
OREO at December 31, 2018, consisted of $483,000 in commercial real estate properties. At December 31, 2018, there
was one $272,000 mortgage loan secured by residential real estate in the process of foreclosure.
Note 6 - Premises and Equipment
Premises and equipment consisted of the following at December 31, 2018, and 2017:
Land
Buildings and improvements
Leasehold improvements
Furniture, fixtures and equipment
Computer hardware and software
Construction in process
Less accumulated depreciation and amortization
Total premises and equipment, net
December 31,
2018
2017
(In thousands)
$
2,226
19,566
3,076
4,971
2,342
507
32,688
(11,357)
21,331
$
2,226
19,436
1,917
4,743
2,323
67
30,712
(10,098)
20,614
$
$
Depreciation and amortization expense was $1.6 million for the year ended December 31, 2018 and $1.3 million and
$1.1 million for the years ended December 31, 2017 and 2016, respectively.
Note 7 - Fair Value of Financial Instruments
The Company has adopted ASU 2016-01, and therefore, is measuring the fair value of loans receivable under the exit
price notion rather than the previous method of entry price notion. The methodology used to estimate the fair values of other
110
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial instruments did not change from the adoption of ASU 2016-01. Under the exit price notion used at December 31, 2018,
the fair value estimate of loans receivable was based on similar techniques, with the addition of current origination spreads, liquidity
premiums, or credit adjustments. The fair value of nonperforming loans is based on the underlying value of the collateral for
periods prior to and after adoption of ASU 2016-01. The fair value estimate of loans receivable at December 31, 2017, was not
restated under the exit price notion and was based on discounted cash flow.
The Company determines the fair values of its financial instruments based on the fair value hierarchy which requires an
entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair values. Observable
inputs reflect market data obtained from independent sources, while unobservable inputs reflect its estimate for market assumptions.
Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of
the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions that market
participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from an
independent source. Unobservable inputs are assumptions based on the Company’s own information or estimate of assumptions
used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information
available on the measurement date.
All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy:
• Level 1 - Quoted prices for identical instruments in active markets.
• Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in
markets that are not active; and model-derived valuations whose inputs are observable.
• Level 3 - Instruments whose significant value drivers are unobservable.
The Company used the following methods to measure fair value on a recurring or nonrecurring basis.
• Financial instruments with book value equal to fair value: The fair value of financial instruments that are short-term
or reprice frequently and that have little or no risk are considered to have a fair value equal to book value. These
instruments include cash on hand and in banks, interest-bearing deposits, accrued interest receivable, and accrued
interest payable. FHLB stock is not publicly-traded, however, it may be redeemed on a dollar-for-dollar basis, for any
amount the Bank is not required to hold, subject to the FHLB’s discretion. The fair value is therefore equal to the book
value.
•
•
Investments available-for-sale: The fair value of all investments, excluding FHLB stock, was based upon quoted market
prices for similar investments in active markets, identical or similar investments in markets that are not active, and
model-derived valuations whose inputs are observable.
Loans receivable: The fair value of loans receivable at December 31, 2018 was calculated from inputs reflective of
current market pricing for similar instruments, to include current origination spreads, liquidity premiums, and credit
adjustments. The fair value of nonperforming loans is estimated using the fair value of the underlying collateral.
• OREO: The fair value of OREO properties is measured at the lower of the carrying amount or fair value, less costs to
sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In
cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
• Derivatives: The fair value of derivatives is based on dealer quotes, pricing models, discounted cash flow methodologies
or similar techniques for which the determination of fair value may require significant management judgment or
estimation.
•
Liabilities: The fair value of deposits with no stated maturity, such as statement savings, interest bearing checking,
and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is
based on the discounted value of contractual cash flows using current interest rates for certificates of deposit with
similar remaining maturities. The fair value of FHLB advances is estimated based on discounting the future cash flows
using current interest rates for debt with similar remaining maturities.
111
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tables below present the balances of assets and liabilities measured at fair value on a recurring basis (there were no
transfers between Level 1, Level 2 and Level 3 recurring measurements during the periods presented):
December 31, 2018
Fair Value
Measurements
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable
Inputs (Level 3)
(In thousands)
$
23,643
$
— $
23,643
$
6,287
22,061
8,979
10,544
47,438
23,218
142,170
1,662
—
—
—
—
—
—
—
—
6,287
22,061
8,979
10,544
47,438
23,218
142,170
1,662
$
143,832
$
— $
143,832
$
—
—
—
—
—
—
—
—
—
—
December 31, 2017
Fair Value
Measurements
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable
Inputs (Level 3)
(In thousands)
Available-for-sale investments:
Mortgage-backed investments:
Fannie Mae
Freddie Mac
Ginnie Mae
Other
Municipal bonds
U.S. Government agencies
Corporate bonds
Total available-for-sale investments
Derivative fair value asset
Available-for-sale investments:
Mortgage-backed investments:
Fannie Mae
Freddie Mac
Ginnie Mae
Municipal bonds
U.S. Government agencies
Corporate bonds
$
26,564
$
— $
26,564
$
5,472
21,576
13,395
42,633
22,602
—
—
—
—
—
—
—
— $
5,472
21,576
13,395
42,633
22,602
132,242
$
1,526
133,768
—
—
—
—
—
—
—
—
—
Total available-for-sale investments
132,242
$
Derivative fair value asset
$
1,526
133,768
The estimated fair value of Level 2 investments is based on quoted prices for similar investments in active markets,
identical or similar investments in markets that are not active, and model-derived valuations whose inputs are observable.
112
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tables below present the balances of assets and liabilities measured at fair value on a nonrecurring basis at
December 31, 2018, and 2017.
December 31, 2018
Quoted Prices
in
Active Markets
for Identical
Assets (Level 1)
Significant
Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs
(Level 3)
Fair Value
Measurements
Impaired loans (included in loans receivable, net)(1)
OREO
Total
$
$
10,087
483
10,570
$
$
(In thousands)
— $
—
— $
— $
10,087
—
483
— $
10,570
_______________
(1) Total value of impaired loans is net of $62,000 of specific reserves on performing TDRs.
December 31, 2017
Quoted Prices
in
Active Markets
for Identical
Assets (Level 1)
Significant
Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs
(Level 3)
Fair Value
Measurements
Impaired loans (included in loans receivable, net)(1)
OREO
Total
$
$
17,849
483
18,332
$
$
(In thousands)
— $
—
— $
— $
—
— $
17,849
483
18,332
________________
(1) Total value of impaired loans is net of $135,000 of specific reserves on performing TDRs.
The following tables present quantitative information about Level 3 fair value measurements for financial instruments
measured at fair value on a nonrecurring basis at December 31, 2018 and 2017.
