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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2019
 
 
or
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
           For the transition period from ____________ to ____________
 
Commission File Number: 001-33652
 
 
FIRST FINANCIAL NORTHWEST, INC.
(Exact name of registrant as specified in its charter)
 
Washington
 
26-0610707
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
 
 
201 Wells Avenue South, Renton, Washington
 
98057
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant’s telephone number, including area code:
 
(425) 255-4400
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock, $0.01 par value per share
 
FFNW
 
The Nasdaq Stock Market, LLC

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

YES    X   NO      

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

YES    X   NO      

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



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

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

YES       NO   X   



Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: as of November 6, 2019, 10,289,153 shares of the issuer’s common stock, $0.01 par value per share, were outstanding.



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


2

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


Part 1. Financial Information

Item 1. Financial Statements
 
September 30, 2019
 
December 31, 2018
Assets
 
(Unaudited)
 
 
Cash on hand and in banks
$
7,615

 
$
8,122

Interest-earning deposits
6,103

 
8,888

Investments available-for-sale, at fair value
138,224

 
142,170

Loans receivable, net of allowance of $13,161 and $13,347
1,083,850

 
1,022,904

Federal Home Loan Bank ("FHLB") stock, at cost
6,341

 
7,310

Accrued interest receivable
4,407

 
4,068

Deferred tax assets, net
1,202

 
1,844

Other real estate owned ("OREO")
454

 
483

Premises and equipment, net
22,346

 
21,331

Bank owned life insurance ("BOLI"), net
31,681

 
29,841

Prepaid expenses and other assets
4,242

 
3,458

Goodwill
889

 
889

Core deposit intangible
1,005

 
1,116

Total assets
$
1,308,359


$
1,252,424

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 
Deposits:
 
 
 
Noninterest-bearing deposits
$
49,398

 
$
46,108

Interest-bearing deposits
967,430

 
892,924

Total deposits
1,016,828

 
939,032

FHLB advances
121,000

 
146,500

Advance payments from borrowers for taxes and insurance
5,043

 
2,933

Accrued interest payable
382

 
478

Other liabilities
10,004

 
9,743

Total liabilities
1,153,257

 
1,098,686

 
 

 
 
Commitments and contingencies


 


Stockholders' Equity
 

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

 

Common stock, $0.01 par value; authorized 90,000,000 shares; issued and
outstanding 10,296,053 shares at September 30, 2019, and 10,710,656
shares at December 31, 2018
103

 
107

Additional paid-in capital
87,835

 
93,773

Retained earnings
71,592

 
66,343

Accumulated other comprehensive loss, net of tax
(1,042
)
 
(2,253
)
Unearned Employee Stock Ownership Plan ("ESOP") shares
(3,386
)
 
(4,232
)
Total stockholders' equity
155,102

 
153,738

Total liabilities and stockholders' equity
$
1,308,359

 
$
1,252,424


See accompanying selected notes to consolidated financial statements.

3


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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
13,897

 
$
12,631

 
$
40,784

 
$
38,103

Investments available-for-sale
1,066

 
1,063

 
3,334

 
3,002

Interest-earning deposits
158

 
59

 
246

 
141

Dividends on FHLB stock
97

 
135

 
290

 
343

Total interest income
15,218

 
13,888

 
44,654

 
41,589

Interest expense
 

 
 

 
 

 
 

Deposits
5,037

 
2,912

 
13,189

 
7,623

FHLB advances
529

 
917

 
2,255

 
2,794

Total interest expense
5,566

 
3,829

 
15,444

 
10,417

Net interest income
9,652

 
10,059

 
29,210

 
31,172

Provision (recapture of provision) for loan losses
100

 
200

 
(300
)
 
(4,200
)
Net interest income after provision (recapture of provision)
 for loan losses
9,552

 
9,859

 
29,510

 
35,372

Noninterest income
 

 
 

 
 

 
 