Fair
Value
Valuation
Technique(s)
December 31, 2018
Unobservable Input(s)
(Dollars in thousands)
Range
(Weighted Average
Change in Fair
Value)
Impaired Loans $ 10,087 Market approach
Appraised value discounted by market or
borrower conditions
0.0% (0.00%)
OREO
$
483 Market approach
Appraised value less selling costs
0.0% (0.00%)
Fair
Value
Valuation
Technique(s)
December 31, 2017
Unobservable Input(s)
(Dollars in thousands)
Range
(Weighted Average
Change in Fair
Value)
Impaired Loans $ 17,849 Market approach
Appraised value discounted by market or
borrower conditions
0.0% (0.00%)
OREO
$
483 Market approach
Appraised value less selling costs
0.0% (0.00%)
113
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value calculation of the Company’s financial instruments are an attempt to incorporate market conditions at a
specific point in time. The underlying assumptions are generally subjective and involve uncertainties. Therefore, these fair value
estimates are not intended to represent the underlying value of the Company as a whole.
The carrying amounts and estimated fair values of financial instruments at December 31, 2018, and 2017, were as follows:
December 31, 2018
Fair Value Measurements Using:
Carrying Value
Estimated
Fair Value
Level 1
Level 2
Level 3
(In thousands)
Financial Assets:
Cash on hand and in banks
$
8,122
$
8,122
$
8,122
$
Interest-earning deposits
Investments available-for-sale
Loans receivable, net
FHLB stock
Accrued interest receivable
Derivative fair value asset
Financial Liabilities:
Deposits
Certificates of deposit, retail
Certificates of deposit, brokered
Advances from the FHLB
Accrued interest payable
8,888
142,170
1,022,904
7,310
4,068
1,662
450,033
391,174
97,825
146,500
478
8,888
142,170
1,012,114
7,310
4,068
1,662
450,033
390,101
97,466
146,357
478
8,888
—
—
—
—
—
450,033
—
—
—
—
— $
—
142,170
—
7,310
4,068
1,662
—
390,101
97,466
146,357
478
—
—
—
1,012,114
—
—
—
—
—
—
—
—
December 31, 2017
Fair Value Measurements Using:
Carrying Value
Estimated
Fair Value
Level 1
Level 2
Level 3
(In thousands)
Financial Assets:
Cash on hand and in banks
$
9,189
$
9,189
$
Interest-earning deposits
Investments available-for-sale
Loans receivable, net
FHLB stock
Accrued interest receivable
Derivative fair value asset
Financial Liabilities:
Deposits
Certificates of deposit, retail
Certificates of deposit, brokered
Advances from the FHLB
Accrued interest payable
6,942
132,242
988,662
9,882
4,084
1,526
430,750
333,264
75,488
216,000
326
6,942
132,242
980,578
9,882
4,084
1,526
430,750
331,199
74,947
214,477
326
9,189
$
6,942
— $
—
—
—
—
—
—
430,750
—
—
—
—
132,242
—
9,882
4,084
1,526
—
331,199
74,947
214,477
326
—
—
—
980,578
—
—
—
—
—
—
—
—
Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value
of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial
instruments.
114
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 8 - Accrued Interest Receivable
Accrued interest receivable consisted of the following at December 31, 2018 and 2017:
Loans receivable
Investments
Interest-earning deposits
Note 9 - Deposits
Deposit accounts consisted of the following at December 31, 2018 and 2017:
Noninterest-bearing
Interest-bearing demand
Statement savings
Money market
Certificates of deposit, retail (1)
Certificates of deposit, brokered
$
$
$
$
December 31,
2018
2017
(In thousands)
3,366
$
699
3
4,068
$
3,492
590
2
4,084
December 31,
2018
2017
$
(In thousands)
46,108
40,079
24,799
339,047
391,174
97,825
939,032
$
45,434
38,224
28,456
318,636
333,264
75,488
839,502
_______________
(1) Shown net of $58,000 and $107,000 fair value adjustment.
At December 31, 2018, scheduled maturities of certificates of deposit were as follows:
December 31,
2019
2020
2021
2022
2023
thereafter
Amount
(In thousands)
230,338
92,718
90,944
32,868
42,131
—
488,999
$
$
Deposits included public funds of $28.5 million and $21.5 million at December 31, 2018 and 2017, respectively.
Certificates of deposit equal to or exceeding the FDIC insured amount of $250,000 included in deposits at
December 31, 2018, and 2017, were $129.3 million and $84.3 million, respectively. Interest expense on certificates equal to or
exceeding $250,000 totaled $1.8 million, $1.1 million, and $975,000 for the years ended December 31, 2018, 2017, and 2016,
respectively.
Included in total deposits are accounts of $16.0 million and $7.6 million at December 31, 2018, and 2017, respectively
which are controlled by related parties.
115
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest expense on deposits for the periods indicated was as follows:
Interest-bearing demand
Statement savings
Money market
Certificates of deposit, retail
Certificates of deposit, brokered
Note 10 - Other Borrowings
Year Ended December 31,
2018
79
34
3,550
5,825
1,730
11,218
2017
(In thousands)
73
$
42
1,779
4,362
1,261
7,517
$
$
$
$
$
2016
30
47
870
3,934
1,220
6,101
At December 31, 2018, and 2017, the Bank maintained credit facilities with the FHLB totaling $554.8 million and
$406.5 million, respectively. The credit facility was collateralized by $216.4 million of single-family residential mortgages,
$180.8 million of commercial real estate loans and $74.2 million of multifamily loans under a blanket lien arrangement at
December 31, 2018. At December 31, 2017, the credit facility was collateralized by $190.7 million of single-family residential
mortgages, $161.8 million of commercial real estate loans, and $70.1 million of multifamily loans under a blanket lien arrangement.
The Bank also had $126.2 million unused line-of-credit facilities with other financial institutions at December 31, 2018, with
interest payable at the then stated rate.
Outstanding advances at the FHLB for the years ended December 31 2018, and 2017 consisted of the following:
Year ended December 31,
2018
2017
(Dollars in thousands)
Maximum borrowing outstanding at any month end
$
224,000
$
Average borrowing outstanding during year
Balance outstanding at end of year
Average rate paid during the year
Weighted-average rate paid at end of year
183,667
146,500
1.92%
2.62
231,500
192,227
216,000
1.30%
1.60
Scheduled maturities of Federal Home Loan Bank outstanding advances at December 31, 2018, were as follows:
Year Ended December 31,
FHLB overnight Fed Funds
2019
2020
2021
$
$
Note 11 - Derivatives
Balance Due
(Dollars in thousands)
Weighted Average Interest Rate at
December 31, 2018
31,500
60,000
—
55,000
146,500
2.63%
2.44
—
2.81
The Company uses a derivative financial instrument, which qualifies as a cash flow hedge, to manage the risk of changes
in future cash flows due to interest rate fluctuations. The hedged instrument is a $50.0 million three-month FHLB advance that
will be renewed every three months at the fixed interest rate at that time. The agreement has a five year term and stipulates that
the counterparty will pay the Company interest at three-month LIBOR and the Company will pay fixed interest of 1.34% on the
$50.0 million notional amount. The Company pays or receives the net interest amount quarterly and includes this amount as part
of FHLB advances interest expense on the Consolidated Income Statement.
116
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The cash flow hedges were determined to be fully effective during all periods presented. As such, no ineffectiveness has
been included in net income.
The following table presents the fair value of derivative instruments as of December 31, 2018 and 2017:
Balance Sheet
Location
Interest rate swaps on FHLB debt designated as cash
flow hedge
Other assets
Total derivatives
2018 Fair Value
2017 Fair Value
(In thousands)
$
$
1,662
1,662
$
$
1,526
1,526
The following table presents the net gains of derivative instruments recorded in accumulated other comprehensive
income:
Interest rate swaps on FHLB debt designated as cash
flow hedge
Other assets
$
108
$
125
Balance Sheet
Location
2018 Amount of
Gain Recognized
In OCI
(In thousands)
2017 Amount of
Gain Recognized
In OCI
Note 12 - Benefit Plans
Multi-employer Pension Plans
The Company participates in the Pentegra Defined Benefit Plan for Financial Institutions (“The Pentegra DB Plan”), a
tax-qualified defined-benefit pension plan that covers substantially all employees after one year of continuous employment. Pension
benefits vest over a period of five years of credited service. The Pentegra DB Plan’s Employer Identification Number is 13-5645888
and the Plan Number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-
employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective
bargaining agreements in place that require contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand
behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used
to provide benefits to participants of other participating employers.
As of March 31, 2013, the Pentegra DB Plan was frozen, eliminating all future benefit accruals for employees. Each
employee’s accrued benefit was determined as of March 31, 2013.
The funding target is the present value of all benefits that have accrued as of the first day of the current plan year (July 1).
Because interest rates used to calculate the present value of all benefits (5.71% for 2018 and 5.89% for 2017) is significantly
higher than current market rates, the funding target does not represent the Company’s actual liability upon withdrawal from
participation in the Pentegra DB Plan, which is significantly larger than the funding target. The table below presents the funded
status (market value of plan assets divided by funding target) of the plan as of July 1:
Source
First Financial Northwest’s Plan(1)
2018
2017
Valuation Report
Valuation Report
102.7%
104.8%
_________________
(1) Market value of plan assets reflects any contributions received through June 30, 2018, or 2017, respectively.
Total contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $367.1 million and $153.2 million
for the plan years ended June 30, 2017 and June 30, 2016 respectively. The Company’s contributions to the Pentegra DB Plan are
not more than 5% of the total contributions to the Pentegra DB Plan. The Company’s policy is to fund pension costs as accrued.
117
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Total contributions during the years ended December 31, 2018, 2017, and 2016 were:
2018
2017
2016
Date Paid
Amount
Date Paid
Amount
Date Paid
Amount
10/9/2018
11/13/2018
Total
$
$
43
497
540
(in thousands)
10/12/2017
11/30/2017
Total
$
$
38
502
540
10/7/2016
11/23/2016
Total
$
$
40
500
540
Supplemental Executive Retirement Plan
The Company has entered into post-employment agreements with certain key officers to provide supplemental retirement
benefits. The Company recorded $18,000, $69,000 and $36,000 of deferred compensation expense for the years ended
December 31, 2018, 2017, and 2016, respectively.
401(k) Plan
The Company has a savings plan under Section 401(k) of the Internal Revenue Code, covering substantially all employees
after 90 days of continuous employment. Under the plan, employee contributions up to 6% will be matched 50% by the Company.
Such matching becomes vested over a period of five years of credited service. Employees may make investments in various stock,
money market, or fixed income plans. The Company contributed $312,000, $261,000 and $201,000 to the plan for the years ended
December 31, 2018, 2017, and 2016, respectively.
Employee Stock Ownership Plan
The Company provides an ESOP for the benefit of substantially all employees. The ESOP borrowed $16.9 million from
First Financial Northwest and used those funds to acquire 1,692,800 shares of First Financial Northwest’s stock at the time of the
initial public offering at a price of $10.00 per share. The loan matures on October 8, 2022 and has a fixed interest rate of 4.88%.
Shares purchased by the ESOP with the loan proceeds are held in a suspense account and are allocated to ESOP participants
on a pro rata basis as principal and interest payments are made by the ESOP to First Financial Northwest. The loan is secured by
shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Company’s discretionary contributions
to the ESOP and earnings on the ESOP assets. Annual principal and interest payments of $1.6 million were made by the ESOP
during 2018, 2017, and 2016.
As shares are committed to be released from collateral, the Company reports compensation expense equal to the daily
average market prices of the shares and the shares become outstanding for EPS computations. The compensation expense is accrued
throughout the year.
A summary of key transactions for the ESOP for the periods indicated follows:
ESOP contribution expense
(In thousands)
$
1,906
$
1,941
$
Dividends on unallocated ESOP shares used to reduce ESOP contribution
166
175
1,605
183
Year Ended December 31,
2018
2017
2016
118
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Shares held by the ESOP at December 31, 2018 and 2017, are as follows:
December 31,
2018
2017
(Dollars in thousands, except share data)
Allocated shares
Unallocated shares
Total ESOP shares
1,269,600
423,200
1,692,800
Fair value of unallocated shares
$
6,547
$
Stock-Based Compensation
1,156,747
536,053
1,692,800
8,314
In June 2016, First Financial Northwest’s shareholders approved the First Financial Northwest, Inc. 2016 Equity Incentive
Plan (“2016 Plan”). This plan provides for the granting of incentive stock options (“ISO”), non-qualified stock options (“NQSO”),
restricted stock and restricted stock units. The 2016 Plan expires in June 2026. The 2016 Plan established 1,400,000 shares available
to grant with a maximum of 400,000 of these shares available to grant as restricted stock awards. Each share issued as a restricted
stock award counts as two shares towards the total shares available to be awarded.
As a result of the approval of the 2016 Plan, the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“2008 Plan”)
was frozen and no additional awards will be made. Restricted stock awards and stock options that were granted under the 2008
Plan will continue to vest and be available for exercise, subject to the 2008 Plan provisions. At December 31, 2018, there were
1,290,670 total shares available for grant under the 2016 Plan, including 345,335 shares available to be granted as restricted stock.
Under the 2016 Plan, the vesting date for each option award or restricted stock award is determined by an award committee
and specified in the award agreement. In the case of restricted stock awards granted in lieu of cash payments of directors’ fees,
the grant date is used as the vesting date.
Total compensation expense for the both the 2008 Plan and 2016 Plan for the years ended December 31, 2018, 2017, and
2016 was $650,000, $574,000, and $622,000, respectively. The related income tax benefit was $137,000, $201,000 and $218,000
for the years ended December 31, 2018, 2017, and 2016, respectively.