Net gain (loss) on sale of investments
88

 
1

 
80

 
(20
)
BOLI income
235

 
245

 
693

 
718

Wealth management revenue
245

 
145

 
702

 
400

Deposit related fees
179

 
167

 
555

 
503

Loan related fees
290

 
273

 
562

 
533

Other
2

 
10

 
26

 
16

Total noninterest income
1,039

 
841

 
2,618

 
2,150

Noninterest expense
 
 
 

 
 

 
 

Salaries and employee benefits
4,813

 
4,732

 
14,547

 
14,325

Occupancy and equipment
924

 
814

 
2,688

 
2,412

Professional fees
440

 
353

 
1,262

 
1,123

Data processing
478

 
356

 
1,393

 
1,031

OREO related expenses, net
1

 
1

 
33

 
4

Regulatory assessments
13

 
126

 
286

 
391

Insurance and bond premiums
95

 
95

 
288

 
355

Marketing
118

 
85

 
280

 
269

Other general and administrative
573

 
639

 
1,670

 
1,805

Total noninterest expense
7,455

 
7,201

 
22,447

 
21,715

Income before federal income tax provision
3,136

 
3,499

 
9,681

 
15,807

Federal income tax provision
631

 
707

 
1,927

 
3,071

Net income
$
2,505

 
$
2,792

 
$
7,754

 
$
12,736

Basic earnings per common share
$
0.25

 
$
0.27

 
$
0.77

 
$
1.24

Diluted earnings per common share
$
0.25

 
$
0.27

 
$
0.77

 
$
1.22

Basic weighted average number of common shares outstanding
9,901,586

 
10,356,994

 
9,989,970

 
10,280,287

Diluted weighted average number of common shares outstanding
9,991,011

 
10,468,802

 
10,091,631

 
10,405,315


See accompanying selected notes to consolidated financial statements.

4


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


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Net income
$
2,505

 
$
2,792

 
$
7,754

 
$
12,736

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Unrealized holding gains (losses) on investments available-for-sale
662

 
(600
)
 
3,062

 
(3,002
)
Tax (provision) benefit
(139
)
 
126

 
(643
)
 
630

Reclassification adjustment for net (gains) losses realized in income
(88
)
 
(1
)
 
(80
)
 
20

Tax benefit (provision)
18

 

 
17

 
(4
)
(Losses) gain on cash flow hedge
(237
)
 
88

 
(1,449
)
 
928

Tax benefit (provision)
50

 
(18
)
 
304

 
(194
)
Other comprehensive income (loss), net of tax
266

 
(405
)
 
1,211

 
(1,622
)
Total comprehensive income
$
2,771

 
$
2,387

 
$
8,965

 
$
11,114


See accompanying selected notes to consolidated financial statements.



5


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

 
Three Months Ended September 30, 2018
 
Shares
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss,
 net of tax
 
Unearned
ESOP
Shares
 
Total Stockholders’ Equity
Balances at June 30, 2018
10,916,556

 
$
109

 
$
96,344

 
$
63,042

 
$
(2,145
)
 
$
(4,796
)
 
$
152,554

Net income

 

 

 
2,792

 

 

 
2,792

Other comprehensive loss, net of tax

 

 

 

 
(405
)
 

 
(405
)
Issuance of common stock - restricted stock awards, net

 

 
(41
)
 

 

 

 
(41
)
Compensation related to stock options and restricted stock awards

 

 
130

 

 

 

 
130

Allocation of 28,213 ESOP shares

 

 
231

 

 

 
282

 
513

Canceled common stock - restricted stock awards
(2,000
)
 

 

 

 

 

 

Cash dividend declared and paid ($0.08 per share)

 

 

 
(830
)
 

 

 
(830
)
Balances at September 30, 2018
10,914,556

 
$
109

 
$
96,664

 
$
65,004

 
$
(2,550
)
 
$
(4,514
)
 
$
154,713

 
Nine Months Ended September 30, 2018
 
Shares
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss,
 net of tax
 
Unearned
ESOP
Shares
 
Total Stockholders’ Equity
Balances at December 31, 2017
10,748,437

 
$
107

 
$
94,173

 
$
54,642

 
$
(928
)
 
$
(5,360
)
 
$
142,634

Net income

 

 

 
12,736

 

 

 
12,736

Other comprehensive loss, net of tax

 

 

 

 
(1,622
)
 

 
(1,622
)
Exercise of stock options
137,940

 
1

 
1,364

 

 

 

 
1,365

Issuance of common stock - restricted stock awards, net
30,179

 
1

 
(41
)
 

 

 

 
(40
)
Compensation related to stock options and restricted stock awards

 

 
539

 

 

 

 
539

Allocation of 84,640 ESOP shares

 

 
629

 

 

 
846

 
1,475

Canceled common stock - restricted stock awards
(2,000
)
 

 

 

 

 

 

Cash dividend declared and paid ($0.23 per share)

 

 

 
(2,374
)
 

 

 
(2,374
)
Balances at September 30, 2018
10,914,556

 
$
109

 
$
96,664

 
$
65,004

 
$
(2,550
)
 
$
(4,514
)
 
$
154,713


6


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

 
Three Months Ended September 30, 2019
 
Shares
 
Common 
Stock
 
Additional 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss,  net of tax
 
Unearned
ESOP
Shares
 
Total
Stockholders' Equity
Balances at June 30, 2019
10,375,325

 
$
104

 
$
88,725

 
$
69,976

 
$
(1,309
)
 
$
(3,668
)
 
$
153,828

Net income

 

 

 
2,505

 

 

 
2,505

Other comprehensive income, net of tax

 

 

 

 
267

 

 
267

Issuance of common stock - restricted stock awards, net
8,580

 

 

 

 

 

 

Compensation related to stock options and restricted stock awards

 

 
226

 

 

 

 
226

Allocation of 28,214 ESOP shares

 

 
120

 

 

 
282

 
402

Repurchase and retirement of common stock
(87,852
)
 
(1
)
 
(1,236
)
 

 

 

 
(1,237
)
Cash dividend declared and paid ($0.09 per share)

 

 

 
(889
)
 

 

 
(889
)
Balances at September 30, 2019
10,296,053

 
$
103

 
$
87,835

 
$
71,592

 
$
(1,042
)
 
$
(3,386
)
 
$
155,102

 
Nine Months Ended September 30, 2019
 
Shares
 
Common 
Stock
 
Additional 
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss,  net of tax
 
Unearned
ESOP
Shares
 
Total
Stockholders' Equity
Balances at December 31, 2018
10,710,656

 
$
107

 
$
93,773

 
$
66,343

 
$
(2,253
)
 
$
(4,232
)
 
$
153,738

Net income

 

 

 
7,754

 

 

 
7,754

Other comprehensive income, net of tax

 

 

 

 
1,211

 

 
1,211

Issuance of common stock - restricted stock awards, net
25,278

 

 
(93
)
 

 

 

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

 

 
457

 

 

 

 
457

Allocation of 84,640 ESOP shares

 

 
444

 

 

 
846

 
1,290

Repurchase and retirement of common stock
(433,952
)
 
(4
)
 
(6,746
)
 

 

 

 
(6,750
)
Canceled common stock - restricted stock awards
(5,929
)
 

 

 

 

 

 

Cash dividend declared and paid ($0.26 per share)

 

 

 
(2,592
)
 

 

 
(2,592
)
Beginning balance adjustment from adoption of Topic 842

 

 

 
87

 

 

 
87

Balances at September 30, 2019
10,296,053

 
$
103

 
$
87,835

 
$
71,592

 
$
(1,042
)
 
$
(3,386
)
 
$
155,102


See accompanying selected notes to consolidated financial statements.