Stock Options
Under the 2008 Plan, stock option awards were granted with an exercise price equal to the market price of First Financial
Northwest's common stock at the grant date. These option awards have a vesting period of five years, with 20% vesting on the
anniversary date of each grant date, and a contractual life of ten years. Any unexercised stock options will expire ten years after
the grant date, or sooner in the event of the award recipient’s death, disability or termination of service with the Company.
Under the 2016 Plan, the exercise price and vesting period for stock options are determined by the award committee and
specified in the award agreement, however, the exercise price shall not be less than the fair market value of a share as of the grant
date. Any unexercised stock option will expire 10 years after the award date or sooner in the event of the award recipient’s death,
disability, retirement, or termination of service.
A cashless exercise of vested stock options may occur by the option holder surrendering the number of options valued
at the current stock price at the time of exercise to cover the total cost to exercise. The surrendered options are canceled and are
unavailable for reissue.
The fair value of each option award is estimated on the grant date using a Black-Scholes model that uses the assumptions
noted in the table below. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical
employment data is used to estimate the forfeiture rate. The historical volatility of the Company’s stock price over a specified
period of time is used for the expected volatility assumption. First Financial Northwest bases the risk-free interest rate on the U.S.
Treasury Constant Maturity Indices in effect on the date of the grant. First Financial Northwest elected to use the “simplified”
method permitted by the U.S. Securities and Exchange Commission to calculate the expected term. This method uses the vesting
term of an option along with the contractual term, setting the expected life at the midpoint.
There were no stock options granted in 2018, 2017, or 2016.
119
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the Company’s stock option plan awards activity for the year ended December 31, 2018 follows:
Weighted-
Average
Exercise Price
Shares
Weighted-
Average
Remaining
Contractual
Term in Years
Aggregate
Intrinsic
Value
Outstanding at December 31, 2017
452,940
$
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2018
Expected to vest assuming a 3% forfeiture rate over
the vesting term
Exercisable at December 31, 2018
—
(137,940)
—
315,000
313,950
280,000
10.21
—
9.90
—
10.34
10.34
10.16
4.98
$
1,615,600
4.98
4.83
1,611,762
1,487,670
As of December 31, 2018, there was $116,000 of total unrecognized compensation cost related to nonvested stock options.
The cost is expected to be recognized over the remaining weighted-average vesting period of 1.4 years.
Restricted Stock Awards
A summary of changes in nonvested restricted stock awards for the year ended December 31, 2018, follows:
Nonvested Shares
Shares
Weighted Average
Grant Date
Fair Value
Nonvested at December 31, 2017
Granted
Vested
Nonvested at December 31, 2018
Expected to vest assuming a 3% forfeiture rate over the vesting term
5,000
$
30,179
(14,192)
20,987
20,357
10.88
17.14
16.77
15.90
As of December 31, 2018 there was $57,000 of total unrecognized compensation costs related to nonvested shares granted
as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of two
months. The total fair value of shares vested during the years ended December 31, 2018, and 2017 were $238,000 and $187,000,
respectively.
Note 13 - Federal Income Taxes
The components of income tax expense for the years indicated are as follows:
Current
Deferred
Total income tax expense
Year Ended December 31,
2018
2017
2016
(In thousands)
$
$
3,973
(280)
3,693
$
$
3,204
1,738
4,942
$
$
2,164
1,548
3,712
On December 22, 2017, the U.S. Government enacted the Tax Act. The Tax Act amends the Internal Revenue Code to
reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduces
the corporate federal income tax rate from a maximum of 35% to a flat 21% rate. The corporate income tax rate reduction was
effective January 1, 2018. The Tax Act required a revaluation of the Company’s deferred tax assets and liabilities to account for
120
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the future impact of lower corporate tax rates and other provisions of the legislation. As a result of the Company’s revaluation,
the DTA was reduced at December 31, 2017 through a one-time increase to the provision for income tax of $807,000.
A reconciliation of the tax provision based on the statutory corporate rate of 21% for the year ended December 31, 2018,
and 35% during the years ended December 31, 2017 and 2016, on pretax income is as follows:
Income tax expense at statutory rate
$
3,904
$
4,697
$
4,412
Year Ended December 31,
2018
2017
2016
(In thousands)
Income tax effect of:
Tax exempt interest, net
Benefit of lower federal tax bracket
DTA revaluation
Other, net
Total income tax expense
(53)
—
—
(158)
3,693
$
(107)
(98)
807
(357)
4,942
$
(103)
—
—
(597)
3,712
$
The DTA, included in the accompanying consolidated balance sheets, consisted of the following at the dates indicated:
Deferred tax assets:
ALLL
Reserve for unfunded commitments
Deferred compensation
Net unrealized loss on investments available-for-sale
Alternative minimum tax credit carryforward
Employee benefit plans
OREO market value adjustments
Accrued expenses
Core deposit intangible
Expenses to facilitate branch acquisition
Split dollar life insurance
Deferred lease
Total deferred tax assets
Deferred tax liabilities:
FHLB stock dividends
Loan origination fees and costs
Gain on fair value of cash flow hedge
Fixed assets
Goodwill
Other, net
Total deferred tax liabilities
Deferred tax assets, net
December 31,
2018
2017
2016
(In thousands)
$
2,801
$
2,700
$
3,803
96
293
640
—
527
4
111
18
26
51
98
329
259
—
533
4
112
5
62
—
18
4,585
$
—
4,102
$
110
903
349
1,271
17
91
271
1,321
320
891
4
84
2,741
1,844
$
$
2,891
1,211
$
$
$
$
$
131
592
557
45
951
231
453
—
—
—
—
6,763
552
1,477
467
869
—
256
3,621
3,142
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
121
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
At December 31, 2018 and 2017, the Company had no net operating loss carryforward. The remaining alternative tax
credit carryforward of $45,000 was exhausted during 2017.
As a result of the bad debt deductions taken in years prior to 1988, retained earnings includes accumulated earnings of
approximately $4.5 million, on which federal income taxes have not been provided. If, in the future, this portion of retained
earnings is used for any purpose other than to absorb losses on loans or on property acquired through foreclosure, federal income
taxes may be imposed at the then-prevailing corporate tax rates. The Bank does not contemplate that such amounts will be used
for any purpose that would create a federal income tax liability; therefore no provision has been made.
Under GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that a portion of the
deferred tax asset will not be realized. In order to support a conclusion that a valuation allowance is not needed, management
evaluates both positive and negative evidence under the “more likely than not” standard. The weight given to the potential effect
of negative and positive evidence should be commensurate with the extent to which the strength of the evidence can be objectively
verified. As of December 31, 2018, it was determined the full deferred tax asset would be realized in future periods and a valuation
allowance would not be necessary.
Note 14 - Regulatory Capital Requirements
Under Federal regulations, pre-conversion retained earnings are restricted for the protection of pre-conversion depositors.