7


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

 
Nine Months Ended September 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
7,754

 
$
12,736

Adjustments to reconcile net income to net cash provided by
operating activities:
 
 
 
Recapture of provision for loan losses
(300
)
 
(4,200
)
OREO market value adjustments
29

 

Net amortization of premiums and discounts on investments
626

 
812

(Gain) loss on sale of investments available-for-sale
(80
)
 
20

Depreciation of premises and equipment
1,330

 
1,228

Loss on sale of premises and equipment
5

 

Deferred federal income taxes
320

 
(449
)
Allocation of ESOP shares
1,290

 
1,475

Stock compensation expense
457

 
539

BOLI income
(693
)
 
(718
)
Changes in operating assets and liabilities:
 
 
 
(Increase) decrease in prepaid expenses and other assets
(2,122
)
 
2,319

Increase in advance payments from borrowers for taxes and insurance
2,110

 
2,222

Increase in accrued interest receivable
(339
)
 
(580
)
(Decrease) increase in accrued interest payable
(96
)
 
215

Increase in other liabilities
348

 
337

Net cash provided by operating activities
10,639

 
15,956

Cash flows from investing activities:
 

 
 

Proceeds from sales, calls and maturities of investments available-for-sale
5,057

 
15,186

Principal repayments on investments available-for-sale
4,859

 
5,385

Purchases of investments available-for-sale
(3,534
)
 
(33,011
)
Net increase in loans receivable
(60,646
)
 
(2,695
)
Redemption of FHLB stock
969

 
2,472

Purchase of premises and equipment
(2,350
)
 
(1,891
)
Proceeds from BOLI
310

 

Purchase of BOLI
(1,457
)
 

Net cash used by investing activities
(56,792
)
 
(14,554
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Net increase in deposits
$
77,796

 
$
76,777

Advances from the FHLB
196,500

 
320,500

Repayments of advances from the FHLB
(222,000
)
 
(387,500
)
Proceeds from stock options exercises

 
1,365

Net share settlement of stock awards
(93
)
 
(40
)
Repurchase and retirement of common stock
(6,750
)
 

Dividends paid
(2,592
)
 
(2,374
)
Net cash provided by financing activities
42,861

 
8,728

 
 
 
 

8


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

 
Nine Months Ended September 30,
 
 
2019
 
2018
Net (decrease) increase in cash and cash equivalents
(3,292
)
 
10,130

Cash and cash equivalents at beginning of period
17,010

 
16,131

Cash and cash equivalents at end of period
$
13,718

 
$
26,261

 
 
 
 
Supplemental disclosures of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

Interest paid
$
15,540

 
$
10,202

Federal income taxes paid
1,860

 
3,175

 
 
 
 
Noncash items:
 
 
 
Change in unrealized loss on investments available-for-sale
$
2,982

 
$
(2,982
)
Change in gain on cash flow hedge
(1,449
)
 
928

Initial recognition of right-of-use asset
1,853

 

Initial recognition of lease liability
1,853

 


See accompanying selected notes to consolidated financial statements.


9



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

Note 1 - Description of Business

First Financial Northwest, Inc. (“First Financial Northwest”), a Washington corporation, was formed on June 1, 2007 for the purpose of becoming the holding company for First Financial Northwest Bank (the “Bank”) in connection with the conversion from a mutual holding company structure to a stock holding company structure completed on October 9, 2007. First Financial Northwest’s business activities generally are limited to passive investment activities and oversight of its investment in First Financial Northwest Bank. Accordingly, the information presented in the consolidated financial statements and accompanying data, relates primarily to First Financial Northwest Bank. First Financial Northwest is a bank holding company, having converted from a savings and loan holding company on March 31, 2015, and as a bank holding company is subject to regulation by the Federal Reserve Bank of San Francisco. First Financial Northwest Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State Department of Financial Institutions (“DFI”).

At September 30, 2019, First Financial Northwest Bank operated in eleven locations in Washington with the headquarters and six branch locations in King County and five branch locations in Snohomish County. The Bank has received regulatory approval to open an additional branch in Kirkland, Washington, located in King County. This branch is scheduled to open in the fourth quarter of 2019. In addition, the Bank has applied for regulatory approval to open a new branch in University Place, Washington, which would expand the Bank’s presence into Pierce County. The Bank’s primary market area consists of King, Snohomish, Pierce and Kitsap counties, Washington.

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

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

Note 2 - Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC (“2018 Form 10-K”). In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the unaudited interim consolidated financial statements in accordance with GAAP have been included. All significant intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. Operating results for the nine months ended September 30, 2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. In preparing the unaudited consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the allowance for loan and lease losses (“ALLL”), the valuation of other real estate owned (“OREO”) and the underlying collateral of impaired loans, deferred tax assets, the right-of-use asset and lease liability on our operating leases, and the fair value of financial instruments.

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

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



10


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


Note 3 - Recently Issued Accounting Pronouncements

Recent Accounting Pronouncements Adopted in 2019

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

In March 2017, FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. The Company adopted this ASU as of January 1, 2019, with no material impact on the Company's consolidated financial statements.

Recent Accounting Pronouncements

ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) as amended by ASU 2018-19, ASU 2019-04 and ASU 2019-05, was originally issued in June 2016. This ASU replaces the existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses that have taken place during the reporting period. The measurement of expected credit losses will be based on historical information, current conditions, and reasonable and supportable forecasts that impact the collectability of the reported amount. Available‑for‑sale securities will bifurcate the fair value mark and establish an allowance for credit losses through the income statement for the credit portion of that mark. The interest portion will continue to be recognized through accumulated other comprehensive income or loss. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is adopted. This ASU is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, assuming the adoption of an ASU implementing the FASB Board decision in October 2019 to extend the adoption date for smaller reporting companies, such as the Company. The Company is evaluating our current expected loss methodology of our loan and investment portfolios to identify the necessary modifications in accordance with this standard and expects a change in the processes and procedures to calculate the ALLL, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. A valuation adjustment to our ALLL or investment portfolio that is identified in this process will be reflected as a one-time adjustment in equity rather than earnings. ASU 2019-05 issued in April 2019 further provides that entities that have certain financial instruments measured at amortized cost that have credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of Topic 326. The fair value option applies to available-for-sale debt securities. This ASU is effective upon adoption of ASU 2016-13, and should be applied on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition as of the adoption date. We are in the process of compiling historical and industry data that will be used to calculate expected credit losses on our loan portfolio to ensure we are fully compliant with the ASU at the adoption date and are evaluating the potential impact adoption of this ASU will have on our consolidated financial statements. The Company intends to adopt ASU 2016-13 in the first quarter of 2023, and as a result, our allowance for loan losses may increase. Until our evaluation is complete, however, the magnitude of the increase will not be known.
    
In August 2018, FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove certain disclosure requirements regarding transfers between Level 1 and Level 2 of the fair value hierarchy and changes in unrealized gains and losses for recurring

11


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


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 April 2019, FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments--Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This ASU provides clarification and guidance on recently issued ASUs regarding recognition and measurement of financial assets, credit losses on financial instruments and accounting for derivatives and hedging activities. This ASU is effective for fiscal years beginning after December 15, 2019 for the portions related to topics 326 an 825. For the portion related to topic 815, this ASU is effective for concurrent adoption with ASU 2016-13. Adoption of ASU 2019-04 is not expected to have a material impact on the Company’s consolidated financial statements.

In April 2019, FASB issued ASU 2019-05, Financial Instruments--Credit Losses (Topic 326), Targeted Transition Relief. The amendments in this ASU provide entities that have certain financial instruments measured at amortized cost that have credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of Topic 326. The fair value option applies to available-for-sale debt securities. This ASU is effective when ASU 2016-13 is adopted, and will be applied on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition as of the adoption date. Adoption of ASU 2019-05 is not expected to have a material impact on the Company’s consolidated financial statements.

Note 4 - Investments

Investments available-for-sale are summarized as follows at the dates indicated:
 
September 30, 2019
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
   Fannie Mae
$
23,182

 
$
315

 
$
(9
)
 
$
23,488

   Freddie Mac
6,231

 
159

 

 
6,390

   Ginnie Mae
22,642

 
201

 
(243
)
 
22,600

   Other
11,660

 
113

 
(21
)
 
11,752

Municipal bonds
6,376

 
312

 

 
6,688

U.S. Government agencies
44,706

 
43

 
(756
)
 
43,993

Corporate bonds
23,492

 
343

 
(522
)
 