The Company is a bank holding company under the supervision of the Federal Reserve Bank of San Francisco. Bank
holding companies are subject to capital adequacy requirements of the Board of Governors of the Federal Reserve System (the
“Federal Reserve”) under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve Board,
except that, pursuant to the Economic Growth, Regulatory Relief and Consumer Protection Act, effective August 30, 2018, a bank
holding company with consolidated assets of less than $3 billion is generally not subject to the Federal Reserve’s capital regulations,
which parallel the FDIC’s capital regulations. The Bank is a federally insured institution and thereby is subject to the capital
requirements established by the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory and, possibly,
additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial
statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet
specific capital regulations that involve quantitative measures of their assets, liabilities, and certain off-balance- sheet items as
calculated under regulatory accounting practices, and until August 30, 2018, First Financial Northwest was subject to similar
capital regulations. At December 31, 2017, and if the Company were subject to regulatory guidelines for bank holding companies
with $3.0 billion or more in assets at December 31, 2018, the Company exceeded all regulatory requirements.
The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts
and ratios (set forth in the table that follows) of total and Tier 1 capital to risk-weighted assets (as defined in the regulations) and
of Tier 1 capital to average assets.
As of December 31, 2018, according to the most recent notification from the FDIC, the Bank was categorized as
well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the
notification that management believes have changed the Bank’s category.
122
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
First Financial Northwest Bank’s actual capital amounts and ratios at December 31, 2018, and 2017, are presented in the
following table.
Actual
Amount
Ratio
For Capital Adequacy
Purposes
Amount
Ratio
(Dollars in thousands)
To be Well Capitalized
Under Prompt Corrective
Action Provisions
Amount
Ratio
December 31, 2018:
Total risk-based capital
$
140,220
14.68% $
76,417
8.00% $
95,521
10.00%
Tier 1 risk-based capital
128,257
13.43
57,313
6.00
76,417
8.00
Common equity tier 1
capital (“CET1”)
128,257
13.43
42,985
Tier 1 leverage capital
128,257
10.37
49,491
4.50
4.00
62,089
61,863
6.50
5.00
December 31, 2017:
Total risk-based capital
$
134,292
13.77% $
78,006
8.00% $
97,507
10.00%
Tier 1 risk-based capital
122,090
12.52
58,504
6.00
78,006
8.00
Common equity tier 1
capital
122,090
12.52
43,878
Tier 1 leverage capital
122,090
10.20
47,874
4.50
4.00
63,379
59,843
6.50
5.00
In addition to the minimum CET1, Tier 1, total capital and leverage ratios, First Financial Northwest and the Bank have
to maintain a capital conservation buffer consisting of additional CET1 capital above the required minimum levels in order to
avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of
eligible retained income that could be utilized for such actions. The capital conservation buffer requirement began to be phased
in on January 1, 2016 when more than 0.625% of risk-weighted assets was required, and increased by 0.625% on each subsequent
January 1, until fully implemented to an amount more than 2.5% of risk-weighted assets on January 1, 2019. As of
December 31, 2018, the conservation buffer requirement was 1.875% and the Bank’s actual conservation buffer was 6.68%.
Note 15 - Commitments and Contingencies
Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, the Company makes loan
commitments, typically unfunded loans and unused lines of credit, to accommodate the financial needs of its customers. These
arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Company’s
normal credit policies, including collateral requirements, where appropriate. Commitments to extend credit are agreements to lend
to customers in accordance with predetermined contractual provisions. These commitments are for specific periods or, may contain
termination clauses and may require the payment of a fee. The total amounts of unused commitments do not necessarily represent
future credit exposure or cash requirements, in that commitments can expire without being drawn upon. Unfunded commitments
to originate loans or extend credit totaled $126.1 million at December 31, 2018, and $126.4 million at December 31, 2017.
Lease Commitments. First Financial Northwest Bank has entered into lease commitments for its branches located in Mill
Creek, Edmonds, Renton, Bellevue, Woodinville, Smokey Point, Lake Stevens, Bothell, and Kent, all in Washington. The following
table sets forth, at December 31, 2018, the Bank’s commitment for future lease payments under our operating leases:
123
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ending December 31,
Future Minimum Lease Payments
(In thousands)
2019
2020
2021
2022
2023
Thereafter
Total
$
$
510
504
328
294
187
161
1,984
Legal Proceedings. The Company and its subsidiaries are from time to time defendants in and are threatened with various
legal proceedings arising from their regular business activities. Management, after consulting with legal counsel, is of the opinion
that the ultimate liability, if any, resulting from these pending or threatened actions and proceedings will not have a material effect
on the consolidated financial statements of the Company.
Employment Contracts and Severance Agreements. The Company has change in control severance agreements with key
officers that offer specified terms of salary coverage. In addition, the Company has employment contracts with certain executives
that include specified terms of salary coverage as a result of involuntary termination due to change in control or other circumstances.
124
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 16 - Parent Company Only Financial Statements
Presented below are the condensed balance sheets, income statements and statements of cash flows for First Financial
Northwest.
FIRST FINANCIAL NORTHWEST, INC.
Condensed Balance Sheets
Assets
Cash and cash equivalents
Interest-bearing deposits
Investment in subsidiaries
Receivable from subsidiaries
Other assets
Total assets
Liabilities and Stockholders’ Equity
Liabilities:
Payable to subsidiaries
Deferred tax liability, net
Other liabilities
Total liabilities
Stockholders’ equity
Total liabilities and stockholders’ equity
FIRST FINANCIAL NORTHWEST, INC.
Condensed Income Statements
December 31,
2018
2017
(In thousands)
$
140
$
22,362
130,209
1,207
52
151
14,309
125,530
2,933
47
$
153,970
$
142,970
$
$
47
2
183
232
97
9
230
336
153,738
$
153,970
$
142,634
142,970
Operating income:
Interest income:
Interest-bearing deposits with banks
Total operating income
Operating expenses:
Other expenses
Total operating expenses
Loss before provision for federal income taxes and equity in undistributed
earnings of subsidiaries
Federal income tax benefit
Loss before equity in undistributed loss of subsidiaries
Equity in undistributed earnings of subsidiaries
Year Ended December 31,
2018
2017
2016
(In thousands)
$
$
157
157
$
47
47
92
92
1,557
1,557
(1,400)
(311)
(1,089)
15,988
1,534
1,534
(1,487)
(565)
(922)
9,401
1,913
1,913
(1,821)
(701)
(1,120)
10,012
8,892
Net income
$
14,899
$
8,479
$
125
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FIRST FINANCIAL NORTHWEST, INC.