23,313

Total
$
138,289

 
$
1,486

 
$
(1,551
)
 
$
138,224


12


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


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

 
$
24

 
$
(657
)
 
$
23,643

   Freddie Mac
6,351

 
10

 
(74
)
 
6,287

   Ginnie Mae
23,311

 

 
(1,250
)
 
22,061

   Other
8,983

 
17

 
(21
)
 
8,979

Municipal bonds
10,615

 
49

 
(120
)
 
10,544

U.S. Government agencies
48,190

 
73

 
(825
)
 
47,438

Corporate bonds
23,490

 
399

 
(671
)
 
23,218

Total
$
145,216

 
$
572

 
$
(3,618
)
 
$
142,170

     
    

13


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


The tables below summarize the aggregate fair value and gross unrealized loss by length of time those investment securities have been continuously in an unrealized loss position at the dates indicated:
 
September 30, 2019
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
4,822

 
$
(9
)
 
$

 
$

 
$
4,822

 
$
(9
)
   Freddie Mac

 

 

 

 

 

   Ginnie Mae

 

 
13,581

 
(243
)
 
13,581

 
(243
)
   Other

 

 
6,000

 
(21
)
 
6,000

 
(21
)
Municipal bonds

 

 

 

 

 

U.S. Government agencies
10,072

 
(154
)
 
29,034

 
(602
)
 
39,106

 
(756
)
Corporate bonds

 

 
6,978

 
(522
)
 
6,978

 
(522
)
Total
$
14,894

 
$
(163
)
 
$
55,593

 
$
(1,388
)
 
$
70,487

 
$
(1,551
)
 
December 31, 2018
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
Fair Value
 
Gross Unrealized
Loss
 
(In thousands)
Mortgage-backed investments:
 
 
 
 
 
 
 
 
 
 
 
   Fannie Mae
$
5,480

 
$
(32
)
 
$
16,721

 
$
(625
)
 
$
22,201

 
$
(657
)
   Freddie Mac
1,994

 
(23
)
 
3,185

 
(51
)
 
5,179

 
(74
)
   Ginnie Mae
2,867

 
(8
)
 
19,194

 
(1,242
)
 
22,061

 
(1,250
)
   Other
6,008

 
(21
)
 

 

 
6,008

 
(21
)
Municipal bonds
4,161

 
(46
)
 
934

 
(74
)
 
5,095

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

 
(13
)
 
30,779

 
(812
)
 
36,764

 
(825
)
Corporate bonds

 

 
6,828

 
(671
)
 
6,828

 
(671
)
Total
$
26,495

 
$
(143
)
 
$
77,641

 
$
(3,475
)
 
$
104,136

 
$
(3,618
)

On a quarterly basis, management makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment, recent events specific to the issuer or industry, and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be an other-than-temporary impairment (“OTTI”) are written down to fair value. If the Company intends to sell a debt security, or it is likely that the Company will be required to sell the debt security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the debt security and it is not likely that it will be required to sell the debt security but does not expect to recover the entire amortized cost basis of the debt security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a debt security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the debt security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. The Company had 26 securities and 51 securities in an unrealized loss position, respectively, with 17 and 31 of these securities in an unrealized loss position for 12 months or more, at September 30, 2019, and December 31, 2018, respectively. Management does not believe that any individual unrealized loss as of September 30, 2019, or December 31, 2018, represented OTTI. The decline in fair market value of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent to their

14


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


purchase. Management also reviewed the financial condition of the entities issuing municipal or corporate bonds at September 30, 2019, and December 31, 2018, and determined that an OTTI charge was not warranted.

The amortized cost and estimated fair value of investments available-for-sale at September 30, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed investments, are shown separately.
 
September 30, 2019
 
Amortized Cost
 
Fair Value
 
(In thousands)
Due within one year
$
496

 
$
498

Due after one year through five years
6,683

 
6,790

Due after five years through ten years
18,669

 
18,442

Due after ten years
48,726

 
48,264

 
74,574

 
73,994

Mortgage-backed investments
63,715

 
64,230

Total
$
138,289

 
$
138,224


Under Washington state law, in order to participate in the public funds program the Company is required to pledge eligible securities as collateral in an amount equal to 50% of the public deposits held less the FDIC insured amount. Investment securities with market values of $15.7 million and $15.6 million were pledged as collateral for public deposits at September 30, 2019, and December 31, 2018, respectively, both of which exceeded the collateral requirements established by the Washington Public Deposit Protection Commission.

For the three months ended September 30, 2019, there were sales and maturities on investment securities of $2.0 million, generating a net gain of $88,000. For the nine months ended September 30, 2019, there were calls, sales, and maturities on investment securities of $5.1 million, generating a net gain of $80,000. For the three and nine months ended September 30, 2018, the Bank had calls, sales, and maturities on investment securities of $5.4 million, and $15.2 million, respectively, generating a net gain of $1,000 and a net loss of $20,000, respectively.



15


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


Note 5 - Loans Receivable

Loans receivable are disclosed net of loans in process (“LIP”) and are summarized as follows at the dates indicated: 
 
September 30, 2019
 
December 31, 2018
 
(In thousands)
One-to-four family residential:
 
 
 
Permanent owner occupied
$
205,679

 
$
194,141

Permanent non-owner occupied
164,707

 
147,825

 
370,386

 
341,966

 
 
 
 
Multifamily
171,152

 
169,355

 
 
 
 
Commercial real estate
381,890

 
373,798

 
 
 
 
Construction/land:
 
 
 

One-to-four family residential
47,524

 
51,747

Multifamily
40,078

 
40,502

Commercial
15,913

 
9,976

Land
6,400

 
6,629

 
109,915

 
108,854

 
 
 
 
Business
37,507

 
30,486

Consumer
26,451

 
12,970

Total loans
1,097,301

 
1,037,429

 
 
 
 
Less:
 
 
 

Deferred loan fees, net
290

 
1,178

Allowance for loan and lease losses ("ALLL")
13,161

 
13,347

Loans receivable, net
$
1,083,850

 
$
1,022,904


At September 30, 2019, loans totaling $498.8 million were pledged to secure borrowings from the FHLB of Des Moines compared to $471.4 million at December 31, 2018. In addition, loans totaling $90.6 million and $91.2 million were pledged to the Federal Reserve Bank of San Francisco to secure a line of credit at September 30, 2019 and December 31, 2018, respectively.
    
Credit Quality Indicators. The Company assigns a risk rating to all credit exposures based on a risk rating system designed to define the basic characteristics and identified risk elements of each credit extension. The Company utilizes a nine‑point risk rating system. A description of the general characteristics of the risk grades is as follows:

Grades 1 through 5: These grades are considered to be “pass” credits. These include assets where there is limited 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

16


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


of the debt and are inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.

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

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

As of September 30, 2019, and December 31, 2018, the Company had no loans rated as doubtful or loss. The following tables represent a summary of loans at September 30, 2019, and December 31, 2018 by type and risk category:

 
September 30, 2019
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial
Real Estate
 
Construction/ 
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
Risk Rating:
 
 
 
 
 
 
 
 
 
 
 
 
 
   Pass
$
369,213

 
$
169,041

 
$
381,361

 
$
98,306

 
$
37,507

 
$
26,412

 
$
1,081,840

   Special mention
540

 
2,111

 
529

 
11,609

 

 

 
14,789

   Substandard
633

 

 

 

 

 
39

 
672

Total loans
$
370,386

 
$
171,152

 
$
381,890

 
$
109,915

 
$
37,507

 
$
26,451

 
$
1,097,301


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

 
$
169,355

 
$
372,690

 
$
108,854

 
$
30,486

 
$
12,926

 
$
1,033,621

   Special mention
1,737

 

 
782

 

 

 

 
2,519

   Substandard
919

 

 
326

 

 

 
44

 
1,289

Total loans
$
341,966

 
$
169,355

 
$
373,798

 
$
108,854

 
$
30,486

 
$
12,970

 
$
1,037,429


ALLL. When the Company classifies problem assets as either substandard or doubtful, pursuant to Federal regulations, or identifies a loan where it is uncertain if the Bank will be able to collect all amounts due according to the contractual terms of the loan, it may establish a specific reserve in an amount deemed prudent to address the risk specifically. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to the particular problem assets. When an insured institution classifies problem assets as a loss, pursuant to Federal regulations, it is required to charge-off such assets in the period in which they are deemed uncollectible. The determination as to the classification of the Company’s assets and the amount of valuation allowances is subject to review by bank regulators, who can require the establishment of additional allowances for loan losses.