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash from operating
activities:
Equity in undistributed earnings of subsidiaries
Dividends received from subsidiary
ESOP, stock options, and restricted stock compensation
Change in deferred tax assets, net
Change in receivables from subsidiaries
Change in payables to subsidiaries
Change in other assets
Changes in other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Investments in subsidiaries
ESOP loan repayment
Net cash provided in investing activities
Cash flows from financing activities:
Proceeds from exercise of stock options
Proceeds for vested awards
Net share settlement of stock awards
Repurchase and retirement of common stock
Dividends paid
Net cash used by financing activities
Net increase (decrease) in cash
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Year Ended December 31,
2018
2017
2016
(In thousands)
$
14,899
$
8,479
$
8,892
(15,988)
10,858
28
(7)
7
(50)
(5)
(47)
9,695
334
2,833
3,167
1,365
206
(40)
(3,153)
(3,198)
(4,820)
8,042
14,460
(9,401)
8,528
27
(8)
(1,518)
39
55
98
6,299
—
1,229
1,229
1,309
371
(138)
(5,238)
(2,777)
(6,473)
1,055
13,405
$
22,502
$
14,460
$
(10,012)
4,417
27
40
1,578
(26)
4
21
4,941
—
1,171
1,171
298
370
(98)
(40,812)
(2,803)
(43,045)
(36,933)
50,338
13,405
126
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17 - Earnings Per Share
The following table presents a reconciliation of the components used to compute basic and diluted EPS for the periods
indicated.
Net income
Earnings allocated to participating securities
Earnings allocated to common shareholders
Basic weighted-average common shares outstanding
Dilutive effect of stock options
Dilutive effect of restricted stock grants
Diluted weighted-average common shares outstanding
Basic earnings per share
Diluted earnings per share
Year Ended December 31,
2018
2017
2016
(Dollars in thousands, except share data)
14,899
(28)
14,871
$
$
8,479
(4)
8,475
$
$
8,892
(21)
8,871
10,306,835
10,289,049
11,868,278
108,503
8,849
137,950
10,450
143,605
16,545
10,424,187
10,437,449
12,028,428
1.44
1.43
$
$
0.82
0.81
$
$
0.75
0.74
$
$
$
$
Potential dilutive shares are excluded from the computation of EPS if their effect is anti-dilutive. For the years ended
December 31, 2018 and 2017 there were no anti-dilutive shares outstanding related to options to acquire common stock. For the
year ended December 31, 2016, anti-dilutive shares outstanding related to options to acquire common stock totaled 60,000 because
the incremental shares under the treasury stock method of calculation resulted in them being antidilutive.
127
Note 18 - Summarized Consolidated Quarterly Financial Data (Unaudited)
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents summarized consolidated quarterly data for each of the last three years.
Third
Quarter
First
Quarter
Second
Quarter
Fourth
Quarter
(Dollars in thousands, except share data)
2018
Total interest income
Total interest expense
Net interest income
(Recapture of provision) provision for loan losses
Net interest income after (recapture of provision) provision for
loan losses
Total noninterest income
Total noninterest expense
Income before provision for income taxes
Provision for federal income tax expense
Net income
Basic earnings per share (1)
Diluted earnings per share
2017
Total interest income
Total interest expense
Net interest income
Provision (recapture of provision) for loan losses
Net interest income after provision (recapture of provision) for
loan losses
Total noninterest income
Total noninterest expense
Income before provision for income taxes
Provision for federal income tax expense
Net income
Basic earnings per share (1)
Diluted earnings per share (1)
2016
Total interest income
Total interest expense
Net interest income
(Recapture of provision) provision for loan losses
Net interest income after (recapture of provision) provision for
loan losses
Total noninterest income
Total noninterest expense
Income before provision for income taxes
Provision for federal income tax expense
Net income
$
$
$
$
$
$
$
$
$
$
$
14,113
3,129
10,984
(4,000)
$
13,588
3,459
10,129
(400)
13,888
3,829
10,059
200
14,984
646
7,027
8,603
1,761
6,842
0.67
0.66
10,998
2,136
8,862
200
8,662
535
6,068
3,129
785
2,344
0.23
0.22
9,562
1,781
7,781
(100)
7,881
480
5,773
2,588
763
1,825
$
$
$
$
$
$
$
$
$
10,529
663
7,487
3,705
603
3,102
0.30
0.30
11,343
2,346
8,997
100
8,897
731
6,836
2,792
924
1,868
0.18
0.18
9,896
1,713
8,183
600
7,583
708
6,072
2,219
779
1,440
9,859
841
7,201
3,499
707
2,792
0.27
0.27
12,003
2,628
9,375
500
8,875
731
6,836
2,770
909
1,861
0.18
0.18
10,842
1,908
8,934
900
8,034
673
5,254
3,453
847
2,606
0.22
0.22
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
14,324
4,321
10,003
200
9,803
728
7,746
2,785
622
2,163
0.21
0.21
13,300
2,912
10,388
(1,200)
11,588
211
7,069
4,730
2,324
2,406
0.24
0.23
11,409
2,105
9,304
(100)
9,404
790
5,850
4,344
1,323
3,021
0.29
0.29
Basic earnings per share
Diluted earnings per share
(1) Basic and diluted quarterly earnings per share may not equal total for year due to rounding.
0.14
0.14
$
$
$
$
0.12
0.11
128
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 19 - Revenue Recognition
In accordance with Topic 606, revenues are recognized when goods or services are transferred to the customer in exchange
for the consideration the Company expects to be entitled to receive. To determine the appropriate recognition of revenue for
transactions within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with the
customer; (ii) identify the separate performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the
transaction price to the separate performance obligations in the contract; and (v) recognize revenue when the entity satisfies a
performance obligation. A contract may not exist if there are doubts as to collectability of the amounts the Company is entitled to
in exchange for the goods or services transferred. If a contract is determined to be within the scope of Topic 606, the Company
recognizes revenue as it satisfies a performance obligation. The largest portion of the Company’s revenue is from net interest
income which is not within the scope of Topic 606.
Disaggregation of Revenue
The following table includes the Company’s noninterest income disaggregated by type of service for the years ended
December 31, 2018 and 2017:
Loss on sales of investment securities (1)
BOLI change in cash surrender value (1)
Wealth management revenue
Deposit related fees
Debit card and ATM fees
Loan related fees
Loan interest swap fees
Other
Total noninterest income
____________
(1) Not in scope of Topic 606
Year Ended December 31,
2018
2017
(In thousands)
(20) $
814
611
265
416
425
343
24
2,878
$
(567)
623
919
229
217
571
205
11
2,208
$
$
For the year ended December 31, 2018, substantially all of the Company’s revenues under the scope of Topic 606 are
for performance obligations satisfied at a specified date.
Revenues recognized within scope of Topic 606
Wealth management revenue: Our wealth management revenue consists of commissions received on the investment portfolio
managed by Bank personnel but held by a third party. Commissions are earned on brokerage services and advisory services based
on contract terms at the onset of a new customer’s investment agreement or quarterly for ongoing services. Commissions are paid
by the third party to the Bank when the performance obligation has been completed by both entities.
Deposit related fees: Fees are earned on our deposit accounts for various products or services performed for our customers. Fees
include business account fees, non-sufficient fund fees, stop payment fees, wire services, safe deposit box, and others. These fees
are recognized on a daily or monthly basis, depending on the type of service.
Debit card and ATM fees: Fees are earned when a debit card issued by the Bank is used or when other bank’s customers use our
ATM services. Revenue is recognized at the time the fees are collected from the customer’s account or remitted by the VISA
interchange network.
Loan related fees: Noninterest fee income is earned on our loans for servicing or annual fees on certain loan types.
129
FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loan interest swap fees: For loans participating in an interest rate swap agreement, fees are earned at the onset of the agreement
and are not contingent on any future performance or term length of the loan itself. The performance obligation is satisfied by
entering into the contract and receipt of the fees from the counterparty.
Other: Fees earned on other services, such as merchant services or occasional non-recurring type services, are recognized at the
time of the event or the applicable billing cycle.
Contract Balances
At December 31, 2018, the Company had no contract liabilities where the Company had an obligation to transfer goods
or services for which the Company had already received consideration. In addition, the Company had no material performance
obligations as of this date.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(i) Disclosure Controls and Procedures.
An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of
1934, as amended (the “Exchange Act”) was carried out as of December 31, 2018 under the supervision and with the participation
of our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”), and several other members of our senior management.
The CEO (Principal Executive Officer) and CFO (Principal Financial Officer) concluded that, as of December 31, 2018, First
Financial Northwest’s disclosure controls and procedures were effective in ensuring that information we are required to disclose
in the reports we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time
periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to First Financial Northwest management,
including its CEO and CFO, as appropriate to allow timely decisions regarding required disclosure, specified in the SEC’s rules
and forms.
(a) Management’s report on internal control over financial reporting.
First Financial Northwest’s management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934. First Financial Northwest’s internal control
system is designed to provide reasonable assurance to our management and the Board of Directors regarding the preparation and
fair presentation of published financial statements for external purposes in accordance with generally accepted accounting
principles.
This process includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions of First Financial Northwest; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of First Financial Northwest are being made only in accordance with authorizations of
management and directors of First Financial Northwest; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of First Financial Northwest’s assets that could have a material effect on
the financial statements. A control procedure, no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Also, because of the inherent limitations in all control
procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within
the Company have been detected. Additionally, in designing disclosure controls and procedures, our management was required
to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any
disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. As a result of
these inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Furthermore,
projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because
of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
First Financial Northwest’s management assessed the effectiveness of First Financial Northwest’s internal control over
financial reporting as of December 31, 2018. In making this assessment, management used the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 Framework). Based
130
on that assessment, First Financial Northwest’s management believes that, as of December 31, 2018, First Financial Northwest’s
internal control over financial reporting is effective based on those criteria.
Moss Adams LLP, an independent registered public accounting firm, has audited the Company’s consolidated financial
statements and the effectiveness of our internal control over financial reporting as of December 31, 2018, which is included in
Item 8. Financial Statements and Supplementary Data.
(b) Attestation report of the registered public accounting firm.
The “Report of Independent Registered Public Accounting Firm” included in Item 8 of this Annual Report on Form 10 K
is incorporated herein by reference.
(c) Changes in internal control over financial reporting.
There were no significant changes in First Financial Northwest’s internal control over financial reporting during First
Financial Northwest’s most recent fiscal quarter that have materially affected or are reasonably likely to materially affect, First
Financial Northwest’s internal control over financial reporting.
Item 9B. Other Information
There was no information to be disclosed by us in a report on Form 8-K during the fourth quarter of fiscal 2018 that was
not so disclosed.
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The information required under the section captioned “Proposal 1 - Election of Directors” in First Financial Northwest’s
Definitive Proxy Statement for the 2018 Annual Meeting of Shareholders (“Proxy Statement”) is incorporated herein by reference.
For information regarding the executive officers of First Financial Northwest and the Bank, see the information contained
herein under the section captioned “Item 1. Business - Personnel - Executive Officers of the Registrant.”
Audit Committee Financial Expert
At December 31, 2018 our Audit Committee was composed of Directors Roger H. Molvar (Chairman), Joann E. Lee and
Richard M. Riccobono. Each member of the Audit Committee is “independent” as defined in listing standards of The Nasdaq
Stock Market LLC. Our Board of Directors has designated Directors Roger H. Molvar, Joann E. Lee and Richard M. Riccobono
as the Audit Committee financial experts, as defined in the SEC’s Regulation S-K. Directors Roger H. Molvar, Joann E. Lee and
Richard M. Riccobono are independent as that term is used in Item 407(d)(5)(i)(B) of SEC’s Regulation S-K.
Code of Business Conduct and Ethics
A copy of the Code of Business Conduct and Ethics is available on our website at www.ffnwb.com under Investor Relations
– Corporate Overview – Governance Documents. Additionally, any material amendments to, or waiver from a provision of the
Code of Business Conduct and Ethics will be posted to the same website.
Compliance with Section 16(a) of the Exchange Act
The information required by this item under the section captioned “Section 16 (a) Beneficial Ownership Reporting
Compliance” in the Proxy Statement is incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item under the sections captioned “Executive Compensation” and “Directors’
Compensation” in the Proxy Statement are incorporated herein by reference.
131
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Beneficial Owners and Management.
The information required by this item under the section captioned “Security Ownership of Certain Beneficial Owners and
Management” in the Proxy Statement is incorporated herein by reference.
(b) Security Ownership of Management.
The information required by this item under the section captioned “Security Ownership of Certain Beneficial Owners and
Management” in the Proxy Statement is incorporated herein by reference.
(c) Change In Control
First Financial Northwest is not aware of any arrangements, including any pledge by any person of securities of First Financial
Northwest, the operation of which may at a subsequent date result in a change in control of First Financial Northwest.
(d) Equity Compensation Plan Information
The following table summarizes share and exercise price information about First Financial Northwest’s equity compensation
plans as of December 31, 2018.
Number of securities to
be issued upon exercise
of outstanding options,
warrants, and rights
Weighted-average
exercise price of
outstanding options,
warrants, and rights
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(a)
(b)
(c)
315,000
$
—
N/A
315,000
$
10.34
—
N/A
10.34
—
1,290,670
N/A
1,290.67
Plan category
Equity compensation plans (stock options)
approved by security holders:
2008 Equity Incentive Plan(1)
2016 Equity Incentive Plan (2)
Equity compensation plans not approved by
security holders
Total
___________________
(1) The 839,634 restricted shares granted under the 2008 Equity Incentive Plan were purchased by First Financial Northwest in
open market transactions and subsequently issued to First Financial Northwest’s directors and certain employees. As of
December 31, 2018, the restricted shares granted under the 2008 Equity Incentive Plan were fully vested.
(2) The shares available for grant under the 2016 Equity Incentive Plan include 345,335 shares of restricted stock. Each share
granted as restricted stock reduces the total available shares for grant by two shares.