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, failure to comply with contractual terms of the loan or stale financial information from the borrower and/or guarantors. Loans identified as criticized (watch and special mention) or classified (substandard, doubtful or loss) are subject to problem loan reporting every three months.

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

17


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


 
At or For the Three Months Ended September 30, 2019
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
3,085

 
$
1,643

 
$
4,607

 
$
2,271

 
$
1,120

 
$
331

 
$
13,057

   Recoveries
3

 

 

 

 

 
1

 
4

(Recapture) provision
(56
)
 
91

 
(122
)
 
(73
)
 
37

 
223

 
100

Ending balance
$
3,032

 
$
1,734

 
$
4,485

 
$
2,198

 
$
1,157

 
$
555

 
$
13,161

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
At or For the Nine Months Ended September 30, 2019
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
3,387

 
$
1,680

 
$
4,777

 
$
2,331

 
$
936

 
$
236

 
$
13,347

   Recoveries
31

 
45

 

 

 

 
38

 
114

  (Recapture) provision
(386
)
 
9

 
(292
)
 
(133
)
 
221

 
281

 
(300
)
Ending balance
$
3,032

 
$
1,734

 
$
4,485

 
$
2,198

 
$
1,157

 
$
555

 
$
13,161

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ALLL by category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
3,001

 
$
1,734

 
$
4,485

 
$
2,198

 
$
1,157

 
$
555

 
$
13,130

Specific reserve
31

 

 

 

 

 

 
31

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
$
370,386

 
$
171,152

 
$
381,890

 
$
109,915

 
$
37,507

 
$
26,451

 
$
1,097,301

Loans collectively evaluated for impairment (1)
365,813

 
171,152

 
379,764

 
98,306

 
37,507

 
26,412

 
1,078,954

Loans individually evaluated for impairment (2)
4,573

 

 
2,126

 
11,609

 

 
39

 
18,347

____________ 

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




18


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


 
At or For the Three Months Ended September 30, 2018
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
3,265

 
$
1,928

 
$
4,494

 
$
2,121

 
$
674

 
$
272

 
$
12,754

   Recoveries
2

 

 

 
160

 

 

 
162

   Provision (recapture)
265

 
(189
)
 
(16
)
 
(84
)
 
236

 
(12
)
 
200

Ending balance
$
3,532

 
$
1,739

 
$
4,478

 
$
2,197

 
$
910

 
$
260

 
$
13,116

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
At or For the Nine Months Ended September 30, 2018
 
One-to-Four
Family
Residential
 
Multifamily
 
Commercial 
Real Estate
 
Construction/
Land
 
Business
 
Consumer
 
Total
 
(In thousands)
ALLL:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,837

 
$
1,820

 
$
4,418

 
$
2,816

 
$
694

 
$
297

 
$
12,882

   Recoveries
4,248

 

 
14

 
172

 

 

 
4,434

   (Recapture) provision
(3,553
)
 
(81
)
 
46

 
(791
)
 
216

 
(37
)
 
(4,200
)
Ending balance
$
3,532

 
$
1,739

 
$
4,478

 
$
2,197

 
$
910

 
$
260

 
$
13,116

 
 
 
 
 
 
 
 
 
 
 
 
 
 
ALLL by category:
 
 
 
 
 
 
 
 
 
 
 
 
 
General reserve
$
3,446

 
$
1,739

 
$
4,471

 
$
2,197

 
$
910

 
$
260

 
$
13,023

Specific reserve
86

 

 
7

 

 

 

 
93