Item 13. Certain Relationships and Related Transactions and Director Independence
The information required by this item under the sections captioned “Meetings and Committees of the Board of Directors
and Corporate Governance Matters - Corporate Governance - Transactions with Related Persons,” and “Meetings and Committees
of the Board of Directors and Corporate Governance Matters - Corporate Governance - Director Independence” in the Proxy
Statement are incorporated herein by reference.
Item 14. Principal Accounting Fees and Services
The information required by this item under the section captioned "Proposal 4- Ratification of the appointment of Moss
132
Adams as our independent auditor for 2019” in the Proxy Statement is incorporated herein by reference.
Item 15. Exhibits and Financial Statement Schedules
(a) Exhibits
PART IV
3.1
3.2
4.0
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
14
21
23
31.1
31.2
32.1
32.2
101
Articles of Incorporation of First Financial Northwest (1)
Amended and Restated Bylaws of First Financial Northwest (2)
Form of stock certificate of First Financial Northwest (1)
Amended Employment Agreement between First Financial Northwest Bank and Joseph W. Kiley III (3)
Form of Change in Control Severance Agreement for Executive Officers (4)
Amended Executive Supplemental Retirement Plan Participation Agreement with Joseph W. Kiley III (5)
2008 Equity Incentive Plan (6)
2016 Equity Incentive Plan (7)
Forms of incentive and non-qualified stock option award agreements under the 2008 Equity Incentive Plan(8)
Form of restricted stock award agreement under the 2008 Equity Incentive Plan (8)
Employment Agreement between First Financial Northwest Bank and Richard P. Jacobson (3)
Separation Agreement and General Release between First Financial Northwest Bank and Gregg DeRitis dated
August 31, 2017 (9)
Form of restricted stock award agreement under the 2016 Equity Incentive Plan (10)
Form of incentive stock option award agreement under the 2016 Equity Incentive Plan (11)
Form of non-qualified stock option award agreement under the 2016 Equity Incentive Plan (11)
Form of restricted stock award agreement under the 2016 Equity Incentive Plan (12)
Offer letter for Randy T. Riffle (13)
Form of Involuntary Termination Agreement with Randy T. Riffle (14)
Form of Change in Control Severance Agreement with Randy T. Riffle (14)
Code of Business Conduct and Ethics (posted on the Company’s website at www.fsbnw.com pursuant to Regulation
S-K section 229.406(c))
Subsidiaries
Consent of Independent Registered Public Accounting Firm- Moss Adams LLP
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
The following materials from First Financial Northwest’s Annual Report on Form 10-K for the year ended
December 31, 2018, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance
Sheets; (2) Consolidated Income Statements; (3) Consolidated Statements of Comprehensive Income; (4)
Consolidated Statements of Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Notes to
Consolidated Financial Statements.
______________
Copies of these exhibits are available upon written request to Investor Relations, First Financial Northwest, Inc., 201
Wells Avenue South, Renton, Washington 98057
(1) Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-1 (333-143539)
(2) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated June 15, 2017.
(3) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 5, 2013.
(4) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated September 9, 2014.
(5) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 11, 2017.
(6) Filed as Appendix A to First Financial Northwest’s definitive proxy statement dated April 15, 2008.
(7) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated June 15, 2016.
(8) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 1, 2008.
133
(9) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated September, 8, 2017.
(10) Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for March 31, 2018 filed on
May 8, 2018.
(11) Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-8 on June 15, 2016 (333-212029).
(12) Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for September 30, 2018 filed
November 7, 2018.
(13) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 20, 2018.
(14) Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 3, 2019.
Item 16. Form 10-K Summary.
None.
134
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: March 13, 2019
FIRST FINANCIAL NORTHWEST, INC.
By: /s/ Joseph W. Kiley III
Joseph W. Kiley III
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Roger H. Molvar
Roger H. Molvar
/s/ Joseph W. Kiley III
Joseph W. Kiley III
/s/ Richard P. Jacobson
Richard P. Jacobson
/s/ Christine A. Huestis
Christine A. Huestis
/s/ Gary F. Faull
Gary F. Faull
/s/ Joann E. Lee
Joann E. Lee
/s/ Kevin D. Padrick
Kevin D. Padrick
/s/ Daniel L. Stevens
Daniel L. Stevens
/s/ Richard M. Riccobono
Richard M. Riccobono
Chairman of the Board and Director
March 13, 2019
President, Chief Executive Officer and Director
March 13, 2019
(Principal Executive Officer)
Chief Financial Officer and Director
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
(Principal Financial Officer)
Vice President and Controller
(Principal Accounting Officer)
Director
Director
Director
Director
Director
135
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Cor po r ate a n d
S h are h ol de r I nf or ma tio n
Di re c t or s a n d
Ex e c u t ive M a na ge me n t
CORPORATE HEADQUARTERS
FIRST FINANCIAL NORTHWEST, INC.
201 Wells Avenue South
Renton, WA 98057
Phone: (425) 255-4400
Fax: (425) 228-7227
www.ffnwb.com
SUBSIDIARIES
First Financial Northwest Bank
First Financial Diversified Corporation
TRANSFER AGENT
Computershare
462 South 4th Street, Suite 1600
Louisville, KY 40202
Phone: (781) 575-4226
Toll Free: (800) 368-5948
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Moss Adams, LLP
2707 Colby Avenue, Suite 801
Everett, WA 98201
SEC COUNSEL
Breyer & Associates
8180 Greensboro Drive, Suite 785
McLean, VA 22102
STOCK EXCHANGE
First Financial Northwest, Inc. common stock trades on the
NASDAQ Global Select Market under the symbol FFNW.
INVESTOR AND SHAREHOLDER INFORMATION
Requests for company information, or to receive a copy of
this Annual Report to Shareholders without charge, may be
sent to:
First Financial Northwest, Inc.
Investor Relations
201 Wells Avenue South
PO Box 360
Renton, WA 98057
Directors
Roger H. Molvar, Chairman
Gary F. Faull
Richard P. Jacobson
Joseph W. Kiley III
Joann E. Lee
Kevin D. Padrick
Patricia M. Remch
Richard M. Riccobono
Daniel L. Stevens
FINANCIAL NORTHWEST BANK
Executive Management
Joseph W. Kiley III, President and
Chief Executive Officer
Richard P. Jacobson, Executive Vice President,
Chief Financial Officer and Chief Operating Officer
Randy T. Riffle, Executive Vice President,
Chief Credit Officer
Ronnie J. Clariza, Senior Vice President,
Chief Risk Officer
Dalen D. Harrison, Senior Vice President,
Chief Deposit Officer
Simon Soh, Senior Vice President,
Chief Lending Officer
ANNUAL MEETING OF SHAREHOLDERS
Wednesday, June 12, 2019
9:00 a.m. Pacific Time
First Financial Northwest, Inc.
207 Wells Avenue South
Renton, Washington 98057